Lehman Brothers Examiners Report COMBINED

UNITEDSTATESBANKRUPTCYCOURT
SOUTHERNDISTRICTOFNEWYORK
x
:
Inre : Chapter11CaseNo.
:
LEHMANBROTHERSHOLDINGSINC., : 0813555(JMP)
etal., :
: (JointlyAdministered)
Debtors. :
x
REPORTOF
ANTONR.VALUKAS,EXAMINER

Jenner&BlockLLP
353N.ClarkStreet
Chicago,IL606543456
3122229350

919ThirdAvenue
37thFloor
NewYork,NY100223908
2128911600

March11,2010 CounseltotheExaminer

VOLUME1OF9
SectionsI&II:Introduction,ExecutiveSummary&ProceduralBackground
SectionIII.A.1:Risk
EXAMINERSREPORT

TABLEOFCONTENTS

VOLUME1
Introduction,SectionsI&II:ExecutiveSummary&ProceduralBackground
Introduction ...................................................................................................................................2
I. ExecutiveSummaryofTheExaminersConclusions ......................................................15
A. WhyDidLehmanFail?AreThereColorableCausesofActionThatArise
FromItsFinancialConditionandFailure?..................................................................15
B. AreThereAdministrativeClaimsorColorableClaimsForPreferencesor
VoidableTransfers? ........................................................................................................24
C. DoColorableClaimsAriseFromTransfersofLBHIAffiliateAssetsto
Barclays,orFromtheLehmanALITransaction?.......................................................26
II. ProceduralBackgroundandNatureoftheExamination................................................28
A. TheExaminersAuthority .............................................................................................28
B. DocumentCollectionandReview ................................................................................30
C. SystemsAccess ................................................................................................................33
D. WitnessInterviewProcess .............................................................................................35
E. CooperationandCoordinationWiththeGovernmentandParties ........................37
SectionIII.A.1:Risk
III.ExaminersConclusions .......................................................................................................43
FromItsFinancialConditionandFailure?..................................................................43
1. BusinessandRiskManagement .............................................................................43
a) ExecutiveSummary............................................................................................43
(1)TheExaminerDoesNotFindColorableClaimsThatLehmans
SeniorOfficersBreachedTheirFiduciaryDutyofCareby
FailingtoObserveLehmansRiskManagementPoliciesand
Procedures......................................................................................................47
SeniorOfficersBreachedTheirFiduciaryDutytoInformthe
BoardofDirectorsConcerningTheLevelofRiskLehmanHad
Assumed.........................................................................................................52
DirectorsBreachedTheirFiduciaryDutybyFailingtoMonitor
LehmansRiskTakingActivities................................................................54
b) Facts.......................................................................................................................58
(1)FromMovingtoStorage:LehmanExpandsItsPrincipal
Investments....................................................................................................58
(a)LehmansChangedBusinessStrategy .................................................59
(b)TheIncreasedRiskFromLehmansChangedBusiness
Strategy.....................................................................................................62
(c) ApplicationofRiskControlstoChangedBusinessStrategy ...........65
(i) StressTestingExclusions ................................................................66
(ii) RiskAppetiteLimitIncreaseForFiscal2007...............................70
(iii)DecisionNotToEnforceSingleTransactionLimit.....................73
(d)TheBoardsApprovalofLehmansGrowthStrategy .......................76
(2)LehmanDoublesDown:LehmanContinuesItsGrowthStrategy
DespitetheOnsetoftheSubprimeCrisis..................................................78
(a)LehmansResidentialMortgageBusiness...........................................82
(i) LehmanDecidestoCurtailSubprimeOriginationsbut
ContinuestoPursueAltAOriginations ..................................82
(ii) TheMarch20,2007BoardMeeting...............................................90
(b)TheExplosioninLehmansLeveragedLoanBusiness .....................95
(i) RelaxationofRiskControlstoAccommodateGrowthof
LehmansLeveragedLoansBusiness ...........................................97
(c) InternalOppositiontoGrowthofLeveragedLoansBusiness .......100
(d)GrowthofLehmansCommercialRealEstateBusinessatthe
StartoftheSubprimeCrisis.................................................................103
(i) RelaxationofRiskControlstoAccommodateGrowthof
LehmansCommercialRealEstateBusiness..............................105
(ii) InternalOppositiontoGrowthofCommercialReal
EstateBusiness ...............................................................................107
(iii)Archstone ........................................................................................108
ii

a. LehmansCommitment............................................................108
b. RiskManagementofLehmansArchstone
Commitment..............................................................................112
(e) NagioffsReplacementofGelbandasHeadofFID .........................114
(f) TheBoardofDirectorsAwarenessofLehmansIncreasing
RiskProfile .............................................................................................116
(3)EarlyWarnings:RiskLimitOverages,FundingConcerns,and
theDeepeningSubprimeCrisis ................................................................117
(a)NagioffandKirkTrytoLimitLehmansHighYieldBusiness......119
(b)JulyAugust2007ConcernsRegardingLehmansAbilityto
FundItsCommitments ........................................................................123
(c) LehmanDelaystheArchstoneClosing .............................................128
(d)LehmanIncreasestheRiskAppetiteLimittoAccommodate
theAdditionalRiskAttributabletotheArchstone
Transaction.............................................................................................131
(e) CashCapitalConcerns .........................................................................134
(f) LehmansTerminationofItsResidentialMortgage
Originations ...........................................................................................138
(g)September,October,andNovember2007MeetingsofBoard
ofDirectors.............................................................................................139
(i) RiskAppetiteDisclosures.............................................................139
(ii) LeveragedLoanDisclosures ........................................................144
(iii)LeverageRatiosandBalanceSheetDisclosures........................147
(iv)LiquidityandCapitalDisclosures...............................................148
(4)LateReactions:LehmanSlowlyExitsItsIlliquidRealEstate
Investments..................................................................................................150
(a)Fiscal2008RiskAppetiteLimitIncrease ...........................................152
(b)January2008MeetingofBoardofDirectors .....................................154
(c) ExecutiveTurnover...............................................................................156
(d)CommercialRealEstateSellOff:TooLittle,TooLate ...................157
(e) LehmansCompensationPractices.....................................................161
iii

c) Analysis ..............................................................................................................163
Procedures....................................................................................................164
(a)LegalStandard.......................................................................................164
(b)Background............................................................................................166
(i) CountercyclicalGrowthStrategywithRespectto
ResidentialMortgageOrigination...............................................171
(ii) LehmansConcentrationofRiskinItsCommercialReal
EstateBusiness ...............................................................................172
(iii)ConcentratedInvestmentsinLeveragedLoans ........................175
(iv)FirmWideRiskAppetiteExcesses..............................................179
(v) FirmWideBalanceSheetLimits .................................................181
(vi)StressTesting ..................................................................................181
(vii)Summary:OfficersDutyofCare ..............................................182
BoardofDirectorsConcerningtheLevelofRiskLehmanHad
Assumed.......................................................................................................183
LehmansRiskTakingActivities..............................................................188
(a)LehmansDirectorsareProtectedFromDutyofCare
LiabilitybytheExculpatoryClauseandtheBusiness
JudgmentRule.......................................................................................188
(b)LehmansDirectorsDidNotViolateTheirDutyofLoyalty ..........190
(c) LehmansDirectorsDidNotViolateTheirDutytoMonitor .........191
(i) ApplicationofCaremarktoRiskOversight:InreCitigroup
Inc. ....................................................................................................191
(ii) ApplicationofCaremarkandCitigrouptoLehmans
Directors ..........................................................................................193
iv

VOLUME2
SectionIII.A.2:Valuation
2. Valuation ..................................................................................................................203
a) ExecutiveSummary..........................................................................................203
(1)ScopeofExamination .................................................................................210
(2)SummaryofApplicableLegalStandards................................................212
(3)SummaryofFindingsandConclusions...................................................214
b) OverviewofValuationofLehmansCommercialRealEstate
Portfolio ..............................................................................................................215
(1)OverviewofLehmansCREPortfolio......................................................217
(a)SummaryofPortfolio ...........................................................................217
(b)OverviewofValuationofCREPortfolio ...........................................220
(i) GREGLeaders ................................................................................220
(ii) ParticipantsintheValuationProcess .........................................220
(c) ChangesintheCREPortfoliofrom2006through2008...................223
(d)PerfectStormImpactonCREValuationin2008..........................227
(2)OutsideReviewofLehmansCREValuationProcess...........................232
(a)SEC ..........................................................................................................233
(b)Ernst&Young .......................................................................................237
c) SeniorManagementsInvolvementinValuation.........................................241
(1)SeniorManagementsGeneralRoleWithRespecttoCRE
Valuation ......................................................................................................243
(2)SeniorManagementsInvolvementinValuationintheSecond
Quarterof2008 ............................................................................................245
(3)SeniorManagementsInvolvementinValuationintheThird
Quarterof2008 ............................................................................................247
(a)SeniorManagementsAccount ...........................................................248
(b)PaulHughsonsAccount .....................................................................253
(c) OtherAccounts......................................................................................254
(4)ExaminersFindingsandConclusionsWithRespecttoSenior
ManagementsInvolvementinCREValuation ......................................265
d) ExaminersAnalysisoftheValuationofLehmansCommercial
Book ....................................................................................................................266
(1)ExecutiveSummary....................................................................................266
(2)LehmansValuationProcessforitsCommercialBook .........................270
(3)ExaminersFindingsandConclusionsastotheReasonableness
ofLehmansValuationofItsCommercialBook.....................................274
(a)AsoftheSecondQuarterof2008 .......................................................274
(b)AsoftheThirdQuarterof2008 ..........................................................282
e) ExaminersAnalysisoftheValuationofLehmansPrincipal
TransactionsGroup ..........................................................................................285
(2)OverviewofLehmansPTGPortfolio......................................................292
(3)EvolutionofLehmansPTGPortfolioFrom2005Through2008.........296
(4)LehmansValuationProcessforItsPTGPortfolio.................................303
(a)TheRoleofTriMontintheValuationProcessforLehmans
PTGPortfolio .........................................................................................306
(i) LehmansIssueswithTriMontsData ........................................311
(ii) LehmanChangedItsValuationMethodologyforItsPTG
PortfolioinLate2007.....................................................................312
(b)TheRoleofLehmansPTGBusinessDeskintheValuation
ProcessforLehmansPTGPortfolio ..................................................319
(c) TheRoleofLehmansProductControlGroupinPrice
TestingtheValuationofLehmansPTGPortfolio ...........................321
(d)TheInfluenceofLehmansPTGBusinessDeskuponthe
PriceTestingFunctionofLehmansProductControlGroup.........326
(5)TheExaminersFindingsandConclusionsastothe
ReasonablenessofLehmansValuationofPTGPortfolio.....................329
(a)LehmanDidNotMarkPTGAssetstoMarketBasedYield ...........331
(b)TheEffectofNotMarkingtoMarketBasedYield...........................337
(i) EffectofCap*105NotMarkingtoMarketBasedYield .........337
(ii) EffectofIRRModelsNotMarkingtoMarketBased
Yield .................................................................................................342
(iii)EffectofProductControlPriceTestingNotMarkingto
MarketBasedYield .......................................................................349
(iv)EffectofModifyingTriMontsDataintheThirdQuarter
of2008..............................................................................................351
(c) ExaminersFindingsandConclusionsastotheEffectofNot
MarkingLehmansPTGPortfoliotoMarketBasedYield ..............353
vi

f) ExaminersAnalysisoftheValuationofLehmansArchstone
Positions .............................................................................................................356
(2)LehmansAcquisitionofArchstone.........................................................364
(a)BackgroundonArchstone ...................................................................364
(b)AcquisitionofArchstone .....................................................................365
(i) AnalystReaction ............................................................................367
(ii) LehmansSyndicationEfforts ......................................................370
(iii)BridgeandPermanentEquityatClosing...................................374
(iv)CapitalStructureatClosing .........................................................375
(v) PriceFlex .........................................................................................377
(vi)Standard&PoorsCreditRating .................................................380
(3)LehmansValuationofArchstone ............................................................382
(a)ValuationBetweenCommitmentandClosing .................................386
(b)ValuationasoftheClosingDate ........................................................388
(c) ValuationasoftheFourthQuarterof2007.......................................390
(d)ValuationIssuesDuringtheFirstQuarterof2008...........................391
(i) BarronsArticle ..............................................................................391
a. ArchstonesResponsetotheBarronsArticle.......................392
b. LehmansResponsetotheBarronsArticle ..........................394
(ii) January2008ArchstoneUpdate ..................................................396
(iii)ValuationasofFebruary29,2008................................................399
(iv)FirstQuarter2008EarningsCallandLenders
DiscussionRegardingModifyingtheArchstoneStrategy ......401
(e) ValuationIssuesDuringtheSecondQuarterof2008......................402
(i) March2008ArchstoneUpdate ....................................................402
(ii) March2008Valuation ...................................................................404
(iii)April2008DowngradebyS&P....................................................407
(iv)EinhornSpeechinApril2008.......................................................407
(v) May2008Valuation.......................................................................408
(vi)SecondQuarter2008EarningsConferenceCall........................411
a. PreparationandLehmansMethodsofAnalyzing
ReasonablenessofValuationsPriortotheCall ....................411
vii

b. DiscussionDuringtheSecondQuarter2008Earnings
Call ..............................................................................................412
(vii)LehmansRevisedPlantoSellArchstonePositions................414
(f) ValuationIssuesDuringtheThirdQuarterof2008.........................416
(i) DiscussionAmongLendersinJuly2008....................................417
(ii) August2008Valuation..................................................................417
(g)ProductControlsReviewofArchstoneValuations........................418
(4)ExaminersAnalysisofLehmansValuationProcessforits
ArchstonePositions ....................................................................................419
(a)DiscountedCashFlowValuationMethod ........................................421
(i) RentGrowth ...................................................................................422
a. NetOperatingIncome..............................................................426
b. SensitivityAnalysis...................................................................429
(ii)ExitCapitalizationRate..................................................................431
(iii)ExitPlatformValue .......................................................................433
(iv)DiscountRate..................................................................................436
(b)SumofthePartsMethod .....................................................................438
(c) ComparableCompanyMethod ..........................................................440
(i) PotentialOvervaluationBasedonPrimaryComparable
Companies ......................................................................................445
(5)ExaminersAnalysisoftheReasonablenessofLehmans
ValuationofitsArchstonePositionsonaQuarterlyBasis ...................446
(a)ReasonablenessasoftheFourthQuarterof2007.............................446
(b)ReasonablenessasoftheFirstQuarterof2008.................................449
(i) BarronsArticle ..............................................................................450
(ii) DiscussionsAmongArchstone,TishmanandLenders ...........458
(iii)LehmansValuationDuringtheFirstQuarterof2008.............459
(iv)SumoftheParts .............................................................................460
(v)DCFMethod ....................................................................................464
(vi)ExaminersFindingsandConclusionsastothe
ReasonablenessofLehmansArchstoneValuationasof
theEndoftheFirstQuarterof2008 ............................................466
(c) ReasonablenessasoftheSecondQuarterof2008............................468
(i)SecondQuarterEarningsCall ........................................................469
viii

(ii)SumoftheParts ..............................................................................476
(iii)DCFModel......................................................................................477
(iv)RentGrowth ...................................................................................478
(v)ExitCapitalizationRate..................................................................479
(vi)QuantificationofChangesinAssumptions ...............................480
(vii)ExaminersFindingsandConclusionsastothe
theEndoftheSecondQuarterof2008 .......................................481
(d)ReasonablenessasoftheThirdQuarterof2008...............................484
(i)SumoftheParts................................................................................487
(ii)DCFModel.......................................................................................488
(iii)RentGrowth ...................................................................................489
(iv)ExitCapitalizationRate.................................................................490
(v)QuantificationofChangesinAssumptions ................................491
(vi)ExaminersFindingsandConclusionsastothe
theEndoftheThirdQuarterof2008 ..........................................492
g) ExaminersAnalysisoftheValuationofLehmansResidential
WholeLoansPortfolio......................................................................................494
(1)ResidentialWholeLoansOverview .........................................................494
(2)LehmansU.S.ResidentialWholeLoansin2008 ...................................497
(3)LehmansValuationProcessforitsResidentialWholeLoans..............501
(a)LehmansMay2008PriceTesting ......................................................504
(b)LehmansAugust2008PriceTesting .................................................515
(4)ExaminersIndependentValuationofLehmansResidential
WholeLoansPortfolio................................................................................520
(5)ExaminersFindingsandConclusionsWithRespecttothe
ReasonablenessofLehmansValuationofItsResidentialWhole
LoansPortfolio ............................................................................................525
(h)ExaminersAnalysisoftheValuationofLehmansRMBSPortfolio ........527
(i) ExaminersAnalysisoftheValuationofLehmansCDOs .........................538
(1)LehmansPriceTestingProcessforCDOs ..............................................543
(2)PriceTestingResultsfortheSecondandThirdQuarters2008 ............551
(a)LehmansPriceTestingofitsCeagoCDOs.......................................553
ix

(3)ExaminersReviewofLehmansLargestU.S.ABS/CRECDO
Positions .......................................................................................................562
ReasonablenessofLehmansValuationofitsCDOs .............................567
(j) ExaminersAnalysisoftheValuationofLehmansDerivatives
Positions .............................................................................................................568
(1)OverviewofLehmansDerivativesPositions.........................................568
(2)LehmansUseofCreditSupportAnnexestoMitigate
DerivativesRisk ..........................................................................................574
(3)LehmansPriceTestingofitsDerivativesPositions ..............................578
(k)ExaminersAnalysisoftheValuationofLehmansCorporateDebt
Positions .............................................................................................................583
(1)OverviewofLehmansCorporateDebtPositions .................................583
(2)LehmansPriceTestingofitsCorporateDebtPositions.......................585
ValuationofLehmansCorporateDebtPositions..................................589
(a)RelianceonNonTrades.......................................................................590
(b)QualityControlErrorsMismatchedCompanies ..........................591
(c)NoTestingofInternalCreditRating ..................................................592
(l) ExaminersAnalysisoftheValuationofLehmansCorporate
EquitiesPositions ..............................................................................................594
(1)OverviewofLehmansCorporateEquitiesPositions............................594
(2)LehmansValuationProcessforitsCorporateEquitiesPositions.......596
ValuationofLehmansCorporateEquitiesPositions............................599
(a)ImpairedDebtwithNoEquityMarkDown.....................................601
(b)StaticMarks............................................................................................603
VOLUME2(CONT.)
SectionIII.A.3:Survival
3. LehmansSurvivalStrategiesandEfforts ...........................................................609
a) IntroductiontoLehmansSurvivalStrategiesandEfforts..........................609
(1)ExaminersConclusions .............................................................................609
(2)IntroductiontoLehmansSurvivalStrategies ........................................612
b) LehmansActionsin2008PriortotheNearCollapseofBearStearns......622
(1)RejectionofCapitalInvestmentInquiries ...............................................623
(a)KIAOffer................................................................................................624
(b)KDBMakesItsInitialApproach.........................................................625
(c) ICDsInitialApproach .........................................................................626
(2)DivergentViews..........................................................................................627
(a)CompetitorsRaiseCapital ...................................................................627
(b)InternalWarningsRegardingCapital................................................629
c) ActionsandEffortsFollowingtheNearCollapseofBearStearns ............631
(1)LehmansAttempttoIncreaseLiquidity.................................................633
(2)LehmansAttempttoReduceitsBalanceSheet .....................................634
(3)LehmanSellsStocktoPrivateandPublicInvestors ..............................638
(4)SpinCo ..........................................................................................................640
(a)EvolutionofSpinCo..............................................................................642
(b)ExecutionIssues ....................................................................................644
(i) EquityHole .....................................................................................645
(ii) OutsideFinancingforSpinCo......................................................649
(iii)SECIssues .......................................................................................653
a. AuditingandAccountingIssues ............................................653
b. TaxFreeStatus ..........................................................................658
(iv)ValuationofAssets ........................................................................659
(c) BarclaysSpinCo ...............................................................................661
(5)PotentialStrategicPartners........................................................................662
(a)BuffettandBerkshireHathaway ........................................................664
(i) March2008......................................................................................664
(ii) LastDitchEffortwithBuffett.......................................................667
(b)KDB .........................................................................................................668
(i) DiscussionsBegin ..........................................................................668
(ii) DiscussionsResume:SecondRoundofTalksbetween
KDBandLehman...........................................................................673
(iii)ThirdRoundofTalksbetweenKDBandLehman....................677
(iv)KDBsSeptember9,2008Announcement..................................681
(c) MetLife....................................................................................................687
(d)ICD ..........................................................................................................691
xi

(e) BankofAmerica....................................................................................694
(i) InitialDiscussionsintheSummerof2008 .................................694
(ii) TalksResumeinSeptember .........................................................696
(f) Barclays...................................................................................................703
(6)GovernmentCommunications..................................................................711
(a)TreasuryDinner ....................................................................................712
(b)ShortSales ..............................................................................................713
(c) PossibilityofFederalAssistance.........................................................716
(7)LehmansBankruptcy ................................................................................718
VOLUME3
SectionIII.A.4:Repo105
4. Repo105 ...................................................................................................................732
a) Repo105ExecutiveSummary......................................................................732
b) Introduction .......................................................................................................750
c) WhytheExaminerInvestigatedLehmansUseofRepo105
Transactions .......................................................................................................764
d) ATypicalRepo105Transaction .....................................................................765
(1)TheGenesisofLehmansRepo105Programin2001 ............................765
(2)Repo105TransactionsVersusOrdinaryRepoTransactions ...............766
(a)LehmansAccountingTreatmentofRepo105Transactions
VersusOrdinaryRepoTransactions ..................................................768
(b)LehmansAccountingPolicyforRepo105Transactions................775
(c) TheAccountingPurposeoftheLargerHaircut ...............................777
(d)LehmanDidNotRecordaCashBorrowingbutRecordeda
DerivativeAssetinaRepo105Transaction......................................781
(3)AnatomyofRepo105TransactionsandtheLinklatersTrueSale
OpinionLetter .............................................................................................782
(4)TypesofSecuritiesUsedinRepo105Transactions ...............................793
(5)ProductControllersManuallyBookedRepo105Transactions ...........797
e) ManagingBalanceSheetandLeverage .........................................................800
(1)LehmanManagementsFocusinLate2007onReducingthe
FirmsReportedLeverage..........................................................................802
(a)LehmansCalculationofNetLeverage .............................................804
xii

(2)ByJanuary2008,LehmanDecidedtoCutitsNetLeveragein
HalftoWinBacktheConfidenceoftheMarket,Lendersand
Investors .......................................................................................................805
(a)BartMcDade,asNewlyAppointedBalanceSheetCzar,
AdvisedtheExecutiveCommitteeinMarch2008toCap
LehmansUseofRepo105Transactions ...........................................809
(b)McDadeBecamePresidentandCOOonJune12,2008and
AuthorizedtheReductionofRepo105Usage..................................819
(3)TheMarketsIncreasedScrutinyoftheLeverageofInvestment
Banks.............................................................................................................822
(a)TheCostofDeleveraging ....................................................................825
(4)StickyInventoryandFIDsBalanceSheetBreachesHampered
LehmansAbilitytoManageItsNetLeverage .......................................828
(5)DeleveragingResultedinIntensePressureatQuarterEndto
MeetBalanceSheetTargetsforReportingPurposes .............................843
(6)LehmansEarningsCallsandPressReleaseStatements
RegardingLeverage....................................................................................845
(a)AnalystsStatementsRegardingLehmansLeverage .....................850
f) ThePurposeofLehmansRepo105ProgramWastoReverse
EngineerPubliclyReportedFinancialResults..............................................853
(1)LehmanDidNotDiscloseItsAccountingTreatmentFororUse
ofRepo105TransactionsinItsForms10Kand10Q...........................853
(a)LehmansOutsideDisclosureCounselWasUnawareof
LehmansRepo105Program ..............................................................855
(2)LehmansRepo105PracticeImprovedtheFirmsPublicBalance
SheetProfileatQuarterEnd .....................................................................856
(a)ContemporaneousDocumentsConfirmThatLehman
UndertookRepo105TransactionstoReduceItsBalance
SheetandReverseEngineerItsLeverage..........................................859
(b)WitnessStatementstotheExaminerRegardingtheTrue
PurposeofLehmansRepo105Practice ............................................867
(3)QuarterEndSpikesinLehmansRepo105UsageAlsoSuggest
theTruePurposeofLehmansRepo105PracticeWasBalance
SheetManipulation.....................................................................................870
(4)Repo105TransactionsServedNoBusinessPurposeOtherThan
BalanceSheetReduction ............................................................................877
xiii

(a)Repo105TransactionsCameataHigherCostthanOrdinary
RepoTransactions.................................................................................877
(b)WitnessesAlsoStatedThatFinancingWasNottheReal
MotiveforUndertakingRepo105Transactions...............................882
g) TheMaterialityofLehmansRepo105Practice ...........................................884
(1)TheRepo105ProgramExposedLehmantoPotential
ReputationalRisk....................................................................................884
(2)LehmansRepo105PracticeHadaMaterialImpacton
LehmansNetLeverageRatio ...................................................................888
(a)LehmanSignificantlyExpandedItsRepo105PracticeinLate
2007andEarly2008 ..............................................................................890
(3)BalanceSheetTargetsforFIDBusinessesWereUnsustainable
WithouttheUseofRepo105Transactions .............................................899
(4)RatingAgenciesAdvisedtheExaminerthatLehmans
AccountingTreatmentandUseofRepo105Transactionsto
ManageItsNetLeverageRatioWouldHaveBeenRelevant
Information ..................................................................................................902
(5)GovernmentRegulatorsHadNoKnowledgeofLehmansRepo
105Program .................................................................................................910
(a)OfficialsfromtheFederalReserveBankWouldHave
WantedtoKnowaboutLehmansUseofRepo105
Transactions ...........................................................................................910
(b)SecuritiesandExchangeCommissionCSEMonitorsWere
UnawareofLehmansRepo105Program.........................................913
h) KnowledgeofLehmansRepo105ProgramattheHighestLevelsof
theFirm ..............................................................................................................914
(1)RichardFuld,FormerChiefExecutiveOfficer .......................................917
(2)LehmansFormerChiefFinancialOfficers .............................................921
(a)ChrisOMeara,FormerChiefFinancialOfficer ...............................921
(b)ErinCallan,FormerChiefFinancialOfficer......................................930
(c) IanLowitt,FormerChiefFinancialOfficer .......................................937
(3)LehmansBoardofDirectors.....................................................................945
i) Ernst&YoungsKnowledgeofLehmansRepo105Program ..................948
(1)Ernst&YoungsComfortwithLehmansRepo105Accounting
Policy.............................................................................................................948
(2)TheNettingGrid .....................................................................................951
xiv

(a)QuarterlyReviewandAudit...............................................................953
(3)Ernst&YoungWouldNotOpineontheMaterialityof
LehmansRepo105Usage .........................................................................954
(4)MatthewLeesStatementsRegardingRepo105toErnst&
Young............................................................................................................956
(5)AccountingMotivatedTransactions........................................................962
j) TheExaminersConclusions ...........................................................................962
(1)Materiality ....................................................................................................963
(a)WhetherLehmansRepo105TransactionsTechnically
CompliedwithSFAS140DoesNotImpactWhethera
ColorableClaimExists .........................................................................964
(2)DisclosureRequirementsandAnalysis ...................................................967
(a)DisclosureObligations:RegulationSKandtheMD&A ...............968
(b)DutytoDisclose ....................................................................................972
(c) LehmansPublicFilings .......................................................................973
(i) SummaryofLehmans2000through2007PublicFilings........974
(ii) Lehmans2007Form10K,FirstQuarter2008Form10
Q,andSecondQuarter2008Form10Q.....................................977
a. TreatmentofRepoTransactionsandSFAS140....................978
b. NetLeverage..............................................................................980
c. Derivatives .................................................................................981
d. AReaderofLehmansForms10Kand10QWould
NotHaveBeenAbletoAscertainThatLehman
EngagedinTemporarySalesUsingLiquidSecurities ........984
(d)ConclusionsRegardingLehmansFailuretoDisclose ....................985
(3)ColorableClaims.........................................................................................990
(4)FiduciaryDutyClaims ...............................................................................991
(a)BreachofFiduciaryDutyClaimsagainstBoardofDirectors ........991
(b)BreachofFiduciaryDutyClaimsagainstSpecificLehman
Officers....................................................................................................992
(i) RichardFuld ...................................................................................996
a. ThereIsSufficientEvidencetoSupportaFindingBy
theTrierofFactThatFuldWasatLeastGrossly
NegligentinCausingLehmantoFileMisleading
PeriodicReports ........................................................................997
xv

(ii) ChrisOMeara ..............................................................................1002

a. ThereIsSufficientEvidenceToSupportaColorable
ClaimThatOMearaWasatLeastGrosslyNegligent
inAllowingLehmantoFileMisleadingFinancial
StatementsandEngageinMaterialVolumesofRepo
105Transactions ......................................................................1007
b. ThereIsSufficientEvidenceToSupportaColorable
ClaimThatOMearaBreachedHisFiduciaryDuties
byFailingtoInformtheBoardandHisSuperiorsof
LehmansRepo105Practice ..................................................1009
(iii)ErinCallan ....................................................................................1013
a. ThereIsSufficientEvidenceToSupportaFindingBy
theTrierofFactThatCallanBreachedHerFiduciary
DutiesbyCausingLehmantoMakeMaterially
MisleadingStatements ...........................................................1017
b. ThereIsSufficientEvidencetoSupportaColorable
ClaimThatCallanBreachedHerFiduciaryDutyof
CarebyFailingtoInformtheBoardofDirectorsof
LehmansRepo105Program ................................................1019
(iv)IanLowitt ......................................................................................1021
(c) Remedies ..............................................................................................1024
(5)MalpracticeClaimsAgainstErnst&Young .........................................1027
(a)BackgroundandLegalStandards ....................................................1028
(i) ProfessionalStandards................................................................1028
(ii) CommonLawStandards ............................................................1031
(b)ThereIsSufficientEvidencetoSupportaColorableClaim
ThatErnst&YoungWasNegligent.................................................1032
(i) MalpracticeinFailuretoAdviseAuditCommitteeof
Repo105ActivityandLeesAllegations..................................1033
(ii) Lehmans2008Forms10Q ........................................................1040
(iii)Lehmans2007Form10K ..........................................................1048
(iv)EffectonPriorFilings ..................................................................1050
(v) CausationandDamages .............................................................1051
(c) PossibleDefenses ................................................................................1053
xvi

VOLUME4
SectionIII.A.5:SecuredLenders
5. PotentialClaimsAgainstLehmansSecuredLenders.....................................1066
a) IntroductionandExecutiveSummary.........................................................1066
(1)JPMorgan....................................................................................................1068
(2)Citibank ......................................................................................................1073
(3)HSBC...........................................................................................................1077
(4)OtherLenders ............................................................................................1080
(5)TheFederalReserveBankofNewYork................................................1081
(6)LehmansLiquidityPool..........................................................................1082
b) LehmansDealingsWithJPMorgan .............................................................1084
(1)Facts.............................................................................................................1084
(a)OverviewofJPMorganLehmanRelationship ...............................1084
(b)TripartyRepoPriorto2008 ...............................................................1089
(c) JPMorganRestructuresItsApproachtoTripartyRisk .................1094
(d)LehmanBeginsPostingAdditionalCollateral ...............................1101
(e) JPMorganConcernOverLehmanCollateralinAugust2008 ......1105
(f) TheAugustAgreements ....................................................................1113
(g)BackgroundtotheSeptember9CollateralRequestand
SeptemberAgreements ......................................................................1125
(h)September9CallsBetweenStevenBlackandRichardFuld ........1138
(i) SeptemberAgreements ......................................................................1143
(j) DailyLiquidityPoolUpdatesFromLehmantoJPMorgan ..........1156
(k)September11CollateralRequestPursuanttotheSeptember
Agreements ..........................................................................................1158
(l) AdditionalValuationAnalysesbyJPMorganBeginning
September11........................................................................................1165
(m)LehmanRequestsforReturnofCollateral.....................................1168
(2)AnalysisofPotentialClaims ...................................................................1172
(a)TheEvidenceDoesNotSupportaColorableClaimAgainst
JPMorganforEconomicDuress........................................................1173
(i) LegalBackground:EconomicDuress .......................................1173
xvii

(ii) ThereIsNoAvailableEvidenceofanExpressUnlawful
ThreatMadebyJPMorganinConnectionWiththe
FormationoftheSeptemberAgreements ................................1174
(iii)TheAvailableEvidenceSuggestsJPMorganDidNot
HaveanImproperPurpose ........................................................1178
(iv)ThereWasaDegreeofNegotiationOvertheTermsof
theSeptemberAgreements ........................................................1181
(b)ThereIsInsufficientEvidencetoSupportaColorableClaim
ThattheSeptemberAgreementsAreInvalidforLackof
Consideration ......................................................................................1183
(c)ThereisSufficientEvidencetoSupporttheExistenceofa
Technical,ButNotColorable,ClaimThattheSeptember
AgreementsAreInvalidforLackofAuthority ..............................1186
(i) TonucciMayHaveActedWithApparentAuthority.............1190
(ii) ThereIsSubstantialEvidenceThatLehmanRatifiedthe
SeptemberAgreements ...............................................................1193
(d)ThereIsInsufficientEvidencetoSupportaColorableClaim
ThatJPMorganFraudulentlyInducedtheSeptember
Agreements ..........................................................................................1198
(e) ThereIsInsufficientEvidencetoSupportaColorableClaim
forBreachofContractoftheSeptemberAgreementsBased
onJPMorgansRefusaltoReturnCollateral ...................................1200
(i) LegalBackground:ContractualObligationsUnder
SeptemberAgreements ...............................................................1200
(ii) ThereWasNoWrittenNoticeforCollateralReturn ..............1208
(f) ThereIsEvidencetoSupportaColorable,ButNotStrong,
ClaimThatJPMorganBreachedtheImpliedCovenantof
GoodFaithandFairDealingbyDemandingExcessive
CollateralinSeptember2008.............................................................1210
(i) LegalStandardsGoverningImpliedCovenantofGood
FaithandFairDealing.................................................................1211
(ii) ThereIsSufficientEvidenceToSupportaColorable,But
NotaStrong,ClaimThatJPMorganViolatedtheImplied
CovenantbyDemandingExcessiveCollateral .......................1214
(iii)ATrierofFactWillLikelyHavetoResolveaWaiver
Defense ..........................................................................................1220
c) LehmansDealingsWithCitigroup..............................................................1224
xviii

(1)Facts.............................................................................................................1224
(a)CitigroupProvidedContinuousLinkedSettlementService
andOtherClearingandSettlementOperationstoLehman .........1224
(i) BackgroundInformationontheContinuousLinked
SettlementServiceCitiProvidedtoLehman...........................1224
(ii) OtherClearingandSettlementServicesThatCiti
ProvidedtoLehman....................................................................1227
(iii)CitisClearingandSettlementExposuretoLehman,
Generally .......................................................................................1229
(iv)TheTermsofLehmansCLSAgreementwithCiti .................1231
(b)LehmanProvideda$2BillionCashDepositwithCition
June12,2008ToSupportitsClearingNeeds..................................1233
(i) TheMarketEnvironmentandOtherCircumstances
SurroundingCitisRequestforthe$2BillionCash
DepositonJune12 .......................................................................1235
(ii) ThePartiesDidNotSharetheSameUnderstandingof
theTermsofthe$2BillionCashDeposit .................................1242
a. WhatLehmanUnderstoodtheTermsoftheDeposit
ToBe..........................................................................................1243
b. WhatCitiUnderstoodtheTermsoftheDepositToBe.....1245
c. TheExactTermsoftheComfortDepositAre
UnknownBecausetheTermsWereNotReducedto
Writing......................................................................................1250
(iii)CitiKnewtheComfortDepositwasIncludedin
LehmansLiquidityPool ............................................................1250
(c) CollateralPledgeDiscussionsBetweenLehmanandCiti
BeganinJune2008andContinuedUntilSeptember2008 ...........1251
(i) TheUnexecutedPledgeAgreement:thePartiesAgreed
toNegotiatetheTermsbutNotExecutetheAgreement
UntilItWasNeeded ....................................................................1251
(ii) CitiHadDifficultyPricingtheCollateralOfferedby
LehmanasaSubstitutefortheCashDeposit ..........................1254
(iii)TheGuarantyAmendmentWasSignedinaFireDrill
onSeptember9,2008...................................................................1261
a. EventsPriortotheSigningoftheSeptember9
GuarantyAmendmentfromCitisPerspective ..................1263
xix

b. EventsPriortotheSigningoftheSeptember9
GuarantyAmendmentfromLehmansPerspective..........1265
c. NegotiationsBetweenLehmanandCitiPersonnel
RegardingWhichLehmanEntitiesWereToBeAdded
totheParentGuarantybytheSeptember9Guaranty
Amendment .............................................................................1268
(iv)September12,2008:ALehmanCollateralAccountatCiti
wasActivatedAfterTwoMonthsofDiscussion,and
LehmanSignedanAmendmenttotheDirectCustodial
ServicesAgreement .....................................................................1273
(d)LehmansClearingEnvironmentatCitiDuringtheWeekof
September8,2008................................................................................1276
(i) CitiRequiredLehmanToOperateUnderLower
DaylightOverdraftLimits ..........................................................1276
(ii) LehmanDepositedAmountsinExcessofthe$2Billion
DepositatVariousTimesin2008WithCiti.............................1279
(iii)CitiEndeavoredToHelpLehmaninSeptember2008,
PriortotheBankruptcyFiling ...................................................1281
(iv)LehmansAccountsatCitiClosedonFridaySeptember
12WithFundsinExcessofthe$2BillionDeposit..................1284
(e) CitisParticipationinLehmanWeekendEvents........................1285
(f) CitisActionsTowardLehmanAfterLehmanFiledfor
BankruptcyProtection........................................................................1287
(i) CitiContinuedtoProvideCLSServicesforLehman,But
NotinanEntirelyUninterruptedManner...............................1287
(ii) PriortoLehmansBankruptcyFiling,CitiSetOffa
PortionoftheCashDeposit .......................................................1290
(2)AnalysisofPotentialColorableClaims .................................................1291
(a)ValidityoftheSeptember9GuarantyAmendment......................1291
(i) EconomicDuress..........................................................................1291
a. LegalFramework ....................................................................1292
b. TheEvidenceDoesNotSupporttheExistenceofa
ColorableClaimAgainstCitiforEconomicDuress ..........1293
(ii) TheFailureofConsideration......................................................1297
a. LegalFramework ....................................................................1298
xx

ColorableClaimAgainstCitiforFailureof
Consideration ..........................................................................1298
(b)BreachoftheDutyofGoodFaithandFairDealingin
ConnectionWiththeCLSServicesAgreement ..............................1300
(i) TheEvidenceDoesNotSupporttheExistenceofa
ColorableClaimAgainstCitiforBreachoftheDutyof
GoodFaithandFairDealinginConnectionWiththe
CLSServicesAgreement.............................................................1301
d) LehmansDealingsWithHSBC ....................................................................1303
(1)OverviewofHSBCsRelationshipWithLehman ................................1305
(a)HSBCProvidedCRESTClearingandSettlementServicesto
Lehman .................................................................................................1306
(b)OverviewoftheOperativeAgreements..........................................1309
(2)TheExaminersInvestigationofParticularTransactions ...................1311
(a)HSBCCancelleda$1BillionIntradayCreditFacility ...................1311
(b)LehmanMaintaineda$1BillionSegregatedDepositwith
HSBC.....................................................................................................1312
(c) LehmanDeposited$750MillionwithHSBConJune24...............1314
(d)LehmanCommitted$25MilliononAugust15toHSBCs
SyndicatedLendingFacility ..............................................................1315
(e) LehmanPledged$6MilliontoHSBCasCollateralforLetters
ofCredit................................................................................................1317
(f) OtherSignificantExposures ..............................................................1318
(3)HSBCRequiredLehmantoProvideApproximately$1Billionin
CollateralWhileQuietlyEndingTheirRelationship...........................1319
(a)HSBCDeterminedtoEndItsRelationshipwithLehman.............1319
(b)HSBCDemandedCollateralforIntradayCredit ...........................1322
(c) HSBCAgreedToAccommodateLehmanatQuarterEnd ...........1325
(d)LehmanDepositedtheCashCollateralWithHSBC......................1326
(e) LehmanNegotiatedNewTermsandExecutedtheCash
Deeds ....................................................................................................1327
(i) LehmanSecuredConcessionsintheU.K.CashDeeds..........1327
(ii) LehmanExecutedtheHongKongCashDeedLateon
September12 ................................................................................1329
xxi

(f) HSBCandLBHIStipulatedToSetoffandReturnSomeofthe
FundsCoveredbytheU.K.CashDeeds .........................................1332
(4)OtherIssuesStemmingfromHSBCsCollateralDemand..................1333
(a)LehmanIncludedtheDepositsCoveredbytheCashDeeds
inItsReportedLiquidityPool...........................................................1333
(b)HSBCConsideredWithholdingPaymentsorRequiring
PrefundingofTradesintheAsiaPacificRegionPriorto
LehmansBankruptcy ........................................................................1336
(5)TheEvidenceDoesNotSupporttheExistenceofColorable
ClaimsArisingFromHSBCsDemandThatLehmanProvide
CashCollateralandExecuteCashDeedsinOrderforHSBCto
ContinueProvidingClearingandSettlementServices .......................1336
(a)TheParametersoftheExaminersAnalysis....................................1336
(b)TheFactsProvideLittletoNoSupportforInvalidatingthe
U.K.CashDeeds..................................................................................1339
(i) AnalyticalFramework ................................................................1339
a. EnglishLawGovernsContractClaimsArisingfrom
theU.K.CashDeeds ...............................................................1339
b. EnglishContractLawTreatsDeedsDifferentlyfrom
OtherContracts .......................................................................1340
(ii) TheEvidenceDoesNotSupporttheExistenceofa
ColorableClaimThattheU.K.CashDeedsAreInvalid
forWantofConsideration ..........................................................1341
(iii)TheEvidenceDoesNotSupporttheExistenceofa
ColorableClaimforEconomicDuressBecausethe
CRESTAgreementAllowedHSBCToCeaseClearing
andSettlementatItsAbsoluteDiscretion................................1343
a. ElementsofEconomicDuress...............................................1343
b. ApplicationtoLehmanFacts ................................................1344
c. OtherTransactionsDoNotGiveRisetoEconomic
DuressClaims..........................................................................1346
(iv)TheEvidenceDoesNotSupporttheExistenceofa
ColorableClaimthatHSBCViolatedaDutyofGood
FaithandFairDealingbyDemandingCashCollateral .........1348
a. EnglishLawDoesNotRecognizeaPrincipleofGood
FaithandFairDealingofGeneralApplication ..................1349
xxii

(v) TheEvidenceDoesNotSupporttheExistenceofa
ColorableClaimthatHSBCViolatedtheNotice
ProvisionoftheCRESTAgreement ..........................................1352
a. ConstructionofTerms............................................................1352
(vi)TheCashDeedsWereNotContractsofAdhesionor
StandardFormContracts............................................................1355
a. CharacteristicsofStandardFormContractsor
ContractsofAdhesion............................................................1355
(c) OtherPotentialTheoriesofLiability................................................1357
(i) EnglishLawGovernstheRemainingPotentialClaims
EvenThoughTheyAreNotCoveredbytheChoiceof
LawProvisionoftheCashDeeds..............................................1357
a. AnalyticalFramework............................................................1357
b. ApplicationtoRemainingPotentialClaims........................1359
(ii) TheEvidenceDoesNotSupportTheExistenceOfa
ColorableClaimForUnjustEnrichmentBecause
LehmanConveyedaBenefitonHSBCPursuantto
LehmansValidContractualObligations.................................1360
a. ElementsofUnjustEnrichment ............................................1361
(iii)TheEvidenceDoesNotSupportaColorableClaimThat
HSBCBreachedaFiduciaryDutytoLehmanBecause
HSBCandLehmanWereSophisticatedPartiesina
RelationshipGovernedbyanAgreementThatLimited
HSBCsObligations .....................................................................1363
a. ElementsofBreachofFiduciaryDutyand
Misappropriation ....................................................................1364
(iv)TheEvidenceDoesNotSupportaColorableClaimthat
HSBCsDemandforCollateralTortiouslyInterfered
WithLehmansOtherBusinessorContractsBecause
HSBCWasActingToProtectItsOwnEconomic
Interests .........................................................................................1367
xxiii

a. ElementsofTortiousInterference ........................................1368
(v) TheEvidenceDoesNotSupportaFindingthatHSBC
FraudulentlyorNegligentlyMisrepresentedItsPlanto
Withdraw ......................................................................................1371
a. ElementsofFraudandMisrepresentation ..........................1371
e) LehmansDealingsWithBankofAmerica .................................................1375
f) LehmansDealingswithBankofNewYorkMellon .................................1376
(1)BNYMDemandsandReceivesaCollateralDeposit ...........................1377
(2)TheDepositIsSignificantBecauseofInternalLehmanConcerns
AboutIncludingItinItsPool..................................................................1379
g) LehmansDealingsWithStandardBank.....................................................1382
h) LehmansDealingsWiththeFederalReserveBankofNewYork ..........1385
(1)TheFRBNYSupervisesDepositTakingInstitutionsandAssists
inManagingMonetaryPolicy,butLacksAuthorityToRegulate
InvestmentBankHoldingCompanies...................................................1385
(2)InResponsetotheBearStearnsNearCollapse,theFRBNY
CreatedaVarietyofFacilitiesToBackstoptheLiquidityof
BrokerDealers;Lehman,InTurn,DrewonTheseFacilities..............1387
(a)ThePrimaryDealerCreditFacility ..................................................1387
(b)TheMarketGreetedtheCreationofthePDCFasaPositive
StepTowardBackstoppingBrokerDealerLiquidity,andas
ShoringUpLehmansLiquidity .......................................................1390
(c) InAdditiontoaLiquidityBackstop,LehmanViewedthe
PDCFasanOutletforItsIlliquidPositions ....................................1392
(d)LehmanWasReluctanttoDrawonthePDCFBecauseofa
PerceivedStigmaAttachedtoBorrowingfromtheFacility .....1396
(e) LehmanAccessedthePDCFTenTimesin2008;Lehmans
UseofthePDCFWasConcentratedinPeriodsImmediately
AftertheBearStearnsNearCollapse,andImmediatelyAfter
LBHIFiledforBankruptcy ................................................................1398
(3)OtherFRBNYLiquidityFacilities ...........................................................1400
(a)TheTermSecuredLendingFacility .................................................1400
(b)OpenMarketsOperations..................................................................1401
i) LehmansLiquidityPool................................................................................1401
xxiv

(1)IntroductionandExecutiveSummary...................................................1401
(2)TheImportanceofLiquiditytoBrokerDealersandInvestment
BankHoldingCompaniesGenerally .....................................................1406
(3)LehmansLiquidityPool..........................................................................1408
(a)ThePurposeandCompositionofLehmansLiquidityPool ........1408
(b)LehmanTestedItsLiquidityPoolandSharedtheResultsof
TheseTestswithRatingAgencies ....................................................1413
(c) MarketParticipantsFormedFavorableOpinionsof
LehmansLiquidityontheBasisofLehmans
RepresentationsAboutItsLiquidityPool .......................................1415
(4)LehmansClearingBanksSoughtCollateralPledgesandCash
DepositsToSecureIntradayCreditRisk;LehmanIncludedThis
CollateralinItsLiquidityPool................................................................1417
(a)LehmanPledgedCLOsandOtherSecuritiestoJPMorgan
ThroughouttheSummerof2008toMeetTripartyRepo
MarginRequirements.........................................................................1417
(b)TheSecuritiesPostedtoMeetJPMorgansMargin
RequirementsWereIncludedinLehmansLiquidityPool ..........1422
(c) OnJune12,2008,LehmanTransferred$2BilliontoCitias
ComfortforContinuingCLSSettlement .....................................1424
(d)TheCitiComfortDepositWasIncludedinLehmans
LiquidityPool ......................................................................................1430
(e) OnAugust25,2008,LehmanExecutedaSecurityAgreement
withBankofAmerica,GrantingtheBankaSecurityInterest
ina$500MillionDeposit ...................................................................1433
(f) LBHIandJPMorganExecutedanAmendmenttotheJune
2000ClearanceAgreement,aSecurityAgreementanda
HoldingCompanyGuaranty,allDatedAugust26,2008 .............1436
(g)LehmanAssetsSubjecttotheAugustSecurityAgreement
WereIncludedinLehmansLiquidityPool ....................................1439
(h)September2,2008:LehmanTransferredJustUnder$1Billion
toHSBCtoContinueClearingOperations,andEncumbered
ThiswithCashDeedsExecutedonSeptember9and
September12........................................................................................1441
(i) TheHSBCDepositWasRepresentedasLiquidandWas
IncludedinLBHIsLiquidityPool ...................................................1446
xxv

(j) LehmanandJPMorganExecutedAnotherRoundofSecurity
DocumentationDatedSeptember9,2008;LehmanMade$3.6
Billionand$5BillionPledgestoJPMorganSubjecttothe
TermsofTheseAgreements ..............................................................1446
(k)LehmanMadeaDeposittoBankofNewYorkMellonto
CoverIntradayExposure,andIncludedThatDepositinIts
LiquidityPool ......................................................................................1448
(l) TheCumulativeImpactofLehmansInclusionofClearing
BankCollateralandDepositsinItsLiquidityPool........................1450
(5)DisclosuresConcerningtheInclusionofClearingBank
CollateralinLehmansLiquidityPool...................................................1454
(a)LehmanDidNotDiscloseonItsJune16,2008Second
QuarterEarningsCallThatItWasIncludingthe$2Billion
CitiComfortDepositinItsLiquidityPool ..................................1454
(b)LehmanDidNotDiscloseinItsSecondQuarter200810Q,
FiledJuly10,2008,ThatItWasIncludingBoththe$2Billion
CitibankComfortDepositandApproximately$5.5Billion
ofSecuritiesCollateralPledgedtoJPMorganinItsLiquidity
Pool........................................................................................................1455
(c) LehmanDidNotDiscloseOnItsSeptember10,2008
EarningsCallThataSubstantialPortionofItsLiquidityPool
WasEncumberedbyClearingBankPledges .................................1457
(d)SeniorExecutivesDidNotDisclosetotheBoardofDirectors
attheSeptember9,2008FinanceCommitteeMeetingthe
FactThataSubstantialPortionofItsLiquidityPoolWas
EncumberedbyClearingBankPledges ..........................................1460
(e) LehmanOfficersDidNotDisclosetotheBoardofDirectors
ThatItsLiquidityPositionWasSubstantiallyImpairedby
CollateralHeldatClearingBanksUntiltheEveningof
September14,2008..............................................................................1464
(f) LowittsViewsonIncludingClearingBankCollateralinthe
LiquidityPool ......................................................................................1466
(6)RatingAgenciesWereUnawareThatLehmanWasIncluding
ClearingBankCollateralinItsLiquidityPool .....................................1467
(a)Fitch.......................................................................................................1467
(b)Standard&Poors ...............................................................................1468
(c) Moodys................................................................................................1469
xxvi

(7)TheFRBNYDidNotViewtheClearingBankCollateralinthe
LiquidityPoolasUnencumbered.......................................................1469
(8)TheSEC,LehmansPrimaryRegulator,WasUnawareofthe
ExtenttoWhichLehmanWasIncludingClearingBank
CollateralinItsLiquidityPool;totheExtentItWasAware,the
SECDidNotViewThisPracticeasProper ...........................................1472
(9)CertainLehmanCounselWereAwareThatAgreementswithIts
ClearingBanksWereStructuredtoIncludeClearingBank
CollateralinItsLiquidityPool,butDisclaimedKnowledge
ConcerningWhatAssetsWereAppropriateorInappropriatefor
theLiquidityPool .....................................................................................1476
(10)LehmansAuditorsMonitoredLehmansLiquidityPool,but
ViewedtheCompositionofthePoolasaRegulatoryIssue...............1478
(11)ThereIsInsufficientEvidenceToSupportaDetermination
ThatAnyOfficerorDirectorBreachedaFiduciaryDutyin
ConnectionWiththePublicDisclosureofLehmansLiquidity
Pool..............................................................................................................1479
VOLUME4(CONT.)
SectionIII.A.6:Government
6. TheInteractionBetweenLehmanandtheGovernment .................................1482
a) Introduction .....................................................................................................1482
b) TheSECsOversightofLehman ...................................................................1484
(1)TheCSEProgram ......................................................................................1484
(2)LehmansParticipationintheCSEProgram ........................................1487
(3)TheSEC/OIGFindings .............................................................................1490
(4)TheViewFromtheTop ...........................................................................1492
c) TheFRBNYsOversightofLehman .............................................................1494
d) TheFederalReservesOversightofLehman ..............................................1502
e) TheTreasuryDepartmentsOversightofLehman ....................................1505
f) TheRelationshipoftheSECandFRBNYinMonitoringLehmans
Liquidity ...........................................................................................................1507
(1)TheSECPerformedOnlyLimitedMonitoringofLehmans
LiquidityPool ............................................................................................1508
xxvii

(2)TheSECandFRBNYDidNotAlwaysShareInformationAbout
Lehman .......................................................................................................1511
g) TheGovernmentsPreparationfortheLehmanWeekend
MeetingsattheFRBNY ..................................................................................1516
h) OntheEveningofFriday,September12,2008,theGovernment
ConvenedaMeetingoftheMajorWallStreetFirmsinanAttempt
toFacilitatetheRescueofLehman ...............................................................1523
i) LehmansBankruptcyFiling .........................................................................1535
VOLUME5
SectionIII.B:AvoidanceActions
B. AreThereAdministrativeClaimsorColorableClaimsforPreferencesor
VoidableTransfers ......................................................................................................1544
1. ExecutiveSummary..............................................................................................1544
2. ExaminersInvestigationofPossibleAdministrativeClaimsAgainst
LBHI(FirstBullet) .................................................................................................1546
a) Summary ..........................................................................................................1546
b) Introduction .....................................................................................................1547
c) LehmansCashManagementSystem ..........................................................1549
(1)LBHIsRoleasCentralBanker................................................................1550
(2)GlobalCashandCollateralManagement .............................................1551
(3)LehmansExternalandVirtualBankAccounts....................................1554
(4)BankAccountReconciliations.................................................................1560
d) EffectoftheBankruptcyontheCashManagementSystem.....................1562
e) CashTransfersGivingRisetoAdministrativeClaims..............................1564
(1)CashTransfersfromLBHIAffiliatestoLBHI.......................................1565
(2)CashReceivedbyLBHIonBehalfofLBHIAffiliates..........................1566
(3)OtherRelevantTransactions ...................................................................1568
3. ExaminersInvestigationofPossibleAvoidanceActions(Third,Fourth
andEighthBullets)................................................................................................1570
a) Summary ..........................................................................................................1570
b) LBHISolvencyAnalysis.................................................................................1570
(1)Introduction ...............................................................................................1570
(2)MarketBasedValuationAnalysis ..........................................................1573
xxviii

(a)BasisforUtilizationofaMarketBasedValuationAnalysis.........1573
(b)MarketValueofAssetsApproach....................................................1577
(i) ImpliedAssetValue ....................................................................1578
(ii) SmallEquityCushion..................................................................1580
(iii)LimitationsoftheMarketBasedApproach.............................1581
a. ApplicationofRetrojection....................................................1583
b. TheApplicationofCurrentAwareness...........................1584
(3)Conclusion .................................................................................................1587
c) LBHIAffiliateSolvencyAnalysis .................................................................1587
(1)Summary ....................................................................................................1587
(2)DescriptionoftheExaminersAnalysis.................................................1595
(3)DebtorbyDebtorAnalysis .....................................................................1610
(a)LehmanCommercialPaperInc.........................................................1610
(b)CESAviation,CESAviationVLLC,CESAviationIX ..................1615
(c) LBSpecialFinancing...........................................................................1618
(d)LBCommodityServices.....................................................................1622
(e) LuxembourgResidentialPropertiesLoanFinanceS.A.R.L..........1627
(f) LBOTCDerivatives............................................................................1628
(g)LB745LLC...........................................................................................1629
(h)LBDerivativeProducts ......................................................................1631
(i) LBFinancialProducts.........................................................................1633
(j) LBCommercialCorporation .............................................................1635
(k)BNCMortgageLLC ............................................................................1638
(l) EastDoverLimited .............................................................................1638
(m)LehmanScottishFinance ..................................................................1640
(n)PAMIStatlerArms..............................................................................1641
d) UnreasonablySmallCapital ..........................................................................1642
(1)Summary ....................................................................................................1645
(2)AnalysisoftheUnreasonablySmallCapitalTest ............................1648
(a)SummaryofLegalStandard..............................................................1648
(b)LehmansCountercyclicalStrategy..................................................1650
(c) LehmansRepoBookandLiquidityRisk........................................1654
(i) BearStearnsDemonstratestheLiquidityRiskAssociated
WithRepoFinancing...................................................................1656
xxix

(ii) QualityandTenorofLehmansRepoBook.............................1658
(d)DeleveragingtoWinBackMarketConfidence ..........................1662
(e) BeginningintheThirdQuarterof2008,LehmanCouldHave
ReasonablyAnticipatedaLossofConfidenceWhichWould
HaveTriggeredItsLiquidityRisk....................................................1665
(f) LehmanWasNotSufficientlyPreparedtoAbsorba
LiquidityCrisisMarkedbyaSuddenLossofNon
Government,NonAgencyRepoFunding ......................................1674
(i) LehmansLiquidityPool ............................................................1675
(ii) LiquidityStressTests ..................................................................1678
(iii)OtherCapitalAdequacyMetrics...............................................1687
a. CashCapitalSurplus ..............................................................1687
b. EquityAdequacyFramework ...............................................1688
c. CSECapitalRatio ....................................................................1690
(g)LBHIAffiliateUnreasonablySmallCapitalAnalysis................1692
e) InsiderPreferencesAgainstLBHI(ThirdBullet) .......................................1694
(1)Summary ....................................................................................................1694
(2)LegalSummary .........................................................................................1696
(3)SourcesofPotentialPreferentialActivity..............................................1698
(4)DeterminationsandAssumptionsonSection547(b)Elements .........1705
(5)ScopeofDefensesUnderSection547(c) ................................................1710
(6)FindingsforLBSF......................................................................................1713
(7)FindingsforLBCS .....................................................................................1718
(8)FindingsforLCPI......................................................................................1722
f) PreferencesAgainstNonLBHILehmanAffiliates(FourthBullet).........1730
g) AvoidanceAnalysisofLBHIandLBHIAffiliatesAgainstFinancial
ParticipantsandPreChapter11Lenders(FourthandEighth
Bullets) ..............................................................................................................1731
(1)Summary ....................................................................................................1731
(2)APBAnalysis .............................................................................................1734
(3)CashDisbursementAnalysis ..................................................................1737
(4)PledgedCollateralAccountsAnalysis...................................................1738
(5)AvoidanceAnalysisforCertainPreChapter11Lendersand
FinancialParticipants ...............................................................................1739
(a)JPMorganAvoidanceAnalysis .........................................................1739
xxx

(i) Background...................................................................................1739
(ii) AvoidabilityoftheSeptemberAgreementsand
TransfersinConnectionwiththeSeptemberAgreements....1742
a. AvoidabilityoftheSeptemberGuarantyasa
ConstructiveFraudulentObligation ....................................1743
1. ThereIsEvidenceToSupportAFindingThat
LBHIIncurredanObligationWithinthe
ApplicableLookBackPeriodsWhenitExecuted
theSeptemberGuaranty ..................................................1743
LBHIReceivedLessThanReasonablyEquivalent
ValueorDidNotReceiveFairConsiderationin
ExchangeforGrantingJPMorgantheSeptember
Guaranty.............................................................................1744
3. InsolvencyasofSeptember10,2008 ..............................1757
4. UndercapitalizationasofSeptember10,2008 ..............1758
b. DefensestoAvoidabilityoftheSeptemberGuaranty.......1758
1. ApplicabilityoftheGoodFaithDefenseofSection
548(c)oftheBankruptcyCodeandSection279of
theN.Y.DebtorCreditorLawtotheSeptember
Guaranty.............................................................................1758
2. ApplicabilityoftheSafeHarborProvisionstothe
SeptemberGuaranty.........................................................1762
c. AvoidabilityofTransfersofCollateralinConnection
withtheSeptemberGuaranty ...............................................1767
1. LBHIsCollateralTransfersandPostPetition
Setoffs..................................................................................1767
2. ApplicationOfTheSafeHarborsToThe$8.6
BillionCashCollateralTransfers ....................................1776
3. ThereIsEvidenceToSupportPotentialStateLaw
ClaimsAvailabletoLBHIPursuanttoSection541
toAvoidtheTransfersInConnectionwiththe
SeptemberGuaranty.........................................................1781
4. TotheExtenttheSeptemberGuarantyProvided
foraGuarantyofNonProtectedContract
Obligations,OrtotheExtentJPMorgan
LiquidatedCollateralPursuanttoNonProtected
xxxi

ContractExposure,aColorableBasisExiststhat
theSafeHarborProvisionsarenotApplicable ............1787
(iii)AvoidabilityoftheAugustAgreementsandTransfersin
ConnectionwiththeAugustAgreements................................1794
a. AvoidabilityoftheAugustGuarantyasa
ConstructiveFraudulentObligation ....................................1794
1. LBHIIncurredanObligationWithinthe
ApplicableLookBackPeriodsWhenitExecuted
theAugustGuaranty........................................................1794
2. ThereIsEvidenceThatLBHIReceivedLessThan
ReasonablyEquivalentValueorDidNotReceive
FairConsiderationinExchangeforGranting
JPMorgantheAugustGuaranty .....................................1795
3. InsolvencyasofAugust29,2008....................................1797
4. UndercapitalizationandInabilitytoPayDebtsas
TheyComeDueasofAugust29,2008 ..........................1797
b. DefensestoAvoidabilityoftheAugustGuaranty.............1797
c. AvoidabilityofTransfersofCollateralinConnection
WiththeAugustGuaranty ....................................................1798
(iv)AvoidabilityoftheAugustandtheSeptemberSecurity
AgreementsAndCollateralTransfersPursuantto
Section548(a)(1)(A) .....................................................................1801
(v) AvoidabilityoftheTransfersofCollateralinConnection
withtheSeptemberGuarantyPursuanttoSection547(b)
oftheBankruptcyCode ..............................................................1806
(vi)AvoidabilityofObligationsofLBHItoFundsManaged
byJPMorgan .................................................................................1813
(b)CitiAvoidanceAnalysis ....................................................................1817
(i) Background...................................................................................1817
(ii) Avoidabilityofthe$2BillionDeposit ......................................1821
(iii)AvoidabilityoftheAmendedGuaranty ..................................1821
(iv)Avoidabilityofthe$500MillionTransferFromanLBHI
AccounttoanLBIAccount ........................................................1827
(c) FRBNYAvoidanceAnalysis..............................................................1829
(d)HSBCAvoidanceAnalysis ................................................................1830
(i) Background...................................................................................1830
xxxii

(ii) TheU.K.CashDeedTransactions.............................................1832
(iii)TheHongKongCashDepositTransactions............................1833
(iv)September9,2009Stipulation ....................................................1834
(v) AvoidabilityoftheJanuary4,2008Guaranty .........................1835
(vi)AvoidabilityoftheHongKongCashDeedTransactions......1836
(vii)AvoidabilityoftheU.K.CashDeed.........................................1836
(viii)AvoidabilityoftheTransferoftheRemaining
Collateral .......................................................................................1837
(e) StandardBankAvoidanceAnalysis.................................................1837
(f) BNYMAvoidanceAnalysis...............................................................1839
(g)BofAAvoidanceAnalysis..................................................................1840
(h)CMEAvoidanceAnalysis..................................................................1841
(i) Summary.......................................................................................1841
(ii) Background...................................................................................1843
a. EnergyDerivatives .................................................................1851
b. FXDerivatives .........................................................................1852
c. InterestRateDerivatives........................................................1852
d. EquityDerivatives ..................................................................1853
e. AgriculturalDerivatives ........................................................1854
(iii)DefensestoAvoidabilityofClaims...........................................1855
a. ApplicabilityofCEAPreemption.........................................1855
b. ApplicabilityofSelfRegulatoryOrganization
Immunity..................................................................................1862
c. ApplicabilityoftheSafeHarborProvisionsofthe
BankruptcyCode ....................................................................1870
h) AvoidanceAnalysisofLBHIAffiliatePaymentstoInsider
Employees(FourthBullet) .............................................................................1871
(1)Summary ....................................................................................................1871
(2)Methodology..............................................................................................1873
(3)ApplicableLegalStandards.....................................................................1874
(4)Findings ......................................................................................................1882
(a)LBHIAffiliateSeverancePayments .................................................1882
(b)LBHIAffiliateBonusPayments ........................................................1887
(c)LBHIsAssumptionsofLimitedPartnershipInterests ..................1889
xxxiii

4. ExaminersInvestigationofPossibleBreachesofFiduciaryDutyby
LBHIAffiliateDirectorsandOfficers(FifthBullet) .........................................1894
a) FiduciaryDutyStandardforaWhollyOwnedAffiliateSubsidiary
underDelawareLaw ......................................................................................1896
b) FiduciaryDutyStandardforaWhollyOwnedAffiliateSubsidiary
underNewYorkLaw.....................................................................................1902
(1)LCPIsBackgroundandOfficersandDirectors ..................................1905
(a)DutyofCare.........................................................................................1907
(b)DutytoMonitor ..................................................................................1909
c) BreachofFiduciaryDutyforAidingorAbettingUnderDelaware
Law....................................................................................................................1911
5. ExaminersAnalysisofLehmansForeignExchangeTransactions
(SecondBullet).......................................................................................................1912
a) Summary ..........................................................................................................1912
b) ForeignExchangeatLehman ........................................................................1913
c) ForeignExchangeTransactionsDuringtheStubPeriod ..........................1923
6. ExaminersReviewofIntercompanyTransactionsWithinThirtyDays
ofLBHIsBankruptcyFiling(SeventhBullet) ..................................................1938
a) Summary ..........................................................................................................1938
b) Discussion ........................................................................................................1939
c) Analysis ............................................................................................................1942
d) AnalysisofOverallNetIntercompanyDataforthe2007and2008
PeriodsofAnalysis .........................................................................................1942
(1)LBHI ............................................................................................................1942
(2)LBIE.............................................................................................................1945
(3)LBSF ............................................................................................................1947
e) AnalysisofNetDailyIntercompanyDataforthe2007and2008
PeriodsofAnalysis .........................................................................................1949
7. ExaminersAnalysisofLehmansDebttoFreddieMac .................................1951
xxxiv

VOLUME5(CONT.)
SectionIII.C:BarclaysTransaction
Barclays,orFromtheLehmanALITransaction?...................................................1961
1. ExecutiveSummary..............................................................................................1961
a) PurposeofInvestigation ................................................................................1961
(1)BarclaysSaleTransaction.........................................................................1961
(2)LehmanALITransaction .........................................................................1963
b) SummaryofConclusions...............................................................................1963
(1)BarclaysTransaction.................................................................................1963
(2)LehmanALITransaction .........................................................................1965
2. Facts.........................................................................................................................1965
a) LehmanBusinessesandAssets.....................................................................1965
(1)LBHIAffiliateOperatingCompanies ....................................................1970
(a)LBCS......................................................................................................1970
(b)LBCC .....................................................................................................1972
(c) LCPI ......................................................................................................1975
(d)LBSF ......................................................................................................1978
(e) LOTC.....................................................................................................1980
(f) LBDPandLBFP...................................................................................1981
(g)LBF ........................................................................................................1984
(h)BNC .......................................................................................................1986
(2)LBHIAffiliateSinglePurposeEntities...................................................1987
(a)LB745....................................................................................................1987
(b)CESAviationEntities .........................................................................1987
(c) PAMIStatler ........................................................................................1988
(d)EastDover ............................................................................................1988
(e) ScottishFinance ...................................................................................1989
(f) LuxembourgS.A.R.L. .........................................................................1989
(g)Navigator .............................................................................................1990
(3)SaleTransaction.........................................................................................1991
3. WhetherAssetsofLBHIAffiliatesWereTransferredtoBarclays.................1997
a) AnalysisofSecuritiesTransferredtoBarclays ...........................................1998
xxxv

(1)SecuritiesTransferredtoBarclays ..........................................................1999
(a)LehmansSecuritiesTradingRecordsandSystems ......................2005
(i) General ..........................................................................................2005
(ii) GFSSystemAssessment .............................................................2008
a. ComparisonofGFSDatatoLehmans10QFilings ..........2009
b. ComparisonofGFSDatatoLehmansGeneralLedger ....2009
c. ReliabilityofSeptember12Data...........................................2010
(iii)GFSDataExtractedbyExaminer ..............................................2010
(2)AnalysisofGFSData................................................................................2012
(a)CUSIPsNotAssociatedWithLBHIAffiliateEntities....................2014
(b)CUSIPsAssociatedSolelyWithanLBHIAffiliateEntity .............2015
(c) CUSIPsAssociatedWithBothLBIandLBHIAffiliate
Entities ..................................................................................................2016
(i) CUSIPsAssociatedWithSubordinatedEntities .....................2016
(ii) SecuritiesFinancingTransactions .............................................2021
(iii)AlternativeAnalyses ...................................................................2024
(d)817CUSIPsWithNoGFSData .........................................................2025
(i) September19,2008GFSDataset................................................2026
(ii) SearchbyISINNumberandProductID..................................2027
(iii)TMSSourceSystem .....................................................................2027
(iv)AdditionalDataSources .............................................................2028
b) AnalysisofTangibleAssetTransfers...........................................................2030
(1)LB745..........................................................................................................2033
(2)LBCS............................................................................................................2035
(3)LCPI ............................................................................................................2036
(4)LBSF ............................................................................................................2038
(5)CES ..............................................................................................................2039
(6)CESV ..........................................................................................................2041
(7)CESIX .........................................................................................................2042
c) AnalysisofIntangibleAssetTransfers ........................................................2044
(1)CustomerInformationAssets .................................................................2045
(2)ProprietarySoftware ................................................................................2051
(3)AssembledWorkforce ..............................................................................2054
4. LehmanALITransaction .....................................................................................2055
xxxvi

5. Conclusions............................................................................................................2063
a) Summary ..........................................................................................................2063
b) ColorableClaimsArisingfromTransferofLBHIAssets..........................2064
(1)ThereAreNoColorableClaimsAgainstBarclaysArisingfrom
TransferofLBHIAffiliateSecurities ......................................................2064
(2)ThereAreColorable,LimitedClaimsAgainstBarclaysArising
fromTransferofLBHIAffiliateOfficeEquipmentandLBCS
CustomerInformation..............................................................................2076
(a)BankruptcyCodeClaims ...................................................................2077
(i) Section542.....................................................................................2077
(ii) Section548.....................................................................................2081
(b)CommonLawClaims.........................................................................2083
(i) RecoveryofChattel .....................................................................2083
(ii) Conversion....................................................................................2086
(iii)UnjustEnrichment.......................................................................2088
(iv)TradeSecretMisappropriation ..................................................2090
(v) UnfairCompetition .....................................................................2092
(vi)TortiousInterferenceWithEmploymentRelations................2094
(3)ClaimsAgainstLBHIAffiliateOfficersandDirectors ........................2096
(a)DutyofCare.........................................................................................2098
(b)DutyofGoodFaith .............................................................................2100
(c) DutytoMonitor ..................................................................................2101
c) LehmanALITransaction ...............................................................................2103
6. BarclaysTransaction.............................................................................................2103
a) PreBankruptcyNegotiations........................................................................2104
(1)BarclaysInterestinaTransactionInvolvingLehman ........................2104
(2)NegotiationsBeforeSeptember15 .........................................................2110
b) LBHIBankruptcy ............................................................................................2116
(1)LBHIFilesChapter11 ..............................................................................2116
(2)PostPetitionClearingandFinancing ....................................................2116
c) NegotiationsLeadingtoAPA .......................................................................2124
(1)Participants ................................................................................................2127
(2)StructureofTransaction...........................................................................2129
xxxvii

(3)NegotiationsRegardingSecuritiesPositionstobePurchasedby
Barclays.......................................................................................................2131
(a)OnSeptember15and16,LehmanandBarclaysReview
LehmansSecuritiesPositionsandMarks .......................................2131
(b)BarclaysAgreestoPurchaseLongSecuritiesPositions
WithaBookValueofApproximately$70Billion ......................2138
(4)NegotiationsRegardingContractCureandEmployee
CompensationLiabilities .........................................................................2143
(a)ContractCureCosts............................................................................2143
(b)CompensationLiabilities ...................................................................2147
d) ConsiderationandApprovalofTransactionDescribedinAPAby
LBHIandLBIBoardsofDirectors................................................................2153
e) TransactionDescribedtotheCourtonSeptember17 ...............................2155
(1)SaleMotion ................................................................................................2155
(2)September17SaleProceduresHearing .................................................2157
f) BetweenSeptember17and19,theSecuritiesPositionsBeing
AcquiredbyBarclaysChange .......................................................................2160
(1)TheReplacementTransaction .............................................................2160
(2)$15.8BillionRepo......................................................................................2170
(3)September19AgreementtoTransferAdditionalAssets....................2175
(a)Excess15c33Assets ...........................................................................2178
(b)AdditionalSecurities ..........................................................................2182
(c) OCCMargin.........................................................................................2184
g) TheCourtsConsiderationandApprovaloftheProposed
Transaction.......................................................................................................2188
(1)September19,2008SaleHearing ............................................................2188
(2)TheSaleOrder ...........................................................................................2192
h) TransactionClosing ........................................................................................2194
(1)JPMorgan/BarclaysDisputes...................................................................2194
(2)TheCommitteesRole ..............................................................................2197
(3)December2008SettlementBetweenTrustee,Barclaysand
JPMorgan....................................................................................................2208

xxxviii
EXAMINERS REPORT
TABLE OF APPENDICES
VOLUME6
Tab1 LegalIssues
VOLUME7
Tab2 Glossary,Acronyms&Abbreviations
Tab3 KeyIndividuals
Tab4 WitnessInterviewList
Tab5 DocumentCollection&Review
Tab6 LehmanSystems
Tab7 Bibliography
VOLUME8
Tab8 RiskManagementOrganizationandControls
Tab9 RiskAppetiteandVaRUsageVersusLimitsChart
Tab10 CalculationofCertainIncreasesinRiskAppetiteLimits
Tab11 Compensation
Tab12 ValuationArchstone
Tab13 SurvivalStrategiesSupplement
Tab14 ValuationCDO
Tab15 NarrativeofSeptember4Through15,2008
Tab16 ValuationResidentialWholeLoans
i
Tab17 Repo105
Tab18 SummaryofLehmanCollateralatJPMorgan
Tab19 LehmansDealingswithBankofAmerica
KnowledgeofSeniorLehmanExecutivesRegardingThe
Tab20
InclusionofClearingBankCollateralintheLiquidityPool
Tab21 LBHISolvencyAnalysis
Tab22 PreferencesAgainstLBHIandOtherLehmanEntities
VOLUME9
AnalysisofAPB,JournalEntry,CashDisbursement,and
Tab23
JPMorganCollateral
Tab24 ForeignExchangeTransactions
IntercompanyTransactionsOccurringWithinThirtyDaysBefore
Tab25
Bankruptcy
Tab26 CUSIPswithBlankLegalEntityIdentifiers
Tab27 CUSIPsNotAssociatedwithanLBHIAffiliate
Tab28 CUSIPsAssociatedSolelywithanLBHIAffiliate
Tab29 CUSIPsAssociatedwithBothLBIandLBHIAffiliates
Tab30 CUSIPsAssociatedwithSubordinatedEntities
CUSIPsAssociatedwithLBHIAffiliatesNotDeliveredtoLBIina
Tab31
FinancingTrade
Tab32 September19,2008GFSDataset
Tab33 SummaryBalanceSheetsofLBHIAffiliates
Tab34 TangibleAssetBalanceSheetVariations
ii

x
:
:
etal., :
Debtors. :
x
REPORTOF
EXAMINERANTONR.VALUKAS
Introduction
SectionsI&II:ExecutiveSummary&ProceduralBackground
TABLEOFCONTENTS
Introduction ...................................................................................................................................2
I. ExecutiveSummaryofTheExaminersConclusions.....................................................15
A. WhyDidLehmanFail?AreThereColorableCausesofActionThat
AriseFromItsFinancialConditionandFailure?.....................................................15
VoidableTransfers?......................................................................................................24
Barclays,orFromtheLehmanALITransaction? ....................................................26
II. ProceduralBackgroundandNatureoftheExamination ..............................................28
A. TheExaminersAuthority ...........................................................................................28
B. DocumentCollectionandReview..............................................................................30
C. SystemsAccess..............................................................................................................33
D. WitnessInterviewProcess...........................................................................................35
E. CooperationandCoordinationWiththeGovernmentandParties ......................37
INTRODUCTION
OnJanuary29,2008, Lehman BrothersHoldingsInc. (LBHI1) reportedrecord
revenues of nearly $60 billion and record earnings in excess of $4 billion for its fiscal
yearendingNovember30,2007.2DuringJanuary2008,Lehmansstocktradedashigh
as $65.73 per share and averaged in the high to midfifties,3 implying a market
capitalizationofover$30billion.4Lessthaneightmonthslater,onSeptember12,2008,
Lehmansstockclosedunder$4,adeclineofnearly95%fromitsJanuary2008value.5
OnSeptember15,2008,LBHIsoughtChapter11protection,6inthelargestbankruptcy
proceedingeverfiled.7
TherearemanyreasonsLehmanfailed,andtheresponsibilityisshared.Lehman
was more the consequence than the cause of a deteriorating economic climate.
1Thereareasignificantnumberofacronyms,abbreviationsandotherspecializedtermsusedthroughout
this Report. To avoid the necessity of defining terms repeatedly, the Report will generally use them
without definition; the reader should consult the Glossary attached as Appendix 2. Except where the
specificidentityofanentityisrelevantandsetout,thisReportwilluseLehmantorefercollectivelyto
LehmanBrothersHoldingsInc.(LBHI)andallofitsaffiliatesandsubsidiaries.
2LehmanBrothersHoldingsInc.(LBHI),AnnualReportfor2007asofNov.30,2007(Form10K)(filed
Jan.29,2008),atp.29(LBHI200710K).LBHIwastheholdingcompanyforhundredsofindividual
corporate entities, twentytwo of which are currently Chapter 11 debtors in jointly administered
proceedings.
3 Morningstar Document Research Co., LBHI Historic Stock Prices, Jan. 1, 2008 through Sept. 15, 2008,
[LBEXEXM00000114](printedfromwww.10kwizard.com)(lastvisitedFeb.3,2010).
4LBHI,QuarterlyReportasofFeb.29,2008(Form10Q)(filedonApr.9,2008),atp.1(LBHI10QApr.
9,2008)(554millioncommonequitysharesoutstandingtimes$55=approximately$30billion).
5Morningstar Document Research Co., LBHI Historic Stock Prices (Jan. 1, 2008 through Sept. 15,
,2008)[LBEXEXM00000114](printedfromwww.10kwizard.com)(lastvisitedFeb.3,2010).
6Voluntary Petition (Chapter 11), Docket No. 1, Lehman Brothers Holdings Inc., No. 0813555 (Bankr.
S.D.N.Y.Sept.15,2008).
7Yalman Onaran & John Helyar, Fuld Sought Buffet Offer He Refused as Lehman Sank (Update 1),
Bloomberg.com(Nov.10,2008),atp.2.
2
Lehmans financial plight, and the consequences to Lehmans creditors and
shareholders, was exacerbated by Lehman executives, whose conduct ranged from
serious but nonculpable errors of business judgment to actionable balance sheet
manipulation;bytheinvestmentbankbusiness model, which rewardedexcessive risk
takingandleverage;andbyGovernmentagencies,whobytheirownadmissionmight
betterhaveanticipatedormitigatedtheoutcome.
Lehmansbusinessmodelwasnotunique;allofthemajorinvestmentbanksthat
existed at the time followed some variation of a highrisk, highleverage model that
required the confidence of counterparties to sustain. Lehman maintained
approximately $700 billion of assets, and corresponding liabilities, on capital of
approximately $25 billion.8 But the assets were predominantly longterm, while the
liabilities werelargelyshortterm.9Lehmanfundeditselfthroughtheshorttermrepo
marketsandhadtoborrowtensorhundredsofbillionsofdollarsinthosemarketseach
dayfromcounterpartiestobeabletoopenforbusiness.10Confidencewascritical.The
momentthatrepocounterpartiesweretoloseconfidenceinLehmananddeclinetoroll
overitsdailyfunding,Lehmanwouldbeunabletofunditselfandcontinuetooperate.
8LBHI200710K,atp.29;LBHI10QApr.9,2008,atpp.56.
9ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atp.8.
10ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atpp.4,8(Lehmanfinancedthemajorityofits
balancesheetintheshorttermrepomarket,morethan$200billionadayin2008;Lehmanwasrelianton
shorttermsecuredfinancingtoconductitsdailyoperations);ExaminersInterviewofRaymondAbary,
Mar.12,2009.
3
Sotoowiththeotherinvestmentbanks,hadtheycontinuedbusinessasusual.Itisno
coincidencethatnomajorinvestmentbankstillexistswiththatmodel.11
In 2006, Lehman made the deliberate decision to embark upon an aggressive
growth strategy, to take on significantly greater risk, and to substantially increase
leverage on its capital.12 In 2007, as the subprime residential mortgage business
progressedfromproblemtocrisis,Lehmanwasslowtorecognizethedevelopingstorm
and its spillover effect upon commercial real estate and other business lines. Rather
than pull back, Lehman made the conscious decision to double down, hoping to
profit from a countercyclical strategy.13 As it did so, Lehman significantly and
repeatedlyexceededitsowninternalrisklimitsandcontrols.14
With the implosion and near collapse of Bear Stearns in March 2008, it became
clearthatLehmansgrowthstrategyhadbeenflawed,somuchsothatitsverysurvival
11Bank of America, Press Release, Bank of America Buys Merrill Lynch Creating Unique Financial
Services Firm (Sept. 15, 2008) (announcing its acquisition of Merrill Lynch); Morgan Stanley, Press
Release,MorganStanleyandCititoFormIndustryLeadingWealthManagementBusinessThroughJoint
Venture(Jan.13,2009)(announcingjointventurewithCitisSmithBarneyGrouptoformMorganStanley
Smith Barney); Federal Reserve, Press Release, Sept. 21, 2008 (announcing that the Federal Reserve
grantedtheapplicationsbyGoldmanSachsandMorganStanley,thelasttwomajorinvestmentbanks,to
become bank holding companies); Goldman Sachs, Press Release, Sept. 21, 2008 (announcing that
GoldmanSachswillbecomeabankholdingcompanyandwillberegulatedbytheFederalReserve).
12SeeDavidGoldfarb,Lehman,GlobalStrategyOffsite(Mar.2006)[LBEXDOCID2489987].
13ExaminersInterviewofDr.HenryKaufman,May19,2009,atp.9(ataMarch20,2007Boardmeeting,
managementadvisedthatvirtuallyallsubprimeoriginatorshavecutbackontheiroperationsorgone
out of business, but, despite that fact, it was managements view that the current distressed
environmentprovidessubstantialopportunitiesasinthelate1990s).
14Duff & Phelps, High Yield Total Usage Versus Limits (Nov. 19, 2009), at pp. 49 (showing that
Lehmans monthly average risk appetite exceeded its limit by $41 million in July 2007, $62 million in
August 2007, $608 million in September 2007, $670 million in October 2007, $508 million in November
2007,$562millioninDecember2007,$708millioninJanuary2008,and$578millioninFebruary2008).
4
wasinjeopardy.15ThemarketswereshakenbyBearsdemise,andLehmanwaswidely
considered to be the next bank that might fail.16 Confidence was eroding. Lehman
pursuedanumberofstrategiestoavoiddemise.
Buttobuyitselfmoretime,tomaintainthatcriticalconfidence,Lehmanpainted
amisleadingpictureofitsfinancialcondition.
Lehmanrequiredfavorableratingsfromtheprincipalratingagenciestomaintain
investor and counterparty confidence; and while the rating agencies looked at many
thingsinarrivingattheirconclusions,itwasclearandcleartoLehmanthatitsnet
leverage and liquidity numbers were of critical importance.17 Indeed, Lehmans CEO
RichardS.Fuld,Jr.,toldtheExaminerthattheratingagencieswereparticularlyfocused
on net leverage;18 Lehman knew it had to report favorable net leverage numbers to
15ExaminersInterviewofHenryM.Paulson,Jr.,June25,2009,atp.11(formerSecretaryoftheTreasury
PaulsonstatedthatafterBearStearnsnearcollapsehewaslessoptimisticaboutLehmanschancesthan
Fuld,andheinformedFuldthatLehmanneededtoraisecapital,findastrategicpartnerorsellthefirm).
16ExaminersInterviewofTimothyF.Geithner,Nov.24,2009,atp.2(formerPresidentoftheFRBNYand
currentTreasurySecretaryGeithnerbelievedthatafterBearStearnsnearcollapse,Lehmanwasthemost
vulnerableinvestmentbank);ExaminersInterviewofBenS.Bernanke,Dec.22,2009,atp.3(Chairmanof
the Federal Reserve Bernanke believed that, after Bear Stearns, Lehman was the next most vulnerable
bank); Examiners Interview of Henry M. Paulson, Jr., June 25, 2009, at p. 2 (Paulson thought Lehman
could be next to fail after Bear Stearns); Examiners Interview of Christopher Cox, Jan. 8, 2010, at p. 8
(formerChairmanoftheSECCoxsaidthatafterBearStearnscollapsedLehmanwastheSECsnumber
onefocus.Lehmanhadsuffereddiminutionofvalueandhadtroubledassets).
17Erin M. Callan, Lehman Brothers Leverage Analysis (Apr. 7, 2008), at p. 1 [LBEXDOCID 1401225]
(Reducingleverage[i]snecessarytoremoverefinancingriskandwinbacktheconfidenceofthemarket,
lenders, and investors.); Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at p. 8 (rating
agencieslookedatnetleverage);ExaminersInterviewofMichaelMcGarvey,Sept.11,2009,atp.5(senior
managementmadeaconcertedefforttomanageandreducethebalancesheetwithaviewtowardsthe
ratingagencies);ExaminersInterviewofEileenA.Fahey,Fitch,Sept.17,2009,atp.6;Standard&Poors
RatingsDirect, LiquidityManagement In Times OfStress: How The MajorBrokerDealersFare(Nov.8,
2007),atp.3[LBHI_SEC07940_439424].
18ExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,atp.7.
maintain its ratings and confidence. So at the end of the second quarter of 2008, as
Lehman was forced to announce a quarterly loss of $2.8 billion resulting from a
combinationofwritedownsonassets,salesofassetsatlosses,decreasingrevenues,and
losses on hedges it sought to cushion the bad news by trumpeting that it had
significantlyreduceditsnetleverageratiotolessthan12.5,thatithadreducedthenet
assetsonitsbalancesheetby$60billion,andthatithadastrongandrobustliquidity
pool.19
Lehmandidnotdisclose,however,thatithadbeenusinganaccountingdevice
(known within Lehman as Repo 105) to manage its balance sheet by temporarily
removing approximately $50 billion of assets from the balance sheet at the end of the
firstandsecondquartersof2008.20Inanordinaryrepo,Lehmanraisedcashbyselling
assetswithasimultaneousobligationtorepurchasethemthenextdayorseveraldays
later; such transactions were accounted for as financings, and the assets remained on
Lehmansbalancesheet.InaRepo105transaction,Lehmandidexactlythesamething,
but because the assets were 105% or more of the cash received, accounting rules
permittedthetransactionstobetreatedassalesratherthanfinancings,sothattheassets
19FinalTranscriptofLehmanBrothersHoldingsInc.SecondQuarterPreliminaryEarningsCall(June9,
2008),atpp.78.
20LBHI200710K,atp.63;LBHI10QApr.9,2008,atp.72;LehmanBrothersHoldingsInc.,Quarterly
Report as of May 31, 2008 (Form 10Q) (filed on July 10, 2008), at p. 88 (LBHI 10Q July 10, 2008);
ExaminersInterviewofMartinKelly,Oct.1,2009;ExaminersInterviewofEdGrieb,Oct.2,2009.
6
could be removed from the balance sheet.21 With Repo 105 transactions, Lehmans
reportednetleveragewas12.1attheendofthesecondquarterof2008;butifLehman
hadusedordinaryrepos,netleveragewouldhavetohavebeenreportedat13.9.22
Contemporaneous Lehman emails describe the function called repo 105
wherebyyoucanrepoapositionforaweekanditisregardedasatruesaletogetridof
netbalancesheet.23LehmanusedRepo105fornoarticulatedbusinesspurposeexcept
to reduce balance sheet at the quarterend.24 Rather than sell assets at a loss, [a]
Repo 105 increase would help avoid this without negatively impacting our leverage
ratios.25 Lehmans Global Financial Controller confirmed that the only purpose or
motivefor[Repo105]transactionswasreductioninthebalancesheetandthatthere
wasnosubstancetothetransactions.26
Lehman did not disclose its use or the significant magnitude of its use of
Repo105totheGovernment,totheratingagencies,toitsinvestors,ortoitsownBoard
21SeeSectionIII.A.4(discussingRepo105).
22LBHI 10Q July 10, 2008, at p. 89; Duff & Phelps, Repo 105 Balance Sheet Accounting Entry and
LeverageRatiosSummary(Oct.2,2009),atp.7.SeealsoSectionI.AofthisReport,whichdiscussesnet
leverage.
23 Email from Anthony Jawad, Lehman, to Andrea Leonardelli, Lehman (Feb. 29, 2008) [LBEXDOCID
224902].
24EmailfromRaymondChan,Lehman,toPaulMitrokostas,Lehman,etal.(Jul.15,2008)[LBEXDOCID
3384937].
25JosephGentile,Lehman,ProposedRepo105/108TargetIncreasefor2007(Feb.10,2007),atp.1[LBEX
DOCID2489498],attachedtoemailfromJosephGentile,Lehman,toEdGrieb,Lehman(Feb.10,2007)
[LBEXDOCID2600714].
26ExaminersInterviewofMartinKelly,Oct.1,2009,atp.9.
ofDirectors.27Lehmansauditors,Ernst&Young,wereawareofbutdidnotquestion
LehmansuseandnondisclosureoftheRepo105accountingtransactions.28
In midMarch 2008, after the Bear Stearns near collapse, teams of Government
monitors from the Securities and Exchange Commission (SEC) and the Federal
Reserve Bank of New York (FRBNY) were dispatched to and took up residence at
Lehman,29tomonitorLehmansfinancialconditionwithparticularfocusonliquidity.30
27LehmandidnotdiscloseitsuseofRepo105inpublicfilings.ExaminersInterviewofEdGrieb,Oct.2,
2009, at p. 14; Examiners Interview of Marie Stewart, Sept. 2, 2009, at p. 15; Examiners Interview of
MatthewLee,July1,2009,atp.16.LehmandidnotdiscloseitsuseofRepo105toratingagencies.See
Lehman,S&PRatingsQ22008Update(June5,2008)[S&PExaminer000946](Lehmandidnotdiscloseits
useofRepo105toStandard&Poorsinitsratingspresentation);Lehman,FitchRatingsQ22008Update
(June3,2008)[LBHI_SEC07940_513239](LehmansimilarlydidnotdiscloseitsuseofRepo105toFitchas
part of its presentation where Lehman touted its balance sheet reduction). The Examiner interviewed
representatives from the three leading ratings agencies, Fitch, S&P and Moodys, and none had
knowledgeofLehmansuseofRepo105/108transactions,eitherbynameorbydescription.Examiners
InterviewofEileenA.Fahey,Sept.17,2009,atp.7;ExaminersInterviewofDianeHinton,Sept.22,2009,
atp.6;ExaminersInterviewofPeterE.Nerby,Oct.8,2009,atp.5.Lehmandidnotdiscloseitsuseof
Repo105 toGovernment regulators. Examiners Interview ofRonald S. Marcus,Nov.4, 2009, at p. 11;
Examiners Interview of Timothy F. Geithner, Nov. 24, 2009, at p. 5; Examiners Interview of Jan H.
Voigts,Oct.1,2009.LehmandidnotdiscloseitsuseofRepo105toitsBoardofDirectors.Examiners
Interview of Dr. Henry Kaufman, Sept. 2, 2009, at p. 21; Examiners Interview of Jerry A. Grundhofer,
Sept.16,2009,atp.10;ExaminersInterviewofRolandHernandez,Oct.2,2009;ExaminersInterviewof
SirChristopherGent,Oct.21,2009,atp.22;ExaminersInterviewofRogerBerlind,Dec.18,2009,atp.4.
28Examiners Interview of Ernst & Young, Repo 105 session, Oct. 16, 2009, at pp. 89 (statement of
WilliamSchlich);ExaminersInterviewofErnst&Young,Nov.3,2009,atpp.1415(statementofHillary
Hansen).
29ExaminersInterviewofMatthewEichner,Nov.23,2009,atp.5(EichnertoldtheExaminerthatafter
Bear Stearns nearly collapsed, the SEC had monitors onsite at Lehman almost all the time. Eichner
also told the Examiner that the FRBNY had people in residence with actual offices at Lehman);
Examiners Interview of Jan H. Voigts, Aug. 25, 2009, at p. 1 (Voigtsmonitored Lehmans liquidity
position,embeddedonsitewiththefirm,fromMarch16,2008throughmidSeptember,2008).
30ExaminersInterviewofTimothyF.Geithner,Nov.24,2009,atp.4(afterBearStearnsnearlycollapsed,
GeithnermetwithLehmanandotherinvestmentbanksaboutmovingthebankstoamoreconservative
place regarding capital and liquidity. Geithner indicated that his primary concern was Lehmans
funding structure. He told the Examiner that he was consumed with figuring out how to make
Lehmangetmoreconservativelyfunded).
8
Lehman publicly asserted throughout 2008 that it had a liquidity pool sufficient to
weatheranyforeseeableeconomicdownturn.31
ButLehmandidnot publiclydisclosethat byJune2008 significantcomponents
ofitsreportedliquiditypoolhadbecomedifficulttomonetize.32AslateasSeptember
10, 2008, Lehman publicly announced that its liquidity pool was approximately $40
billion;33 but a substantial portion of that total was in fact encumbered or otherwise
illiquid.34 From June on, Lehman continued to include in its reported liquidity
substantial amounts of cash and securities it had placed as comfort deposits with
various clearing banks; Lehman had a technical right to recall those deposits, but its
abilitytocontinueitsusualclearingbusinesswiththosebankshaditdone sowasfar
fromclear.35ByAugust,substantialamountsofcomfortdepositshadbecomeactual
31FinalTranscript of Lehman Brothers Holdings Inc. Second Quarter 2008 Preliminary Earnings Call
(June, 9, 2008), at p. 8 (Lehmans liquidity pool reported at $45 billion); Final Transcript of Lehman
BrothersHoldingsInc.SecondQuarter2008EarningsCall(June16,2008),atp.6(Lehmansliquiditypool
reported at $45 billion); Final Transcript of Lehman Brothers Holdings Inc. Third Quarter 2008
PreliminaryEarningsCall(Sept.10,2008),atp.10(Lehmansliquiditypoolreportedat$42billion).
32Lehman,LiquidityPoolTableListingCollateralandAbilitytoMonetize(Sept.12,2008)[LBEXWGM
784607](listing$30.1billionofassetsaslowabilitytomonetize).
33FinalTranscriptofLehmanBrothersHoldingsInc.ThirdQuarter2008PreliminaryEarningsCall(Sept.
10,2008),atp.10.
34Examiners Interview of Paolo R. Tonucci, Sept. 16, 2009, at p. 19 (Lehman included $2 billion that it
pledged to Citibank as a comfort deposit in its liquidity pool); Security Agreement between LBHI and
Bank of America, N.A. (Aug. 25, 2008) [LBEXDOCID 000584] (providing for a $500 million security
depositfromLehmantoBofA);Lehman,LiquidityPoolTableListingCollateralandAbilitytoMonetize
(Sept.9,2008),atp.2[LBHI_SEC07940_557815](showingthe$500millionBofAdepositintheliquidity
pool); Lehman, Liquidity Update (Sept. 10, 2008), at p. 3 ($1 billion in Lehmans liquidity pool was
earmarkedtoHSBCandlistedasLowabilitytomonetize.).
35SeeSectionIII.A.5(discussingpotentialclaimsagainstsecuredlenders).
pledges.36 By September 12, two days after it publicly reported a $41 billion liquidity
pool,thepoolactuallycontainedlessthan$2billionofreadilymonetizableassets.37
Months earlier, on June 9, 2008, Lehman preannounced its second quarter
resultsandreportedalossof$2.8billion,itsfirsteverlosssincegoingpublicin1994.38
Despite that announcement, Lehman was able to raise $6 billion of new capital in a
publicofferingonJune12,2008.39ButLehmanknewthatnewcapitalwasnotenough.
TreasurySecretaryHenryM.Paulson,Jr.,privatelytoldFuldthatifLehmanwasforced
to report further losses in the third quarter without having a buyer or a definitive
survivalplaninplace,Lehmansexistencewouldbeinjeopardy.40
OnSeptember 10, 2008, Lehmanannouncedthat itwasprojectinga$3.9billion
loss for the third quarter of 2008.41 Although Lehman had explored options over the
summer, it had no buyer in place; its only announced survival plan was to spin off
36Id.
37See Lehman, Liquidity Pool Table Listing Collateral and Ability to Monetize (Sept. 12, 2008) [LBEX
WGM 784607] (listing $1.4 billion of assets as high ability to monetize and $934 million of assets as
midabilitytomonetize).
38Lehman Brothers Holdings Inc., Press Releases (Mar. 14, 2007, June 12, 2007, Sept. 18, 2007, Dec. 13,
2007,Mar.18,2008andJune9,2008).
39Lehman Brothers Holdings Inc., Press Release (June 12, 2008); Lehman Brothers Holdings Inc., Press
Release(June16,2008).
40Fulddoesnotrecallthatwarning.ExaminersInterviewofRichardS.Fuld,Jr.,Sept.30,2009,atp.3,
butPaulsontoldtheExaminerthatheconsistentlycommunicatedtoFuldhowdireLehmanssituation
wasandthathepointedlyurgedFuldtofindabuyerafterLehmanannounceda$2.8billionlossforthe
secondquarterof2008,ExaminersInterviewofHenryM.Paulson,June25,2009,atpp.1115.
41FinalTranscriptofLehmanBrothersHoldingsInc.ThirdQuarter2008PreliminaryEarningsCall(Sept.
10, 2008), at p. 8; Lehman Brothers Holdings Inc., Press Release (Sept. 10, 2008), at p. 1
[LBHI_SEC07940_042866].
10
troubledassetsinto a separateentity.SecretaryPaulsonsprediction turned outto be
rightitwasnotenough.
BythecloseoftradingonSeptember12,2008,Lehmansstockpricehaddeclined
to$3.65pershare,a94%dropfromthe$62.19January2,2008price.42
70.00 $62.19
60.00
50.00
40.00 $31.75
Lehman Stock Price $27.50
30.00
$20.96
20.00
$7.79 $7.25
10.00 $3.65
0.00
2-Jan-08 17-Mar-08 10-Jun-08 1-Jul-08 9-Sep-08 10-Sep-08 12-Sep-08
Landmark Dates

Over the weekend of September 1214, an intensive series of meetings was
conducted by and among Treasury Secretary Paulson, FRBNY President Timothy F.
Geithner,SECChairmanChristopherCox,andthechiefexecutivesofleadingfinancial
institutions.43 Secretary Paulson began the meetings by stating the Government was
there to do all it could but that it could not fund a solution.44 The Governments
42Morningstar DocumentResearch Co.,LBHI Historic StockPrices (Jan.1, 2008 throughSept. 15,2008)
[LBEXEXM00000114](printedfromwww.10kwizard.com)(lastvisitedonFeb.3,2010).
43Examiners Interview of Henry M. Paulson, Jr., June 25, 2009, at p. 15; Examiners Interview of
ChristopherCox,Jan.8,2010,atpp.1517;ExaminersInterviewofThomasC.Baxter,Jr.,May20,2009at
p.9.
44ExaminersInterviewofHenryM.Paulson,Jr.,June25,2009,atpp.1516(PaulsontoldtheExaminer
that these meetings were part of the Governments attempt to pull a rabbit out of a hat and save
Lehman); Examiners Interview of Thomas C. Baxter, Jr., May 20, 2009 at pp. 910 (FRBNY General
Counsel Baxter told the Examiner thatPaulson explained to the group that the purpose ofthe meeting
wastwofold(1)toattempttofacilitatetheacquisitionofLehman;and(2)inthealternative,toresolve
theconsequencesofLehmansfailure).
11
analysiswasthatitdidnothavethelegalauthoritytomakeadirectcapitalinvestment
in Lehman, and Lehmans assets were insufficient to support a loan large enough to
avoidLehmanscollapse.45
It appeared by early September 14 that a deal had been reached with Barclays
whichwouldsaveLehmanfromcollapse.46Butlaterthatday,thedealfellapartwhen
thepartieslearnedthattheFinancialServicesAuthority(FSA),theUnitedKingdoms
bankregulator,refusedtowaiveU.K.shareholderapprovalrequirements.47
Lehmannolongerhadsufficientliquiditytofunditsdailyoperations.48Onthe
eveningofSeptember14,SECChairmanCoxphonedtheLehmanBoardandconveyed
the Governments strong suggestion that Lehman act before the markets opened in
45ExaminersInterviewofHenryM.Paulson,Jr.,June25,2009,atpp.1617(PaulsontoldtheExaminer
thatheconcludedthattheFederalGovernmentlackedauthoritytoinjectcapitalintoLehman,evenvia
an exigent circumstances loan from the Federal Reserve, because Lehman was not an institution
perceived to have capital and able to provide a guarantee.); Chairman of the Federal Reserve Ben S.
Bernanke,SpeechattheKansasCityFederalBankConferenceinJacksonHole,Wyoming(Aug.21,2009)
([T]he companysavailable collateralfell well short of theamount needed tosecure a FederalReserve
loan of sufficient size to meet its funding needs.); Examiners Interview of Ben S. Bernanke, Dec. 22,
2009,atp.2(Lehmansassetsandsecuritiesfellconsiderablyshortoftheobligationsthatwouldbecome
due).
46ExaminersInterviewofRichardS.Fuld,Jr.,Apr.28,2009,atp.9(FuldtoldtheExaminerthatonthe
morning of September 14, 2008, he woke up thinking he had a transaction in place with Barclays);
LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Sept.13,2008),atp.1[LBEX
AM003927003931](TheLehmanBoardmetat5:00p.m.todiscussapotentialdealwithBarclays).
47Examiners Interview of Henry M. Paulson, Jr., June 25, 2009, at pp. 1920; Examiners Interview of
RichardFuld,Jr.,Apr.28,2009,at9.InawrittenstatementtotheExaminer,theFSAsaidthatitnever
received a formal request to waive the shareholderapproval requirement. According to the FSAs
statement,theFSAhadseriousconcernsaboutthelackofprecedentforsuchwaivers.TheFSAwasalso
concernedaboutLehmansliquidityandfunding.FSA,StatementoftheFinancialServicesAuthorityto
theExaminer(Jan.20,2010),atpp.8,10.
48Lehman, Liquidity of Lehman Brothers [Draft] (Oct. 7, 2008), at p. 9 [LBHI_SEC07940_844701] (LBIE
facedacashshortageof$4.5billiononSeptember15,2008).
12
Asia.49 On September 15, 2008, at 1:45 a.m., LBHI filed for Chapter 11 bankruptcy
protection.50
Sortingoutwhetherandtheextenttowhichthefinancialupheavalthatfollowed
was the direct result of the Lehman bankruptcy filing is beyond the scope of the
Examinersinvestigation.Butthoseeventshelpputintocontextthesignificanceofthe
Lehman filing. The Dow Jones index plunged 504 points on September 15.51 On
September 16, AIG was on the verge of collapse; the Government intervened with a
financial bailout package that ultimately cost about $182 billion.52 On September 16,
2008,thePrimaryFund,a$62billionmoneymarketfund,announcedthatbecauseof
thelossitsufferedonitsexposuretoLehmanithadbrokenthebuck,i.e.,itsshare
49ExaminersInterviewofChristopherCox,Jan.8,2010,atpp.1617(CoxcalledLehmansBoardtourge
that Lehman take whatever action it decided upon as soon as possible, before the markets opened.
Duringthecall,Coxrelated,FRBNYGeneralCounselThomasC.Baxter,Jr.,addedthatithadbeenmade
clearinthemeetingsearlierthatdaythattheactionshouldbethatLehmandeclarebankruptcy.Cox
told the Examiner that the SEC was not offering guidance or trying to influence the fiduciary
responsibilitiesof[Lehmans]directors.).
50VoluntaryPetition(Chapter11),DocketNo.1,LehmanBrothersHoldingsInc.,CaseNo.0813555(Bankr.
S.D.N.Y.Sept.15,2008);DocketActivityReport,LehmanBrothersHoldingsInc.,CaseNo.0813555(Bankr.
S.D.N.Y.Sept.15,2008).
51AlexandraTwin,StocksGetPummeled,CNNMoney.com,Sept.21,2008,atp.1(statingWallStreetsees
worst day in 7 years with Dow down 504 points . . . ), available at

http://money.cnn.com/2008/09/15/markets/markets_newyork2/index.htm(lastvisitedJan.28,2010).
52SewellChan,BernankeWantsanAuditofFedsBailoutofAIG,N.Y.Times,Jan.19,2010(statingthatthe
FRBNYandTreasuryDepartmentmadeabout$182billionavailabletoAIG).
13
pricehadfallentolessthan$1pershare.53OnOctober3,2008,Congresspasseda$700
billionTroubledAssetReliefProgram(TARP)rescuepackage.54
Inhisrecentreconfirmationhearings,FederalReserveChairmanBenBernanke,
speaking of the overall economic crisis, candidly conceded that there were mistakes
madeallaroundandweshouldhavedonemore.55Lehmanshouldhavedonemore,
donebetter.Someofthesefailingsweresimplyerrorsofjudgmentwhichdonotgive
risetocolorablecausesofaction;somegobeyondandareindeedcolorable.
* * *
PartIofthisReportprovidesanexecutivesummaryoftheExaminersfindings
andconclusions.
PartIIdiscussestheproceduralbackgroundoftheExaminersappointment,the
Examiners authority, and the manner in which the Examiner conducted his
investigation.
PartIIIdetailsthefactsandanalysison the topics assignedby theCourt tothe
ExaminerandcontainstheExaminersanalysisandconclusions.
53SeeMarkus K. Brunnermeier, Deciphering the Liquidity and Credit Crunch 20072008, 23 J. Econ.
Perspectives, Winter 2009, at 87 (2009); NewYorkFed.org, Financial Turmoil Timeline,
http://www.newyorkfed.org/research/global_economy/Crisis_Timeline.pdf(lastvisitedJan.26,2010).
54DavidM.Herszenhorn,ACuriousCoalitionOpposedBailoutBill,N.Y.Times,Oct.3,2008,atp.1.
55Edmund L. Andrews, Bernanke Says Fed Should Have Done More, N.Y. Times, Dec. 4, 2009, at p. 1.
TheofficialtranscriptofChairmanBenS.BernankesConfirmationHearingBeforetheSenateCommittee
on Banking, Housing, and Urban Affairs, Dec. 3, 2009, was not available at the time this Report was
released.
14
I. EXECUTIVESUMMARYOFTHEEXAMINERSCONCLUSIONS
TheOrderappointingtheExaminer(theExaminerOrder)assignstenspecific
bulletedtopicsfortheExaminertoinvestigate;inaddition,theExaminerOrderdirects
the Examiner to perform the duties specified in Section 1106(a)(3) and (4) of the
BankruptcyCode,thatis,tofileastatementof. . .anyfactascertained pertaining to
fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the
managementoftheaffairsofthedebtor,ortoacauseofactionavailabletotheestate.56
Becausethetenbulletedtopicssetoutatpages34oftheExaminerOrderoverlap,the
Examiner has grouped theminto threesubstantiveareas:(A)WhyDid Lehman Fail?
Are There Colorable Causes of Action That Arise From Its Financial Condition and
Failure?(B)AreThereAdministrativeClaimsorColorableClaimsforPreferencesor
Voidable Transfers? and (C) Are There Colorable Claims Arising Out of the Barclays
SaleTransaction?
FromItsFinancialConditionandFailure?
Section(A)addressesthefifth,eighthandtenthbulletsoftheExaminerOrder:
[Bullet10]TheeventsthatoccurredfromSeptember4,2008throughSeptember15,2008
orpriortheretothatmayhaveresultedincommencementoftheLBHIChapter11case.
[Bullet5]Whethertherearecolorableclaimsforbreachoffiduciarydutiesand/oraiding
or abetting any such breaches against the officers and directors of LBCC and/or other
DebtorsarisinginconnectionwiththefinancialconditionoftheLehmanenterpriseprior
tothecommencementoftheLBHIChapter11caseonSeptember15,2008.
56OrderDirectingAppointmentofanExaminerPursuanttoSection1104(c)(2)oftheBankruptcyCode,at
pp.35,DocketNo.2569,LehmanBrothersHoldingsInc.,CaseNo.0813555(Bankr.S.D.N.Y.Jan.16,2009).
15
[Bullet8]Thetransactionsandtransfers,includingbutnotlimitedtothepledgingor
grantingofcollateralsecurityinterestamongthedebtorsandthepreChapter11lenders
and/orfinancialparticipantsincludingbut notlimitedto,JPMorgan Chase,Citigroup,
Inc.,BankofAmerica,theFederalReserveBankofNewYorkandothers.
Lehmanfailedbecauseitwasunabletoretaintheconfidenceofitslendersand
counterparties and because it did not have sufficient liquidity to meet its current
obligations. Lehman was unable to maintain confidence because a series of business
decisions had left it with heavy concentrations of illiquid assets with deteriorating
valuessuchasresidentialandcommercialrealestate.Confidencewasfurthereroded
whenitbecamepublicthatattemptstoformstrategicpartnershipstobolsteritsstability
had failed.57 And confidence plummeted on two consecutive quarters with huge
reported losses, $2.8 billion in second quarter 200858 and $3.9 billion in third quarter
2008,59withoutnewsofanydefinitivesurvivalplan.
ThebusinessdecisionsthatbroughtLehmantoitscrisisofconfidencemayhave
beeninerrorbutwerelargelywithinthebusinessjudgmentrule.Butthedecisionnot
todisclosetheeffectsofthosejudgmentsdoesgiverisetocolorableclaimsagainstthe
57SeeLehmanBrothersHoldingsInc.,MinutesofMeetingoftheBoardofDirectors(Mar.31,2008)
(LehmanapproachedWarrenE.Buffettaboutapotential$3.5billionprivateinvestment,butdiscussions
werepreliminaryanddidnotresultinanyagreementonterms)[LBEXAM003597604];Examiners
InterviewofRichardS.Fuld,Jr.,May6,2009,atp.11(FuldtoldtheExaminerthatKDBspressreleaseon
Sept.9,2008,announcingthatnegotiationsbetweenKDBandLehmanaboutastrategicpartnershiphad
ended,triggeredLehmansdecisiontoannouncethirdquarterearningsearly.AccordingtoFuld,
LehmansstockdroppedsignificantlyafterKDBsannouncementandshortsellerswerekickingthe
daylightsoutofLehman);MorningstarDocumentResearchCo.,LBHIHistoricStockPrices(Jan.1,2008
throughSept.15,2008)[LBEXEXM000001](printedfromwww.10kwizard.com)(lastvisitedonFeb.3,
2010(Lehmansstockfell45%afterKDBsannouncement).
58LehmanBrothersHoldingsInc.,PressRelease(June9,2008).
59LehmanBrothersHoldingsInc.,PressRelease(Sept.10,2008).
16
senior officers who oversaw and certified misleading financial statements Lehmans
CEORichardS.Fuld,Jr.,anditsCFOsChristopherOMeara,ErinM.CallanandIanT.
Lowitt. There are colorable claims against Lehmans external auditor Ernst & Young
for, among other things, its failure to question and challenge improper or inadequate
disclosuresinthosefinancialstatements.
The Examiner Order does not contain a definition of what constitutes a
colorableclaim.TheSecondCircuithasdescribedcolorableclaimsasonesthaton
appropriate proof would support a recovery,60 much the same as that undertaken
when a defendant moves to dismiss a complaint for failure to state a claim.61 But
under such a standard, the Examiner would find colorable claims wherever bare
allegationsmightsurviveamotiontodismiss.Becausehehasconductedanextensive
factual investigation, the Examiner believes it is more appropriate to use a higher
thresholdstandard,andinthisReportacolorableclaimisoneforwhichtheExaminer
hasfoundthatthereissufficientcredibleevidencetosupportafindingbyatrieroffact.
TheExaminerisnottheultimatedecisionmaker;whetherclaimsareinfactvalidwill
beforthetriersoffacttowhomclaimsarepresented.Theidentificationofaclaimby
the Examiner as colorable does not preclude the existence of defenses and is not a
60InreSTNEnters.,779F.2d901,905(2dCir.1985).
61InreKDIHoldings,Inc.,277B.R.493,508(Bankr.S.D.N.Y.1999)(quotingInreAmericasHobbyCenter,
223B.R.275,281(Bankr.S.D.N.Y.1998)),accordInreAdelphiaCommcnsCorp.,330B.R.364,376(Bankr.
S.D.N.Y.2005).
17
prediction as to how a court or a jury may resolve any contested legal, factual, or
credibilityissues.62
AlthoughRepo105transactionsmaynothavebeeninherentlyimproper,thereis
a colorable claim that their sole function as employed by Lehman was balance sheet
manipulation.LehmansownaccountingpersonneldescribedRepo105transactionsas
anaccountinggimmick63andalazywayofmanagingthebalancesheetasopposed
tolegitimatelymeetingbalancesheettargetsatquarterend.64LehmanusedRepo105
toreducebalancesheetatthequarterend.65
In 200708, Lehman knew that net leverage numbers were critical to the rating
agenciesandtocounterpartyconfidence.66Itsabilitytodeleveragebysellingassetswas
severely limited by the illiquidity and depressed prices of the assets it had
accumulated.67 Against this backdrop, Lehman turned to Repo 105 transactions to
62Foramorecompleteanalysisofthelawrelatingtothecolorableclaimstandard,seeAppendix1.The
Examinerisnottheultimatedecisionmakeronanycolorableclaim;hesimplyisdirectedtoidentifythe
existenceofsuchclaims.WhiletheExaminerhasevaluatedtheattimesconflictingevidencetomakehis
determinationsastopotentialcolorableclaims,itisneithernecessarynorappropriatefortheExaminerto
make credibility assessments or resolve conflicting evidence; that will be the responsibility of a trier of
factwhenandifthoseclaimsarelitigated.
63ExaminersInterviewofMurtazaBhallo,Sept.14,2009,atp.3.
64ExaminersInterviewofMarieStewart,Sept.2,2009,atp.7.
65EmailfromRaymondChan,Lehman,toPaulMitrokostas,Lehman,etal.(July15,2008)[LBEXDOCID
3384937].
66Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at p. 8 (rating agencies looked at net
leverage); Examiners Interview of Michael McGarvey, Sept. 11, 2009, at p. 2; Examiners Interview of
AnurajBismal,Sept.16,2009,atpp.56(BismaltoldtheExaminerthatmeetingleverageratiotargetswas
themostcriticalissue(averyhottopic)forseniormanagementbytheendof2007).
67ExaminersInterviewofTimothyF.Geithner,Nov.24,2009,atpp.78(Startinginmid2007,manyof
Lehmans inventory positions had grown increasingly sticky i.e., difficult to sell without incurring
18
temporarily remove $50 billion of assets from its balance sheet at first and second
quarter ends in 2008 so that it could report significantly lower net leverage numbers
than reality.68 Lehman did so despite its understanding that none of its peers used
similar accounting at that time to arrive at their leverage numbers, to which Lehman
wouldbecompared.69
Lehmandefinedmateriality,forpurposesofreopeningaclosedbalancesheet,as
any item individually, or in the aggregate, that moves net leverage by 0.1 or more
(typically$1.8billion).70LehmansuseofRepo105movednetleveragenotbytenths
butbywholepoints:
substantial losses. Moreover, selling sticky inventory at reduced prices could also have led to loss of
marketconfidenceinLehmansvaluationsforinventoryremainingonthefirmsbalancesheet).
68Lehman,SpreadsheetSummarizingTotalRepo105&Repo108(May30,2008)[LBEXDOCID2078195]
(totalRepo105firmwideonFeb.29,2008was$49.102billionandonMay30,2008was$50.383billion).
69ExaminersInterviewofMartinKelly,Oct.1,2009,atp.8(KellytoldtheExaminerthatLehmanwasthe
last of the CSE firms to continue using Repo 105type transactions to manage its balance sheet by late
2007);ExaminersInterviewofMarieStewart,Sept.2,2009,atp.4(StewartbelievedthatLehmanwasthe
lastofitspeergroupusingRepo105transactionsbyDecember2007).
70Ernst&Young,WalkthroughTemplate:BalanceSheetCloseProcess(Nov.30,2007),atp.14[EYSEC
LBHICORPGAMX07033384].
19
Date Repo105 Reported Net Difference

Usage Net Leverage
Leverage Without
Repo105
Q42007 $38.6B71 16.172 17.873 1.7
Q12008 $49.1B74 15.475 17.376 1.9
Q22008 $50.4B77 12.178 13.979 1.8
Lehmansfailuretodisclosetheuseofanaccountingdevicetosignificantlyand
temporarily lower leverage, at the same time that it affirmatively represented those
lowleveragenumberstoinvestorsaspositivenews,createdamisleadingportrayalof
Lehmanstruefinancialhealth.80Colorableclaimsexistagainsttheseniorofficerswho
were responsible for balance sheet management and financial disclosure, who signed
and certified Lehmans financial statements and who failed to disclose Lehmans use
andextentofRepo105transactionstomanageitsbalancesheet.81
71Lehman,SpreadsheetofTotalRepo105/108Trend[LBHI_SEC07940_1957956](listingtotaluseofRepo
105/108forthefourthquarterof2007as$38.634billion).
72SeeLBHI200710K,atp.29.
73SeeSectionIII.A.4(discussingRepo105/108); Duff&Phelps,Repo105BalanceSheetAccountingEntry
andLeverageRatiosSummary(Oct.2,2009),atp.8.
74Lehman,SpreadsheetofTotalRepo105/108Trend[LBHI_SEC07940_1658543].
75LBHI10QApr.9,2008,atp.72.
77Lehman,SpreadsheetofTotalRepo105/108Trend[LBHI_SEC07940_1658543].
78LBHI10QJuly10,2008,atp.89.
80Examiners Interview of Matthew Lee, July 1, 2009, at p. 15 ([Lehman] was telling the public they
reducedthebalancesheet,butnottellingthemtheyweredoingsobyunartfulmeans.Lehmanhad
waymoreleveragethanpeoplethought;itwasjustoutof[thepublics]sight).
81SeeSectionIII.A.4(discussingRepo105/108).
20
In May 2008, a Lehman Senior Vice President, Matthew Lee, wrote a letter to
management alleging accounting improprieties;82 in the course of investigating the
allegations,Ernst&YoungwasadvisedbyLeeonJune12,2008thatLehmanused$50
billion of Repo 105 transactions to temporarily move assets off balance sheet and
quarterend.83ThenextdayonJune13,2008Ernst&YoungmetwiththeLehman
BoardAuditCommitteebutdidnotadviseitaboutLeesassertions,despiteanexpress
direction from the Committee to advise on all allegations raised by Lee.84 Ernst &
YoungtookvirtuallynoactiontoinvestigatetheRepo105allegations.85Ernst&Young
took no steps to question or challenge the nondisclosure by Lehman of its use of $50
billionoftemporary,offbalancesheettransactions.ColorableclaimsexistthatErnst&
Youngdidnotmeetprofessionalstandards,bothininvestigatingLeesallegationsand
inconnectionwithitsauditandreviewofLehmansfinancialstatements.86
82LetterfromMatthewLee,SeniorVicePresident,Lehman,toMartinKelly,Controller,Lehman,etal.,re:
possibleaccountingimproprieties(May16,2008),atpp.13[EYLELBHIKEYPERS5826885].
83Examiners Interview of Ernst & Youngs Hillary Hansen, Nov. 3, 2009 at p. 14; email from Beth
Rudofker,Lehman,toWilliamSchlich,Ernst&Young(June5,2008)[EYSECLBHIML000001000142],
forwarding May 21, 2008 email from Matthew Lee regarding second request for balance sheet
substantiation.
84Examiners Interview of Roger Berlind, Dec. 18, 2009, at p. 2; Examiners Interview of Michael L.
Ainslie, Dec. 22, 2009, at pp. 23; Examiners Interview of Sir Christopher Gent, Jan. 20, 2010, at p. 2;
Examiners Interview of Thomas Cruikshank, Jan. 20, 2010, at p. 3; Examiners Interview of Beth
Rudofker, Dec. 15, 2009, at pp. 67; see also Lehman Brothers Holdings Inc., Minutes of the Audit
Committee(June13,2008)[LBEXAM00375960].
85Examiners Interview of Ernst & Youngs Hillary Hansen, Nov. 3, 2009, at p. 15 (Hansen told the
ExaminerthatshedidnofurtherfollowupspecificallyonRepo105/108becauseE&Ywasinthemidstof
collectingallthedata,anditsinvestigationwasnotfinalized).
86SeeSectionIII.A.4(discussingRepo105/108).
21
Inthesectionsthatfollow,thisreportwilldescribeindetailthefactsandanalysis
thatsupporttheExaminersconclusions.Thatdetailwillincludethebasesnotonlyfor
thecolorable claimsthattheExaminer has found,butalso for thosetheExaminer has
consideredbutnotfound.TheExaminerbelievesitisappropriatetosetforththefacts
andanalysisoncolorableclaimsthathehasnotfoundinequaldetail,sothattheparties
canunderstandtheprocessthatledtothoseconclusions.TheissuesthattheExaminer
investigated were framed by the Examiner Order itself, by suggestions made by the
parties and Government agencies with whom the Examiner has had extensive
coordination, and by the natural course of investigation, where a new path (such as
Repo105)wasuncoveredinthecourseoftheinvestigation.
TheReportbeginswithadiscussionofthebusinessdecisionsthatLehmanmade
well before the bankruptcy, and the risk management issues raised by those business
decisions. Ultimately, the Examiner concludes that while certain of Lehmans risk
decisions can be described in retrospect as poor judgment, they were within the
businessjudgmentruleanddonotgiverisetocolorableclaims.Butthosejudgments,
andthefactsrelatedtothem,provideimportantcontextfortheothersubjectsonwhich
the Examiner has found colorable claims. For example, after saddling itself with an
enormous volume of illiquid assets that it could not readily sell, Lehman increasingly
turned to Repo 105 to manage its balance sheet and reduce its reported net leverage.
22
Lehmans acquisition of illiquid assets is also the predicate for the liquidity and
valuationissuesinvestigatedbytheExaminer.
Accordingly, the report will detail the following subjects that the Examiner has
explored:
1. Business and Risk Management The Examiner has explored this subject
because it is central to the question of how and why Lehman amassed the
assets that ultimately it could not monetize in time to maintain liquidity,
acceptable leverage and confidence. The Examiner explored Lehmans
reactiontothesubprimelendingcrisisandothereconomiceventstoanalyze
whetherLehmansofficersanddirectorsfulfilledtheirfiduciaryduties.The
ExaminerconcludesthatsomeofLehmansmanagementsdecisionscanbe
questioned in retrospect, but none fall outside the business judgment rule;
theExaminerfindsnocolorableclaims.87
2. Valuation The Examiner has explored this subject because it is central to

the question of Lehmans solvency and to whether Lehmans financial
statements were accurately stated. The Examiner concludes that Lehmans
valuation procedures may have been wanting and that certain valuations
mayhavebeenunreasonableforpurposesofabankruptcysolvencyanalysis.
The Examiners conclusion that valuations were unreasonable for solvency
analysis does not necessarily mean that individuals acted with sufficient
scienter to support claims for breach of fiduciary duty, and the Examiner
doesnotfindsufficientcredibleevidencetosupportcolorableclaims.88
3. SurvivalTheExaminerhasexploredthissubjectbecauseitiscentraltothe
questionwhethertheofficersanddirectorsdischargedtheirfiduciaryduties.
TheExaminerfindsnocolorableclaims.89
4. Repo105TheExaminerhasexploredthissubjectafteruncoveringtheissue
in the course of his investigation. The Examiner finds there are colorable
claims against Richard Fuld, Jr., Christopher OMeara, Erin Callan, and Ian
Lowittinconnectionwiththeirfailuretodisclosetheuseofthepracticeand
87SeeSectionIII.A.1(discussingLehmansriskmanagement).
88SeeSectionIII.A.2(discussingLehmansvaluation).
89SeeSectionIII.A.3(discussingLehmanssurvival).
23
against Ernst & Young for its failure to meet professional standards in
connectionwiththatlackofdisclosure.90
5. Secured Lenders The Examiner has explored this subject because it was
specificallyassignedaspartofthe Examiner Orderandbecausethesubject
wasaddressedinmultiplecommunicationswiththeparties.TheExaminer
finds colorable claims against JPMorgan Chase (Chase) and CitiBank in
connection with modifications of guaranty agreements and demands for
collateral in the final days of Lehmans existence.91 The demands for
collateral by Lehmans Lenders had direct impact on Lehmans liquidity
pool;LehmansavailableliquidityiscentraltothequestionofwhyLehman
failed.
6. Lehmans Interaction With Government Agencies As part of the

Examinersoverallinvestigation,itwasnecessarytoconsidertheinteraction
between Lehman and the Government agencies who regulated and
monitoredLehman;forexample,LehmanofficerssuggestedtotheExaminer
that he should consider, in the course of determining whether they had
breachedanyfiduciaryduties,thecompletenessofthedisclosurestheymade
totheGovernment.92
VoidableTransfers?
Section(B)addressesthefirst,second,third,fourth,seventhandeighthbulletsof
theExaminerOrder:
[Bullet 1] Whether LBCC [Lehman Brothers Commercial Corporation] or any other

entity that currently is an LBHI Chapter 11 debtor subsidiary or affiliate (LBHI
Affiliate(s)) has any administrative claims against LBHI resulting from LBHIs cash
90SeeSectionIII.A.4(discussingRepo105/108).Afterreachingthetentativeconclusionthattheseclaims
existed,theExaminercontactedcounselforeach,advisedthemofthebasisforthepotentialfinding,and
invitedeachofthemtopresentanyadditionalfactsormaterialsthatmightbearonthefinalconclusion.
The Examiner had individual, facetoface meetings with each and carefully considered the materials
raised by each. While the Examiner was directed to credible facts and arguments that might form the
basis for successful defenses, the Examiner concluded in all cases that these possible defenses do not
changehisnowfinalconclusionthatthereissufficientcredibleevidencefromwhichatrieroffactcould
findabreachofdutyafterweighingthecredibleevidenceonbothsidesoftheissue.
91SeeSectionIII.A.5(discussingpotentialclaimsagainstLehmanssecuredlenders).
92SeeSectionIII.A.6(discussingthegovernmentsrole).
24
sweeps of cash balances, if any, from September 15, 2008, the commencement date of
LBHIsChapter11case,throughthedatethatsuchapplicableLBHIaffiliatecommenced
itsChapter11case.
[Bullet2]Allvoluntaryandinvoluntarytransfersto,andtransactionswith,affiliates,
insidersandcreditorsofLBCCoritsaffiliates,inrespectofforeignexchangetransactions
and other assets that were in the possession or control of LBHI Affiliates at any time
commencingonSeptember15,2008throughthedaythateachLBHIAffiliatecommenced
itsChapter11case.
[Bullet3]WhetheranyLBHIAffiliatehascolorableclaimsagainstLBHIforpotentially
insiderpreferencesarisingundertheBankruptcyCodeorstatelaw.
[Bullet4]WhetheranyLBHIAffiliatehascolorableclaimsagainstLBHIoranyother
entities for potentially voidable transfers or incurrences of debt, under the Bankruptcy
Codeorotherwiseapplicablelaw.
[Bullet 7] The intercompany accounts and transfers among LBHI and its direct and
indirectsubsidiaries,includingbutnotlimitedto:LBI,LBIE,LehmanBrothersSpecial
Finance(LBSF)andLBCC,duringthe30dayperiodprecedingthecommencementof
theChapter11casesbyeachdebtoronSeptember15,2008orthereafterorsuchlonger
periodastheExaminerdeemsrelevanttotheInvestigation.
[Bullet8]Thetransactionsandtransfers,includingbutnotlimitedtothepledgingor
grantingofcollateralsecurityinterestamongthedebtorsandthepreChapter11lenders
and/orfinancialparticipantsincluding butnotlimited to,JPMorgan Chase,Citigroup,
Inc.,BankofAmerica,theFederalReserveBankofNewYorkandothers
The Examiner has identified approximately $60 million of administrative
claims.93
TheExaminerhasidentifiedcolorableclaimsthattherewerealimitednumberof
preferentialtransfers.94
93SeeSectionIII.B.2(discussingpossibleadministrativeclaims).
94SeeSectionIII.B.3(discussingpossibleavoidanceactions).
25
TheExaminerhasdeterminedthattherearealimitednumberofcolorableclaims
foravoidanceactionsagainstJPMorgan95andCitibank.96
Barclays,orFromtheLehmanALITransaction?
Section(C)addressesthesixthandninthbulletsoftheExaminerOrder:
[Bullet6]WhetherassetsofanyLBHIAffiliates(otherthanLehmanBrothers,Inc.)were
transferred to Barclays Capital Inc. as a result of the sale to Barclays Capital Inc. that
wasapprovedbyorderoftheBankruptcyCourtenteredSeptember20,2008,andwhether
consequences to any LBHI Affiliate as a result of the consummation of the transaction
createdcolorablecausesofactionthatinuretothebenefitofthecreditorsofsuchLBHI
subsidiaryoraffiliate.
[Bullet 9] The transfer of the capital stock of certain subsidiaries of LBI on or about
September19,2008toLehmanALIInc.
In the course of reviewing whether affiliates other than LBI were adversely
impactedbytheBarclayssale,theExaminerreviewedthefactsrelatedtothetransferof
LBIassetsinthepostfilingsaletoBarclays.Becausetheissuesrelatedtothesaleare
thesubjectofactive,pendinglitigationfiledbytheDebtors,onwhichdiscoveryisfar
fromcomplete,theExaminerexpressesnoviewonthemeritsofthatlitigationandwill
limithimselftosettingoutthefactualrecordhehasdevelopedontheissues.97
95The Examiner notified counsel for JPMorgan of his tentative conclusion and counsel made a
presentation in response. The Examiner carefully considered that presentation but concludes that a
colorableclaimexists.
96SeeSectionIII.B.3(discussingpossibleavoidanceactions).
97SeeSectionIII.C(discussingtheBarclayssaletransaction).
26
TheExaminerconcludesthatalimitedamountofassetsofLBHIAffiliatesother
thanLBIwereimproperlytransferredtoBarclays.98
The Examiner concludes that the transfer of capital stock to ALI served a
legitimatepurposeandthattherewasnoimproprietyinthosetransactions.99
98SeeSectionIII.C(discussingtheBarclayssaletransaction).
99SeeSectionIII.C(discussingtheExaminersconclusionsregardingtheLehmanALItransaction).
27
II. PROCEDURALBACKGROUNDANDNATUREOFTHEEXAMINATION
A. TheExaminersAuthority
On January 16, 2009, the United States Bankruptcy Court for the Southern
District of New York entered an order directing the U.S. Trustee to nominate an
Examiner, and outlining the subject matter of the Examiners investigation (the
Examiner Order).100 The Examiner Order lists ten bulleted topics that the Examiner
was to investigateand,further, mandatesthat the Examiner shall perform theduties
specified in sections 1106(a)(3) and (4) of the Bankruptcy Code [unless otherwise
ordered.]101 Under 11 U.S.C. 1106(a)(3), the Examiner is to investigate the acts,
conduct, assets, liabilities, and financial condition of the debtor, the operation of the
debtorsbusinessandthedesirabilityofthecontinuanceofsuchbusiness,andanyother
matterrelevanttothecaseortotheformulationofaplan[unlessorderedotherwise.]
Under 11 U.S.C. 1106(a)(4), the Examiner must, inter alia, file a statement of any
investigation conducted . . . including any fact ascertained pertaining to fraud,
dishonesty, incompetence, misconduct, mismanagement, or irregularity in the
managementoftheaffairsofthedebtor,ortoacauseofactionavailabletotheestate[.]
100OrderDirectingAppointmentofanExaminerPursuanttoSection1104(c)(2)oftheBankruptcyCode,
atpp.35,DocketNo.2569,InreLehmanBrothersHoldingInc.,etal.,CaseNo.0813555(Bankr.S.D.N.Y.
Jan.16,2009).
101Id.atp.5.
28
OnJanuary19,2009,theU.S.TrusteeappointedAntonR.ValukasasExaminer.102
TheCourtapprovedtheappointmentonJanuary20,2009.103 OnFebruary11,2009,the
CourtapprovedtheExaminersrequesttoemployJenner&BlockLLPascounseland
provided the Examiner with authority to issue subpoenas under Fed. R. Bankr. P.
2004.104 On February 17, 2009, the Court approved the Examiners Preliminary Work
Plan.105 On February 25, 2009, the Court authorized the Examiner to employ Duff &
Phelps,LLCashisfinancialadvisors.106
Despite the complexity of Lehmans bankruptcy and the broad scope of the
Examiners investigation, the time available for the examination was limited by the
practicalneedsofthebankruptcyproceeding.TheExaminerinitiallytargetedtheweek
ofFebruary1,2010tosubmithisreporttotheCourtinordertoassurethatthereport
would be available prior to the March 15, 2010 deadline of the Debtors exclusivity
102NoticeofAppointmentofExaminer,DocketNo.2570,InreLehmanBrothersHoldingsInc.,CaseNo.08
13555(Bankr.S.D.N.Y.Jan.19,2009).
103OrderApprovingAppointmentofExaminer,DocketNo.2583,InreLehmanBrothersHoldingsInc.,Case
No.0813555(Bankr.S.D.N.Y.Jan.20,2009).
104OrderAuthorizingtheExaminertoRetainandEmployJenner&BlockLLPasHisCounselNuncPro
Tunc as of January 19, 2009, Docket No. 2803, In re Lehman Brothers Holdings Inc., Case No. 0813555
(Bankr. S.D.N.Y. Feb. 11, 2009); and Order Granting Examiners Motion Directing the Production of
Documents and Authorizing the Examinations of the Debtors Current and Former Officers, Directors
andEmployees,andOtherPersonsandEntities,DocketNo.2804,InreLehmanBrothersHoldingsInc.,Case
No.0813555(Bankr.S.D.N.Y.Feb.11,2009).
105OrderApprovingthePreliminaryWorkPlanofAntonR.Valukas,Examiner,DocketNo.2855,Inre
LehmanBrothersHoldingsInc.,CaseNo.0813555(Bankr.S.D.N.Y.Feb.17,2009).
106OrderAuthorizingtheExaminertoRetainandEmployDuff&PhelpsLLCasHisFinancialAdvisors
NuncProTuncasofFebruary6,2009,DocketNo.2924,InreLehmanBrothersHoldingsInc.,CaseNo.08
13555(Bankr.S.D.N.Y.Feb.17,2009).
29
periodtoproposeaplanofreorganization.107EventhoughtheDebtorshavesuggested
that they may not file a plan by that date, the Examiner determined that all parties
wouldbebetterservedifheadheredtohisselfimposedFebruary2010schedule.
B. DocumentCollectionandReview
The available universe of Lehman email and other electronically stored
documentsisestimatedatthreepetabytesofdataroughlytheequivalentof350billion
pages. The Examiner carefully selected a group of document custodians and search
termsdesignedtoculloutthemostpromisingsubsetofLehmanelectronicmaterialsfor
review.Inaddition,theExaminerrequestedandreceivedhardcopydocumentsfrom
Lehman and both electronic and hard copy documents from numerous third parties
and Government agencies, including the Department of the Treasury, the SEC, the
Federal Reserve, FRBNY, the Office of Thrift Supervision, the SIPA Trustee, Ernst &
Young, JPMorgan, Barclays, Bank of America, HSBC, Citibank, Fitch, Moodys, S&P,
andothers.108
Intotal,theExaminercollectedinexcessoffivemilliondocuments,estimatedto
comprisemorethan40,000,000pages.Allofthesedocumentshavebeenconvertedto
107Order Granting Debtors Motion, Pursuant to Section 1121(d) of the Bankruptcy Code, Requesting
Second Extension of Exclusive Periods for the Filing of and Solicitation of Acceptances for Chapter 11
Plans, Docket No.4449, In re Lehman Brothers Holdings Inc., CaseNo.0813555 (Bankr.S.D.N.Y.July 20,
2009).
108See Appendix 5 for full details of custodians, search request, search terms and related document
metrics. Although a handful of subpoenas were threatened and in a few cases served, ultimately the
Examinerreceivednearlyallrequesteddocumentsvoluntarily.Intheinterestoftimeandefficiency,the
Examiner did not, except where significant deficiencies were apparent, challenge the completeness of
productionorthewithholdingofdocumentsuponclaimsofprivilege.
30
electronic form and are maintained on two computerized databases, Stratify and
CaseLogistix.TheStratifydatabase,whichishousedandmaintainedonserversbythe
Debtors professionals, Alvarez & Marsal, contains approximately four and a half
millionuniquedocuments,andconsistsofcollectedLehmanemailsandattachments;
theCaseLogistixdatabase,whichishousedandmaintainedbytheExaminerscounsel,
Jenner & Block, contains approximately seven hundred thousand unique documents,
primarilyconsistingofthirdpartyproductions.
Documents were reviewed on at least two levels. First level review was
conductedbylawyerstrainedtoidentifydocumentsofpossibleinterestandtocodethe
substantiveareastowhichthedocumentspertained;thosesoidentifiedweresubjected
tofurtherandmorecarefulreviewbylawyersorfinancialadvisorsespeciallyimmersed
intheearmarkedsubjects.Inordertoreducethecostofreview,theExaminersought
andobtainedtheCourtsapprovaltoretaincontractattorneys.109Agroupofmorethan
70contractattorneys,supplementedbyJenner&Blockattorneys,conductedfirstlevel
reviews. All second level (and beyond) reviews were performed by Jenner & Block
attorneysorDuff&Phelpsprofessionals.
109OrderAuthorizingtheExaminertoRetainCertainContractAttorneystoPerformSpecificDocument
ReviewTasksNuncProTuncasofApril15,2009,DocketNo.3577,InreLehmanBrothersHoldingsInc.,
CaseNo.0813555(Bankr.S.D.N.Y.May15,2009);OrderAuthorizingtheExaminertoRetainAdditional
Contract Attorneys to Perform Specific Document Review Tasks Nunc Pro Tunc as of May 11, 2009,
DocketNo.3750,InreLehmanBrothersHoldingsInc.,CaseNo.0813555(Bankr.S.D.N.Y.June3,2009);and
OrderAuthorizingtheExaminertoRetainAdditionalContractAttorneystoPerformSpecificDocument
ReviewTasksNuncProTuncasofJune11,2009,DocketNo.4428,InreLehmanBrothersHoldingsInc.,Case
No.0813555(Bankr.S.D.N.Y.July16,2009).
31
TheExaminerestimatesthathehasreviewedapproximately34,000,000pagesof
documentsinthecourseofhisinvestigation.TheentirebodyofemailintheStratify
database4,439,924documents,approximately26millionpageshasbeenreviewed.110
Approximately340,000oftheCaseLogistixdocumentsroughlyeightmillionpages
havebeenreviewed.111AlthoughalargenumberoftheCaseLogistixdocumentswere
not reviewed, that database is fully searchable, and the Examiner is reasonably
confident that the repeated and focused searches applied against that database have
discoveredmostifnotallofthemostrelevantdocuments.112
In most cases, documents were produced to the Examiner under stipulated
protective orders, which are described in Appendix 5. Subject to those orders, the
document databases createdbytheExaminerremainaresourcefor theestateandthe
parties. The database includes computerized tagging which will allow persons
interested in making their own searches to narrow and focus search requests. The
Examiner will work with the parties and the Court to resolve logistical and
110OnJanuary30,2010,theExaminerreceivedabout55,500uniqueemailsfromtheDebtorsresponsive
tolongoutstandingrequeststhathadnotearlierbeenproducedduetoadatatransferissue.Earlierthat
week, the Examiner received 30,000 pages of documents from Ernst & Young responsive to long
outstanding requests that had not earlier been produced because a single custodians files had
inadvertently not been included. Despite the lateness of the receipt of these documents, the Examiner
wasabletocompletereviewofthembydeployingateamoflawyerstothetask.
111The Examiner is able to count documents loaded in the two databases with precision, but page
numbersareestimates.Onaverage,theemailandattachmentsintheStratifydatabasearesixpagesper
document; the documents in the CaseLogistix database tend to be larger, averaging 23 pages per
document.
112AsubstantialnumberofadditionaldocumentswereproducedinthependingBarclayssalelitigation
in the weeks before this Report was due. Given the ongoing nature of that litigation and the Courts
concurrencethattheExaminerneednotexpressconclusionsonthesestillinactivelitigationissues,those
documentshavenotbeenreviewedexceptonalimited,focusedbasis.
32
confidentiality issues so that the databases can become an asset available to all
interestedparties.
C. SystemsAccess
Answering the questions posed by the Examiner Order necessarily required an
extensiveinvestigationandreviewofLehmansoperating,trading,valuation,financial,
accounting and other data systems. Interrogating those systems proved particularly
challenging, first because the vast majority of the systems had been transferred and
wereunderthecontrolofBarclays;bythetimeoftheExaminersappointment,Barclays
had integrated its own proprietary and confidential data into some of the systems, so
Barclays had legitimate concerns about granting access to those systems. Although it
took some time, Barclays was cooperative and those issues were for the most part
resolved.
The second challenge was moredaunting. Atthe timeofitsbankruptcyfiling,
Lehmanmaintainedapatchworkofover2,600softwaresystemsandapplications.The
Examiner,inconsultationwithhisfinancialadvisors,decidedearlyonthatitwouldnot
becosteffectivetoundertaketheenormouseffortandexpensethatwouldberequired
to learn and access each of these 2,600 systems. Rather, the Examiner directed his
financial advisors to identify and acquire an indepth understanding of the most
promisingofthesystems.
33
The Examinersfinancialadvisorsultimately requestedaccess to 96 ofthe most
relevantsystems.113Theprocessofidentifyingthosepresenteditownchallenges.Many
of Lehmans systems were arcane, outdated or nonstandard. Becoming proficient
enough to use the systems required training in some cases, study in others, and trial
and error experimentation in others. In numerous instances, the Examiners
professionalswouldrequestaccesstoaparticularsystem,expendthetimenecessaryto
learn how to use the system and only then discover that access to two or three
additionalsystemswasrequiredtoanswerthenecessaryquestions.Lehmanssystems
were highly interdependent, but their relationships were difficult to decipher and not
welldocumented.Ittookextraordinaryefforttountanglethesesystemstoobtainthe
necessaryinformation.
BecausesomesystemswereincurrentusebyBarclaysinitsoperations,Barclays
limitedaccessto79oftherequested96systemstoreadonly.Readonlyaccessmade
thereviewandorganizationofdatamoredifficult.Andinsomecases,readonlyaccess
wasseverelyrestricted.Forsomesystems,theabilitytoquerythedataandsearchfora
particulartransactionwaslimitedtocertainparameters.Forothers,theExaminerwas
denieddirectaccessaltogether,requiringtheneedtorequestthatsearchesbedoneby
Barclaysstechnologypersonnel,whowouldthenforwardfindingstotheExaminer.
113SeeAppendix6.
34
Finally, the accessibility of data was complicated by the fact that the filing of a
bankruptcypetitionbyLehmancamewithvirtuallynoadvancepreparation.Thefiling
did not occur at the close of a month or a quarter when Lehman would prepare
reconciliations and summaries of its financial data. Recordkeeping quickly fell into
disarray upon Lehmans hurried filing. Reconstructing data during this period has
provenachallengenotonlyfortheExaminerbutforallwhomustrelyuponthisdatain
LehmansChapter11proceedings.
Intheend,theExaminersfinancialadvisorsweregenerallyabletogetsufficient
datatoinformandsupporttheExaminersReport,buttheremaybeareas,specifically
noted where appropriate in the text below, where data limitations need to be
considered.
D. WitnessInterviewProcess
Shortly after his appointment, the Examiner spoke with examiners from other
large bankruptcy proceedings, including WorldCom, SemCrude and Refco, and
obtainedtheiradviceonbestpractices.Oneofthesuggestionsmadewasthatwherever
possible interviews be conducted informally, without requiring that the witness be
sworn andwithout transcripts. Thereare obviousprosandcons totheuseofsworn,
transcribed interviews. On the plus side, oath and transcription make citations to
testimony more certain; on the minus side, the formality of oath and transcription
inevitably takes moretime,createsadditionalexpenseandmakessomewitnesses less
35
willingtogivefullcooperation;moreover,thecreationoftranscribedstatementsmight
have impacted pending Government investigations. Balancing these factors, the
Examinerdecidedtouseinformalinterviewswhereverpossibleandthatturnedoutto
be possible inall cases.Toassureaccuracy,allinterviews wereconducted byat least
twoattorneys,oneofwhomwasassignedtokeepcarefulnotes.Flashsummarieswere
prepared as soon as possible, usually the day of the interview, and reviewed by all
lawyerspresentwhilerecollectionsremainedsharp;andfullsummariesweremadeand
reviewedassoonaspracticalafterthat.
In the vast majority of cases, the interviewees were represented by counsel.
Nevertheless,theExamineradvisedeachintervieweethatheisaneutralfactfinderand
that he and his professionals should not be deemed to represent the witness nor any
point of view. Consistent with that neutrality, prior to each interview the Examiner
provided advance notice of the topicsheintendedtocover andadvancecopiesof the
documentsheanticipatedshowingthewitness.TheExaminerdidsoinordertomake
the interview as efficient as possible and to permit the witness to refresh recollection
beforetheinterviewratherthanonthefly.Eachwitnesswasencouragedtoadvisethe
Examiner if he or she believed it was appropriate to correct or supplement the
informationgivenduringtheinterview.
Inall,theExaminerhasinterviewedmorethan250individuals.Therewasonly
one individual the Examiner sought to interview but could not. The Examiner
36
requestedaninterviewwithHectorSants,chiefexecutiveoftheUKsFinancialServices
Authority(FSA),todiscusstheFSAsinvolvementintheeventsofLehmanWeekend
and the Barclays transaction. The FSA considered the request, but did not make Mr.
Sants available for an interview. However, the FSA did provide detailed, written
answerstospecificquestionsthatwouldhavebeenposedtoMr.Sants.
AfulllistofthepersonsinterviewedbytheExaminerissetoutinAppendix4.
E. CooperationandCoordinationWiththeGovernmentandParties
The Examiner received extraordinary cooperation, both from parties and non
parties,withoutwhichthecompletionofthisReportwouldhavetakenfarmoretime.
AlthoughtheDebtorsprofessionals and personnel wereandare extremely busywith
the daytoday requirements of Lehmans liquidation, they remained responsive to
almostdailyrequestsforinformationfromtheExaminerandhisprofessionals.Many
parties,suchastheDebtors,provideddocumentstotheExamineronanexpeditedbasis
withouttakingthetimeforprivilegereview,subjecttoclawbackagreements.
Shortlyafterhisappointment,theExaminermetwithandestablishedaregular
line of contact with the SIPA Trustee to share documents, interview summaries and
otherinformationtoavoidduplicationofeffort.TheExaminermetwiththeSECand
three United States Attorney Offices (New Jersey, Eastern District of New York,
SouthernDistrictofNewYork)toestablishprotocolsforclearingproposedinterviews
37
so as not to interfere with any ongoing investigations. And the Examiner met with
interestedpartiestoobtaintheirguidanceandthoughts.
Throughout the course of the investigation, the Examiner conducted regular,
weeklycallswiththeSECandU.S.Attorneystoupdatethemondevelopmentsandto
describesignificantdocumentsandtheresultsofinterviews.TheExaminerhaslikewise
madedocumentsandtheresultsofinterviewsavailabletotheSIPATrustee.
* * * * * * * * * * *
TheReportnowcontinueswiththedetail.
38
x
:
:
etal., :
Debtors. :
x
REPORTOF
Section III.A.1: Risk
TABLEOFCONTENTS
III. ExaminersConclusions......................................................................................................43
1. BusinessandRiskManagement..........................................................................43
a) ExecutiveSummary .......................................................................................43
(1) TheExaminerDoesNotFindColorableClaimsThat
LehmansSeniorOfficersBreachedTheirFiduciaryDutyof
CarebyFailingtoObserveLehmansRiskManagement
PoliciesandProcedures .........................................................................47
LehmansSeniorOfficersBreachedTheirFiduciaryDutyto
InformtheBoardofDirectorsConcerningtheLevelofRisk
LehmanHadAssumed ..........................................................................52
LehmansDirectorsBreachedTheirFiduciaryDutyby
FailingtoMonitorLehmansRiskTakingActivities.........................54
b) Facts..................................................................................................................58
(1) FromMovingtoStorage:LehmanExpandsItsPrincipal
Investments..............................................................................................58
(a) LehmansChangedBusinessStrategy......................................... 59
(b) TheIncreasedRiskFromLehmansChangedBusiness
Strategy............................................................................................. 62
(c) ApplicationofRiskControlstoChangedBusiness
Strategy............................................................................................. 65
(i) StressTestingExclusions ..................................................... 66
(ii) RiskAppetiteLimitIncreaseForFiscal2007 .................... 70
(iii) DecisionNotToEnforceSingleTransactionLimit .......... 73
(d) TheBoardsApprovalofLehmansGrowthStrategy............... 76
(2) LehmanDoublesDown:LehmanContinuesItsGrowth
StrategyDespitetheOnsetoftheSubprimeCrisis ............................78
(a) LehmansResidentialMortgageBusiness................................... 82
(i) LehmanDecidestoCurtailSubprimeOriginations
butContinuetoPursueAltAOriginations .................. 82
(ii) TheMarch20,2007BoardMeeting .................................... 90
39

(b) TheExplosioninLehmansLeveragedLoanBusiness ............. 95

(i) RelaxationofRiskControlstoAccommodate
GrowthofLehmansLeveragedLoansBusiness ............. 97
(c) InternalOppositiontoGrowthofLeveragedLoans
Business .......................................................................................... 100
(d) GrowthofLehmansCommercialRealEstateBusinessat
TheStartoftheSubprimeCrisis................................................. 103
(i) RelaxationofRiskControlstoAccommodate
GrowthofLehmansCommercialRealEstate
Business ................................................................................ 105
EstateBusiness..................................................................... 107
(iii) Archstone ............................................................................. 108
a. LehmansCommitment............................................... 108
Commitment................................................................. 112
(e) NagioffsReplacementofGelbandasHeadofFID................. 114
(f) TheBoardofDirectorsAwarenessofLehmans
IncreasingRiskProfile ................................................................. 116
(3) EarlyWarnings:RiskLimitOverages,FundingConcerns,
andtheDeepeningSubprimeCrisis ..................................................117
(a) NagioffandKirkTrytoLimitLehmansHighYield
Business .......................................................................................... 119
(b) JulyAugust2007ConcernsRegardingLehmansAbility
toFundItsCommitments............................................................ 123
(c) LehmanDelaystheArchstoneClosing ..................................... 128
(d) LehmanIncreasestheRiskAppetiteLimitto
AccommodatetheAdditionalRiskAttributabletothe
ArchstoneTransaction ................................................................. 131
(e) CashCapitalConcerns ................................................................. 134
Originations ................................................................................... 138
(g) September,October,andNovember2007Meetingsof
BoardofDirectors......................................................................... 139
(i) RiskAppetiteDisclosures .................................................. 139
(ii) LeveragedLoanDisclosures.............................................. 144
40

(iii) LeverageRatiosandBalanceSheetDisclosures ............. 147

(iv) LiquidityandCapitalDisclosures .................................... 148
(4) LateReactions:LehmanSlowlyExitsItsIlliquidRealEstate
Investments............................................................................................150
(a) Fiscal2008RiskAppetiteLimitIncrease................................... 152
(b) January2008MeetingofBoardofDirectors............................. 154
(c) ExecutiveTurnover ...................................................................... 156
(d) CommercialRealEstateSellOff:TooLittle,TooLate ........... 157
(e) LehmansCompensationPractices ............................................ 161
c) Analysis .........................................................................................................163
LehmansSeniorOfficersBreachedTheirFiduciaryDutyof
CarebyFailingtoObserveLehmansRiskManagement
PoliciesandProcedures .......................................................................164
(a) LegalStandard .............................................................................. 164
(b) Background.................................................................................... 166
ResidentialMortgageOrigination .................................... 171
(ii) LehmansConcentrationofRiskinItsCommercial
RealEstateBusiness ............................................................ 172
(iii) ConcentratedInvestmentsinLeveragedLoans ............. 175
(iv) FirmWideRiskAppetiteExcesses................................... 179
(v) FirmWideBalanceSheetLimits....................................... 181
(vi) StressTesting ....................................................................... 181
(vii) Summary:OfficersDutyofCare .................................... 182
LehmansSeniorOfficersBreachedTheirFiduciaryDutyto
InformtheBoardofDirectorsConcerningtheLevelofRisk
LehmanHadAssumed ........................................................................183
LehmansDirectorsBreachedTheirFiduciaryDutyby
FailingtoMonitorLehmansRiskTakingActivities.......................188
(a) LehmansDirectorsareProtectedFromDutyofCare
JudgmentRule............................................................................... 188
41

(b) LehmansDirectorsDidNotViolateTheirDutyof
Loyalty............................................................................................ 190
(c) LehmansDirectorsDidNotViolateTheirDutyto
Monitor........................................................................................... 191
(i) ApplicationofCaremarktoRiskOversight:Inre
CitigroupInc.......................................................................... 191
Directors ............................................................................... 193
42

III. EXAMINERSCONCLUSIONS
FromItsFinancialConditionandFailure?
1. BusinessandRiskManagement
a) ExecutiveSummary
In2006,Lehmanadoptedamore aggressivebusinessstrategybyexpanding its
investments in potentially highly profitable lines of business that also carried much
more risk than Lehmans traditional investment banking activities. Through the first
halfof2007,Lehmanfocusedonmakingprincipalinvestmentscommittingitsown
capital in commercial real estate (CRE), leveraged lending, and private equitylike
investments. These investments were considerably riskier for Lehman than its other
businesslinesbecauseLehmanwasacquiringpotentiallyilliquidassetsthatitmightbe
unabletosellinadownturn.114
Lehmancontinuedandevenintensifiedthishighriskstrategyaftertheonsetof
the subprime residential mortgage crisis in late 2006. As some Lehman officers
described it, Lehman shifted from focusing almost exclusively on the moving
business a business strategy of originating assets primarily for securitization or
syndication and distribution to others to the storage business which entailed
making longerterm investments using Lehmans own balance sheet.115 Lehman
114See Tobias Adrian, Federal Reserve Bank of New York, and Hyun Song Shin, Princeton University,
FinancialIntermediaries,FinancialStabilityandMonetaryPolicy(Aug.5,2008),atp.13.
115SeeSectionIII.A.1.bofthisReport.
43

continued to pursue commercial real estate and leveraged loan transactions
aggressivelyuntilJuly2007.116
While the decision to shift into longterm investments was voluntary, market
events pushed Lehman ever further from moving to storage. Lehmans primary
mortgage origination subsidiaries, BNC Mortgage Inc. (BNC) and Aurora Loan
Services, LLC (Aurora), continued to originate subprime and other nonprime
mortgages to a greater extent than other mortgage originators, many of whom had
recentlygoneoutofbusiness,orwouldsoondoso.117BNCsandAurorascontinued
mortgage originations increased the volume of illiquid assets on Lehmans balance
sheet albeit unintentionally because Lehman became unable to securitize and
distributethesemortgagestothirdparties.118
Lehmanscontinuedpursuitofthisaggressivegrowthstrategy,evenintheface
of the subprime crisis, was based on two important calculations by Lehmans
management.First,likesomeothermarketparticipants,nottomentiongovernmental
officials,Lehmansmanagementbelievedthatthesubprimecrisiswouldnotspreadto
117Lehman, Update on Lehman Brothers Subprime Mortgage Origination Business Presentation to

LehmanBoardofDirectors(Mar.20,2007),atp.5[LBHI_SEC07940_025839].
118Lehman,SecuritizedProducts,MBS:NonInvestmentGradeRetainedInterests(Jan.16,2007),atp.1
[LBEXDOCID839039];Lehman,UpdateonLehmanBrothersSubprimeMortgageOriginationBusiness
Presentation to Lehman Board of Directors [Draft] (Mar. 18, 2007), at p. 14 [LBEXDOCID 610173]
(Limited ability to sell below Investment Grade risk profitably in current environment); Examiners
InterviewofMatthewMiller,Sept.24,2009,atp.2.
44

other markets and to the economy generally.119 Second, Lehmans management
believedthatwhileotherfinancialinstitutionswereretrenchingandreducingtheirrisk
profile, Lehman had the opportunity to pick up ground and improve its competitive
position. Lehman had benefited from a similar countercyclical growth strategy
during prior market dislocations, and its management believed it could similarly
benefitfromthesubprimelendingcrisis.120Lehmanmiscalculated.AsLehmansChief
ExecutiveOfficer(CEO)RichardS.Fuld,Jr.lateradmitted,Lehmanunderestimated
both the severity of the subprime crisis and the extent of the contagion to Lehmans
otherbusinesslines.121
The Examiner investigated Lehmans adoption and implementation of this
aggressive countercyclical business strategy for several reasons. First, the potentially
illiquidassetsLehmanacquiredplayedasignificantroleinLehmansultimatefinancial
failure. Lehmans losses were largely concentrated in its commercial real estate
portfolio and in certain less liquid aspects of its residential mortgage origination and
securitization business. Similarly, Lehmans liquidity was compromised by its
119E.g.,ExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,atpp.16,24;ExaminersInterviewof
JosephGregory,Nov.13,2009,atp.7;ExaminersInterviewofTreasurySecretaryTimothyF.Geithner,
Nov.24,2009,atp.3.
121Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at pp. 16, 24; Examiners Interview of
RichardMcKinney,Aug.27,2009,atpp.2,9;RichardS.Fuld,Jr.,Lehman,NotesforSeniorManagement
Speech(June16,2008),atpp.56[LBEXDOCID529241],attachedtoemailfromTaimurHyat,Lehman,
toHerbertH.(Bart)McDadeIII,Lehman,etal.(June25,2008)[LBEXDOCID556064].
45

accumulation of assets that it could not sell, including not only the commercial and
residentialrealestateassets,butalso,toalesserextent,theleveragedloanpositions.
Second, emails written by Lehman risk management personnel suggest that
Lehmanseniormanagementdisregardeditsriskmanagers,itsriskpolicies,anditsrisk
limits.122 Press reports prior to Lehmans bankruptcy stated that in 2007 Lehman had
removed Madelyn Antoncic, Lehmans Chief Risk Officer (CRO), and Michael
Gelband, head of its Fixed Income Division (FID), because of their opposition to
managementsgrowingaccumulationofriskyandilliquidinvestments.123Andexternal
monitors of Lehmans affairs, such as the Office of Thrift Supervision (OTS) and
Moodys Investor Services (Moodys), also raised serious questions about Lehmans
riskmanagement,particularlywithrespecttoitscommercialrealestateinvestments.124
122See,e.g.,emailfromKentaroUmezaki,Lehman,toHerbertH.(Bart)McDadeIII,Lehman,etal.(Sept.
10,2008)[LBEXDOCID1718043](notinghistoryof`endaroundsonriskdecisions,riskmanagements
lackofauthorityandlackofauthorityoverbalancesheetandinabilitytoenforcerisklimits);emailfrom
VincentDiMassimo,Lehman,toChristopherM.OMeara,Lehman(Sept.1,2008)[LBEXDOCID203219]
(whateverriskgovernanceprocesswehadinplacewasultimatelynoteffectiveinprotectingthefirm[.]
RiskAppetitemeasureswerenoteffectiveinestablishingclearenoughwarningsignalsthattheFirmwas
taking on too much risk relative to capital. . . . The [Risk Management] function lacked sufficient
authority within the Firm. Decisionmaking was dominated by the business. . . .); email from Satu
Parikh, Lehman, to Michael Gelband, Lehman, Sept. 15, 2008 [LBEXDOCID 882447] (I am shocked at
thepoorriskmgmtatthehighestlevels,andIdontthinkitstartedwithArchstone.Itisallunbelievable
and I think there needs to be an investigation into the broader issue of malfeasance. Mgmt gambled
recklesslywiththousandsofjobsandshareholderwealth....).
123See, e.g., Yalman Onaran, Lehman FaultFinding Points to Last Man Fuld as Shares Languish,
Bloomberg.com,July22,2008.
124SeeOfficeofThriftSupervision,ReportofExamination,LehmanBrothersHoldingsInc.(asofMay31,
2008),atp.2[LBEXOTS000392](findingthatLehmandidnotemploysoundriskmanagementpractices
initscommercialrealestatebusiness);emailfromStephenLax,Lehman,toErinM.Callan,Lehman,et
al.(June9,2008)[LBEXDOCID017840](forwardingtextofMoodysreleaseannouncingdowngradeof
Lehman ratings outlook: The rating action also reflects Moodys concerns over risk management
46

Accordingly,theExaminerinvestigated(1)whethertherearecolorableclaimsfor
breach of the duty of care against Lehmans officers for the manner in which they
administeredLehmansriskmanagementsysteminconnectionwiththeacquisitionof
these illiquid assets; (2) whether there are colorable claims for breach of the duty of
goodfaithandcandoragainstLehmansofficersforfailingfullytoinformtheBoardof
Directors(theBoard)125oftheextentoftheriskandilliquiditythatLehmanassumed
throughthenewstrategy;and(3)whethertherearecolorableclaimsagainstLehmans
directorsforbreachoftheirdutytomonitorLehmansriskmanagement.
TheExaminer concludesthat the conduct of Lehmans officers,whilesubjectto
questioninretrospect,fallswithinthebusinessjudgmentruleanddoesnotgiveriseto
colorableclaims.TheExaminerconcludesthatLehmansdirectorsdidnotbreachtheir
dutytomonitorLehmansrisks.
(1) TheExaminerDoesNotFindColorableClaimsThatLehmans
Procedures
Delaware law, which governs a Delaware corporation such as Lehman, sets a
high bar for establishing a breach of the fiduciary duty of care.126 Officers and
directors business decisions are generally protected from personal liability by the
decisionsthatresultedinelevatedrealestateexposuresandthesubsequentineffectivenessofhedgesto
mitigatetheseexposures).
125ReferencestotheBoardinthisSectionoftheReportrefertoLehmansoutsidedirectors,nottoFuld,
whowasCEOandChairmanoftheBoard.
126ForadetaileddiscussionofDelawarecorporatefiduciarylaw,seeAppendix1.
47

businessjudgmentrule,andevenifthebusinessjudgmentruledoesnotapply,thereis
no liability unless the officer or director was grossly negligent. In the duty of care
context gross negligence has been defined as reckless indifference to or a deliberate
disregardofthewholebodyofstockholdersoractionswhicharewithouttheboundsof
reason.127
The proof necessary to defeat the business judgment rule and establish gross
negligence is particularly high with respect to risk management and financial
transactions. Banking is inherently risky and prone to financial losses caused by
unforeseenchangesinthemarkets.128 Profitabilitydependslargelyonthefirmsability
toevaluatetherisksofpotential investmentsandbalance themagainsttheirpotential
gains.129 Consequently, to establish a colorable claim that Lehman officers breached
their fiduciary duty by mismanaging business risk, the evidence must show that
Lehmans senior management was reckless or irrational in managing the risks
associated with the principal investment strategy that Lehman pursued during 2006
and2007.130
Lehmanhadsophisticatedpolicies,procedures,andmetricsinplacetoestimate
therisk that thefirmcouldassumewithoutjeopardizing itsabilityto achievea target
127McPaddenv.Sidhu,964A.2d1262,1274(Del.Ch.2008)(quotingBenihanaofTokyo,Inc.v.Benihana,Inc.,
891A.2d150,192(Del.Ch.2005)).
128SeeInreCitigroupInc.SholderDerivativeLitig.,964A.2d106,126(Del.Ch.2009).
129Seeid.
130SeeAppendix1,LegalIssues.
48

rateofreturn,andtoapprisemanagementandtheBoardwhetherLehmanwaswithin
various risk limits.131 Lehman also used an array of stress tests to determine the
potential financial consequences of an economic shock to its portfolio of assets and
investments.132 Lehman had an extensive staff that was devoted solely to risk
management.133
Theserisklimitsandstresstests,however,didnotimposelegalrequirementson
managementorpreventmanagementandtheBoardfromexceedingthoselimitsifthey
chosetodoso.134Theroleoftherisklimitsandstresstestswastocausemanagementto
consider whether a particular investment or a broad business strategy was worth the
riskitcarried.135Inaddition,Lehmanuseditsriskmanagementsystemtopromoteits
capabilities to investors, rating agencies, and regulators.136 Lehmans management
always retained the discretion to use its judgment to decide whether to pursue
particularstrategiesortransactions.137
TheExaminerdidfindthatinpursuingitsaggressivegrowthstrategy,Lehmans
managementchosetodisregardoroverrulethefirmsriskcontrolsonaregularbasis.
ThequestionwhetherthereisacolorableclaimthatLehmansseniorofficersbreached
131SeegenerallyAppendix1,LegalIssues.
132AppendixNo.8,RiskManagementOrganizationandControls.
133Id.
134Id.
135Seeid.
136Id.
137Seeid.
49

their fiduciary duty of care focuses on facts relating to Lehmans acquisition of
potentially illiquid investments in 2007 and the manner in which management used
Lehmans risk management system as part of its process of making investment
decisions:
Lehmans management decided to exceed risk limits with respect to

Lehmans principal investments, namely, the concentration limits on
Lehmans leveraged loan and commercial real estate businesses, including
the single transaction limits on the leveraged loans. These limits were
designed to ensure that Lehmans investments were properly limited and
diversified by business line and by counterparty. Lehman took highly
concentrated risks in these two business lines, and, partly as a result of
marketconditions,ultimatelyexceededitsrisklimitsbymarginsof70%asto
commercialrealestateandby100%astoleveragedloans.138
Lehmansmanagementexcludedcertainriskyprincipalinvestmentsfromits
stresstests.AlthoughLehmanconductedstresstestsonamonthlybasisand
reportedtheresultsofthesestresstestsperiodicallyto regulatorsandtoits
BoardofDirectors,thestresstestsexcludedLehmanscommercialrealestate
investments, its private equity investments, and, for a time, its leveraged
loancommitments.Thus,Lehmansmanagementdidnothavearegularand
systematicmeansofanalyzingtheamountofcatastrophiclossthatthefirm
couldsufferfromtheseincreasinglylargeandilliquidinvestments.139
Lehmandidnotstrictlyapplyitsbalancesheetlimits,whichweredesigned
tocontaintheoverallriskofthefirmandmaintainthefirmsleverageratio
withintherangerequiredbythecreditratingagencies,butinsteaddecided
to exceed those limits. To mitigate the apparent effect of these overages,
LehmanusedRepo105transactionstotakeassetstemporarilyoffthebalance
sheet before the ends of reporting periods. (The Repo 105 transactions are
discussedinSectionIII.A.4ofthisReport.)140
Lehmans management decided to treat primary firmwide risk limit the

risk appetite limit as a soft guideline, notwithstanding Lehmans
138AppendixNo.9,comparingriskappetiteandVaRusageversuslimits.
140Seeid.
50

representations to the Securities Exchange Commission (SEC) and the

Board that the risk appetitelimit wasa meaningful constrainton Lehmans
risktaking.141 Lehman managements decision not to enforce the risk
appetitelimitwasapparentinseveralways:
Between December 2006 and December 2007, Lehman raised its firm
wideriskappetitelimitthreetimes,goingfrom$2.3to$4.0billion.142
BetweenMayandAugust2007,Lehmanomittedsomeofitslargestrisks
from its risk usage calculation. The primary omitted risk was a $2.3
billion bridge equity position in the ArchstoneSmith Real Estate
Investment Trust (Archstone or Archstone REIT) real estate
transaction, an extraordinarily large and risky commitment. Had
Lehmans management promptly included that risk in its usage
calculation,itwouldhavebeenimmediatelyapparentthatLehmanwas
overitsrisklimits.143
After Lehman did include the Archstone risk in the firms risk appetite
usage, Lehman continued to exceed the limit for several more months.
Rather than aggressively reduce Lehmans balance sheet in response to
these indicators of excessive risktaking, Lehman raised its firmwide
risklimitagain.144
Although these decisions by Lehmans management ultimately proved to be
unwise, the Examiner finds insufficient evidence to support a determination that
Lehmans senior officers conduct with respect to risk management was outside the
businessjudgmentruleorrecklessorirrational.145
141 E.g., SEC, Lehman Monthly Risk Review Meeting Notes (July 19, 2007), at p. 5 [LBEXSEC 007363]
(Jeff [Goodman] told us that . . . VaR is just one measure that Lehman uses, and is more of a speed
bump/warningsignthatatrue,hardlimitthatrolefallstoRA[(i.e.riskappetite)].[.]Hesaidthat
Madelyn[Antoncic],Dave[Goldfarb],andtheexecutivecommitteetendtolookmoreatRA.Asanaside,
MadelyncameinafterJeffsexplanationandgavevirtuallythesamespeech);seealsoSectionIII.A.1.bof
thisReport.
143Seeid.
144Seeid.
145SeeSectionIII.A.1.cofthisReport.
51

Based upon their considerable business experience and successful track record,
Lehmansseniormanagersdecidedtoplaceahigherpriorityonincreasingprofitsthan
on keeping the firms risk level within the limits arising from its risk management
policies and metrics. Lehmans senior managers were confident making business
judgmentsbasedontheirunderstandingofthemarkets,anddidnotfeelconstrainedby
the quantitative metrics generated by Lehmans risk management system. These
decisions raise questions about the role of risk management in a complex financial
institution,buttheydonotgiverisetoacolorableclaimofthebreachofthefiduciary
dutyofcaregiventhehighbartoliabilityestablishedbyDelawarelaw.
Assumed
The Examiner finds insufficient evidence to support a determination that
Lehmans senior managers breached their fiduciary duty of candor, which required
them to provide the Board with material reports concerning Lehmans risk and
liquidity.146
Thefactualissuesrelevanttothedutyofcandorarethesameriskmanagement
issues relevant to the duty of care. Lehmans officers did not disclose certain
146Appendix No. 1, Legal Issues; In re Amer. Intl Group, Inc., 965 A.2d 763, 80607 (Del. Ch. 2009) (In
colloquial terms, a fraud on the board has long been a fiduciary violation under our law and typically
involvesthefailureofinsiderstocomecleantotheindependentdirectorsabout...informationthatthe
insidersfearwillbeusedbytheindependentdirectorstotakeactionscontrarytotheinsiderswishes).
52

information concerning the amount or duration of the firmwide risk limit overages,
their decisions to exceed certain concentration limits, or the limitations in the firms
stresstesting.NordidLehmansofficersdisclosethatLehmansoriginationsofAltA
mortgagesmortgagesthatwereconsideredriskierthantypicalprimemortgagesbut
notsoriskyastobecategorizedassubprimewereexposingthefirmtosubprime
mortgage risk, even as Lehman was curtailing originations of loans actually
denominated as subprime. Lehmans directors generally said that if such risk
management issues were significant and longlasting, they would have liked to have
receivedmoreinformationaboutthem,butwouldnotnecessarilyhavetakenactionasa
result.147
However,theExaminerfoundthatLehmansmanagementdidinformtheBoard,
clearly and on more than one occasion, that it was taking increased business risk in
ordertogrowthefirmaggressively;thattheincreasedbusinessriskresultedinhigher
risk usage metrics and ultimately firmwide risk limit overages; and that market
conditions after July 2007 were hampering the firms liquidity.148 Lehmans
management also informed the Board, accurately, that the subprime mortgage crisis
147ExaminersInterviewofRogerS.Berlind,May8,2009,atp.4;ExaminersInterviewofMarshaJohnson
Evans, May 22, 2009, at p. 6; Examiners Interview of Roland A. Hernandez, Oct. 2, 2009, at p. 10;
Examiners Interview of John D. Macomber, Sept. 25, 2009, at p. 17; Examiners Interview of Henry
Kaufman,May19,2009,atp.17;ExaminersInterviewofSirChristopherGent,Oct.21,2009,atpp.1416;
ExaminersInterviewofMichaelAinslie,Sept.22,2009,atpp.34.ForinformationconcerningtheBoard
meetings where these general topics were discussed, the directors statements to the Examiner about
thosemeetings,andthedirectorsstatementsaboutthematerialityofthesefacts,seeSectionIII.A.1.bof
thisReport.
148SectionsIII.A.1.bofthisReport.
53

was constricting profitability and that management was tightening origination
standardsandtakingotherstepstoaddressthatcrisis.149
These disclosures were not so incomplete as to lead to the conclusion that
LehmansmanagementmisledtheBoardofDirectors.NordidLehmansofficershave
a legal duty to disclose additional details to the Board. Lehmans risk limits and
controls were designed primarily for managements internal use in making business
decisions concerning the core issue faced by any financial institution: what business
riskstotakeandwhatbusinessriskstodecline.150Whiletheoverallriskmanagementof
the firm is an appropriate topic for board consideration, the daytoday decisions are
primarilytheresponsibilityofofficers,notdirectors.151
LehmansRiskTakingActivities
Lehmans corporate charter and related aspects of Delaware law protect its
directors from personal liability based upon their business decisions. As a result, the
directorscannotbeheldliableforabreachofthedutyofcare;ratherthedirectorscan
be liable for inadequately monitoring Lehmans affairs only if their failure to monitor
wassoegregiousastorisetothelevelofabreachofthedutyofloyaltyorthedutyof
149SectionIII.A.1.bofthisReport.
150SeeAppendixNo.8,RiskManagementOrganizationandControls.
151See17C.F.R.240.15c31e&15c34(2007)(requiringLehmantosubmitacomprehensivedescription
of its internal risk management control system to the SEC); NYSE, Inc., Listed Company Manual
303A(7)(c)(iii)(D)&cmt.(2010)(requiringauditcommitteeofboardtodiscusspolicieswithrespectto
riskassessmentandriskmanagementwhilenotingthatitisthejoboftheCEOandseniormanagement
toassessandmanagethecompanysexposuretorisk).
54

good faith. The Delaware courts have called this type of claim referred to as a
Caremark claim possibly the most difficult theory in corporation law upon which a
plaintiffmighthopetowinajudgment.152
The conduct typically evaluated in Caremark claims has been the failure to
monitormanagersunlawfulconduct.Incontrasthere,aclaimthatthedirectorsfailed
to satisfy their duty to monitor the extent of risk assumed by management and its
compliancewithcorporateriskpolicieswouldrequireproofthatthedirectorsfailedto
monitor managers judgment as to internal procedures that were not legally binding.
The business judgment rule applies with particular force to such a claim because the
questionofhowmuchriskaninvestmentbankcanreasonablyassumegoestothecore
ofitsbusiness.153
The Examiner finds insufficient evidence of a breach of fiduciary duty by any
Lehmandirector.ThedirectorsreceivedreportsconcerningLehmansbusinessandthe
levelandnatureofitsrisktakingateveryBoardmeeting.Althoughthesereportsnoted
the elevated levels of risk to Lehmans business beginning in late 2006, management
informedthedirectorsthattheincreasedrisktakingwaspartofadeliberatestrategyto
grow the firm. The directors continued to receive such reports throughout 2007, and
wererepeatedlyinformedaboutdevelopmentsinthesubprimemarketsandthecredit
marketsgenerally.Managementassuredthedirectorsthatitwastakingprudentsteps
152InreCaremarkIntlInc.DerivativeLitig.,698A.2d959,967(Del.Ch.1996).
153InreCitigroupInc.SholderLitig.,964A.2d106,126(Del.Ch.2009).
55

toaddresstheserisksbutthatmanagementsawtheunfoldingcrisisasanopportunity
topursueacountercyclicalgrowthstrategy.Managementsreportstothedirectorsdid
notcontainredflagsimposingonthedirectorsadutytoinquirefurther.154
Delawarelawpermitsdirectorstorelyonmanagementsreportsandimmunizes
the directors from personal liability when they do so.155 Consequently, there is
insufficient evidence to establish a colorable claim that Lehmans directors breached
theirdutytomonitorLehmansmanagementofitsrisks.
*****
Although the Examiner does not find colorable claims against Lehmans senior
officers or directors concerning Lehmans risk management, a complete discussion of
thefactsdiscoveredbytheExaminersinvestigationofriskmanagementisimportantin
two fundamental respects. First, the Examiner sets out the facts in detail so that the
Court and the parties have the basis for the Examiners conclusion that Lehman
managementsdecisionswithrespecttoriskanditscountercyclicalgrowthstrategydo
notgiverisetocolorableclaims.
154See,e.g.,LehmanBrothersHoldingsInc.,MinutesofMeetingoftheBoardofDirectors(June19,2007)
[LBHI_SEC07940_026267];Lehman,LehmanBoardofDirectorsMaterialsforJune19,2007BoardMeeting
(June19,2007)[LBHI_SEC07940_026214];LehmanBrothersHoldingsInc.,MinutesofMeetingofBoard
ofDirectors(Sept.11,2007)[LBHI_SEC07940_026364];Lehman,LehmanBoardofDirectorsMaterialsfor
Sept. 11, 2007 Board Meeting (Sept. 7, 2007) [LBHI_SEC07940_026282]; Lehman Brothers Holdings Inc.,
Minutes of Meeting of Board of Directors (Oct. 15, 2007), at p. 6 [LBHI_SEC07940_026407]; Lehman,
Lehman Board of Directors Materials for Oct. 15, 2007 Board Meeting (Oct. 11, 2007)
[LBHI_SEC07940_026371].
155SeeDEL.CODEANN.tit.8,141(e)(2009).
56

Second,thesefactsshowhowLehmansapproachtoriskultimatelycreatedthe
conditionsthatledLehmanstopmanagerstouseRepo105transactionsasdiscussedin
Section III.A.4 of this Report. Lehmans aggressive growth strategy also provides
context for several other issues discussed in this Report, including issues concerning
Lehmansliquiditypoolandassetvaluations.Lehmansgrowthstrategyresultedina
dramaticgrowthofLehmansbalancesheet:
Allfiguresin($Billions) Q406 Q107 Q207 Q307 Q407 Q108 Q208

ReportedNetAssets156 268.936 300.797 337.667 357.102 372.959 396.673 327.774
Lehmansnetassetsincreasedbyalmost$128billionor48%inalittleoverayearfrom
thefourthquarterof2006throughthefirstquarterof2008.
This increase in Lehmans net assets was primarily attributable to the
accumulationofpotentiallyilliquidassetsthatcouldnoteasilybesoldinadownturn.
By one measure, Lehmans holdings of less liquid assets more than doubled during
thesametimeperiodincreasingfrom$86.9billionattheendofthefourthquarterof
2006to$174.6billionattheendofthefirstquarterof2008.157
156Lehmandefinednetassetsastotalassetsexcluding:(1)cashandsecuritiessegregatedandondeposit
for regulatory and other purposes; (2) securities received as collateral; (3) securities purchases under
agreementstoresell;(4)securitiesborrowed;and(5)identifiableintangibleassetsandgoodwill.Lehman
Brothers Holdings Inc., Annual Report for 2007 10K as of Nov. 30, 2007 (Form 10K) (filed on Jan. 29,
2008),atp.63.
157Lehman Brothers Holdings Inc., Lehman Brothers Fact Book Q2 2008 (June 13, 2009), at p. 16
[LBHI_SEC07940_593047]. Lehmans public filings include a different quantification of Lehmans less

liquidassets. According to these sources, Lehmans less liquidasset holdings almost quadrupled from
the third quarter of 2006 until the first quarter of 2008, with a particularly sudden spike in the fourth
quarterof2007.LehmanBrothersHoldingsInc.,QuarterlyReportasofAug.31,2006(Form10Q)(filed
on Oct. 10, 2006), at pp. 16, 7172 (LBHI 10Q (filed Oct 10, 2006)); Lehman Brothers Holdings Inc.,
57

To explainthebusinessand riskdecisions thatledLehman management down
thispath,thefollowingportionsofthisSectionoftheReportdescribe:
1. Lehmansdecisionin2006totakemoreprincipalrisk;
2. The dramatic growth in Lehmans principal investments and in its balance

sheet during the first half of Lehmans fiscal 2007, culminating in the
acquisitionofArchstone,towhichLehmancommittedinMay2007;
3. Itbecameapparentduring2007thatLehmansbalancesheethadgrowntoo
large,andthatLehmanhadtakenontoomuchrisk;
4. How, even after it became apparent that Lehmans growth strategy had
exposed the firm to financial peril, Lehman still acted without sufficient
urgencytodeleverage.
b) Facts
(1) FromMovingtoStorage:LehmanExpandsItsPrincipal
Investments
During the course of 2006, Lehmans management and Board made the
deliberate business decision to increase the firms risk profile generally, andto take
moreriskspecificallywithrespecttoprincipalinvestmentswiththefirmscapital.This
new strategy was directed by Lehmans highest officers primarily Fuld, Joseph
AnnualReportfor2006asofNov.30,2006(Form10K)(filedonFeb.13,2007),atpp.6667(LBHI2006
10K);LehmanBrothersHoldingsInc.,QuarterlyReportasofFeb.28,2007(Form10Q)(filedonApr.9,
2007), at pp. 15, 19, 60 (LBHI 10Q (filed Apr. 9, 2007)); Lehman Brothers Holdings Inc., Quarterly
ReportasofMay31,2007(Form10Q)(filedonJuly10,2007),atpp.17,22,64(LBHI10Q(filedJuly10,
2007));LehmanBrothersHoldingsInc.,QuarterlyReportasofAug.31,2007(Form10Q)(filedonOct.
10, 2007), at pp. 18, 23, 67 (LBHI 10Q (filed Oct. 10, 2007)); Lehman Brothers Holdings Inc., Annual
Reportfor2007asofNov.30,2007(Form10K)(filedonJan.29,2008),atpp.6162,104(LBHI200710
K);LehmanBrothersHoldingsInc.,QuarterlyReportasofFeb.29,2008(Form10Q)(filedonApr.9,
2008),atpp.21,27,55,71(LBHI10Q(filedApr.9,2008));LehmanBrothersHoldingsInc.,Quarterly
ReportasofMay31,2008(Form10Q)(filedonJuly10,2008),atpp.26,29(LBHI10Q(filedJuly10,
2008));seealsoSectionIII.A.1.b.4ofthisReport.
58

Gregory(LehmansPresidentandChiefOperatingOfficer),andHughE.(Skip)McGee
III(GlobalHeadofInvestmentBanking)aftersignificantinternaldebate.
ThisSectionoftheReportdescribestheprincipalinvestmentstrategyadoptedby
Lehman in 2006; explains the risks that this strategy posed to the firm; describes how
Lehmans risk controls were applied (or not) to the new strategy; and explains the
Boardsunderstandingof,andagreementwith,thenewstrategy.
(a) LehmansChangedBusinessStrategy
In2006,Lehmanmadeasignificantchangeinitsbusinessstrategyfromalower
risk brokerage model to a higher risk, capitalintensive banking model. Historically,
Lehman described itself as being primarily in the moving business, not the storage
business.158Lehman,forthemostpart,didnotuseitsbalancesheettoacquireassetsfor
its own investment; rather, Lehman acquired assets such as commercial and
residential real estate mortgages primarily to move them by securitization or
syndicationanddistributiontothirdparties.
During2006,Lehmansmanagementdecidedtoemphasizethestoragebusiness
using Lehmans balance sheet to acquire assets for longerterm investment.159 Fuld
believed that other banks were using their balance sheets to make more proprietary
investments, that these investments were highly profitable relative to theirrisk inthe
158ExaminersInterviewofPaulShotton,June5,2009,atp.12.
159Id.atp.2.
59

thenbuoyanteconomicenvironment,andthatLehmanwasmissingoutonsignificant
opportunitiestodothesame.160
Lehmans management primarily focused on expanding three specific areas of
principalinvestment:commercialrealestate;leveragedloans;andprivateequity.
Commercial real estate investments were considered a strong candidate for
expansion because those investments had historically been a strength of the firm.161
MarkA.Walsh,LehmansheadoftheGlobalRealEstateGroup(GREG),wasoneof
themostsuccessfulandtrustedoperatorsatthefirm;managementbelievedthatWalsh
could investLehmans capital wisely and could distribute any excess risk to other
investors.162 The firm was even willing to make commercial real estate bridge equity
investmentstakingpotentiallyriskierequitypiecesofrealestateinvestmentsonthe
theory that the bridge equity, though riskier than the debt, could quickly be resold to
third parties at a profit.163 Lehman was well paid for bridge equity in the commercial
160Examiners Interview of Richard S. Fuld Jr., Sept. 25, 2009, at pp. 1012 (Fuld said that Lehman
expandedintotheleveragedlending,bridgeequityandprincipalinvestingtogainwalletshare.Fuld
wantedtousethe8020ruletogetthewalletshareofLehmanstopclients.The8020rulesaysthatthe
top20%ofthefirmsclientswillprovide80%ofthefirmsearnings.);ExaminersInterviewofJeremyM.
Isaacs,Oct.1,2009,atp.6.
161ExaminersInterviewofPaulA.Hughson,Oct.28,2009,atp.3.
162ExaminersInterviewofRogerNagioff,Sept.30,2009,atp.14;ExaminersInterviewofMarkWalsh,
Oct. 21, 2009, at pp. 45; email from Jeffrey Goodman, Lehman, to Mark A. Walsh, Lehman (Sept. 19,
2006)[LBEXDOCID1368068].
163ExaminersInterviewofMarkA.Walsh,Oct.21,2009,atp.6.
60

real estate business, and management believed that Walshs distribution network
minimizedtheriskthatthefirmwouldbeunabletosellit.164
The business strategy to expand the leveraged loan business was somewhat
different. Lehmans management recognized that leveraged loans in their own right,
including the bridge equity components of those transactions, were risky relative to
their profitability.165 But Fuld, Gregory, and McGee in particular believed that if
Lehman made loans to private equity sponsors as part of major M&A transactions,
Lehmanwouldbuildlongtermclientrelationshipswiththesponsorsandperhapswith
other institutions involved in the transaction.166Fuld, Gregory, and McGee believed
thateverydollarthatLehmanmadefromaleveragedloanwouldleadtofivedollarsof
followonprofitsinthefuture.167
The firms aggressive growth strategy was apparent in various firmwide
presentationsgivenbyseniormanagementandincertainhighlevelbusinessandrisk
takingdecisionsmadeduring2006andattheoutsetofthe2007fiscalyear.AsDavid
Goldfarb (then Lehmans Global Head of Strategic Partnerships, Principal Investing,
164Lehman,FIDOffsitePresentationandNotes(Sept.28,2006),atp.10[LBEXDOCID2042292,2068495],
attachedtoemailfromMichaelGelband,Lehman,toRichardS.Fuld,Jr.,Lehman,etal.(Sept.26,2006)
[LBEXDOCID2384245].
165Examiners Interview of Kentaro Umezaki, June 25, 2009, at pp. 10, 13; Examiners Interview of
MichaelGelband,Aug.12,2009,atp.6;ExaminersInterviewofAlexKirk,Jan.12,2010,atp.6.
166ExaminersInterviewofHughE(Skip)McGeeIII,Aug.12,2009,atpp.78;ExaminersInterviewof
JosephGregory,Nov.13,2009,atp.3;accordExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,
atp.12.
167ExaminersInterviewofJosephGregory,Nov.13,2009,atp.3;ExaminersInterviewofAlexKirk,Jan.
12,2010,atp.7.
61

and Risk) put it, Lehman was pursuing 13% annual growth in revenues, and to
support this revenue growth [Lehman was] targeting an even faster increase in the
firmsbalancesheet,totalcapitalbaseandriskappetiteeachofwhich[was]projected
to increase by 15% per year.168 Goldfarb noted that Lehman had been pedal to the
metalingrowthmodefortheprevioustwoyears,butplannedtocontinuethatgoing
forward.169Thatyear,FuldandGelband(thenheadofFID)alsogavepresentationsin
whichtheydiscussedLehmansaggressivegrowthstrategy.170
(b) TheIncreasedRiskFromLehmansChangedBusiness
Strategy
ThebusinessstrategythatLehmanpursuedbeginningin2006wasriskyinlight
ofthefirmshighleverageandsmallequitybase.Commercialrealestateinvestments,
leveragedloansandotherprincipalinvestmentsconsumedmorecapital,entailedmore
risk,andwerelessliquidthanLehmanstraditionallinesofbusiness.171
The lack of liquidity increased the risk to the firm in several ways. Having a
largevolumeofilliquidassetsmadeitmuchmoredifficultforthefirmtoaccomplish
168DavidGoldfarb,Lehman,GlobalStrategyOffsitePresentation(Mar.2006),atpp.3031[LBEXDOCID
1342496],attachedtoemailfromChristopherM.OMeara,Lehman,toJacquelineRoncagliolo,Lehman
(Apr.3,2006)[LBEXDOCID1357100].
169Id.atp.10.
170ExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,atp.11;Lehman,FIDOffsitePresentation
and Notes (Sept. 28, 2006) [LBEXDOCID 2042292, 2068495], attached to email from Michael Gelband,
Lehman,toRichardS.Fuld,Jr.,Lehman,etal.(Sept.26,2006)[LBEXDOCID2384245].
171 Less liquid investments were Level 3. Level 1 assets have readily available markets to provide
pricesandliquidity,suchasexchangetradedequities.Level2assetshaveobservableeventstoprovide
pricing, such as comparable sales. Level 3 assets have no readily available pricing mechanism and
thereforearelessliquidthanLevel1and2assets.
62

threeimportantgoalsinadifficultfinancialenvironment:toraisecash;tohedgerisks;
ortosellassetstoreducetheleverageinitsbalancesheet.
When a financial institution suffers losses, it often needs to raise cash to fund
itself.172 But illiquid investments are difficult to use for that purpose because they
cannotbesoldquickly.173Whenilliquidinvestmentsaresoldinadifficultmarket,the
seller often takes a much larger loss on the sale than on a liquid asset.174 Similarly,
illiquidassetsaremoredifficulttouseascollateralforborrowing.175Theyoftencannot
beusedintherepomarket,whichwasacrucialsourceoffundingforinvestmentbanks
such as Lehman.176 If a borrower pledges illiquid assets as collateral, there will be a
largerhaircut,thatis,adiscountfromthemarketvalueofthepledgedcollateral,than
forliquidassets.177
172SeeLehman,CapitalAdequacyReview(Sept.11,2008),atp.1[LBEXDOCID012124].
173See Tobias Adrian, Federal Reserve Bank of New York, and Hyun Song Shin, Princeton University,
FinancialIntermediaries,FinancialStabilityandMonetaryPolicy(Aug.5,2008),atp.13.
174MartinOehmke,PuttingtheBrakesonCollateralLiquidations,ColumbiaBusinessSchoolIdeasatWork,
July28,2009,
http://www4.gsb.columbia.edu/ideasatwork/feature/731624/Putting+the+Brakes+on+Collateral+Liquidati
ons(lastvisitedonFeb.1,2010).
175Id.; see alsoMoodys Investor Services, Press Release: Moodys Text: ChangesLehman Outlook From
StableToNegative(June9,2008).
176Examiners Interview of Anuraj Bismal, Sept. 16, 2009, at p. 10; Lehman, Accounting Policy Manual
(Sept.9,2006)[LBEXDOCID3213287],attachedtoemailfromMarieStewart,Lehman,toMartinKelly,
Lehman,etal.(Dec.5,2007)[LBEXDOCID3223385].
177See Lehman, Update on Risk, Liquidity and Capital Adequacy Presentation (Aug. 17, 2007), at p. 48
[LBEXDOCID 2031705] (Lehmans funding framework took account of the inability to fund illiquid
assetsthroughtherepomarket;thereforethefirmalwaysfundedilliquidholdingswithlongtermassets
andliabilities).
63

Financial institutions generally engage in transactions designed to hedge their
risks.178Butilliquidinvestmentsaretypicallymoredifficulttohedge.179Infact,Lehman
decidednottotrytohedgeitsprincipalinvestmentriskstothesameextentasitsother
exposures for precisely this reason its senior officers believed that hedges on these
investmentswouldnotworkandcouldevenbackfire,aggravatinginsteadofmitigating
Lehmanslossesinadownturn.180Asaresult,Lehmanacquiredalargevolumeofun
hedgedassetsthatultimatelycausedLehmansignificantlosses.181
Inadifficultfinancialenvironment,italsoisimportantforfinancialinstitutions
to be able to reduce their leverage and risk profile.182 The more highly leveraged the
institutionis,themoreimportantitisfortheinstitutiontobeginreducingleverageas
soonasmarketconditionsturnagainstit.Butiftheneedtoreduceleverageforcesthe
sale of illiquid assets at a loss, it has a double impact; in addition to the loss, the
178Cf. Examiners Interview of Alex Kirk, Jan. 12, 2010, at p. 9; Examiners Interview of Roger Nagioff,
Sept.30,2009,atpp.3,13.
179Cf.ExaminersInterviewofRogerNagioff,Sept.30,2009,atpp.3,13.
180Examiners Interview of Roger Nagioff, Sept. 30, 2009, at pp. 3, 13; Examiners Interview of Roger
Berlind, May 8, 2009, at p. 7; Examiners Interview of Fred S. Orlan, Sept. 21, 2009, at p. 6; Examiners
Interview of Paul Shotton, June 5, 2009, at pp. 78; Examiners Interview of Kentaro Umezaki, June 25,
2009,atp.17;Lehman,2ndQuarter2007Review:CreditFacilitationGroup(June2007),atpp.12[LBEX
DOCID 514908]; Lehman, Leveraged Finance Risk Presentation (June 2007), at p. 12 [LBEXDOCID
3283752];emailfromChristopherM.OMeara,Lehman,toIanT.Lowitt,Lehman(Sept.27,2007)[LBEX
DOCID 193218]; email from Jeffrey Goodman, Lehman, to Christopher M. OMeara, Lehman (Oct. 1,
2007) [LBEXDOCID 201866]; email from Jeffrey Goodman, Lehman, to Paul Shotton, Lehman, et al.
(Mar. 19, 2008) [LBEXDOCID 335666]; Andrew J. Morton, Lehman, Hedging Fixed Incomes Portfolio
Presentation (Aug. 8, 2008), at pp. 2, 3, 8, 11 [LBEXDOCID 011869], attached to email from Thomas
Odenthal,Lehman,toAndrewJ.Morton,Lehman,etal.(Aug.6,2008)[LBEXDOCID069824].
181Examiners Interview of Roger Nagioff, Sept. 30, 2009, at pp. 3, 13; Examiners Interview of Paul
Shotton,June5,2009,atpp.78.
182Cf.ExaminersInterviewofTreasurySecretaryTimothyF.Geithner,Nov.24,2009,atpp.78.
64

perception can be that there is air in the valuation of the other illiquid assets that
remainonthebalancesheet,exacerbatingtheriskofalossofconfidenceinthefirms
future.183
During the declining market of 200708, Lehman suffered from all these
problems.Lehmanhaddifficultysellingstickyassetsandwasunabletoreduceits
balancesheetquicklythroughtypicalmeans.Instead,Lehmanexpandedthevolumeof
Repo 105 transactions that misleadingly and temporarily reduced its balance sheet
solelyforthepurposeofthefirmspublicfinancialreports.184
(c) ApplicationofRiskControlstoChangedBusiness
Strategy
Lehmans principal investments in illiquid assets presented new and increased
formsofrisktothefirm,butLehmansmanagementdidnotrecalibratethefirmspre
existing risk controls to ensure that its new investments were properly evaluated,
monitoredandlimited.Ifanything,tofacilitatethenewinvestmentstrategy,Lehmans
management relaxed its controls in several ultimately fateful ways, discussed below.
Lehmans senior officerstook this tack notwithstanding their periodic statements to
183Id.;seeMoodysInvestorServices,PressRelease:MoodysText:ChangesLehmanOutlookFromStable
ToNegative(June9,2008).
184SeeSectionIII.A.4ofthisReport.
65

LehmansBoard,theratingagencies,andtheSECthatitsriskmanagementsystemwas
arigorousindependentcheckontherisksundertakenbyitsbusinesslines.185
(i) StressTestingExclusions
One of Lehmans major risk controls was stress testing. Historically, Lehmans
stress testing had not been designed to encompass the risks posed to the firm by
principal investments in real estate and private equity, because those positions
previouslymadeupasmallportionofLehmansportfolio.186Lehmandidnotreviseits
stresstestingtoaddressitsevolvingbusinessstrategy.
Lehman was required by the SEC187 to conduct some form of regular stress
testing on its portfolio to quantify the catastrophic loss it could suffer over a defined
period of time.188 Lehman ran a series of stress tests based on13 or 14 different
scenarios.189Someofthescenarioswerehistoricalevents,suchasthe1987stockmarket
185MadelynAntoncic,RiskManagementPresentationtoStandard&Poors[Draft](Aug.17,2007),atp.5
[LBEXDOCID 342851] (Global Risk Management Division is independent of the trading areas),
attached to email from Lisa Rathgeber, Lehman, to Jeffrey Goodman, Lehman, et al. (Aug. 15, 2007)
[LBEXDOCID305205];SECDivisionofMarketRegulation,LehmanBrothersConsolidatedSupervised
Entity Market and Credit Risk Review (June 2005), at pp. 34 [LBEXDOCID 2125011] (saying Risk
Management was independent of Lehmans business units), attached to email from Michelle Danis,
SEC, to David Oman, Lehman, et al. (Apr. 21, 2006) [LBEXDOCID 2068428]; Lehman, Risk Update
Presentation to Lehman Board of Directors (July 18, 2006), at pp. 5, 8 [LBEXDOCID 2125293] (saying
Lehmans risk approach applie[d] analytical rigor overlaid with sound practical judgment; Lehman,
Risk Management Update Presentation to Lehman Board of Directors (Apr. 15, 2008), at pp. 12
[LBHI_SEC07940_02790929](sayingLehmanprovidedanindependentviewofrisk).
186ExaminersInterviewofPaulShotton,Oct.16,2009,atp.2.
187Seeinfra,SectionIII.A.6.
188ExaminersInterviewoftheSecuritiesandExchangeCommission,Aug.24,2009,atp.13.
189See, e.g., Lehman, Stress Test Report for March 31, 2006 [LBEXDOCID 2078161], attached to email
fromSandeepGarg,Lehman,toPatrickWhalen,Lehman,etal.(Apr.24,2006)[LBEXDOCID2118206];
Lehman,StressTestReportforFebruary28,2007[LBEXDOCID632363],attachedtoemailfromMelda
66

crash or the 1998 Russian financial crisis, while other scenarios were hypothesized by
Lehmans risk managers.190 Lehmans management represented to its external
constituents that regular and comprehensive stress tests were performed to evaluate
the potential P&L impact on the Firms portfolio of abnormal yet plausible market
conditions.191 Stress testing was designed to measure tail riska one in ten year
typeevent.
When Lehman first adopted stress testing in about 2005, it applied the testing
only to its tradable instruments such as stocks, bonds, and other securities; it did not
include its untraded assets such as its commercial real estate or private equity
investments.192 Because these assets did not trade freely, they were not considered
susceptible to stress testing over a shortterm scenario.193 And since Lehman did not
thenhavesignificantinvestmentsintheseareas,excludingthemfromthestresstesting
Elagoz,Lehman,toPaulShotton,Lehman,etal.(Mar.9,2007)[LBEXDOCID630356];StressTestReport
forOctober31,2007[LBEXDOCID632432],attachedtoemailfromJeffreyGoodman,Lehman,toCherie
Gooley, Lehman (Dec. 19, 2007) [LBEXDOCID 665513]; Stress Test Report for Apr. 30, 2008 [LBEX
DOCID3296803],attachedtoemailfromMarkWeber,Lehman,toCherieGooley,Lehman,etal.(May
28,2008)[LBEXDOCID3302270].
190Lehman, Risk Management Presentation to Fitch (Apr. 7, 2006), at p. 47 [LBEXDOCID 691768];
Lehman,Risk,Liquidity,Capital,andBalanceSheetUpdatePresentationtoFinanceandRiskCommittee
ofLehmanBoardofDirectors(Sept.11,2007),atp.28[LBEXAM067167].
191E.g., Madelyn Antoncic, Lehman, Risk Management Presentation to Standard & Poors [Draft] (Aug.
17,2007),atpp.3839[LBEXDOCID342851],attachedtoemailfromLisaRathgeber,Lehman,toJeffrey
Goodman,Lehman,etal.(Aug.15,2007)[LBEXDOCID305205].
192Examiners Interview of Paul Shotton, Oct. 16, 2009, at pp. 56; Examiners Interview of Jeffrey
Goodman,Aug.28,2009.
193ExaminersInterviewofJeffreyGoodman,Aug.28,2009.
67

did not undermine the usefulness of the results.194 The SEC was aware of this
exclusion.195
Atvariouspointsin2006and2007,Lehmansriskmanagersconsideredwhether
toincludeprincipalinvestmentsinLehmansstresstesting.196Aninternalauditadvised
that Lehman address the main risks in the Firms portfolio, including illiquidity
andconcentrationrisk.197ButLehmandidnottakesignificantstepstoincludethese
privateequitypositionsinthestresstestinguntil2008,eventhoughtheseinvestments
becameanincreasinglylargeportionofLehmansriskprofile.198
Until late 2007, Lehmans stress testing also excluded its leveraged loan
commitments i.e., the leveraged loans that Lehman had committed to fund in the
future,buthadnotyetclosed.199Thisexclusionappearstohavebeeninadvertent.200
194ExaminersInterviewofPaulShotton,Oct.16,2009,atpp.56.
195Examiners Interview of Matthew Eichner, Nov. 23, 2009, at p. 12; Examiners Interview of Paul
Shotton,Oct.16,2009,atp.6.
196EmailfromMarcHenn,Lehman,toMariaTurner,Lehman,(Mar.2,2007)[LBEXDOCID264992];e
mail from Melda Elagoz, Lehman, to Jeffrey Goodman, Lehman, et al. (June 11, 2007) [LBEXDOCID
384503];Lehman,2006CompetitorAnalysisKeyConsiderations(Dec.1,2006)[LBEXDOCID2110930],
attachedtoemailfromMireyNadler,Lehman,toFredSteinberg,Lehman(Dec.1,2006)[LBEXDOCID
2042308];emailfromGerardReilly,Lehman,toChristopherM.OMeara,Lehman(May17,2006)[LBEX
DOCID1342418];emailfromJamesBallentine,Lehman,toMichaelGelband,Lehman,etal.(Jan.4,2007)
[LBEXDOCID384818].
197Lehman,InternalVaRAuditReport[Draft](Feb.26,2007),atp.3[LBEXDOCID232917],attachedto
emailfromLisaRathgeber,Lehman,toPaulShotton,Lehman(Feb.26,2007)[LBEXDOCID232916].
198ExaminersInterviewofChristopherM.OMeara,Aug.14,2009,atp.25.
199Examiners Interview of Roger Nagioff, Sept. 30, 2009, at pp. 1011; Examiners Interview of Paul
Shotton,Oct.16,2009,atp.4;emailfromMeldaElagoz,Lehman,toJefferyGoodman,Lehman(July16,
2007)[LBEXDOCID385103];emailfromJefferyGoodman,Lehman,toStephenLax,Lehman,etal.(Nov.
14,2007)[LBEXDOCID297400].
200Examiners Interview of Roger Nagioff, Sept. 30, 2009, at pp. 1011; Examiners Interview of Paul
Shotton,Oct.16,2009,atp.4.
68

Because Lehmans stress testing did not include its real estate investments, its
private equity investments or, during a crucial time period, its leveraged loan
commitments,Lehmansmanagementpursueditstransitionfromthemovingbusiness
to the storage business without the benefit of regular stress testing on the primary
businesslinesthatwerethesubjectofthisstrategicchange.Forexample,asdescribed
below, Lehman entered into a series of large and risky commercial real estate
transactionsinthefirsthalfof2007withoutstresstestingtheparticulartransactionsand
withoutconductingregularstresstestingonLehmansaggregatecommercialrealestate
book.201
This exclusion was significant. Experimental stress tests conducted in 2008
showedthatalargeproportionofLehmanstailriskperhapsevenalargemajorityof
its overall tail risk lay with the businesses that were previously excluded from the
stress testing. One stress test posited maximum potential losses of $9.4 billion,
including$7.4billioninlossesonthepreviouslyexcludedrealestateandprivateequity
positions,andonly$2billiononthepreviouslyincludedtradingpositions.202Another
stresstestshowedtotallossesof$13.4billion,ofwhich$2.5billionwasattributableto
202Lehman, Stress Test Report (June 30, 2008), at p. 3 [LBEXDOCID 3326829], attached to email from
NancyMalik,Lehman,toPaulShotton,Lehman,etal.(June30,2008)[LBEXDOCID3301915];Lehman,
PrivateEquityandRealEstateStresses,GlobalMarketRiskManagementpresentation(June30,2008),at
pp.34[LBEXDOCID3301916]attachedtoemailfromNancyMalik,Lehman,toPaulShotton,Lehman,
etal.(June30,2008)[LBEXDOCID3301915].
69

the firms included positions, and $10.9 billion was attributable to the excluded
positions.203
Butthesestresstestswereconductedlongaftertheseassetshadbeenacquired,
andtheywereneversharedwithLehmansseniormanagement.204Foramoredetailed
discussionofLehmansstresstesting,seeAppendix8,RiskManagementOrganization
andControls.
(ii) RiskAppetiteLimitIncreaseForFiscal2007
Lehmanhadaseriesofriskappetitelimitsthatitconsideredthecenterofits
approach to risk.205 Risk appetite was a measure that aggregated the market risk,
credit risk, and event risk faced by Lehman.206 Lehman had an elaborate set of
proceduresdesignedtocalculatetheriskappetiteusageineachofitsbusinesslines,
each of its divisions,and for the firm asa whole.207 These risk appetite usage figures
werecalculatedeveryday.208
203Lehman, Stress Test Report (June 30, 2008), at p. 1 [LBEXDOCID 384227] attached to email from
NancyMalik,Lehman,toPaulShotton,Lehman,etal.(Sept.2,2008)[LBEXDOCID385413].
204ExaminersInterviewofMarkWeber,Aug.11,2009,atp.14;ExaminersInterviewofChristopherM.
OMeara,Sept.23,2009,atp.19.
205See,e.g.,JaredPedowitz,BMRMMarketRiskManagementWalkthroughTemplate(Nov.30,2007),at
p.9 [EYLELBHIKEYPERS 1015089]; Madelyn Antoncic, Lehman, Risk Management Presentation to

Standard&Poors [Draft](Aug.17,2007),at p.23 [LBEXDOCID342851],attached to email fromLisa
Rathgeber,Lehman,toJeffreyGoodman,Lehman,etal.(Aug.15,2007)[LBEXDOCID305205].
206Madelyn Antoncic, Lehman, Risk Management Presentation to Standard & Poors [Draft] (Aug. 17,
2007), at p. 21 [LBEXDOCID 342851], attached to email from Lisa Rathgeber, Lehman, to Jeffrey
Goodman,Lehman,etal.(Aug.15,2007)[LBEXDOCID305205].
207SEC Division of Market Regulation, Lehman Brothers Consolidated Supervised Entity Market and
CreditRiskReview(2005),atpp.45[LBEXDOCID2125011].
208See, e.g., email from Jenny Peng, Lehman, to David Goldfarb, Lehman, et al. (Oct. 12, 2007) [LBEX
DOCID 152049] (containing summary Daily Risk Appetite and VaR Report for Oct. 10, 2007), and
70

Atthebeginningofeachyear,Lehmansetnumericallimitsontheriskappetite
usageitwaswillingtotakeforeachsuchbusinessunitandforthefirmasawhole.209
ManagementpresentedthefirmwidelimittotheBoard.210
Under Lehmans limit policy, lowerlevel limits applicable to a single business
line or geographic area were relatively soft and could be exceeded based on
appropriate authority.211 Lehmans higherlevel limits were harder and required
greaterauthorizationiftheywereexceeded.212Thefirmwideriskappetitelimitwasthe
hardestofall,andifitwasexceeded,theRiskCommitteeofthefirmwasrequired
toconsiderthepropercourseofactiontotake.213TheRiskCommitteewascomposedof
the Executive Committee of the firm, the Chief Risk Officer (CRO), and the Chief
FinancialOfficer(CFO).Whileonewitnesssaidthattheonlypermissiblereactionto
attachedspreadsheet(Oct.12,2007)[LBEXDOCID150128](containingdailyriskappetitereport,global
riskappetitereportorganizedbyrisktype,anddailyVaRreport).
209SEC Division of Market Regulation, Lehman Brothers Consolidated Supervised Entity Market and
Credit Risk Review (2005), at pp. 45 [LBEXDOCID 2125011]. See Appendix 8, Risk Management
OrganizationandControls(discussingriskappetitelimits).RiskappetitemeasuredtheamountLehman
couldloseinagiveyearandstillachieveanacceptablelevelofnetprofit.
210Itisnotclearwhetherthepresentationwasforratificationandapprovalorsimplyforinformation.See
e.g.,Lehman,2008FinancialPlanSummaryPresentationtoLehmanBoardofDirectors(June29,2008),at
p.11[LBHI_SEC07940_027374].
211Lehman,MarketRiskManagementLimitPolicyManual(Oct.2006),atp.2[LBHI_SEC07940_767665),
attached to email from Christopher M. OMeara to Kristi Michelle Reynolds (Apr. 7, 2008)
[LBHI_SEC07940_767661].
212Lehman Brothers Global Risk Management, Second Quarter 2008 Report (July 21, 2008), at p. 29
[LBEXDOCID738522],attachedtoemailfromElizabethAgosto,Lehman,toJeffreyGoodman,Lehman,
etal.(July21,2008)[LBEXDOCID670132].
213E.g.,SEC,LehmanMonthlyRiskReviewMeetingNotes(July19,2007),atp.5[LBEXSEC007363];SEC
Division of Market Regulation, Lehman Brothers Consolidated Supervised Entity Market and Credit
RiskReview(2005),atp.6[LBEXDOCID2125011].
71

exceeding the firmwide limit was immediately reducing the risk faced by the firm,214
most Lehman personnel said that senior management could cure a limit excess by
grantingatemporaryreprievefromthelimitorbyincreasingthelimit.215Aswiththe
stresstests,managementdescribedtheriskappetitelimitstoregulators,ratingagencies
andtheBoardasameaningfulcontrolthatLehmanusedtomanageitsrisktaking.216
At the end of 2006, Lehman dramatically increased its risk appetite limits
applicabletofiscal2007.Thefirmwidelimitincreasedfrom$2.3billionto$3.3billion,
and subsidiary limits also increased significantly, particularly insofar as the principal
investingbusinesseswereconcerned.217
These increases in the risk appetite limits were somewhat controversial. The
CROatthetime,MadelynAntoncic,arguedforasignificantlylowerincreaseto$2.6or
$2.7 billion, and the much higher $3.3 billion figure was apparently the result of a
214ExaminersInterviewofKentaroUmezaki,June25,2009,atp.5.
215E.g.,ExaminersInterviewofMadelynAntoncic,Oct.6,2009,atp.7;ExaminersInterviewwithDavid
Goldfarb,Sept.21,2009,atp.5;ExaminersInterviewofPaulShotton,June5,2009,atpp.1011(saying
thatthefirmwideriskappetitelimitwasahardlimit,thebreachofwhichhadtobecuredbyeither
reducingthefirmsoverallriskorraisingthelimit).
216MadelynAntoncic,RiskManagementPresentationtoStandard&Poors[Draft](Aug.17,2007),atp.
23 [LBEXDOCID 342851], attached to email from Lisa Rathgeber, Lehman, to Jeffrey Goodman,
Lehman, et al. (Aug. 15, 2007) [LBEXDOCID 305205]; SEC Division of Market Regulation, Lehman
BrothersConsolidatedSupervisedEntityMarketandCreditRiskReview(June2005),atpp.45[LBEX
DOCID2125011],attachedtoemailfromMichelleDanis,SEC,toDavidOman,Lehman,etal.(Apr.21,
2006)[LBEXDOCID2068428];Lehman,RiskUpdatePresentationtoLehmanBoardofDirectors(July18,
2007),atpp.1112[LBEXDOCID2125293].
217LehmanBrothers,2007RiskAppetiteLimit(Jan.7,2007),atp.1[LBEXDOCID158938],attachmentto
email from Robert Azerad, Lehman, to Madelyn Antoncic, Lehman (Jan. 11, 2007) [LBEXDOCID
158331].
72

compromise with other senior managers.218 Moreover, to justify the increased limit
amount, Lehman changed the way that it calculated the limit; had Lehman used the
samemethodtocalculatethe2007limitthatithadusedtocalculatethe2006limit,the
2007limitwouldhavebeenseveralhundredmilliondollarslower.219
Increasingthefirmwidelimitto$3.3billionfacilitatedarapidexpansionofthe
firms risk profile between 2006 and 2007. As described below,within the first few
monthsoffiscal2007,Lehmanquicklyusedthefullamountofthenew$3.3billionrisk
appetite limit and then some. In late 2007 and early 2008, Lehman relaxed its risk
appetitelimitsinseveralotherways,whicharedescribedbelow.Foramoredetailed
discussion of Lehmans risk appetite limits, see Appendix 8, Risk Management
OrganizationandControls.
(iii) DecisionNotToEnforceSingleTransactionLimit
In 2006, to facilitate the planned expansion of the leveraged loan business,
Lehmans Executive Committee decided to be more flexible with respect to the firms
single transaction limit.220 The single transaction limit was actually two limits one
limit applicable to the notional amount of the expected leveraged loan and a second
218Examiners Interview of Madelyn Antoncic, Mar. 27, 2009, at p. 13; email from David Goldfarb,
Lehman, to Madelyn Antoncic, Lehman, et al. (Nov. 2, 2006) [LBEXDOCID 2125677]; email from
MadelynAntoncic,Lehman,toChristopherM.OMeara,Lehman(Nov.2,2006)[LBEXDOCID2125679];
email from Christopher M. OMeara, Lehman, to Madelyn Antoncic, Lehman (Nov. 2, 2006) [LBEX
DOCID2125680].
219Lehman, 2007 Financial Plan Presentation to Finance and Risk Committee of the Board of Directors
(Jan.30,2007),atpp.2122[LBEXAM067099].
220ExaminersInterviewofAlexKirk,Jan.12,2010,atpp.78.
73

limit applicable to a calculated amount that Lehman was at risk of losing on the
leveraged loan. The limits were partly a function of Lehmans equity. Lehman had
previouslyagreedwiththeratingagenciesthatitwouldadoptasingletransactionlimit
akintolimitspreviouslyadoptedbycommercialbanks.221
AlthoughLehmansExecutiveCommitteealwaysretainedthefreedomtowaive
the single transaction limit as to any individual transaction, Lehman informed its
external constituents that this prerogative would be exercised only in rare
circumstances.222
Inlate2006,Lehmansmanagementdecidednottoenforcethesingletransaction
limit because it had cost Lehman significant opportunities.223 Because Lehman had a
dramatically smaller equity base than its commercial banking competitors, and a
somewhat smaller equity base even than its investment banking competitors, Lehman
had a lower single transaction limit than its competitors, which forced it to forgo or
limititsparticipationinanumberofbigdeals.224Lehmansmanagementdecidedthat
221Appendix8,RiskManagementOrganizationandControls.
222Madelyn Antoncic, Lehman, Standard Risk Management Presentation (Undated), at p. 21 [LBEX
DOCID 194031], attached to email from Paul Shotton, Lehman, to Christopher M. OMeara, Lehman
(Feb. 20, 2008) [LBEXDOCID 214223]; Madelyn Antoncic, Lehman, Standard Risk Management
Presentation,atp.21[LBEXDOCID194031].
223ExaminersInterviewofAlexKirk,Jan.12,2010,atpp.78;Lehman,AppendixtoFinancialSponsors
Strategies (Including Lending Capacity Solutions) Presentation to the Executive Committee (Aug. 3,
2006),atp.6[LBEXDOCID1343776],attachedtoemailfromBlairSieff,Lehman,toMadelynAntoncic,
Lehman,etal.(Aug.2,2006)[LBEXDOCID1360977].
224Lehman, Appendix to Financial Sponsors Strategies (including Lending Capacity Solutions)
PresentationtotheExecutiveCommittee(Aug.3,2006),atpp.3,6[LBEXDOCID1343776],attachedtoe
mail from Blair Sieff, Lehman, to Madelyn Antoncic, Lehman, et al. (Aug. 2, 2006) [LBEXDOCID
74

inthefuture,itwouldparticipateinsuchdealswithoutregardtothesingletransaction
limit.225Moreover,Lehmandidnotapplythesingletransactionlimittoitscommercial
real estate deals, even though some of its risk managers advocated for this broader
applicationofthelimit.226
Likethedecisiontoincreasethefirmwideriskappetitelimit,thedecisionnotto
enforce the single transaction limit was controversial within Lehmans management.
Alex Kirk, then head of Lehmans Credit Business, had primary responsibility for the
leveraged loan business, thought that the single transaction limit was an important
methodoflimitingthefirmsriskonitsleveragedloans.227Antoncicalsothoughtthat
the firm should continue to abide by the single transaction limit in part because the
substantive terms of the leveraged loans were increasingly lopsided in favor of the
private equity sponsors and unfavorable for the lending banks.228 Although Antoncic
1360977];Lehman,FinancialSponsorsStrategies(includingLendingCapacitySolutions)Presentationto
the Executive Committee (Aug. 3, 2006), at pp. 1011 (LBEXDOCID 1343775], attached to email from
BlairSieff,Lehman,toMadelynAntoncic,Lehman,etal.(Aug.2,2006)([LBEXDOICD1360977].
225EmailfromJoeLi,Lehman,toPaulMitrokostas,Lehman(Aug.30,2007)[LBEXDOCID2547330];Joe
Li,Lehman,STLBacktestingExcelSpreadsheet(July25,2007)[LBEXDOCID2506462],attachedtoemail
from Joe Li, Lehman, to Fred S. Orlan, Lehman, et al. (July 25, 2007) [LBEXDOCID 2563167]; accord
ExaminersInterviewofAlexKirk,Jan.12,2010,atpp.78.
226Cf. Examiners Interview of Madelyn Antoncic, Oct. 6, 2009, at p. 12; email from Jeffrey Goodman,
Lehman,toZevKlasewitz,Lehman(Jan.17,2007)[LBEXDOCID794864];emailfromJeffreyGoodman,
Lehman,toZevKlasewitz,Lehman(Feb.12,2007)[LBEXDOCID794879].
227ExaminersInterviewofAlexKirk,Jan.12,2010,atpp.78.
228ExaminersInterviewofMadelynAntoncic,Mar.27,2009,atp.9.
75

thoughtthefirmshouldabidebythesingletransactionlimit,229KirkandAntoncicwere
overruledbyFuld,Gregory,andMcGee.230
(d) TheBoardsApprovalofLehmansGrowthStrategy
Lehmans Board fully embraced Lehmans growth strategy. In a January 2007
Board meeting, the directors were informed of the large increase in the risk appetite
limit for fiscal 2007, and of the firms intention to expand its footprint in principal
investments,andtheyagreedwithLehmansseniorofficersthatLehmanneededtotake
moreriskinordertocompete.231AllofthedirectorstoldtheExaminerthattheyagreed
withLehmansgrowthstrategyatthetimeitwasundertaken.232.
AlthoughtheperiodicmaterialsthattheFinanceandRiskCommittee233received
aboutthefirmsstresstestingdisclosedthattestswereconductedonthefirmstrading
portfolio and We subject both our trading and our counterparty portfolio to stress
229Id.;ExaminersInterviewofAlexKirk,Jan.12,2010,atpp.68.
230ExaminersInterviewofAlexKirk,Jan.12,2010,atpp.78;ExaminersInterviewofMadelynAntoncic,
Mar.27,2009,atp.9.
231Examiners Interview of Sir. Christopher Gent, Oct. 21, 2009, at pp. 78; Examiners Interview of
ThomasCruikshank,Oct.8,2009,atpp.23;ExaminersInterviewofRolandA.Hernandez,Oct.2,2009;
ExaminersInterviewofJohnD.Macomber,Sept.28,2009,atp.12;ExaminersInterviewofMichaelL.
Ainslie, Sept. 22, 2009, at p. 8; Examiners Interview of Marsha Johnson Evans, May 22, 2009, at p. 12;
ExaminersInterviewofDr.HenryKaufman,May19,2009,atpp.78,14;ExaminersInterviewofRoger
Berlind,May8,2009,atpp.67;ExaminersInterviewofJohnF.Akers,Apr.22,2009,atp.9.
232Id.
233The Board had a Finance and Risk Committee that generally met twice a year and received more
detailedinformationthanthefullBoardonthesetopics.Dr.HenryKaufman,formermanagingdirector
ofSalmonBrothers,wastheheadoftheFinanceandRiskCommittee.
76

tests,234managementdidnotinformtheFinanceandRiskCommitteethatmanyofthe
firms commercial real estate and private equity investments were excluded from the
firmsstresstests.235
The omission was noted on January 29, 2008, when the Finance and Risk
Committeereceivedmaterialsstatingthatrealestateownedandprivateequitywere
excluded from the stress testing.236 No member of the Board who was asked by the
Examiner about the issue recalled noticing this revised disclosure, and no member
recalledLehmansofficersexplainingitorotherwisebringingittotheattentionofthe
Board.237Somedirectorswerenotconcernedabouttheexclusionoftheseinvestments
from the stress testing, saying that the exclusions appeared reasonable at the time.238
234Lehman Brothers Holdings Inc., Risk, Liquidity, Capital and Balance Sheet Update Presentation to
FinanceandRiskCommitteeofLehmanBoardofDirectors(Sept.11,2007),atp.28[LBEXAM067167
233].
235Examiners Interview of Paul Shotton, Oct. 16, 2009, at p. 5; see also Lehman Brothers Holdings Inc.,
Risk, Liquidity, Capital and Balance Sheet Update Presentation to Finance and Risk Committee of
LehmanBoardofDirectors(Sept.11,2007),atp.29[LBEXAM067167233].
236 Lehman, 2008 Financial Plan Presentation to Lehman Finance and Risk Committee of the Board of
Directors(Jan.29,2008),atp.19[LBHI_SEC07940_068559].
237Cf.ExaminersInterviewofJerryA.Grundhofer,Sept.16,2009,atp.7;ExaminersInterviewofRoland
A.Hernandez,Oct.2,2009;ExaminersInterviewofJohnD.Macomber,Sept.25,2009,atp.4;Examiners
Interview ofDr. Henry Kaufman, Sept. 2,2009,at p. 11; contraExaminers Interview of Christopher M.
OMeara,Sept.23,2009,atp.18.
238 Examiners Interview of Dr. Henry Kaufman, Sept. 2, 2009, at pp. 23, 1011 (Despite [these]
exclusions, [Kaufman] was not concerned with the result to the stress tests.); Examiners Interview of
JerryA.Grundhofer,Sept.16,2009,atp.7(sayingtheexclusionlookedreasonableandthatitwouldbe
hardfor[Grundhofer]tobelieveLehmanwasnotfollowingthestandardforconductingstresstests.);see
Examiners Interview of Sir Christopher Gent, Oct. 21, 2009, at pp. 1314 (saying he did not find stress
testshelpfulandthoughtsomeassetsmightbeexcluded).
77

However,onedirectorsaidthatiftheexclusionwasmaterial,hewouldhavewantedto
knowaboutit.239
The Board also was not told that Lehmans management had decided not to
applythesingletransactionlimitstoitsleveragedloans.AlthoughtheExaminerhas
found no evidence that before 2008, Lehmans management had represented to the
Board that any single transaction limit had been adopted,240 some directors said that
concentration limits were important protections for the firm, and they would have
wantedtoknowaboutsignificantexcessesaboveconcentrationlimits.241
In sum, during the second half of 2006, Lehman began to pursue a more
aggressive principal investment strategy, and it relaxed several risk limits to facilitate
thatstrategy.
(2) LehmanDoublesDown:LehmanContinuesItsGrowth
StrategyDespitetheOnsetoftheSubprimeCrisis
Late in the second half of 2006, the first signs of weakness in the subprime
residential mortgage market were apparent.242 For example, delinquency rates on
subprimeloans,whichhadhoverednear10%in2004and2005,reached13%bytheend
239 ExaminersInterviewofJohnD.Macomber,Sept.25,2009,atp.11.
240See,e.g.,Lehman,RiskUpdatePresentationtoLehmanBoardofDirectors(July18,2006)[LBEXWGM
986315](notmentioningsingletransactionlimit);butseeLehman,RiskManagementUpdatePresentation
toLehmanBoardofDirectors(Apr.15,2008),atp.1[LBHI_SEC07940_027909](WehaveanoverallRisk
Appetitelimitwhichissupplementedby...singletransaction,countryandotherconcentrationlimits.).
241Examiners Interview of Dr. Henry Kaufman, Sept. 2, 2009, at p. 6; Examiners Interview of John
Macomber,Sept.25,2009,atpp.6,17.
242BankforInternationalSettlements,77thAnnualReport(June24,2007),atp.109.
78

of 2006.243 In addition, after peaking in mid2006, housing prices began to decline
steeply.244Thisdeclineinpricesthreatenedthesubprimemortgagemarketbecausethe
markets health depended on continued price appreciation in housing.245 As a result,
beginninginNovember2006,significantwideningofspreadsonnoninvestmentgrade
tranches of home equity loans was evident.246 By the spring of 2007, the crisis had
advancedtothepointthatseveralmajorsubprimelendershadgonebankruptorbeen
acquiredbystrongerpartners.247
Lehmans management saw the subprime crisis as an opportunity to pick up
groundonitscompetitors.248Lehmansmanagementadoptedacountercyclicalgrowth
243Id.
244Standard & Poors, Press Release: Home Price Declines Worsen As We Enter the Fourth Quarter of
2008 According to the S&P/CaseShiller Home Price Indices (Dec. 30, 2008), at p. 1 (available at
http://www2.standardandpoors.com/spf/pdf/index/CSHomePrice_Release_123062.pdf); see also Vikas
Bajaj,HomePricesFallinMoreThanHalfofNationsBiggestMarkets,N.Y.Times,Feb.16,2007,atp.C1.
245GaryGorton,Information,Liquidityandthe(Ongoing)Panicof20072(NIBRWorkingPaperNo.w14649,
2009);seealsoGaryGorton&AndrewMetrick,SecuritizedBankingandtheRunonRepo5(YaleIntlCenter
forFinance,WorkingPaperNo.0914,2009).
247Id.atpp.10910.
248Lehman,2008FinancialPlanSummaryPresentationtoLehmanBoardofDirectors(Jan.24,2008),atp.
5[LBHI_SEC07940_027374](Currentenvironmentpresentsauniquelongtermgrowthopportunityfor
the Firm.... The Firms competitors, with the notable exceptions of Goldman Sachs and JP Morgan
Chase, have sustained large losses, weakening their competitive positions.... This presents an
opportunity for the Firm to pursue a countercyclical growth strategy, similar to what it did during the
20012002downturn,toimproveitscompetitivepositionand,overtime,generatesuperiorreturnsforour
shareholders.);seealsoLehman,UpdateonLehmanBrothersSubprimeMortgageOriginationBusiness
PresentationtoLehmanBoardofDirectors(Mar.20,2007),atp.10[LBHI_SEC07940_025834](Mostof
large subprime independents have gone out of business, have been sold or are selling.... Current
distressed environment provides substantial opportunities, as in late 1990s); Lehman, Notes for
Presentation for the Fixed Income Division OffsiteMeeting (Sept. 26,2006), at pp. 1012 [LBEXDOCID
1715601](statingthatLehmanviewedthe2006growthstrategyasacountercyclicalopportunitytogrow
business),attachedtoemailfromLesleyOramasScala,Lehman,toMichaelGelband,Lehman(Sept.26,
2006)[LBEXDOCID1945744].
79

strategy.249Lehmansmanagementbelievedthatthesubprimecrisiswouldnotspread
totheeconomygenerally,oreventothecommercialrealestatemarket,whereLehman
wasamajorplayer.250Inpastrecessionsandfinancialcrises,Lehmanhadsuccessfully
takenonmoreriskwhileitscompetitorsretrenched.251
During the first half of 2007, Lehman continued its growth strategy. Although
Lehmansmanagementdecidedtocurtailitsresidentialmortgageoriginationbusiness,
it did so less dramatically than many of its competitors in that business, several of
whichwentoutofbusiness.252
Lehman, along with other market participants and government regulators,
underestimated the severity of the subprime mortgage crisis;253 the subprime crisis
impaired Lehmans ability to securitize and sell residential mortgages and forced the
firm to retain an increasingly large volume of residential mortgagerelated risk on its
249Id.
250Id.
251Id.

LehmanBoardofDirectors(Mar.20,2007),atpp.5,10[LBHI_SEC07940_025834];emailfromDimitrios
Kritikos,Lehman,toJeffreyGoodman,Lehman(Feb.2,2007)[LBEXDOCID566140](Whiletherestof
the industry is tightening credit and increasing prices in these areas, we are moving in the opposite
direction.).
253Examiners Interview of Treasury Secretary Timothy F. Geithner, Nov. 24, 2009, at p. 3; Examiners
InterviewofRichardS.Fuld,Jr.,Sept.25,2009,atpp.16,24;ExaminersInterviewofRichardMcKinney,
Aug. 27, 2009, at pp. 2, 9; Richard S. Fuld, Jr., Lehman, Notes for Senior Management Speech (June 16,
2008), at pp. 56 [LBEXDOCID 529241], attached to email from Taimur Hyat, Lehman, to Herbert H.
McDadeIII,Lehman,etal.(June25,2008)[LBEXDOCID556064].
80

ownbalancesheet.254Atthesametime,duringthefirsttwoquartersof2007,Lehman
continued to grow its leveraged loan, commercial real estate, energy, and principal
investments businesses.255 Lehmans growth strategy culminated in the acquisition of
the Archstone REIT in late May 2007.256 Together, these transactions continued the
ongoing increase in the size of Lehmans balance sheet, with a particularly strong
concentrationinassetsthatcouldnoteasilybesoldinacrisis.Beginninginthefourth
quarterof2006,FIDsbusinessesconsistentlyexceededtheirlimitseventhoughreturns
on assets and earnings were decreasing.257 By February 2007, FID had a serious
balancesheetissue.258
ThisSectionoftheExaminersReportdiscussesLehmansactionswithrespectto
each of these business lines separately below. This Section also discusses the major
personnelmoveduringthefirsthalfof2007thereplacementofMichaelGelbandwith
Roger Nagioff as the head of FID. Finally, this section discusses the extent to which
254Lehman,SecuritizedProducts,MBS:NonInvestmentGradeRetainedInterests(Jan.16,2007),atpp.1,
3 [LBEXDOCID 839039], attached to email from James Guarino, Lehman, to Richard McKinney,
Lehman,etal.(Jan.16,2007)[LBEXDOCID865925].
255SeeSectionIII.A.1.b.1ofthisReport.
256SeeSectionIII.A.1.b.2.dofthisReport.
257Lehman,FixedIncomeDivisionBalanceSheetManagement(Apr.2007),atp.2[LBEXDOCID787297],
attachedtoemailfromKieronKeating,Lehman,toDavidN.Sherr,Lehman,etal.(June6,2007)[LBEX
DOCID808850];LehmanBalanceSheetandDisclosureScorecardForTradeDateApr.21,2008(Apr.22,
2008),atp.3[LBEXDOCID3187588],attachedtoemailfromTalLitvin,Lehman,toHerbertH.McDade
III,Lehman,etal.(Apr.22,2008)[LBEXDOCID3187333].
258EmailfromJosephGentile,Lehman,toMichaelGelband,Lehman,etal.(Feb.21,2007)[LBEXDOCID
810934].
81

Lehmans officers informed the Board of Directors of the continuing expansion of
Lehmansbalancesheetandrisktaking.
(a) LehmansResidentialMortgageBusiness
(i) LehmanDecidestoCurtailSubprimeOriginationsbut
ContinuetoPursueAltAOriginations
Inthesecondhalfof2006,Lehmanbegantoseethefirstcracksinthesubprime
mortgage market.259 Lehman reacted to these signs by tightening its origination
standards,particularlywithrespecttosubprimemortgages,260butLehmancontinuedto
pursue growth in its mortgage origination business generally, particularly through its
AltA originator, Aurora.261 AltA loans are a somewhat loosely defined category
between prime and subprime that are designed for borrowers with good credit
records who do not meet standard guidelines for documentation requirements.262
259Examiners Interview of Thomas L. Wind, Apr. 21, 2009, at p. 8; Examiners Interview of Susan
Harrison, Apr. 28, 2009, at pp. 2, 5; Examiners Interview of Marie Jean Burruel, Apr. 28, 2009, at p. 5;
Dimitrios Kritikos, Lehman, BNC Risk Review December 2006 (Jan. 20, 2007), at p. 50 [LBEXDOCID
251077];DimitriosKritikos,Lehman,RiskReview:AuroraandBNCFebruary2007(Mar.19,2007),atp.
10[LBEXDOCID188325].
260Dimitrios Kritikos, Lehman, BNC Risk Review December 2006 (Jan. 20, 2007), at p. 6 [LBEXDOCID
251077];Lehman,MaterialsPreparedforOfficeofThriftSupervisionSafetyandSoundness/Compliance
Examination2007(Aug.13,2007),atpp.1315[LBEXDOCID538654];Lehman,PresentationtoMoodys
[Draft] (Oct. 16, 2007), at pp.1215 [LEHFINRAEMAIL00088455]; Lehman, Presentation to Radian:
MortgageOperationsReview(July24,2007),atpp.1517[LBEXDOCID839141];ExaminersInterviewof
MarieJeanBurruel,Apr.28,2009,atpp.810;ExaminersInterviewofDimitriosKritikos,Apr.16,2009,at
p.8.
261DimitriosKritikos,Lehman,AuroraLoanServicesRiskReviewJanuary2008(Feb.7,2008),atpp.10,
12[LBEXDOCID394711].
262SaundraF.Braunstein,DirectorofDivisionofConsumerandCommunityAffairs,BoardofGovernors
oftheFederalReserve,TestimonyBeforeU.S.HouseofRepresentativesCommitteeonFinancialServices,
Subcommittee on Financial Institutions and Consumer Credit (Mar. 27, 2007); see also Lehman, Product
Definitions of AltA, Mortgage Maker, and Subprime (Oct. 17, 2007), at p. 1 [LBEXDOCID 537902];
82

Although Lehmans AltA mortgages were never as risky as subprime mortgages, its
AltAmortgagesbecameincreasinglyriskytowardstheendof2006andthebeginning
of2007.263ThisportionoftheReportdescribesthoseevents.
Lehman considered its residential mortgage securitization business to be a
distribution business.264 Lehman had a vertically integrated residential mortgage
businessinwhichBNCoriginatedsubprimeloansandAuroraoriginatedAltAloans,
and Lehman itself securitized pools of those mortgages into residential mortgage
backed securities (RMBS).265 BNC and Aurora were part of Lehmans Mortgage
CapitalDivision,whichoriginatedresidentialmortgages,whileFIDwasresponsiblefor
securitizing the mortgages.266 By selling the RMBS to investors, Lehman shifted the
risks of the underlying mortgages to the investors.267 Lehman, however, bore the risk
thatitwouldnotbeabletosecuritizethemortgagesorselltheRMBS.268Themortgages
Cynthia Angell & Clare D. Rowley, Federal Deposit Insurance Corp., FDIC Outlook (Second Quarter
2006)(lastupdatedMar.21,2007)
(http://www.fdic.gov/bank/analytical/regional/ro20062q/na/2006_summer04.html)
263Email from Dimitrios Kritikos, Lehman, to Jeffrey Goodman, Lehman (Jan. 31, 2007) [LBEXDOCID
380035]; Dimitrios Kritikos, Lehman, Selected trends from Aurora Risk Review (Feb. 2, 2007), at p. 2
[LBEXDOCID537846];ExaminersInterviewofDimitriosKritikos,July29&30,2009,atpp.12,1415.
264Madelyn Antoncic, Lehman, 2007 Bondholder Meeting Presentation (Oct. 18, 2007), at p. 6 [LBEX
DOCID 244792]; Lehman, Presentation to Standard and Poors, Lehman Brothers Securitized Products
Business(Oct.7,2005),atp.2[LBEXDOCID095356];Lehman,StrategicandFinancialReview(Jan.18,
2008),atp.9[LBEXDOCID1412341];ExaminersInterviewofRichardMcKinney,Aug.27,2009,atp.5.
265VikasShilpiekandula,Lehman,AnOverviewoftheResidentialMortgageMarket(Oct.25,2007),atp.
2[LBEXDOCID894664].
266ExaminersInterviewofDavidN.Sherr,May6,2009,atp.4.
[LBEXDOCID839039].
268Id.;Lehman, Presentation to Standard and Poors, Lehman Brothers Securitized Products Business
(Oct.7,2005),atpp.9,10[LBEXDOCID095356].
83

thatLehmancouldnotshifttothirdpartyinvestorsthroughsecuritizationwereknown
asretainedinterests.269
Bylate2006,Lehmansnoninvestmentgraderetainedinterestsbegantoincrease
sharply;investorsweregrowingincreasinglycautiousaboutpurchasingRMBSbonds
backed by subprime mortgages, and as a result the [Lehman residential mortgage
trading] desk [was] struggling to sell residuals and [noninvestment grade] bonds.270
Lehmans diminished ability to shift the mortgagebased risk to investors meant that
the formerly profitable moving business could become a moneylosing storage
business.271
At the same time, Lehmans mortgage business experienced other troubling
trends,includingsharpincreasesinrepurchaserequests,risesindelinquencyratesand
a spike in firstpayment defaults.272 By the fourth quarter of 2006, Lehmans internal
researchreportsweresuggestingthatinvestorsinRMBSbonds,andparticularlythose
backedbysubprimemortgages,wouldbecomeincreasinglyriskaverse,andsubprime
backedRMBSbondswouldbeatheightenedriskofaratingagencydowngrade.273
[LBEXDOCID839039];seealsoLBHI_SEC07940_58117410Q(filedApr.9,2008),atpp.20,55.
[LBEXDOCID839039].
271Id.atp.1.
272ExaminersInterviewofSusanHarrison,Apr.28,2009,atpp.2,5;DimitriosKritikos,Lehman,BNC
RiskReviewDecember2006(Jan.20,2007),atp.50[LBEXDOCID251077];DimitriosKritikos,Lehman,
RiskReview:AuroraandBNCFebruary2007(Mar.19,2007),atp.10[LBEXDOCID188325].
273Srinivas Modukuri, Lehman, Securitized Products Outlook for 2007: Bracing for a Credit Downturn
(Dec.2006),atpp.8,19[LBEXDOCID245013].
84

Because ofthesetrends,Lehman tightenedits subprimelendingoperations. In
about August 2006, Lehman replaced BNCs CEO and also created a new executive
position (filled by Thomas L. Wind) to oversee both BNC and Aurora operations.274
Wind and new BNC CEO Steven Skolnik initiated changes to BNCs underwriting
guidelinesandproductmix.275Thesechangesincludedreductioninthesizeofoneof
BNCs leading lending programs, known as 80/20, in which BNC extended two
separateloanstobringtheborrowersloantovalueratioto100%basedonlyonincome
dataasstatedbytheborrower.276Productionunderthe80/20programdroppedbytwo
thirds from 2005 to 2006, and BNC discontinued the program entirely in late March
2007.277Yeteveninearly2007,BNCwasoriginatingasubstantialquantityofsubprime
mortgages (about $750 million worth during the month of February 2007, for
274ExaminersInterviewofThomasL.Wind,Apr.21,2009,atpp.3,8;ExaminersInterviewofDimitrios
Kritikos,July2930,2009,atpp.89;ExaminersInterviewofRichardMcKinney,Aug.27,2009,atpp.56;
ExaminersInterviewofLanaFranksHarber,Sept.23,2009,atp.6;Lehman,PresentationtotheOfficeof
ThriftSupervision,LehmanBrothersBank,FSB:Safety&Soundness/ComplianceExamination2007(Aug.
7, 2007), at p. 5 [LBEXDOCID 1693347]; Lehman, Update on Lehman Brothers Subprime Mortgage
Origination Business Presentation to Lehman Board of Directors (Mar. 20, 2007), at p. 6
[LBHI_SEC07940_025834].
275ExaminersInterviewofThomasL.Wind,Apr.21,2009,atpp.6,78.
276Dimitrios Kritikos, Lehman, BNC Risk Review December 2006 (Jan. 20, 2007), at p. 6 [LBEXDOCID
251077];ExaminersInterviewofMarieJeanBurruel,Apr.28,2009,atpp.810.
277Lehman, Materials Prepared for Office of Thrift Supervision Safety and Soundness/Compliance
Examination 2007 (Aug. 13, 2007), at p. 13 [LBEXDOCID 538654]; Lehman, Presentation to Moodys
[Draft] (Oct. 16, 2007), at p. 12 [LEHFINRAEMAIL00088444]; Lehman, Presentation to Radian:
Mortgage Operations Review (July 24, 2007), at p. 14 [LBEXDOCID 839141]; Examiners Interview of
MarieJeanBurruel,Apr.28,2009,atpp.810;ExaminersInterviewofDimitriosKritikos,Apr.16,2009,at
p.8.
85

example).278 Lehman did not discontinue subprime lending (as Lehman defined it)
throughBNCuntilitsclosureofBNConAugust22,2007.279
Lehman executives had different recollections concerning whether managers
withinFIDhadadvocatedanearlierandmorerapidreductioninLehmanssubprime
mortgageoriginations.280CertainFIDexecutivesnotedthatLehmanmanagersfromthe
Mortgage Capital Division wished to continue aggressive origination and that
MortgageCapitalsviewprevailed,whileothersinMortgageCapitaldidnotrecallthe
disagreement or maintained that FID could have reduced originations itself if it
wished.281
278Dimitrios Kritikos, Lehman, Risk Review: Aurora and BNC February 2007 (Mar. 19, 2007), at p. 6
[LBEXDOCID188325].
279ExaminersInterviewofLanaFranksHarber,Sept.23,2009,atp.12;ExaminersInterviewofTheodore
P. Janulis, Sept. 25, 2009, at p. 3; Examiners Interview of Marie Jean Burruel, Apr. 28, 2009, at p. 10;
Lehman Brothers Holdings Inc., Press Release: Lehman Brothers Announces Closure of BNC Mortgage
(Aug. 22, 2007) [LBEXDOCID 880148]; Lehman, Subprime(r) (Sept. 4, 2007), at p. 14 [LBEXDOCID
894656];emailfromEdwardGrieb,Lehman,toChristopherM.OMeara,Lehman(Aug.22,2007)[LBEX
DOCID197143];emailfromTashaPelio,Lehman,toJasjit(Jesse)Bhattal,Lehman,etal.(Aug.22,2007)
[LBEXDOCID176893].
280ExaminersInterviewofKentaroUmezaki,June25,2009,atpp.2,15;ExaminersInterviewofMichael
Gelband,Aug.12,2009,atpp.2,1012;ExaminersInterviewofLanaFranksHarber,Sept.23,2009,atpp.
4,6;ExaminersInterviewofTheodoreP.Janulis,Sept.25,2009,atpp.3,5.
CompareExaminersInterviewofKentaroUmezaki,June25,2009,atpp.2,15(statingthathe,Gelband
281
and Sherr, wanted to scale back originations while Janulis did not); Examiners Interview of Michael
Gelband,Aug.12,2009,atp.11;(recallingthataslateas2007,herecommendedmanagingtheresidential
realestatebusinessmoreconservatively,andthatingeneral,MCDhadanincentivetocontinuetopush
fororiginationsbecauseitwasrewardedwhenitsoriginationvolumeswerehighandtheriskwasshifted
to the Securitized Products Group after the mortgages were originated.), with Examiners Interview of
DavidN.Sherr,Sept.25,2009,atpp.23,45(statingthathedidnotrecalladisputebetweenMCDand
FID over any proposed scaling back of originations, but that there was tension between FID and MCD
overthecontroloftheresidentialmortgageoriginationbusiness,);ExaminersInterviewofTheodoreP.
Janulis,Sept.25,2009,atpp.3,5(statingthathedidnotrecalladisagreementaboutwhetheroriginations
shouldbeslowedandthatFIDcouldhaveslowedoriginationvolumesifitwishedtodoso);Examiners
Interview of Lana Franks Harber, Sept. 23, 2009, at p. 6. (stating that she did not recall internal
86

EvenasLehmanwastighteningstandardsonitssubprimeoriginationsthrough
BNC, Lehman was also using its Aurora subsidiary to expand its AltA lending.282
Moreover,AurorasAltAlendingreachedborrowersoflessercreditqualitythanthose
whohistoricallyhadbeenconsideredAltAborrowers.283Thevehicleforthataspectof
the Aurora business plan was the Mortgage Maker product.284 As Mortgage Maker
expanded to more than half of Auroras AltA production by February 2007, many of
Auroras loans denominated as AltA came more and more to resemble the subprime
loans that Lehman was supposedly exiting by tightening origination standards at
BNC.285
By late January 2007, Lehmans residential mortgage analyst began to notice
disturbingtrendswithrespecttoAurorasMortgageMakerprogram:
presentations by Gelband questioning the continued viability of subprime residential lending); see also
ExaminersInterviewofJosephGregory,Nov.13,2009,atp.10(suggestingthatheagreedwithMCDs
viewandapprovedastrategyofcontinuingtooriginateresidentialmortgagesaggressively).
282ExaminersInterviewofCarlPeterson,May27,2009,atpp.68.
283Id.atpp.57.
284Id. at p. 5; Examiners Interview of Diane May, Apr. 16, 2009, at p. 5; Aurora Loan Services,
PresentationtoSecuritiesandExchangeCommission(Feb.67,2007),atp.2[LBEXDOCID357348].
285ExaminersInterviewofDavidN.Sherr,May6,2009,atp.8;ExaminersInterviewofJohnVedra,Apr.
15,2009,atp.8;ExaminersInterviewofDianeMay,Apr.16,2009,atp.5;DimitriosKritikos,Lehman,
Risk Review: Aurora and BNC February 2007 (Mar. 19, 2007), at p. 4 [LBEXDOCID 188325]; see also e
mail from Dimitrios Kritikos, Lehman, to Ken Linton, Lehman, et al. (Mar. 30, 2007) [LBEXDOCID
286265](notingthattheriskiersegmentsofMortgageMakerperformedthreetofivetimesworsethanthe
restofAurorasloans);RussellV.Brady,Aurora,ResponsetoLXSPerformanceIssues(Jan.24,2007),atp.
1 [LBEXDOCID 885450] (suggesting that Aurora needed to [d]etermine whether a segment of the
[Mortgage]Makerpopulationshouldbeservicedsimilartosubprime);emailfromRichardMcKinney,
Lehman, to Thomas L. Wind, Aurora, et al. (Feb. 12, 2007) [LBEXDOCID 1369758] (noting that the
performance of Lehmans LXS securitizations that consisted mostly of Mortgage Maker had worsened
versusitslargestcompetitorfor2006production,andstatingExpectedsubordinationlevelsare11.7%to
AAA loss coverage. This compares with 2025% for a typical subprime deal. That is, we are creating
worse performance than subprime, while the rating agencies assume our performance should be
substantiallybetter).
87

Looking at the trends on originations and linking them to first payment

defaults,thestoryisugly:ThelastfourmonthsAurorahasoriginatedthe
riskiest loans ever, with every month being riskier than the one before
theindustrymeanwhilehaspulledbackduringthattime.286
Atthesametime,otherparticipantsintheAltAindustrywerereportingdefaultrates
andlatepaymentdatathatindicatedthat[t]hecreditdeterioration[inAltA]hasbeen
almostparalleltotheoneofthesubprimemarket.287Thus,whileAurorasmortgages
werenotasriskyassubprimemortgages,Aurorasriskprofilewasincreasinginmuch
thesamewayastheriskinsubprimemortgages.
Asaresultofallthesefactors,Lehmansriskmanagerssometimesconsideredthe
Mortgage Maker loans to be distinct from AltA mortgages, and described Mortgage
MakerasAltB.288WhilethetermAltBwasnotanacceptedtermorcategorizationin
the business, Lehmans managers occasionally used it as a way of differentiating the
riskier mortgages in the Mortgage Maker program from what had more traditionally
beenconsideredAltAmortgages,thoughnotsoriskyastomeritthelabelsubprime.289
286Email from Dimitrios Kritikos, Lehman, to Jeffrey Goodman, Lehman (Jan. 31, 2007) [LBEXDOCID
380035].
287DimitriosKritikos,Lehman,RiskReview:AuroraandBNCFebruary2007[Draft](Mar.9,2007),atp.1
[LBEXDOCID538518].
288EmailfromDimitriosKritikos,Lehman,toJefferyGoodman,Lehman(Mar.12,2007)[LBEXDOCID
307101] (Auroras product is far from AltA anymore. The traditional AltA program is only 40% of
Auroras production); email from Dimitrios Kritikos, Lehman, to Charlie Lu, Lehman (Apr. 12, 2007)
[LBEXDOCID 566105] (MortgageMaker is NOT AltA); Dimitrios Kritikos, Lehman, Selected trends
fromAuroraRiskReviewFebruary2007(Feb.2,2007),atp.2[LBEXDOCID537846](Theproductmix
ofAuroraproductionhasshiftedsubstantiallyinthelast6monthsfromAltAtoMortgageMaker(Alt
B)).
289DimitriosKritikos,Lehman,SelectedtrendsfromAuroraRiskReviewFebruary2007(Feb.2,2007),at
p. 2 [LBEXDOCID 537846]; Examiners Interview of Dimitrios Kritikos, July 2930, 2009, at pp. 3, 18
(statingthatMortgageMakerloanswereneitherAltAnorsubprime).
88

To make matters worse, Lehmans risk managers saw indications that Lehman
wouldnotbeabletodistributetheriskonthemortgagesitwasoriginating.ByJanuary
2007,itwasapparentthatLehmansholdingofnoninvestmentgraderetainedinterests
insecuritizationshadbeenincreasing.290AndbyMarch2007,Lehmanwasnotingsharp
declinesinsecuritizationrevenue,291causingtheSecuritizedProductsGroupwithinFID
toexceeditsriskappetiteandVaRlimits.292
TorespondtotheserisksinitsAltAportfolio,inMarch2007Lehmanundertook
aseriesofchangesdesignedtomakeMortgageMakerloanslessavailabletoborrowers
with lower credit scores, or to borrowers who wished to take out loans at 100% of a
homesvalue.293AlthoughthevolumeofMortgageMakerloansoriginatedbyLehman
[LBEXDOCID839039].
291Lehman,MortgageUpdate1Q07,atp.9[LBHI_SEC07940_845984].
292See, e.g.,George Hansman, Lehman, Securitized Products Risk Appetite and VaR limit and overage
graphs(May17,2007)[LBEXDOCID861260];emailfromLehmanRisk,toLehmanRiskLimitExcesse
mailgroup(Mar.8,2007)[LBEXDOCID229930];emailfromLehmanRisk,toLehmanRiskLimitExcess
email group (Mar. 19, 2007) [LBEXDOCID 229944]; email from Lehman Risk, to Lehman Risk Limit
Excess email group (Mar. 22, 2007) [LBEXDOCID 229954]; email from Lehman Risk, to Lehman Risk
Limit Excess email group (Apr.9, 2007) [LBEXDOCID 790039]; email from Lehman Risk, to Lehman
Risk Limit Excess email group (Apr.16, 2007) [LBEXDOCID 790029]; email from Lehman Risk, to
LehmanRiskLimitExcessemailgroup(May29,2007)[LBEXDOCID790059];emailfromLehmanRisk,
to Lehman Risk Limit Excess email group (May30,2007) [LBEXDOCID 790060]; email from Lehman
Risk, to Lehman Risk Limit Excess email group (Sept. 5, 2007) [LBEXDOCID 230188]; email from
LehmanRisk,toLehmanRiskLimitExcessemailgroup(Oct.12,2007)[LBEXDOCID230789903];email
fromLehmanRisk,toLehmanRiskLimitExcessemailgroup(Oct.17,2007)[LBEXDOCID789908];e
mailfromLehmanRisk,toLehmanRiskLimitExcessemailgroup(Oct.18,2007)[LBEXDOCID789910];
email from Lehman Risk, to Lehman Risk Limit Excess email group (Oct. 19, 2007) [LBEXDOCID
789909]; email from Lehman Risk, to Lehman Risk Limit Excess email group (Oct. 22, 2007) [LBEX
DOCID 790089]; email from Lehman Risk, to Lehman Risk Limit Excess email group (Oct. 30, 2007)
[LBEXDOCID789916].
293Dimitrios Kritikos, Lehman, Risk Review: Aurora and BNC February 2007 (Mar. 19, 2007), at p. 3
[LBEXDOCID188325](summarizingunderwritingguidelinechangesatBNCandAurora).
89

declined following implementation of the March 2007 guideline changes, Lehman
continuedtooriginatesignificantvolumesofAltAmortgagesuntilAugust2007.294
(ii) TheMarch20,2007BoardMeeting
On March 20, 2007, the Mortgage Capital and Fixed Income Divisions gave a
presentation to Lehmans Board of Directors about the state of Lehmans residential
mortgage origination and securitization business in light of the deepening subprime
crisis.295 The presentation was given by David N. Sherr, the head of Lehmans
Securitized Products Group; Theodore P. Janulis, the head of the Mortgage Capital
Division; and Lana Franks Harber, Chief Administrative Officer (CAO) of the
MortgageCapitalDivision.296
Whilepreparingtogivethispresentation,Harberemailedoneofhercolleagues
to inform him about a conversation that she had with Lehmans President, Joseph
Gregory,aboutthepresentation:
BoardisnotsophisticatedaroundsubprimemarketJoedoesntwanttoo
muchdetail.HewantstocandidlytalkabouttheriskstoLehmanbutbe
294Dimitrios Kritikos, Lehman, Aurora Loan Services Risk Review January 2008 (Feb. 7, 2008), at p. 12
[LBEXDOCID394711].
295Lehman Brothers Holdings Inc., Minutes of Meeting ofBoard of Directors (Mar.20,2007),at pp.67
[LBHI_SEC07940_025779]; Lehman, Update on Lehman Brothers Subprime Mortgage Origination

BusinessPresentationtoLehmanBoardofDirectors(Mar.20,2007)[LBHI_SEC07940_025834].
Lehman Board of Directors (Mar. 20, 2007) [LBHI_SEC07940_025834]; Examiners Interview of Lana
FranksHarber,Sept.23,2009,atp.2;ExaminersInterviewofTheodoreP.Janulis,Sept.25,2009,atp.2;
ExaminersInterviewofDavidN.Sherr,Sept.25,2009,atp.9.
90

optimisticandconstructivetalkabouttheopportunitiesthatthismarket
createsandhowweareuniquelypositionedtotakeadvantageofthem.297
Consistentwiththisdirection,theBoardpresentationemphasizedthatLehmans
managementconsideredthecrisisanopportunitytopursueacountercyclicalstrategy.298
TheMarch2007Boardpresentationfirstnotedthedifficultiesinthesubprimemarket,
includingthefactthatsevenofthetoptwentysubprimeoriginatorshadalreadybeen
soldtostrongerpartnersorgonebankruptandthatthebusinesswassignificantlyless
profitable than in past years because of lower origination volumes, lower sale and
securitization margins, and increased loan loss reserves.299 The presentation further
noted that in response to these market events, Lehman had improved BNCs risk and
credit profile, tightened its lending criteria, retained new management, and
significantlyreducedheadcount.300
The presentation concluded by highlighting managements belief that Lehman
hadsubstantialopportunities,asinlate1990stoimproveitscompetitiveposition.301
This countercyclical strategy was based on several stated premises. Most important,
LehmansmanagementbelievedthatthesubprimecrisiswouldpresentonlyaLimited
ContagionToOtherMarketsinparticular,Lehmansmanagementdidnotexpectthe
297Email from Lana Franks Harber, Lehman, to Steven Skolnik, BNC Mortgage, et al. (Mar. 9, 2007)
[LBEXDOCID 306198]; accord Examiners Interview of Lana Franks Harber, Sept. 23, 2009, at pp. 910;
ExaminersInterviewofTheodoreP.Janulis,Sept.25,2009,atp.6.
LehmanBoardofDirectors(Mar.20,2007),atpp.1,10[LBHI_SEC07940_025834].
299Id.atpp.45.
300Id.atpp.67.
301Id.atp.10.
91

subprime crisis to have a significant impact on the [b]roader credit markets.302
Lehmansmanagementalsobelievedthatasubstantialpartof[the]subprimemarket
isheretostayandthat[p]rofitabilitywillreturnwhenenvironmentimproves.303In
sum,Lehmanmanagementthoughtthatthemarketwasnearingthebottomofthecycle
in spring and summer of 2007, and that Lehman would benefit from preserving the
optiontoexpandthebusinessinthefuture.304ManagementinformedtheBoardthatthe
down cycle in subprime presented substantial opportunities for Lehman, and that
management expected Lehman to be better positioned for profitable growth once the
industrycycleturned.305
The presentation did not discuss Auroras AltA mortgage originations at all,
notwithstanding the significant concerns that Lehmans residential mortgage analyst
hadrecentlyraisedaboutthatgroupofmortgages.306Instead,thepresentationgrouped
theAltAcategoryofmortgageswithprimeanddescribedPrime/AltAMortgagesas
follows: credit performance not problematic delinquencies are within expected
range.307 Anearlier draft oftheslideshowpresentedto the Board hadused theterm
AltA/AltB Mortgages above the words credit performance not problematic
302Id.atp.9.
303Id.atp.10.
P.Janulis,Sept.25,2009,atp.8;ExaminersInterviewofDavidN.Sherr,Sept.25,2009,atp.6.
305Lehman,UpdateonLehmanBrothersSubprimeOriginationBusinessPresentationtoLehmanBoard
ofDirectors(Mar.20,2007),atpp.1,10[LBHI_SEC07940_025834].
306Id.atpp.110.
307Id.atp.9.
92

delinquenciesarewithinexpectedrange,308butthisreferencetoAltBwasdeletedfrom
thefinalversionofthematerialsinfavorofPrime/AltAMortgages.309
Sherr,Janulis,andHarbertoldtheExaminerthattheydidnotincludeaspecific
referenceto Mortgage Maker or AltBintheir presentation becausethey believed that
the loans in the Mortgage Maker program were distinct from subprime mortgages,
whichwerethesubjectofthepresentation.310TheLehmanriskanalystwhohadstudied
the performance issues in Mortgage Maker told the Examiner that leaving Mortgage
Maker out of a presentation on subprime was proper given the differences between
what Lehman considered subprime (FICO scores below 620) and Mortgage Maker
(averageFICOscoreof691).311
After the Board presentation, Lehman continued to originate subprime and
especially AltA/AltB mortgage loans, thereby pursuing its countercyclical strategy,
andlikelyexacerbatingLehmansresidentialmortgagelosses.TheExaminersfinancial
advisors have estimated the losses from residential mortgage positions from the first
quarterof2007throughthethirdquarterof2008at$7.4billion.312
308Lehman,StateofLehmanBrothersSubprimeMortgageOriginationBusinessPresentationtoLehman
BoardofDirectors[Draft](Mar.15,2007),atp.12[LBEXDOCID2485576].
309Lehman,UpdateonLehmanBrothersSubprimeOriginationBusinessPresentationtoLehmanBoard
ofDirectors(Mar.20,2007),atp.9[LBHI_SEC07940_025834].
P.Janulis,Sept.25,2009,atpp.2,7;ExaminersInterviewofDavidN.Sherr,Sept.25,2009,atp.7.
311ExaminersInterviewofDimitriosKritikos,July2930,2009,atp.19.
312Lehman,MortgageUpdate1Q07(Apr.9,2007)[LBEXDOCID540069];Lehman,MortgageUpdate
2Q07(June8,2007)[LBEXDOCID505835];Lehman,MortgageUpdateJune07(Aug.9,2007)[LBEX
DOCID611902];Lehman,MortgageUpdateAugust07(Sept.25,2007)[LBEXDOCID505889];Lehman,
93

Theselossesweretemperedbyeffectivehedgingstrategiesthroughatleast2007
andintoearly2008.313Betweenthefirstquarterof2007andthethirdquarterof2008,
Lehmanhadagainof$2.96billiononitsresidentialmortgagecredithedges.314Ofthis
$2.96 billion gain, $2.623 billion was gained between the first quarter of 2007 and the
endofthefirstquarterof2008.315Forthesecondandthirdquartersof2008,however,
Lehman had essentially no gains on its hedges.316 As a result, during those quarters,
Lehmansufferedverysubstantiallossesonitsresidentialmortgagebusiness.317
Flash Mortgage Update November 07(Dec. 21, 2007) [LBEXDOCID 505890];Lehman, Flash
MortgageUpdateJanuary07(Feb.15,2008)[LBEXDOCID3237972];Lehman,FlashMortgageUpdate
March 07(Apr. 23,2008) [LBEXDOCID 2432630]; Lehman, Flash Mortgage Update Apr. 07(May
15,2008) [LBEXDOCID 1362958]; Lehman, Flash Mortgage Update May 07(June 11,2008) [LBEX
DOCID3238001];Lehman,SecuritizedProductsP&LJune2008(July11,2008)[LBEXDOCID505776];
Lehman,SecuritizedProductsP&LJuly2008(Aug.14,2008)[LBEXDOCID505778].
313ExaminersInterviewofKentaroUmezaki,June25,2009,atp.17;Lehman,MinutesofMeetingofthe
BoardofDirectors(Sept.11.2007),atp.6[LBHI_SEC07940_263264].
314Lehman,MortgageUpdate1Q07(Apr.9,2007)[LBEXDOCID540069];Lehman,MortgageUpdate
2Q07(June8,2007)[LBEXDOCID505835];Lehman,MortgageUpdateJune07(Aug.9,2007)[LBEX
DOCID611902];Lehman,MortgageUpdateAugust07(Sept.25,2007)[LBEXDOCID505889];Lehman,
Flash Mortgage Update November 07(Dec. 21, 2007) [LBEXDOCID 505890];Lehman, Flash
MortgageUpdateJanuary07(Feb.15,2008)[LBEXDOCID3237972];Lehman,FlashMortgageUpdate
March 07(Apr. 23,2008) [LBEXDOCID 2432630]; Lehman, Flash Mortgage Update Apr. 07(May
15,2008) [LBEXDOCID 1362958]; Lehman, Flash Mortgage Update May 07(June 11,2008) [LBEX
DOCID3238001];Lehman,SecuritizedProductsP&LJune2008(July11,2008)[LBEXDOCID505776];
Lehman,SecuritizedProductsP&LJuly2008(Aug.14,2008)[LBEXDOCID505778].
315Id.
316LBHI10Q(July10,2008),atp.67.
317 The Examiners financial advisors estimate that Lehmans secured losses from residential mortgages
exceeded$1billioninthesecondquarterandinexcessof$3.5billioninthethirdquarterof2008.
94

(b) TheExplosioninLehmansLeveragedLoanBusiness
During the first half of fiscal 2007, the high yield market was active,
notwithstandingtheonsetofthecrisisinthesubprimeresidentialmortgagemarket.318
Like other market actors during this period, Lehman participated in more leveraged
finance deals than ever before and entered into deals that were generally bigger than
the leveraged finance deals it had done in the past.319 Compared to its competitors,
Lehmanwasthemostaggressivelenderperdollarofshareholderequityinthefirsthalf
of2007.320
Lehmancontinueddownthispathdespitethefactthatthetermsofthesedeals
became less and less favorable over time from an investment banking perspective.
Because there was so much competition to finance these loans, sponsors were able to
negotiate terms that significantly increased the risk to the banks. For example,
according to some estimates, covenant light loans loans that did not include
previously standard covenants requiring the borrower to maintain certain levels of
collateral,cashflow,andpaymenttermsincreasedfromlessthan1%ofallleveraged
318Email from Roopali Hall, Lehman (Jan. 4, 2008) [LBHI_SEC07940_066187]; Lehman Loan Syndicate,
YearEndRecap(Jan.7,2008),atp.1[LBHI_SEC07940_066190].
319EmailfromEvetteSaldana,Lehman,toHYCCmembers,Lehman,etal.(June15,2007)[LBEXDOCID
494525];LehmanCreditFacilitationGroup,2ndQuarter2007Review(June2007),atp.1[LBEXDOCID
514908],attachmenttoemailfromEvetteSaldana,Lehman,toHYCCmembers,Lehman,etal.(June15,
2007)[LBEXDOCID494525].
320EmailfromEvetteSaldana,Lehman,toHYCCmembers,Lehman,etal.(June15,2007)[LBEXDOCID
494525];LehmanCreditFacilitationGroup,2ndQuarter2007Review(June2007),atp.6[LBEXDOCID
514908], attached to email from Evette Saldana, Lehman, to HYCC members, Lehman, et al. (June 15,
2007)[LBEXDOCID494525].
95

loans in 2004 to over 18% by 2007 industrywide.321 Lenders such as Lehman also
abandoned certain contractual protections (e.g., material adverse change provisions
(MACs),upfrontsyndication,andjointliability)thatwerepreviouslystandardinthe
leveragedloanindustry.322Insomedeals,Lehmanwastheonlypartytosignthelegal
documents, even though other banks were intended to commit to the loans; thus,
Lehman initially bore all the risk.323 As ofMarch 2007, the rating agenciesperceived
looseningof[Lehmans]riskstandardsparticularlyinleveragedlending....324The
Examiner has not investigated whether the contractual terms of Lehmans leveraged
lendingtransactionsweremoreaggressivethanthoseofitscompetitors.
Between December 2006 and June 2007, Lehman participated in more than 11
leveraged buyout deals that each exceeded $5 billion.325 By April 2007, Lehman had
approximately70highyieldcontingentcommitmentsinitspipelinearecordnumber
321Eric Felder, Lehman, Credit Outlook Presentation (Apr. 16, 2008), at p. 48 [LBHI_SEC07940_393578],
attached to email from Christopher Wichenbaugn, Lehman, to DCMNY, Lehman (Apr. 16, 2008)
[LBHI_SEC07940_393578]; Standard & Poors and LSTA, Leveraged Loan Index, August 2008 Review
(Sept.3,2008),atp.84[LBEXDOCID4404712],attachedtoemailfromKristenVigletta,Lehman(Sept.3,
2008)[LBEXDOCID4326914].
322ExaminersInterviewofMadelynAntoncic,Feb.25,2009,atp.4.
323Id.
324Lehman, Credit Ratings Strategy Presentation (Mar. 1, 2007), at p. 13 [LBEXDOCID 618355]; email
fromStephenLax,Lehman,toJamesP.Seery,Jr.Lehman,etal.(Apr.11,2008)[LBEXDOCID444768].
325EmailfromMiriamOh,Lehman,toPaulParker,Lehman,etal.(July5,2007)[LBEXDOCID3197652];
Lehman,BigLBOUpdate(July3,2007),atp.2[LBEXDOCID3183564].
96

for it.326 In June 2007, Lehmans lending pace had already doubled Lehmans 2006
recordsettingyearforhighgradeandhighyieldcombined.327
When the market started to slow, Lehman suddenly found itself with a huge
volume of commitments on its books and a risk profile that was well above its high
yield businesss risk appetite limits. At the end of the second quarter of 2007,
approximately $36 billion ofcontingentcommitmentsremainedonLehmansbooks.328
FIDwasalmost$20billionoveritsnetbalancesheetlimitforthequarter.329Relatedly,
as described below, Lehman soon vastly exceeded its risk appetite limits for the high
yieldbusiness.
(i) RelaxationofRiskControlstoAccommodateGrowth
ofLehmansLeveragedLoansBusiness
ToaccommodatethegrowthofLehmanshighyieldlendingactivities,Lehmans
managementdecidedtoloosenseveralofthefirmsriskcontrolsthatotherwisewould
havelimitedthefirmsabilitytoengageinmanyofthesedeals.Mostsignificantly,as
discussed above, Lehmans senior management approved a number of deals that
exceededthefirmssingletransactionlimit.
326EmailfromStephenLax,Lehman,toAlexKirk,Lehman,etal.(Apr.26,2007)[LBEXDOCID259369].
327Lehman Credit Facilitation Group, 2nd Quarter 2007 Review (June 2007), at p. 13 [LBEXDOCID
514908], attached to email from Evette Saldana, Lehman, to HYCC members, Lehman, et al. (June 15,
2007)[LBEXDOCID494525].
328AlexKirk,Lehman,LeveragedFinanceRiskPresentation(June2007)[LBEXDOCID158975],attached
toemailfromOliviaLua,Lehman,toChristopherM.OMeara,Lehman(June21,2007)[LBEXDOCID
158975].
329Lehman Brothers, Balance Sheet Trend Presentation (Apr. 2007), at pp. 46 [LBEXDOCID 251418],
attached to email from Kentaro Umezaki, Lehman, to Rebecca Miller, Lehman (May 3, 2007) [LBEX
DOCID346520].
97

Many of the leveraged loans that Lehman funded in 2006 and 2007 were way
overthelimit.330ByJuly2007,Lehmanhadcommittedtoapproximately30dealsthat
exceeded the preexisting $250 million loss threshold, nine deals that would have
exceededanewlyproposedlossthresholdof$400million,331fivedealsthatviolatedthe
notionallimitof$3.6billion,andfourdealsthatwouldhaveviolatedthenotionallimit
of$4.5billionthatwasproposedduringthefourthquarterof2007.332SomeofLehmans
commitmentsexceededthelossthresholdlimitbyafactorofsix.333Withrespectto24of
thelargesthighyielddealsinwhichLehmanparticipated,Lehmancommittedroughly
$10 billion more than the single transaction limit, if enforced, would have allowed.334
These figures arguably understate the extent to which Lehmans leveraged loans
exceededthesingletransactionlimit,sinceLehmanappliedthesingletransactionlimit
onlytotheamountoftheleveragedloanthatLehmanexpectedtofund,notthefull
amountofLehmanscommitment.335
Toaccommodatethegrowthofthehighyieldbusiness,Lehmansmanagement
alsorelaxedthehighyieldbusinesssriskappetitelimits.Despitehavingincreasedthe
330EmailfromJoeLi,Lehman,toPaulMitrokostas,Lehman(Aug.30,2007)[LBEXDOCID2547330].
331JoeLi,Lehman,STLBacktestingExcelSpreadsheet(July25,2007)[LBEXDOCID2506462],attachedto
emailfromJoeLi,Lehman,toFredS.Orlan,Lehman,etal.(July25,2007)[LBEXDOCID2563167].
332Id.
333Id.
334Lehman, Fixed Income Business Strategy, Single Transaction Limit Policy Proposed Improvements
(Sept.2007),atp.3[LBEXDOCID2563444].
335Lehman,PresentationtoLehmanExecutiveCommitteeonLeveragedFinanceRisk(Oct.16,2007),atp.
12[LBEXDOCID506033],attachedtoemailfromBlairSieff,Lehman,toStevenBerkenfeld,Lehman,et
al.(Oct.16,2007)[LBEXDOCID569915].
98

highyieldbusinesssriskappetitelimitatthebeginningof2006andagaininearly2007,
Lehmansincreasinglevelofhighyieldcommitmentscausedittoexceedthehighyield
businesssriskappetitelimitbysignificantamountsin2007and2008.336BylateApril
2007, Lehman had exceeded its newly increased high yield risk appetite limit,337 and
starting in late July, the high yield business usage consistently exceeded its limits.338
As Lehman funded more of its commitments, the leveraged loan exposure soon
doubledthelimitamount.339
Lehmans management made a conscious decision to exceed the risk appetite
limits on leveraged loans.340 Even though the risk appetite limits were divided into
subsidiarylimitsforthebusinesslinesofeachdivision,thelimitsforeachbusinessline
wereflexibleaslongastheaggregatenumbersrolledupwithinthedivisionallimit.341
One Lehman executive questioned whether the firm even had a high yield limit. In
April2007,KentaroUmezaki,HeadofFixedIncomeStrategy,emailedChristopherM.
OMeara, Lehman CFO at the time, and several others, expressing concern that in a
336Appendix:9,comparingriskappetiteandVaRusageversuslimits.
337Id.atp.3.
338Id.atp.4.
339Id.atp.49.
340Examiners Interview of Kentaro Umezaki, June 25, 2009, at p. 13; Examiners Interview of Jeffrey
Goodman,Aug.28,2009.
341ExaminersInterviewofMadelynAntoncic,Mar.27,2009,atp.12;ExaminersInterviewofMadelyn
Antoncic,Oct.6,2009,atp.7.
99

recentfirmwidemeeting,Fuldsentinconsistentmessagesbyencouraginggrowthat
thesametimeLehmanwasnearitsrisklimits.342UmezakinotedtoOMearaandothers:
the majorityof the tradingbusinessesfocusisonrevenues,withbalance

sheet, risk limit, capital or cost implications being a secondary concern.
Thefactthattheyhaventheardthatthoseitemsmatter[in]publicforums
from senior management recently reinforces this revenue oriented
behaviorimplicitly....Examplewhichwevedebatedforyears:waseven
atopicin[theTurnberrymeetingin]FLA:Doweordontwehavealimit
on how much HY LBO related lending/commitment exposure we can
have at any given time? There has been no real one firm outcome to
dateinmyopinion.ImnottheonlyonewhohasthisviewinFID.343
(c) InternalOppositiontoGrowthofLeveragedLoans
Business
LehmansFID,includingGelband,Kirk,andUmezaki,opposedanumberofthe
leveraged loan deals to which Lehman committed during this period, because they
believed that these individual deals were too risky to justify their limited returns.344
Despitetheopposition,theExecutiveCommitteedecidedtoproceedwithmanyofthe
deals.345
342Email from Kentaro Umezaki, Lehman, to Scott J. Freidheim, Lehman, et al. (Apr. 19, 2007) [LBEX
DOCID210193].
343Id.(emphasisadded);emailfromKentaroUmezaki,Lehman,toIanT.Lowitt,Lehman(Apr.18,2007)
[LBEXDOCID743931].
344Examiners Interview of Kentaro Umezaki, June 25, 2009, at p. 10; Examiners Interview of Michael
Gelband,Aug.12,2009,atpp.69;ExaminersInterviewofAlexKirk,Jan.12,2010,atp.2;emailfrom
EricFelder,Lehman,toMichaelGelband,Lehman,etal.(Aug.28,2008)[LBEXDOCID822513];seealsoe
mail from Steven Berkenfeld, Lehman, to Scott J. Freidheim, Lehman (May 11, 2007) [LBEXDOCID
1379290]; email from Bertrand Kan, Lehman, to Richard Atterbury, Lehman (Jan. 30, 2008) [LBEX
DOCID1379129].
345Examiners Interview of Kentaro Umezaki, June 25, 2009, at p. 3; Examiners Interview of Michael
Gelband,Aug.12,2009,atpp.79;ExaminersInterviewofAlexKirk,Jan.12,2010,atpp.2,7;Examiners
InterviewofPaulShotton,June5,2009,atpp.2,67;ExaminersInterviewofHughE.(Skip)McGeeIII,
Aug. 12, 2009, at p. 9; Examiners Interview of Fred S. Orlan, Sept. 21, 2009, at p. 4; email from Eric
100

Some of the opposition to Lehmans increase in leveraged lending was focused
onthebridgeequitycomponentofthosedeals.346SeveralformermembersofLehmans
senior management, including Nagioff, Antoncic, and Berkenfeld, expressed
reservations regarding the firms level of engagement in leveraged loan bridge equity
activities.347 The Examiner, however, also found that sponsors were aggressive in
demandingequitybridgecomponentstofinancing348andthattheInvestmentBanking
Division (IBD) was in favor of providing bridge equity because it believed that
Lehman needed to do so to stay competitive in the industry.349 Despite various
discussions among Lehmans management regarding whether the level of leveraged
loan bridge equity was acceptable and sustainable, Lehmans management never put
anylimitonthebusinesssleveragedloanbridgeequitycommitments.350
Felder,Lehman,toMichaelGelband,Lehman,etal.(Aug.28,2008)[LBEXDOCID822513];seealsoemail
from Steven Berkenfeld, Lehman, to LBEC Member, Lehman, et al. (May 11, 2007) [LBEXDOCID
1379290]; email from Larry Wieseneck, Lehman, to Alex Kirk, Lehman (Jan. 30, 2008) [LBEXDOCID
1379129].
346Email from Roger Nagioff, Lehman, to Madelyn Antoncic, Lehman, et al. (June 29, 2007) [LBEX
DOCID1467654);ExaminersInterviewofFredS.Orlan,Sept.21,2009,atp.7.
347Email from Roger Nagioff, Lehman, to David Goldfarb, Lehman (June 1, 2007) [LBEXDOCID
1581523];emailfromMadelynAntoncic,Lehman,toDavidGoldfarb,Lehman,etal.(June1,2007).
348Email from Steven Berkenfeld, Lehman, to Robert D. Redmond, Lehman (Sept. 23, 2007) [LBEX
DOCID1387569];emailfromAlexKirk,Lehman,to[xxxxxxx]@archwireless.net(May15,2007)[LBEX
DOCID 1379297] (phone number redacted); email from Steven Berkenfeld, Lehman, to LBEC Member,
Lehman,etal.(May11,2007)[LBEXDOCID1379291].
349ExaminersInterviewofFredS.Orlan,Sept.21,2009,atp.7.
350ExaminersInterviewofRogerNagioff,Sept.30,2009,atp.13;ExaminersInterviewofAlexKirk,Jan.
12,2010,atp.8;emailfromRobertD.Redmond,Lehman,toStevenBerkenfeld,Lehman,etal.(May19,
2007)[LBEXDOCID264270];emailfromAlexKirk,Lehman,toRobertD.Redmond,Lehman,etal.(May
21,2007)[LBEXDOCID174236];emailfromStevenBerkenfeld,Lehman,toDavidGoldfarb,Lehman,et
al.(June15,2007)[LBEXDOCID859026].
101

ByApril2007,theoverallsizeofthefirmsleveragedloancommitmentsbecame
controversial.351KirkandGelbandbecameconcernedaboutLehmansoverallexposure.
InApril2007,KirkemailedGelband:
Asaheadsupourriskofmandatedcommitsisupto6mmabptripleour
previoushigh.AlsothecommitsarecominginfastandfuriousIexpect
us to be well north of 30B this quarter. This is also unprecedented. In
addition we are now seeing commitments that have crossed the risk
tolerancesowemayneedyourhelpwiththebankinsayingnotosome
keyclients.352
Ataboutthesametime,Berkenfeld,whowasheadoftheCommitmentCommitteethat
was charged with evaluating individual leveraged loans, noted in an email: The
frenzyofthelastmonthorsoconcernsmeandIdontlikebeingbroughtinatthevery
endandexpectedtomakethesedecisionsinlessthan48hours.353
Antoncic,theCRO,alsoopposedmanyofthetransactionsandtheoverallsizeof
the business. She recalled a conversation in which she told Berkenfeld and Goldfarb
thatthefirmsleveragedloanexposurewasgettingtoolargeandthatlimitshadtobe
imposed.354 When Berkenfeld replied that he liked all of the deals that Lehman was
considering, Antoncic responded that he could like one deal or another, but not all of
thematonce.355
352EmailfromAlexKirk,Lehman,toMichaelGelband,Lehman(Apr.20,2007)[LBEXDOCID2763976].
353EmailfromStevenBerkenfeld,Lehman,toJeanFrancoisAstier,Lehman,et.al.(Mar.30,2007)[LBEX
DOCID351370].
354ExaminersInterviewofMadelynAntoncic,Mar.27,2009,atp.10.
355Id.
102

FuldbelievedthatFIDandGelbandwerenotopposedtoLehmanexpandingits
leveraged loan business.356 Fuld believed that FID simply did not want the leveraged
loansonitsownbalancesheet,becauseitreceivedcreditforonlyhalfoftheincome.357
In contrast, IBD received credit for half of the income but bore no risk.358 Fuld
consideredGelbandsconcernsanintramuralP+Lgrab,whichconcernedhim.359
(d) GrowthofLehmansCommercialRealEstateBusinessat
TheStartoftheSubprimeCrisis
AtthesametimethatLehmanwasrapidlygrowingitsleveragedloanbusiness,
Lehman also dramatically increased its commercial real estate transactions. Lehman
almostdoubledGREGsbalancesheetlimitfrom$36.5billioninthefirstquarter2007to
$60.5billioninthefirstquarter2008,withGREGregularlyexceedingitsbalancesheet
limits.360 For instance, GREG exceeded its balance sheet limit by approximately $600
million in the third quarter 2007 ($56.6 billion balance sheet usage); by approximately
$3.8 billion in the fourth quarter 2007 ($64.3 billion balance sheet usage); and by
approximately$5.2billioninthefirstquarter2008($65.7billionbalancesheetusage).361
356ExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,atpp.5,12,13.
357Id.atp.19.
360Lehman, FIDBalance Sheet Management Presentation (Sept. 2007), at p. 3 [LBEXDOCID 4553137],
attached to email from Janet Marrero,Lehman, toGerardReilly, Lehman (Oct. 8, 2007) [LBEXDOCID
4552976]; Lehman, FIDBalance Sheet Presentation (Jan. 17, 2008), at p. 3 [LBEXDOCID 3363221],
attached to email from Sigrid Stabenow, Lehman, to Erik Addington, Lehman (Jan. 31, 2008) [LBEX
DOCID3384762];Lehman,FixedIncomeQ3BalanceSheetTargets[LBEXDOCID1742006],attachedtoe
mailfromKevinHoran,Lehman,toClementBernard,Lehman(June27,2009)[LBEXDOCID1698861].
361Id.
103

In addition, between the second quarter of 2006 and the second quarter of 2007,
Lehmans real estate bridge equity positions in the United States increased tenfold,
from$116millionto$1.33billion,andthendoubledtomorethan$3billionbytheend
ofthesecondquarterof2008.362
GREGs balance sheet growth was largely the result of a series of large
transactions that Lehman concluded between May 2007 and November 2007. Each of
the following deals increased the balance sheet by over $1 billion in the respective
months:363
May2007,$2.0billionLehmanfinancingtoBroadwayPartnerstoacquirea
subportfolioofBeaconCapitalStrategicPartnersIII,LP.364
May2007,$1.3billionLehmanfinancingtoBroadwayRealEstatePartners
toacquire237ParkAvenue.365
June2007,$1.2billionLehmanfinancingtoApolloInvestmentCorp.fora
takeprivateofInnkeepersUSATrust;366
June 2007, $1.1 billion Lehman financing to Thomas Properties Group to

acquiretheEOPAustinportfolio;367
362Ari Koutouvides, Lehman, Global Real Estate Group Americas Portfolio Summary re the Second
Quarterof2007(Oct.24,2007),atp.2[LBEXDOCID2501404],attachedtoemailfromJonathanCohen,
Lehman, to Paul Higham, Lehman (Oct. 24, 2007) [LBEXDOCID 2558146]; Global Real Estate Group
AmericasPortfolioasofJune30,2008,atp.15[LBEXDOCID1419825].
363Theamountslistedwerelabeledas[m]ovementsontothebalancesheetfortherespectivemonths.
Unlessotherwisenotedinthesource,theseamountsarepresumedtobeamountsfundedinthatperiod.
SeeQuarterlyRealEstateRecapThirdQuarterandYearToDatePresentation(Nov.29,2007),atpp.118
25[LBEXDOCID3504242],attachedtoemailfromPaulHigham,Lehman,toDonaldE.Petrow,Lehman
(Nov.29,2007)[LBEXDOCID3625043].
364
Id.
365Id.
366Id.
367Id.
104

June 2007, $1.7 billion Lehman financing for the acquisition of Northern
Rockscommercialrealestateportfolio;368
July 2007, $1.5 billion Lehman financing to ProLogis to acquire the

Dermodyindustrialportfolio;369
July 2007, $2.9 billion Lehman financing for the acquisition of the Coeur
Defenseofficebuilding;370
August2007,$1.0billionLehmanfinancingfortheacquisitionofNorthern
Rockscommercialrealestateportfolio;371
October 2007, $1.5 billion Lehman financing to Blackstone for its

acquisitionofHiltonHotels;372and
October 2007, $5.4 billion Lehman financing for the acquisition of the
ArchstoneSmithTrust.373
BecauseLehmanencounteredsubsequentdifficultiesinsellingorsecuritizingportions
ofthesedeals,manyoftheabovetransactionsremainedamongthelargestexposureson
LehmansbalancesheetasLehmansfinancialconditiondeterioratedwellinto2008.374
(i) RelaxationofRiskControlstoAccommodateGrowth
ofLehmansCommercialRealEstateBusiness
Aswiththegrowthoftheleveragedloanbusiness,thegrowthofthecommercial
real estatebusinesswas facilitated firstby anincreaseintherisk limitsand then by a
decisiontoexceedthoselimits.InaMay9,2006emailtoUmezaki,PaulA.Hughson,
368Id.
369Id.
370Id.
371 Id.
372Lehman,CommercialmortgagesQ22008(Aug.6,2008),atpp.514[LBEXDOCID018868],attached
toemailfromGerardReilly,Lehman,toIanT.Lowitt,Lehman(Aug.7,2008)[LBEXDOCID011867].
373Id.
374Lehman,GlobalRealEstateGroupUpdate,atpp.211[LBEXDOCID019080](listingtop10risksasof
May31,2008).
105

GREGs Head of Credit Distribution, inquired as to how risk limits meshed with
GREGsplanstoexpandourbusinessinAsia,Europeandourbridgeequitybusiness
globally. I specifically wanted to focus on how we can grow Asia and bridge equity,
given the risk limits . . . .375 Several months later, in September 2006, in an email to
Walsh, Jeffrey Goodman, (seniormost risk manager for FID directly responsible for
GREG) stated that he wanted to followup on a conversation I had with [G]elband a
whilebackconcerningapush(fromGoldfarbetal)totakeonmoreriskinRE(double
yoursize?)andgetyourviewonwhatisrealistictoexpectandwhereyouseethisin
theapprovalprocessinternally.376
Lehmans risk appetite limit for the real estate business increased from $600
million in 2006 to $720 million in 2007.377 But the real estate business quickly felt
pressurefrommanagementtoexceeditsrecentlyincreasedlimit.InaJune2007email,
GoodmantoldAntoncicthatHughsonfelttrapped inthatRoger[Nagioff] and other
seniorfolkswant[ed]themtokeepgrowingthebizandhittingp/lbudgetsbutonthe
otherhandthey[were]over[balancesheet]limitsandrisklimits.378Goodmanadvised
375Email from Kentaro Umezaki, Lehman, to Paul A. Hughson, Lehman (May 9, 2006) [LBEXDOCID
1776281].
376Email from Jeffrey Goodman, Lehman, to Mark A. Walsh, Lehman (Sept. 19, 2006) [LBEXDOCID
1368068].
377Email from Paul A. Hughson, Lehman, to Thomas Pearson, Lehman, et al. (May 23, 2006) [LBEX
DOCID1776282];Lehman,RealEstate>>RiskAppetite/VaR>>SummaryCOB27Aug2007Monday
[LBEXDOCID2912096],attachedtoemailfromPatriciaLuken,Lehman,toPaulHigham,Lehman,etal.
[LBEXDOCID2880146].
378EmailfromJeffreyGoodman,Lehman,toMadelynAntoncic,Lehman(June29,2007)[LBEXDOCID
155724].
106

Hughson that Lehmans commercial real estate group [could not] keep adding deals
withoutaplantoreducetherisksomehow,andthatthereneededtobeadiscussion
withNagioffas[toaskwhetherhecould]cutriskinotherareas(HY?)tofreeupsome
roomor[whetherhewould]bewillingtositoutsomeopportunities.379Management
ultimatelydecidedthatGREGwouldnotbeheldtoanyriskappetitelimits.380
EstateBusiness
As with the leveraged loan business, some Lehman executives voiced concerns
about the risk associated with Lehmans large concentration of commercial real estate
positionsonitsbalancesheet.But,againaswiththeleveragedloanbusiness,Lehmans
management decided to continue to grow the commercial real estate business
notwithstanding those warnings, because that was the strategic imperative of the
firm.381 For example, on May 7, 2007, Goodman emailed Antoncic about the
Archstone transaction discussed below and said that OMeara, then the CFO, ha[d]
significantconcernsregardingoverallsizeof[therealestate]bookandhowmuchofthe
firms equity [was] tied up in such bridge equity deals.382 Lehmans risk managers
were also concerned with the real estate bridge equity deals in which Lehman was
379Id.
380ExaminersInterviewofMarkWalsh,Oct.21,2009,atpp.45.WalshtoldtheExaminerthathewas
toldtodoublethecommercialrealestaterisk.Id.atp.5.
382Email from Jeffrey Goodman, Lehman, to Madelyn Antoncic, Lehman (May 7, 2007) [LBEXDOCID
154953].
107

participating.383Thebridgeequitypositionswereconsideredparticularlyriskybecause
Lehmansbalancesheetwouldbedirectlyaffectedbythedecliningmarketvaluesofthe
underlyingrealestateifthefirmfailedtosellitsbridgeequitypositionsasplanned.384
Nevertheless, by late 2007, Lehman acquired a number of substantial bridge
equity positions, both in the United States and overseas, including: $2.3 billion in
Archstone;385$574millioninProLogis/Dermodyportfolio;386475million($655million)
inCoeurDefense;387$221millioninEOPAustin;388and$195millionintheacquisitionof
the 200 Fifth Avenue building.389 As a result of these acquisitions, real estate bridge
equity went from a negligible business to a multibillion dollar exposure in
approximately18months.
(iii) Archstone
a. LehmansCommitment
The enormous growth of Lehmans commercial real estate balance sheet
culminated in Lehmans commitment to participate in an approximately $22 billion
383Id.;Examiners Interview of Madelyn Antoncic, Mar. 27, 2009, at pp. 89; email from Madelyn
Antoncic,Lehman,toRogerNagioff,Lehman,etal.(June29,2007)[LBEXDOCID1478403];emailfrom
PaulA.Hughson,Lehman,toThomasPearson,Lehman,etal.(May23,2006)[LBEXDOCID1776282].
384ExaminersInterviewofMadelynAntoncic,Mar.27,2009,atpp.89.
385Global Real Estate Group, Lehman, Updated Commitment Committee Memorandum for Archstone
(May22,2007)[LBEXDOCID1350952];Lehman,LehmanBrothersBridgeEquityPipeline(July3,2007)
[LBEXDOCID638275],attachedtoemailfromJeffreyGoodman,Lehman,toDonaldE.Petrow,Lehman,
etal.(July11,2007)[LBEXDOCID670845].
386Lehman,TopRealEstateRiskSummary(Dec.12,2007),atp.2[LBEXDOCID789172].
387Id.;QuarterlyRealEstateRecapThirdQuarterandYearToDatePresentation(Nov.29,2007),atp.124
[LBEXDOCID 3504242], attached to email from Paul Higham, Lehman, to Donald E. Petrow, Lehman
(Nov.29,2007)[LBEXDOCID3625043].
388Id.atp.3.
389Id.atp.4.
108

joint venture with Tishman Speyer for the acquisition of the publiclyheld Archstone
REIT.390Includingunitsunderconstruction,Archstoneownedover88,000apartments,
whichwerespreadacrossmorethan340communitieswithintheUnitedStates.391Mark
Walshwasthedrivingforcebehindthisdeal,butFuldandGregorystronglysupported
itaswell.392
OnMay2,2007,LehmanandTishmanSpeyerprovidedanonbindingletterto
acquire all outstanding shares of Archstone for $64 per share, subject to confirmatory
due diligence.393 After negotiating a price of $60.75 per share and executing a plan of
merger,394 the parties announced the deal publicly on May 29, 2007.395 The deal was
originallyscheduledtoclosebeforeAugust31.396
Lehmans Executive Committee required Walsh to find partners to reduce
Lehmansriskinthedeal.BankofAmericaCorporation(BofA)agreedtofundhalf
390Lehman,ArchstoneQ22008Update,atp.14[LBEXDOCID2929329],attachedtoemailfromLeonard
Cohen,Lehman,toPaulA.Hughson,Lehman(June12,2008)[LBEXDOCID2820780].
391ArchstoneSmithOperatingTrust,AnnualReportfor2006asofDecember31,2006(Form10K)(filed
onMar.1,2007),atp.6.
392Examiners Interview of Mark A. Walsh, Oct. 21, 2009, at pp. 810; Examiners Interview of Joseph
Gregory,Nov.13,2009,atpp.78;ExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,atpp.34.
393James L. Dixson, Lehman, Archstone Transaction Timeline (June 20, 2007), at. p. 2 [LBEXDOCID
2139993],attachedtoemailfromJamesL.Dixson,Lehman,toRobertAshmun,Lehman,etal.(June20,
2007)[LBEXDOCID2139994].
394Id.atp.5;AgreementandPlanofMergerAmongArchstoneSmithTrust,ArchstoneSmithOperating
Trust, River Holding, LP, River Acquisition (MD), LP, and River Trust Acquisition, LP (May 28,
2007)[TSREV00000460554].
395JamesL.Dixson,Lehman,ArchstoneTransactionTimeline(June20,2007),at.pp.5,6[LBEXDOCID
2139993],attachedtoemailfromJamesL.Dixson,Lehman,toRobertAshmun,Lehman,etal.(June20,
2007) [LBEXDOCID 2139994]; Agreement and Plan of Merger for ArchstoneSmith and River Holding
(May 28, 2007) [LBEXDOCID 1759937], attached to email from Kyle Krpata, Weil, Gotshal & Manges
LLP,toDavidE.Shapiro,Wachtell,Lipton,Rosen&Katz,etal.(May29,2007)[LBEXDOCID1870993].
396EmailfromChipHeflin,Lehman,toLoanSales,Lehman(May29,2007)[LBEXDOCID1488757].
109

of the floating rate bank loan and junior mezzanine loan, and to purchase half the
bridgeequity.397BarclaysCapitalInc.(Barclays)signedaparticipationagreementto
take15%ofthebridgeequityand15%ofthedebtintheArchstonedeal,andthen,on
July2,2007,amendedtheagreementtotake25%ofthedebt.398Barclayscommitments
came out of BofAs share of the debt and equity, and thus did not affect Lehmans
exposuretoArchstone.399
TheArchstonedealwasanenormouscommitmentbyLehman,bothintermsof
debt financing and equity. After bringing in BofA and Barclays, Lehman agreed to
makeapermanentequityinvestmentof$250million;agreedtopurchasebridgeequity
of approximately $2.3 billion; and also agreed to fund various debt tranches totaling
$8.5billion.400
397Compare Memorandum from Mark A. Walsh, Lehman, to Executive Committee of Lehman Board of
Directors, Re: Project Easy Living(May 22,2007) [LBEXDOCID1350952],attached to emailfromJulia

Atwood, Lehman, to HYCC Members, Lehman, et al. [LBEXDOCID 1341648] with Memorandum from
MarkA.Walsh,Lehman,toExec.CommitteeofLBHIBoardofDirectors,re:ProjectEasyLiving(May7,
2007), at pp. 1, 3 [LBEXDOCID 147230], attached to email from Mark A. Walsh, Lehman, to Steven
Berkenfeld, Lehman, et al. (May 8, 2007) [LBEXDOCID 141217]; Letter from Scott M. Weiner, Barclays
InvestmentHoldings,Inc.,toLehman,etal.,RedlineCommitmentLetterforArchstone(June11,2007)
[LBEXDOCID2073685];LetterfromScottM.Weiner,BarclaysInvestmentHoldings,Inc.,toLehman,et
al.,ExecutionCopyofCommitmentLetterforArchstone(June11,2007)[LBEXDOCID1451573].
398Id.
399ExaminersInterviewofMarkA.Walsh,Oct.21,2009.
400ProjectEasyLiving,TermSheet(Sponsor)(May28,2007),atp.1[LBEXDOCID1624529],attachedto
emailfromDavidHerman,Weil,Gotshal&MangesLLP,toAndrewDady,SchulteRoth&ZabelLLP,et
al.[LBEXDOCID1383842];ProjectEasyLiving,TermSheet(BridgeEquity)(May28,2007),atp.1[LBEX
DOCID1324526],attachedtoemailfromDavidHerman,Weil,Gotshal&MangesLLP,toAndrewDady,
Schulte Roth & Zabel LLP, et al. [LBEXDOCID 1383842]; River Holdings LP Senior Secured Facilities
CommitmentLetter(May28,2007),atp.1[LBEXDOCID2395952],attachedtoemailfromJulianChung,
Cadwalader,Wickersham&TaftLLP,etal.(May29,2007)[LBEXDOCID2268458].
110

At the time the deal was presented to the Executive Committee, Lehman
intendedtosellallArchstonedebtatclosing.401BecauseLehmanhadpriceflexonthe
Archstonedebt,Lehmanmanagementwasreasonablyconfidentthatitcoulddistribute
thedebtwithoutsufferingaloss.402Priceflexisamechanismthatfacilitatessyndication
orsaleofaloanbytheinitiallenderwithouttakingaloss.403Asamechanicalmatter,
price flex may permit the initial lender to increase the interest rate to attract other
lenders(inwhichcasetheborrowerisrequiredtopayitslendersahigherinterestrate),
orrequiretheborrowertoreimbursethedebtholdersforanylosstheymaysufferasa
result of syndicating or selling the debt to a third party at a price less than par.404
BecauseofthepriceflexontheArchstonedebt,theriskintheArchstonecommitment
washeavilyconcentratedinLehmansequityandbridgeequitycommitments.
Lehmanplannedtosell50%ofitsremainingmezzaninedebtandbridgeequity
positions within two to three weeks of closing (Lehman had already had two large
financial institutions express an interest), and the rest would be sold off over the six
401Lehman,EasyLivingTalkingPointsforExecutiveCommitteeandRatingAgencies(May18,2007),at
p. 2 [LBEXDOCID 200792], attached to email from Paolo R. Tonucci, Lehman, to Christopher M.

OMeara,Lehman,etal.(May18,2007)[LBEXDOCID215761].
402Id.
403 Standard & Poors, Guide to the Loan Market (Sept. 2009), at p. 8,
http://www2.standardandpoors.com/spf/pdf/fixedincome/LoanMarketGuide_2009_Final.pdf (last visited
(lastvisitedonFeb.1,2010);AliciaTaylor&AliciaSansone,THE HANDBOOKOF LOAN SYNDICATIONSAND
TRADING 175 (McGrawHill 2007); Steven M. Vavaria, Standard & Poors, Syndicated LoansA Rated
Market, at Last! (Feb. 12, 2002), http://leeds
faculty.colorado.edu/madigan/3020/Readings/Syndicated_LoansA_Rated_Market_At_Last.pdf (last
visitedonFeb.1,2010).
404Id.
111

months following closing.405 Insofar as Lehmans potential profits were concerned,
Lehmanforecastearningmorethan$1.3billionoveratenyearperiod,includingnearly
$1 billion on Lehmans investment and substantial origination and asset management
fees.406
Commitment
ArchstonewasrepeatedlyconsideredbyboththeCommitmentCommitteeand
ExecutiveCommittee.407Thesecommitteesmandatedsignificantalterationstothedeal
structure,including,mostimportantly,requiringWalshtobringinatleastonepartner
ultimatelyBofAtoreducethesizeofLehmanscommitment.408
Notwithstanding Archstones consideration by the senior management of the
firm, Lehmans risk managers said that they had minimal input in the decision to
acquire Archstone.409 As a result, despite the extraordinary size and risk of Lehmans
commitment to the transaction, Lehmans management did not conduct quantitative
p. 2 [LBEXDOCID 200792], attached to email from Paolo R. Tonucci, Lehman, to Christopher M.

406MemorandumfromMarkA.Walsh,Lehman,toExecutiveCommittee,Lehman,reProjectEasyLiving
(May7,2007),atp.3[LBEXDOCID147230],attachedtoemailfromMarkA.Walsh,Lehman,toSteven
Berkenfeld,Lehman,etal.(May8,2007)[LBEXDOCID141217].
407ExaminersInterviewofDavidS.Lazarus,Nov.18,2009,atpp.67;ExaminersInterviewofPaulA.
Hughson, Oct. 28, 2009, at p. 2; Examiners Interview of Lisa Beeson, Oct. 23, 2009, at p. 4; Examiners
InterviewofKennethCohen,Oct.20,2009,atpp.56.
408Examiners Interview of Steven Berkenfeld, Oct. 5 & 7, 2009, at pp. 1415; Examiners Interview of
RichardS.Fuld,Jr.,Sept.25,2009,atpp.2223.
409Examiners Interview of Jeffrey Goodman, Aug.28, 2009; Examiners Interview of Kentaro Umezaki,
June25,2009,atp.17;ExaminersInterviewofMadelynAntoncic,Feb.25,2009,atp.5.
112

analysesofLehmansexposureinadvanceoftheriskLehmanwasundertaking.410For
example, it does not appear that Lehman systematically analyzed the effect that the
commitmentwouldhaveonthe firmsriskappetitelevels,orconductedstresstesting
onthefirmsburgeoningcommercialrealestateexposures,inadvanceofcommittingto
the transaction. Because of the extraordinary size of the transaction, however
including especially an unprecedented bridge equity commitment it was clear from
the beginning that the Archstone commitment would cause Lehman to exceed its risk
appetitelimits.411
The Office of Thrift Supervision (OTS) criticized Lehmans decision to enter
into the Archstone transaction in excess of its risk appetite limits.412 During OTSs
yearlyreview of Lehman in 2007,the OTS noticed that Lehman had exceeded its risk
appetitelimitsandthattheArchstonedealwaslargelyresponsibleforthatoverage.413
Asaresult,in2008,OTSdecidedtoconductatargetedreviewofLehmanscommercial
real estate business. After that targeted review, OTS issued a negative report,
criticizing Lehman for being materially overexposed in the commercial real estate
market and for entering into the Archstone deal without sound risk management
410ExaminersInterviewofJeffreyGoodman,Aug.28,2009;ExaminersInterviewofMadelynAntoncic,
Mar.27,2009,atp.11.
412Office of Thrift Supervision, Report of Examination, Lehman Brothers Holdings Inc. (Exam starting
July7,2008),atp.2[LBEXOTS000392].
413ExaminersInterviewofRonaldMarcus,Nov.4,2009,atpp.78.
113

practices.414ThereportconcludedthatLehmansbreachofrisklimits,causedlargelyby
theArchstonedeal,contributedtomajorfailingsintheriskmanagementprocess.415
Bycontrast,theSECtoldtheExaminerthatitwasawareoftheriskappetitelimit
excesses, and that it did not secondguess Lehmans business decisions so long as the
limitexcesseswereproperlyescalatedwithinLehmansmanagement.416
(e) NagioffsReplacementofGelbandasHeadofFID
OnMay1,2007,LehmanannouncedthatGelband,thethenactingGlobalHead
of FID, had decided to leave the Firm to pursue other interests, and that Roger
Nagioff would assume the top FID position at Lehman.417 Internally, Lehman
announced that the change was based on philosophical differences among Fuld,
Gregory,andGelbandastothedirectiontotaketogrowthebusiness.418
Gelband was removed from the position for several reasons, including that he
was not aggressive enough in growing the business in accordance with Fulds long
414ExaminersInterviewofRonaldS.Marcus,Nov.4,2009,atpp.78;accordOfficeofThriftSupervision,
ReportofExamination,LehmanBrothersHoldingsInc.(ExamstartingJuly7,2008),atp.2[LBEXOTS
000392].
415Office of Thrift Supervision, Report of Examination, Lehman Brothers Holdings Inc. (Exam starting
July7,2008),atp.2[LBEXOTS000392].
416ExaminersInterviewoftheSecuritiesandExchangeCommission,Aug.24,2009,atp.8.
417LehmanBrothersHoldingsInc.,PressRelease:LehmanBrothersNamesRogerB.NagioffGlobalHead
of Fixed Income (May 2, 2007), at p. 1 [LBEXDOCID 1470086], attached to email from Monique Wise,
Lehman,toJasjit(Jesse)Bhattal,Lehman,etal.(May1,2007)[LBEXDOCID1605828].
418Lehman Brothers, Talking Points & FAQs (May 1, 2007) [LBEXDOCID 1470087], attached to email
from Monique Wise, Lehman, to Jasjit (Jesse) Bhattal, Lehman, et al. (May 1, 2007) [LBEXDOCID
1605828].
114

term revenue targets.419 Fuld and Gregory also clashed with Gelband with respect to
growingthefirmsenergybusinessanditsleveragedloanbusiness.420
Fuld and Gregory chose Nagioff, then the CEO of Lehman Europe, to succeed
Gelband,eventhoughhehadnodirectexperienceinthefixedincomebusiness,andhe
lived in London, not New York.421 Nagioff decided to commute from London for a
portionofeachmonth.422
419ExaminersInterviewofJosephGregory,Nov.5,2009;ExaminersInterviewofRogerNagioff,Sept.30,
2009, at pp. 56 (stating that Gregory informed him that Gelband was forced out because he was not
willing to think creatively about growing Lehmans business and sharing his belief that Gelbands
opposition to the Eagle Energy deal was the last straw); Examiners Interview of Michael Gelband,
Aug. 12, 2009, at pp. 1516; contra Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at p. 18;
ExaminersInterviewofHerbertH.(Bart)McDadeIII,Jan.28,2010,atp.9.
420Examiners Interview of Michael Gelband, Aug. 12, 2009, at pp. 2, 7, 1516; Examiners Interview of
Joseph Gregory, Nov. 5, 2009; Examiners Interview of Roger Nagioff, Sept. 30, 2009, at pp. 56;
Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at p. 18; email from Michael Gelband,
Lehman to Richard S. Fuld, Jr., Lehman (Mar. 6, 2007) [LBEXDOCID 2762454] ([R]isk/reward is not
good here so Im trying to get out of as much illiquid risk as possible.... That is the strategy at the
momentthatallmymanagersarefollowing.Ineedtohavethembeinapositiontobeabletooperate
andcapitalizeifwegothroughaperiodofstress.).
421Examiners Interview of Roger Nagioff, Sept. 30, 2009, at pp. 56; Examiners Interview of Hugh E.
(Skip) McGee, Aug. 12, 2009, at p. 27 (McGee indicated that replacing Gelband with Nagioff was an
unusualideabecauseNagioffsexperiencewaswithEuropeanequitiesandMcDadewouldhavebeena
morelogicalchoicetoreplaceGelband.);ExaminersInterviewofKentaroUmezaki,June25,2009,atp.15
(Umezaki stated that many people, himself included, were surprised at Nagioffs promotion because
Nagioff had no background in fixed income and was not located in the United States at a time when
LehmanwasdealingwithaneconomiccrisislocatedprimarilywithintheUnitedStatesandfurtherthat
AlexKirkorAndrewJ.MortonwouldhavebeenmorelogicalselectionsbutthatGregoryhadindicated
thatNagioffwouldbegoodforthejobbecauseofhisabundanceofbusinessexperienceandawillingness
totakerisks.).
422Examiners Interview of Roger Nagioff, Sept. 30, 2009, at p. 6 (Nagioffs commute would ultimately
provetobeanunsustainablearrangement,asthestrainitcreatedonNagioffsfamilycausedhimtoleave
thecompanyinFebruary2008.).
115

(f) TheBoardofDirectorsAwarenessofLehmansIncreasing
RiskProfile
InaJune19,2007Boardmeeting,OMearapresentedthesecondquarterresults
to the Board.423 Lehmans management generally disclosed the firms increased risk
profile as well as the recently concluded Archstone deal. For example, OMeara
reportedthatthefirmwidequarterlyaverageriskappetiteusageforthesecondquarter
of2007was$2.6billionagainstalimitof$3.3billion,424andtheBoardhadanextended
discussion concerning the fact that the increased risk usage was spread across the
firm.425InJune2007,however,Lehmansdailyrisksystemsreflectedthatthefirmwas
almost at the $3.3billionriskappetitelimit, notincluding theArchstonetransaction
wellabovethe$2.6billionquarterlyaverage.426
TheinclusionoftheArchstonetransactionwascertaintoputLehmanwellover
both its firmwide risk appetite limit and its limit applicable to the real estate
business.427 While the Archstone transaction was discussed at the June meeting,428
423Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (June 19, 2007), at p. 3
[LBHI_SEC07940_026267].
424Id.; Lehman, Second Quarter 2007 Financial Information Presentation to Lehman Board of Directors
(June19,2007),atp.6[LBHI_SEC07940_026226].
425Lehman,SecondQuarter2007FinancialInformationPresentationtoLehmanBoardofDirectorswith
Weliksonsnotes(June19,2007),atp.6[WGM_LBEX_01165].
426See,e.g.,Lehman,DailyRiskAppetiteReport(June19,2007),atp.1[LBEXDOCID3296221],attached
toemailfromRuiLi,Lehman,toManhuaLeng,Lehman,etal.(June19,2007)[LBEXDOCID3295251].
427See,e.g., id.;Mark Weber, Lehman, Chart ShowingRisk Appetite Adjustment for Archstone (July 24,
2008) [LBEXDOCID 425705], attached to email from Mark Weber, Lehman, to PortfolioRisk Support,
Lehman,etal.(July24,2008)[LBEXDOCID265567].
428LehmansBoarddidnotconsiderorapprovetheArchstonetransactioninadvanceofthecommitment.
Examiners Interview of Sir Christopher Gent, Oct. 22, 2009, at p. 3; but cf. Examiners Interview of
MichaelL.Ainslie,Sept.22,2009,atp.8(statingthattheBoardneverformallyapprovedtheArchstone
116

Lehmans management did not inform the Board until October 15, 2007 that Lehman
hadexceededthefirmwideriskappetitelimitformorethanfourmonths.
(3) EarlyWarnings:RiskLimitOverages,FundingConcerns,and
theDeepeningSubprimeCrisis
FromMaytoAugust2007,thefinancialcrisisthathadpreviouslybeencontained
to the subprime residential mortgage market began to spread to other markets,
including the commercial real estate and credit markets, where Lehman was
particularly active. These concerns escalated in June and July 2007, when two Bear
Stearns hedge funds imploded, leading to panic in the credit markets and concerns
more generally that the subprime crisis would spill into the broader economy.429 SEC
Chairman Christopher Cox commented that [o]ur concerns are with any potential
systemicfallout.430
Asaconsequenceofthisgatheringstorm,inthefirsttwoweeksofJuly2007,S&P
placed$7.3billionofresidentialmortgagerelatedsecuritiesonnegativeratingswatch
and announced a review of collateralized debt obligations (CDOs) exposed to
residentialcollateral;Moodysdowngraded$5billionofsubprimemortgagebondsand
acquisition or even discussed the transaction prior to Lehmans commitment to the deal); Examiners
InterviewofJohnF.Akers,Apr.22,2009(same);ExaminersInterviewofRogerBerlind,May8,2009,at
p. 10 (same); Examiners Interview of Thomas Cruikshank, Oct. 8, 2009, at p. 3 (same); Examiners
Interview of Marsha Johnson Evans, May 22, 2009, at p. 14 (same); Examiners Interview of Sir
ChristopherGent,Oct.22,2009,atpp.1213(same);ExaminersInterviewofRolandA.Hernandez,Oct.
2, 2009 (same); Examiners Interview of Dr. Henry Kaufman, May 19, 2009, at p. 15 (same); Examiners
InterviewofJohnD.Macomber,Sept.25,2009,atp.13(same).
429Mark Pittman, Bear Stearns Mortgage Fund Collapse Sends Shock Through CDOs (Update 2), Bloomberg,
June21,2007.
430Id.
117

placed184mortgagebackedCDOtranchesondowngradereview;andFitchplaced33
classes of structured finance CDOs on credit watch negative.431 By the first week of
August2007,GermanysIKBannouncedmajorsubprimerelatedlossesandrequireda
bailout, American Home Mortgage filed for Chapter 11 bankruptcy, and the French
bank BNP Paribas froze redemptions on three of itsfunds, citing an inability to value
theminthecurrentmarket.432
Despitetheseevents,Lehmanwentforwardwithanumberoflargeinvestments,
somepreviouslycommitted,somenew,untilAugust2007,whenitdrasticallycutback
onitsleveragedlending,andlaterin2007,whenitstoppeddoingnewcommercialreal
estatedeals.
ThisSectiondiscussestheconcernsofLehmansmanagersaboutthestateofthe
marketsasearlyasAprilandMay2007andmanagementsactionswithrespecttothe
scale of its leveraged loan business. This Section also discusses the concerns among
someLehmanmanagersinJulyandAugust2007thatLehmanmightbeunabletofund
allofitsleveragedloanandrealestatecommitments,includingArchstone,andLehman
managers decision during this period not to increase the magnitude of Lehmans
macrohedgesonitsleveragedloanandcommercialrealestateportfolio.Finally,this
Section discusses managements decision to terminate its residential mortgage
originationsthroughBNCandAurora.
432Id.
118

(a) NagioffandKirkTrytoLimitLehmansHighYield
Business
Nagioff began to discuss rolling back the growth of the firms leveraged loan
business as soon as he became head of FID on May 2, 2007, but this decision was not
fully effectuated until August 2007, by which time Lehmans leveraged loan exposure
hadgrownto$35.8billionasaresultof$25.4billioninnewcommitments.433
NagiofflearnedaboutthesizeofLehmansleveragedloanexposuresfromKirk,
then Head of Global Credit Products.434 Lehmans leveraged loan business was so
gargantuantheexposuresjumpedoutat[him].435NagioffandKirkbelievedthatthis
was banker business, not broker business, which Lehman did not have the balance
sheettosupport.436Nagioffalsothoughtthatthechanceofasuddenmarketdownturn
washigh,andthatLehmanwasmakingrelativelysmallprofitsfortakingincreasingly
433Lehman, Business and Financial Review Q2 2008 (Aug. 5, 2008), at p. 14 [LBHI_SEC07940_659768];
Lehman,LoanPortfolioGroupWeeklyReview(June8,2007),atpp.38[LBEXDOCID146379];Lehman,
Loan Portfolio Group Weekly Review (June 15, 2007), at pp. 38 [LBEXDOCID 146375]; Lehman, Loan
Portfolio Group Weekly Review (June 22, 2007), at pp. 38 [LBEXDOCID 146376]; Lehman, Loan
Portfolio Group Weekly Review (June 29, 2007), at pp. 38 [LBEXDOCID 146377]; Lehman, Loan
PortfolioGroupWeeklyReview(July6,2007),atpp.38[LBEXDOCID146348];Lehman,LoanPortfolio
GroupWeeklyReview(July13,2007),atpp.38[LBEXDOCID146358];Lehman,LoanPortfolioGroup
Weekly Review (July 20, 2007), at p. 7 [LBEXDOCID 146339]; Lehman, Loan Portfolio Group Weekly
Review(July27,2007),atpp.38[LBEXDOCID146350];Lehman,LoanPortfolioGroupWeeklyReview
(Aug. 10, 2007), at pp. 38 [LBEXDOCID 146341]; email from Jeffrey Goodman, Lehman, to David N.
Sherr,Lehman,etal.(June22,2007)[LBEXDOCID237094].Thereissomeevidenceofinaccuraciesinthe
LPG reports. See, e.g., Gary J. Fox, Lehman, Lehman Brothers Top Exposure Report Lehman Papers
Compared to LPG Data (June 25, 2007) [LBEXDOCID 2461202], attached to email from Gary J. Fox,
Lehman, to Greg L. Smith, Lehman, et al. (June 26, 2009) [LBEXDOCID 2461203]. The calculation
excludesthecommitmenttoTXU.
434ExaminersInterviewofRogerNagioff,Sept.30,2009,atp.8.
435Id.atp.7.
119

large and illiquid risks.437 Nagioff was concerned because the tail risk of Lehmans
leveragedloanbusinesstotaledbillionsofdollars.438
Nagioff also had broader concerns about the state of the credit markets. These
concerns were shared by others outside Lehman and by several of Nagioffs senior
colleagues, who believed that Lehman was operating in a credit bubble.439 Months
later, Antoncic, for example, reflected back on the general consensus that the markets
were in trouble: every one saw the train wreck coming. 64k question is why didnt
anyonegetoutoftheway???440
Although Nagioffs concerns were shared by several others, Nagioff believed
thatitwouldbedifficulttocurtailLehmansleveragedloanbusiness,becauseMcGees
IBD,whichhadchampionedexpansionofthisbusinessfromthestart,hadtoauthorize
thechange.441Moreover,Lehmanhadmanydealsinthepipeline,andthosedealswere
supporting 100 bankers.442 To make matters worse,Kirk believed that Gelband had
been relieved of his position partly as a result of his opposition to the leveraged loan
437ExaminersInterviewofRogerNagioff,Sept.30,2009,atp.8;emailfromGaryMandelblatt,Lehman,
toRogerNagioff,Lehman,etal.(Nov.27,2007)[LBEXDOCID156264].
439Email from Steven Berkenfeld, Lehman, to Roger Nagioff, Lehman (May 10, 2007) [LBEXDOCID
140669]; email from Roger Nagioff, Lehman, to Ian T. Lowitt, Lehman (May 10, 2007) [LBEXDOCID
140666]; email from Christopher M. OMeara, Lehman, to Paulo R. Tonucci, Lehman (Apr. 6, 2007)
[LBEXDOCID 1349076]; emailfrom Christopher M. OMeara,Lehman, to Ian T. Lowitt,Lehman (July
21,2007)[LBEXDOCID211149].
440Email from Madelyn Antoncic, Lehman, to Jack Malvey, Lehman (Apr. 8, 2008)
[LBHI_SEC07940_212356].
442Id.
120

business;NagioffbelievedthathewouldonlygetonechancetoconvinceFuldthatthis
businesshadtobestopped.443
NagioffspoketoFuldonMay31,2007.NagiofftoldFuldthatLehmanwastoo
big in the leveraged lending business and could lose a lot of money in the tail risk.444
NagioffshowedFuldthenumbers,whichreflectedapossible$3.2billionlossundera
stress scenario that was computed specifically for the purpose of this meeting.445
Nagioff told Fuld that Lehman needed to reduce its forward commitments from $36
billionto$20billion,imposerulesontheamountofleverageinthedeals,anddevelopa
frameworkforlimitingandevaluatingthisbusiness.446
Fuldwassurprisedandconcernedbythetailriskintheleveragedloanpositions
and authorized Nagioff to present his analysis to the Executive Committee to get
authorization to move forward with a plan to limit the firms leveraged loan
exposures.447
443Email from Roger Nagioff, Lehman, to Alex Kirk, Lehman (May 31, 2007) [LBEXDOCID 173414];
ExaminersInterviewofRogerNagioff,Sept.30,2009,atp.11;ExaminersInterviewofAlexKirk,Jan.12,
2010, at p. 11 (Kirk stated that Nagioff thought that Gelband had been fired in part for opposing the
leveragedloansbusiness;thus,theyhadtomoveveryslowlyinobtainingauthoritytohaltthebusiness).
444ExaminersInterviewofRogerNagioff,Sept.30,2009,atp.11;emailfromJormenVallecillo,Lehman,
to Roger Nagioff, Lehman, et al. (June 8, 2007) [LBEXDOCID 1620669]; Alex Kirk, Lehman, Leveraged
FinanceRiskPresentation(June8,2007)[LBEXDOCID1416503].
445Examiners Interview of Roger Nagioff, Sept. 30, 2009, at pp. 1112; email from Jormen Vallecillo,
Lehman, to Roger Nagioff, Lehman, et al. (June 8, 2007) [LBEXDOCID 1620669]; Alex Kirk, Lehman,
LeveragedFinanceRiskPresentation(June8,2007),atp.10[LBEXDOCID1416503].
447Id.
121

Several weeks later, Nagioff discussed the leveraged loan exposure with the
Executive Committee. After that conversation, on June 28, 2007, Nagioff was
authorizedbyFuld,Gregory,andMcGeetoconductacrossfirminitiativetoreduce
commitments to $20 billion by the end of 2007.448 The crossfirm initiative entailed
developing more specific and effective limits on Lehmans high yield business
(including single transaction limits) and bridge equity, and developing a plan for
reducingtheexistingexposures.449
InthetwomonthsbetweenNagioffsconversationwithFuldonMay31andthe
slowdownofLehmansleveragedloancommitmentsinAugust2007,thefirmentered
intoanother$25.4billionincommitments.450Forexample,LehmanagreedonJune18,
2007tocommit$2.05billiontotheSequaCorpdeal;tocommit$3.3billiontotheHome
Depot Supply deal on July 19, 2007; to commit $2.4 billion to finance the Houghton
Mifflin deal; and to commit $2.14 billion to finance the Applebees deal on July 16,
448EmailfromStevenBerkenfeld,Lehman,toScottJ.Freidheim,Lehman(June26,2007)[LBEXDOCID
1819424];ExaminersInterviewofRogerNagioff,Sept.30,2009,atp.13.
450Lehman, Loan Portfolio Group Weekly Review (June 8, 2007), at pp. 38 [LBEXDOCID 146379];
Lehman, Loan Portfolio Group Weekly Review (June 15, 2007), at pp. 38 [LBEXDOCID 146375];
Lehman, Loan Portfolio Group Weekly Review (June 22, 2007), at pp. 38 [LBEXDOCID 146376];
Lehman,LoanPortfolioGroupWeeklyReview(July6,2007),atpp.38[LBEXDOCID146348];Lehman,
Loan Portfolio Group Weekly Review (July 13, 2007), at pp. 38 [LBEXDOCID 146358]; Lehman, Loan
PortfolioGroupWeeklyReview(July27,2007),atpp.38[LBEXDOCID146350];Lehman,LoanPortfolio
Group Weekly Review (Aug. 10, 2007), at pp. 38 [LBEXDOCID 146341]. The calculation excludes
LehmanscommitmenttoTXU.
122

2007.451Asaresult,FIDendedthequarterroughly$2billionoveritsnetbalancesheet
limit.452AsNagioffputit,ittooktimetostopthemachine;alotofdealswereinthe
pipeline or under negotiation, and Lehman did not believe that it could abruptly
terminatethosedeals.453
Nagioffwasconcernedthathiseffortsweretoolittletoolate:Sadlyinspiteof
killing BCE which was a 5!bn KKR disaster I am probably 3 months too late in the
job.a big deal got pulled today and others are being restructured down.we are
probably going to get punished for our stupidity.454 Two days later, Nagioff also
wrote: I now have the thing under control . . . if I had the job 6 months earlier we
wouldnotbewhereweare...letshopeitisonlyscratches.455
(b) JulyAugust2007ConcernsRegardingLehmansAbilityto
FundItsCommitments
ByJuly2007,aftertheBearStearnsfundsimplosion,someLehmanexecutives
were concerned that Lehman might not be able to fund all of its commitments.456 For
451Email from Lehman Risk, Lehman, to Risk Limit Excess, Lehman (July 16, 2007) [LBEXDOCID
230109]; Lehman, Loan Portfolio Group Weekly Review (July 20, 2007), at p. 7 [LBEXDOCID 146339];
Lehman, Loan Portfolio Group Weekly Review (July 27, 2007), at pp. 67 [LBEXDOCID 146350];
Appendix:9,comparingriskappetiteandVaRusageversuslimits.
452Lehman,2007BalanceSheetTargetsandUsageGlobal(Oct.17,2007)[LBEXDOCID278229].
453ExaminersInterviewofRogerNagioff,Sept.30,2009,atp.10;ExaminersInterviewofAlexKirk,Jan.
12,2009,atpp.23;accordExaminersInterviewofRichardS.Fuld,Jr.,Dec.9,2009,atpp.1011,1617.
454Email from Roger Nagioff, Lehman, to David Goldfarb, Lehman (June 26, 2007) [LBEXDOCID
1585157]. For a fuller discussion of the effort to reduce the firms high yield exposure, see Sections
III.A.1.b.3andIII.A.1.b.4ofthisReport.
455 Email from Roger Nagioff, Lehman, to David Goldfarb, Lehman (June 28, 2007) [LBEXDOCID
1585167].
456See,e.g.,emailfromPaoloR.Tonucci,Lehman,toSigridM.Stabenow,Lehman(Mar.14,2007)[LBEX
DOCID 1342697]; email from Christopher M. OMeara, Lehman, to Paolo R. Tonucci, Lehman (Apr. 6,
123

example, Lehman had a maximum cumulative outflow funding model designed to
ensurethatLehmanhadsufficientcashsourcestomeettheexpectedcashoutflowsina
stressedmarketenvironment.457Underthatmodel,inJuly2007,thefirms[L]iquidity
Pooloneyearforwardposition[was]short$(0.4)billion.458
The liquidity concerns were the result of several factors. First, as the credit
markets froze, Lehman was unable to distribute its risk in certain leveraged loan and
commercialrealestatedeals,includingArchstone,leavingitwithmoreexposurethanit
hadpreviouslyanticipated.459Inaddition,thefirmhadeffectivelybeenlockedoutof
thecapitalmarkets.460
When Nagioff learned about these concerns, he wrote Ian T. Lowitt, Lehmans
then CoCAO: Kirk and Ken [Umezaki] are panicky. Are they over reacting.461
2007)[LBEXDOCID1349076];Lehman,ChartShowingHighGradeandHighYieldLoanCommitments
(July 19, 2007) [LBEXDOCID 375444], attached to email from Nahill Younis, Lehman, to Kentaro
Umezaki,Lehman(July19,2007)[LBEXDOCID297877];emailfromKentaroUmezaki,Lehman,toIan
Lowitt, Lehman (July 20, 2007) [LBEXDOCID 717108]; email from Ian T. Lowitt, Lehman, to Kentaro
Umezaki, Lehman (July 20, 2007) [LBEXDOCID 717108]; email from Ian T. Lowitt, Lehman, to Paolo
Tonucci,Lehman,etal.(July11,2007)[LBEXDOCID1901826].
457Lehman, Liquidity Management At Lehman Brothers (July 2008), at p. 13 [LBEXDOCID 009007],
attached to email from Rowena T. Carreon, Lehman, to Robert Azerad, Lehman, et. al. (July 31, 2008)
[LBEXDOCID067762].
4583rd QuartertoDate MCO and Cumulative Outflow Analysis (July 11, 2007), at p. 1 [LBEXDOCID
1681748], attached to email from Nahill Younis, Lehman, to Paolo R. Tonucci, Lehman (July 11, 2007)
[LBEXDOCID1901826].
459Examiners Interview of Kentaro Umezaki, June 25, 2009, at p. 16; Examiners Interview of Roger
Nagioff,Sept.30,2009,atp.9;ExaminersInterviewofAlexKirk,Jan.12,2010,atp.12.
460Email from Nahill Younis, Lehman, to Paolo R. Tonucci, Lehman (July 11, 2007) [LBEXDOCID
1901826].
461EmailfromRogerNagioff,Lehman,toIanT.Lowitt,Lehman(July20,2007)[LBEXDOCID175649].
124

Lowittrespondedwithadetailedexplanationoftheproblemandhisviewoftherootof
theproblem:
Ifeverythinggoesasbadlyasitcouldsimultaneouslyitwillbeawful,but
at least at the moment a lot of people have money they are willing to
[l]end to us and if we close them quickly it will make a difference. I do
thinkweneedtogetona`warfooting.[James]Merliandtheguysonthe
desk are panicky and that is feeding back into fid and outside the firm.
Needpeopletobeconfident.Iwoulddescribemypositionbasedonwhat
I know today as anxious but not panicky. Also the discipline we had post
1998aboutfundingcompletelydissipatedwhichaddstothealarm.462
Nagioffresponded:Lastparagraphappliestofirmbroadly.463
Lowitt traced Lehmans difficulty in funding its commitments directly to its
failuretoabidebyitsrisklimits,asLowittwrotetoOMearainalateremailonJuly20,
2007: In case we ever forget; this is why one has concentration limits and overall
portfoliolimits.Marketsdoseizeup.464
Todealwiththeseconcernsonawarfooting,Lowitt,OMeara,Kirk,Umezaki,
and Paolo R. Tonucci, (Lehmans Global Treasurer), set up an AssetLiability
Committee(ALCO)sothatFIDandLehmansTreasuryDepartmentcouldmanage
[the firms] liquidity on a daily basis.465 Prior to the formation of ALCO, Lehmans
462EmailfromIanT.Lowitt,Lehman,toRogerNagioff,Lehman(July20,2007)[LBEXDOCID175646]
(emphasissupplied).
463EmailfromRogerNagioff,Lehman,toIanT.Lowitt,Lehman(July20,2007)[LBEXDOCID175646].
464Email fromIan Lowitt, Lehman, to Christopher M. OMeara, Lehman (July20, 2007) [LBEXDOCID
194066].
465EmailfromIanLowitt,Lehman,toRogerNagioff,Lehman(July20,2007)[LBEXDOCID175646];e
mail from Ian Lowitt, Lehman, to Herbert H. McDade III, Lehman, et al. (July 20, 2007) [LBEXDOCID
175646].
125

TreasuryDepartmentreliedonpipelinereportsfromthebusinesses.466ALCOconvened
frequentmeetingsfromAugust2007throughFebruary2008,467andbegantotrackand
monitor more closely the firms monthly projections for cash capital and maximum
cumulativeoutflow.
The cash capital model was a pillar of the firms funding framework.468 The
sourcesofcashcapitalwereequityanddebtwitharemaininglifeofgreaterthanone
year.469Thefirmalwaysfundedleveragedloansandcommercialrealestatewithcash
capital.470Althoughthefirmcouldfundloansandcommercialrealestateonasecured
basis, it assumed that secured finance would not be available under stressed market
467Seee.g.,Lehman,LBHICCProjections(July30,2007)[LBEXDOCID214312],attachedtoemailfrom
Paolo R. Tonucci, Lehman, to Christopher M. OMeara, Lehman (July 30, 2007) [LBEXDOCID 187182];
ALCOSummaryPackage(Aug.2,2007)[LBEXDOCID514844];ALCOSummaryPackage(Aug.7,2007)
[LBEXDOCID 514847]; ALCO Summary Package (Aug. 16, 2007) [LBEXDOCID 514851]; ALCO
SummaryPackage(Sept.4,2007)[LBEXDOCID514862];ALCOSummaryPackage(Sept.5,2007)[LBEX
DOCID 514863]; ALCO Summary Package (Sept. 6, 2007) [LBEXDOCID 514865]; ALCO Summary
Package(Sept.7,2007)[LBEXDOCID514866];ALCOSummaryPackage(Sept.10,2007)[LBEXDOCID
514867]; ALCO Summary Package (Sept. 12, 2007) [LBEXDOCID 514869]; ALCO Summary Package
(Sept.13,2007)[LBEXDOCID514870];ALCOSummaryPackage(Sept.14,2007)[LBEXDOCID514871];
ALCO Summary Package (Sept. 18, 2007) [LBEXDOCID 514873]; ALCO Summary Package (Sept. 21,
2007) [LBEXDOCID 514875]; ALCO Summary Package (Oct. 25, 2007) [LBEXDOCID 514887]; ALCO
SummaryPackage(Dec.4,2007)[LBEXDOCID104102];ALCOSummaryPackage(Feb.12,2008)[LBEX
DOCID104040].
468Lehman, Implications for the Funding Framework (Aug. 6, 2007), at p. 2 [LBEXDOCID 601971],
attached to email from Angelo Bello, Lehman, to Kentaro Umezaki, Lehman (Aug. 6, 2007) [LBEX
DOCID720559].
469Lehman,UpdateonRisk,Liquidity,andCapitalAdequacyPresentationtoStandardandPoors(Aug.
17,2007),atp.72[LBEXDOCID2031705],attachedtoemailfromShaunK.Butler,Lehman,toElizabeth
R.Besen,Lehman(Aug.28,2007)[LBEXDOCID2374876].
470Id.atp.67.
126

conditions.471Itwasthefirmspolicyalwaystohaveacashcapitalsurplusofatleast$2
billion.472
OnJuly30,2007,ALCOmembersexchangedananalysisshowingthatLehman
did not project having the usual surplus, and in fact projected large deficits of cash
capital.473Morespecifically,LehmansmonthendcashcapitalestimatesforSeptember,
October, and November of the same year were $11.4 billion, $14.5 billion and $9.4
billion.474 This meant that Lehman did not anticipate being able to fund its longterm
obligationswithlongtermassets.
Facedwiththisprospect,inearlyAugust2007,Kirk,LowittandNagioffdecided
toshutdowntheleveragedloanandcommercialrealestatebusinessesuntiltheendof
thethirdquarterof2007.TheyconvincedMcGeeandBerkenfeldtokill everything
fortherestofthequarter.475NagioffbelievedtheExecutiveCommitteeshouldnothave
approvedanylargedealsbeforetheendofthequarter,saying:Donotthinkanylarge
deal can get thru exec[utive committee] pre qtr end . . . this cannot be expressed
471Id.
472Lehman,Risk, Liquidity, Capital and Balance Sheet Update Presentation to the Finance and Risk
CommitteeofLehmanBoardofDirectorson(Sept.11,2007),atp.31[LBEXDOCID505941],attachedto
emailfromPaoloR.Tonucci,Lehman,toChristopherM.OMeara,Lehman,etal.(Sept.9,2007)[LBEX
DOCID552383].
473LBHI CC Projections (July 30, 2007), at p. 2 [LBEXDOCID 214312], attached to email from Paolo
Tonucci,Lehman,toChristopherM.OMeara,Lehman(July30,2007)[LBEXDOCID187182].
474Id.
127

publicly.476Kirkresponded:Good.Wewillneedskip[McGee]tokillasmuchstuffas
earlyaspossible.477
Ataboutthesametime,theleveragedloanmarketgenerallycollapsed,andnew
issuesslowedtoatrickleinthethirdquarter.478Lehmansleveragedloancommitments
thus halted in early August 2007, three months after Nagioff first concluded that
Lehmans exposure was already gargantuan, and two months after Nagioffs first
conversationwithFuldabouttheissue.
(c) LehmanDelaystheArchstoneClosing
Becauseofthefundingconcerns,LehmandelayedtheclosingonArchstonefrom
theoriginallyanticipatedAugust2007closingdatetoOctober5,2007.479Asthemarket
crisis escalated in June and July 2007, Lehman attempted to syndicate its Archstone
debt. But by late July 2007, the institutional market for commercial real estate was
virtuallyclosed,480andLehmansattemptsatsellingArchstonebridgeequitylargely
failed.481
476EmailfromRogerNagioff,Lehman,toAlexKirk,Lehman(Aug.7,2007)[LBEXDOCID173496].
477EmailfromAlexKirk,Lehman,toRogerNagioff,Lehman(Aug.7,2007)[LBEXDOCID173496].
478Lehman,LoanSyndicate/YearEndRecap(Jan.4,2008),atp.5.[LBHI_SEC07940_066190].
479EmailfromRandallB.Whitestone,Lehman,toStevenBerkenfeld,Lehman,etal.(Aug.5,2007)[LBEX
DOCID 988270]; ArchstoneSmith Trust, Press Release: ArchstoneSmith Amends Merger Agreement
With Tishman Speyer Partnership (Aug. 6, 2007) [LBEXDOCID 2140354]; email from Chip Heflin,
Lehman,toLoanSales4thFloor,Lehman(May29,2007)[LBEXDOCID1488757].
480EmailfromMarkWalsh,Lehman,toAlexKirk,Lehman,etal.(July27,2007)[LBEXDOCID174304].
481SeeAppendixgenerallyemailfromPaulA.Hughson,Lehman,toMarkA.Walsh,Lehman,etal.,(July
27, 2007) [LBEXDOCID 155079] (reflecting the fact that on July 27, 2007, D.E. Shaw informed Lehman
thatgiventheselloffinthereitmarketandthevolatilityofthecreditmarketsitsRiskCommitteehad
rejectedthedeal);emailfromJonathanCohen,Lehman,toChristopherM.OMeara,Lehman,etal.(July
128

In the midst of the market deterioration, an analyst at Citigroup issued an
analyst report entitled Archstone Smith Trust (ASN): Could the Buyers Cut Their
Losses and Walk Away?482 The report suggested that Lehman, BofA, and Barclays
mightbebetteroffwalkingawayfromtheArchstonedealandpayingthe$1.5billion
breakupfee,ratherthanclosingthedealatasignificantloss.483
WhilethereportandaWallStreetJournalarticlediscussingitwerewidelyread
atLehman,484Lehmanneverseriouslyconsideredwalkingawayfromthedeal.485One
reason Lehman was comfortable proceeding with the deal was that Lehman was
ultimatelyabletosellapproximately$2.09billioninArchstonedebttoFreddieMac,486
and another $7.1 billion of Archstone debt to Fannie Mae.487 During the same time
27, 2007) [LBEXDOCID 1904232] (showing that by July 2007, Lehman began to worry that the market
implosion might force Lehman to provide $9 billion in funding for the Archstone transaction, rather
thanthe$6.8billionithadpreviouslyassumedwouldbenecessary.).
482Jonathan Litt, Citigroup Global Markets Inc., Archstone Smith Trust (ASN): Could the Buyers Cut Their
LossesandWalkAway?(July26,2007)[LBEXDOCID1714588].
483Id.atpp.12.
484Seee.g.,emailfromWebsterNeighbor,Lehman,toPaulA.Hughson,Lehman(July31,2007)[LBEX
DOCID2500559];emailfromGerardReilly,Lehman,toChristopherM.OMeara,Lehman(Aug.1,2007)
[LBEXDOCID210156];emailfromStephenF.Rossi,Lehman,toAnnaYu,Lehman,etal.(Aug.1,2007)
[LBEXDOCID3271158].
485Examiners Interview of Lisa Beeson, Oct. 23, 2009, at p. 5; Examiners Interview of Mark A. Walsh,
Oct. 21, 2009, at p. 9; Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at p. 4; Examiners
InterviewofRogerNagioff,Sept.30,2009,atp.3;ExaminersInterviewofSirChristopherGent,Oct.21,
2009,atp.3;ExaminersInterviewofJohnD.Macomber,Sept.25,2009,atpp.1314.
486Freddie Mac, Holdco Term Sheet (Sept. 5, 2007) [LBEXDOCID 4452813]; Freddie Mac, Sellco Term
Sheet(Sept.5,2007)[LBEXDOCID4452811];Lehman,ProjectEasyLivingDebtFundingDetail(Oct.5,
2007),atp.1[LBEXDOCID598184].
487Examiners Interview of Mark A. Walsh, Oct. 22, 2009, at p. 9; Examiners Interview of Lisa Beeson,
Oct.23,2009,atp.8;LetterfromLehmanBrothersHoldingsInc.toFannieMaere:RateLockTerms(Sept.
17,2007),atp.1.[LBEXDOCID2704241].
129

period,however,Lehmananditspartnerswereabletosellonly$71millionofthedeals
$4.6billioninbridgeequity.488
The Archstone deal closed on October 5, 2007.489 As of October 12, 2007,
LehmanstotalArchstoneexposurewasapproximately$6billion,$2.39billionofwhich
was in the riskiest equity portions of the deal (permanent equity and bridge equity
portions):490
Permanentequity $250million
Bridgeequity $2.14billion
Mezzanineloan $240million
Termloan $2.47billion
Seniordebt $850million
WhenSecretaryoftheTreasuryHenryM.Paulson,Jr.learnedlatein2007thatLehman
had closed on Archstone, despite the shutdown in the securitization market, he
questioned the wisdom of the decision and the direction in which Lehman was
heading.491
488Lehman,ArchstoneSmithMultifamilyJVDebtandEquityRedemptionSchedule(Jan.3,2008),atp.1
[LBEXDOCID2502413],attachedtoemailfromKeithCyrus,Lehman,toPaulA.Hughson,Lehman,et
al.(Jan.1,2008)[LBEXDOCID2646616].
489Lehman,AcquisitionofArchstoneSmithTrustCorporateClosingDocumentsTableofContents(Oct.
5,2007),atp.2[LBEXWGM960404].
490Lehman, Lehman Expected Share ofReal Estate Commitments (Oct. 17, 2007), at p. 2 [LBEXDOCID
624620].
491ExaminersInterviewofHenryPaulson,June25,2009,atp.9.
130

(d) LehmanIncreasestheRiskAppetiteLimitto
AccommodatetheAdditionalRiskAttributabletothe
ArchstoneTransaction
TheriskinLehmansbookwasdramaticallyincreasingduring2007.492Lehmans
management reacted to the increasing risk appetite usage by increasing its limit
amounts.
Although Lehman ordinarily included the risk appetite usage attributable to a
transactionimmediatelyafterenteringintothecommitmentforthetransaction,Lehman
did not include the very substantial increase in risk appetite usage attributable to
Archstoneintheriskappetitecalculationforalmostthreemonths.493Atleastoneother
realestatebridgeequitytransaction,Dermody/ProLogis,alsowasnotincludedinrisk
appetiteuntilthatdate.494
492 Some of the increase in risk usage, of course, was the result of market volatility and its effect upon
existing assets; some was the result of decisions to close new deals. In any event, usage increased
dramaticallyin2007andlimitswereraisedaccordingly,from$3.3billionto$3.5billionto$4.0billion.See
email from Manhua Leng, Lehman, to Mynor Gonzalez, Lehman, et al. (Sept. 10, 2007) [LBEXDOCID
262797]; email from Christopher M. OMeara, Lehman, to David Goldfarb, Lehman (Aug. 15, 2007)
[LBEXDOCID211183];Lehman,MaterialforMarketRiskControlCommitteeMeeting(Jan.14,2008),at
p.33[LBEXDOCID271352],attachedtoemailfromMarkWeber,Lehman,toPaulShotton,Lehman,et
al. (Jan. 14, 2008) [LBEXDOCID 223263]. As revenues increased, the capacity for risk increased;
management calculated, albeit sometimes by adjusting the formula, that each increase was justified by
anticipated revenues. See email from Madelyn Antoncic, Lehman, to David Goldfarb, Lehman, et al.
(Aug.28,2007)[LBEXDOCID193203];seeAppendix10,showingthecalculationofLehmansincreased
$4.0billionriskappetitelimit.
493See email from Mark Weber, Lehman, to Jeffrey Goodman, Lehman (June 4, 2007) [LBEXDOCID
247960]; Mark Weber, Lehman, Chart Showing Risk Appetite Adjustment for Archstone (July 24, 2008)
[LBEXDOCID425705],attachedtoemailfromMarkWeber,Lehman,toPortfolioRiskSupport,Lehman,
et al. (July 24, 2008) [LBEXDOCID 265567]; see also email from Mark Weber, Lehman, to Laura M.
Vecchio,Lehman(July31,2008)[LBEXDOCID264849].
494Lehman,VaR/RiskAppetiteRestatements,(Nov.12,2007)atp.17[LBEXDOCID271334].
131

If Archstone (and the other transactions) had been included in the firms risk
appetiteusagefromtheArchstonecommitmentdateinlateMay2007,consistentwith
the firms usual practice, Lehman would have been over the firmwide risk appetite
limitformuchoftheinterveningperiod.495Lehmanwouldalsohavebeenovertherisk
appetite limits for FID and the real estate business by substantial margins.496 As the
summerof2007woreon,thevolatilityinthemarketsbegantoexacerbatethesituation,
andLehmansriskappetiteusageincreasedmarkedly,eventhoughLehmangenerally
stoppedenteringintomajornewcommitmentsafterthethirdquarterof2007.497
Archstone and Dermody/ProLogis were not included sooner in Lehmans risk
appetite usage calculation because Lehmans risk managers were trying to calculate a
stable usage amount for these bridge equity transactions. Initial calculations yielded
495Id.
496Id.
497Email from Jeffrey Goodman, Lehman, to Christopher M. OMeara, Lehman, et al. (Dec. 4, 2007)
[LBEXDOCID 251204]; email from Paul Shotton, Lehman, to Christopher M. OMeara, Lehman et al.
(Dec. 6, 2007) [LBEXDOCID 251204]; Examiners Interview of Mark Weber, Aug. 11, 2009, at p. 9;
Examiners Interview of David Goldfarb, Sept. 21, 2009, at p. 8; Examiners Interview of Madelyn
Antoncic,Oct.6,2009,atp.7;ExaminersInterviewofRichardS.Fuld,Jr.,Nov.19,2009,atp.13;butsee
Lehman, September 2007 Financial Information Presentation to Lehman Board of Directors with
ChristopherM.OMearashandwrittennotes(Oct.15,2007),atp.6[LEH_CMO_0000001](attributingthe
increase in risk appetite to increased market volatility as well as increased leveraged finance and
commercialrealestatepositions,particularlysincethemarketenvironmenthadpreventedthefirmfrom
sellingthoseassets);emailfromJoeLi,Lehman,toMadelynAntoncic,Lehman(Sept.11,2007)[LBEX
DOCID 157247] (stating that 50% of the recent VaR increase for Global Capital Products was due to
volatilityand50%wasfromtheoriginationbook);seealsoLehman,FirmwideRiskDriver(Oct.22,2007)
[LBEXDOCID 190147] (attributing the firms rising risk appetite and VaR usage figures primarily to
increasedcorrelationacrossdivisions).
132

varying risk appetite usage figures that Lehmans risk managers considered
unreasonable.498
Once these positions were officially included in risk appetite usage in August
2007,itbecamecleartoseniormanagementthatthefirmhadbeenexceedingthefirm
wideriskappetiteonapersistentbasisforsometime.499Thefirmsriskappetiteusage
startedtobediscussedmorewidelywithinthefirm.500
Lehmanraiseditsfirmwideriskappetitelimitfrom$3.3billionto$3.5billionon
September 7, 2007.501 Lehmans risk managers questioned whether Lehman truly had
increased risktaking capacity, however. Two weeks after the firm first included the
498ExaminersInterviewofJeffreyGoodman,Aug.28,2009;ExaminersInterviewofMarkWeber,Aug.
11, 2009, at p. 4; but cf. Examiners Interview of Madelyn Antoncic, Oct. 6, 2009, at p. 11 (reflecting
statementsthatshewasunawarethatthebridgeequityportionoftheArchstonedealhadbeenexcluded
from the firms risk measurementsand that she hit the roofwhen JeffreyGoodman told her that the
bridgeequityhadnotbeenincludedinthefirmsmetrics).
499ExaminersInterviewofJeffreyGoodman,Aug.28,2009;ExaminersInterviewofPaulShotton,June5,
2009,atp.19;AppendixNo.9,comparingriskappetiteandVaRusageversuslimits;emailfromMark
Weber, Lehman, to Laura M. Vecchio, Lehman (July 31, 2008) [LBEXDOCID 264849]; Mark Weber,
Lehman,ChartShowingRiskAppetiteAdjustmentforArchstone(July24,2008)[LBEXDOCID425705],
attached to email from Mark Weber, Lehman, to Portfolio Risk Support, Lehman, et al. (July 24, 2008)
[LBEXDOCID265567];emailfromMadelynAntoncic,Lehman,toDavidGoldfarb,Lehman,etal.(Aug.
14,2007)[LBEXDOCID211183].
500See Lehman, September 2007 Financial Information Presentation to Lehman Board of Directors (Oct.
15, 2007), at p. 6 [LBHI_SEC07940_026377]; Lehman Brothers Holdings Inc., Minutes of Meeting of the
FinanceandRiskCommitteeoftheBoardofDirectors(Sept.11,2007),atp.2[LBEXAM067018];Lehman
Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Sept. 11, 2007), at p. 3
[LBHI_SEC07940_026364]; email from Madelyn Antoncic, Lehman, to David Goldfarb, Lehman, et al.
(Aug.14,2007)[LBEXDOCID211183].
501EmailfromManhuaLeng,Lehman,toMynorGonzalez,Lehman,etal.(Sept.10,2007)[LBEXDOCID
262797]; email from Christopher M. OMeara, Lehman, to David Goldfarb, Lehman (Aug. 15, 2007)
[LBEXDOCID211183].ButseeemailfromMadelynAntoncic,Lehman,toDavidGoldfarb,Lehman,et
al.(Aug.28,2007)[LBEXDOCID193203](showingthatAntoncicdidnotbelievethatthedecisiontoraise
the limit had been made we did not close the loop on this. Robert worked up some numbers but I
thinkweneedtorevisittheexpectedrevforQ4givenaslowdown).
133

Archstone and Dermody/ProLogis bridge equity positions in the firms risk appetite
usage calculation, Goldfarb emailed OMeara and Antoncic: I thought we increased
[risk]appetitetoreflectYTDperformance?502Antoncicrepliedthattheydidnotclose
the loop on this because of concerns related to a fourthquarter slowdown in
revenues.503Underthemethodologyforcalculatingtheriskappetitelimit,aslowdown
inrevenueswouldhavereducedLehmansabilitytotakerisk.Similarly,inanOctober
2007 CSE meeting, Goodman informed the SEC that Lehman had increased its risk
appetitelimit,butadmittedthattheyprobablyshouldnthaveraisedthelimitto$3.5b
when they did, given that they were almost there and there wasnt enough
headroom.504
(e) CashCapitalConcerns
ALCO continued to have serious concerns about Lehmans cash capital and
liquidity position. Until the final week of September2007, Lehman did not expect its
endingcashcapitalpositionsforthemonthsofSeptember,October,andNovemberto
meetthe$2billionminimumrequirement.505Theaverageendingcashcapitalpositions
502Email from David Goldfarb, Lehman, to Madelyn Antoncic, Lehman, et al. (Aug. 28, 2007) [LBEX
DOCID193203].
503Email from Madelyn Antoncic, Lehman, to David Goldfarb, Lehman, et al. (Aug. 28, 2007) [LBEX
DOCID193203].
504SEC,NotesfromLehmansMonthlyRiskReviewMeeting(Oct.19,2007),atp.6[LBEXSEC007438].
505Lehman, ALCO Summary Package (Sept. 4, 2007), at p. 2 [LBEXDOCID 514862]; Lehman, ALCO
Summary Package (Sept. 5, 2007), at p. 2 [LBEXDOCID 514863]; Lehman, ALCO Summary Package
(Sept.6,2007),atp.2[LBEXDOCID514865];Lehman,ALCOSummaryPackage(Sept.7,2007),atp.2
[LBEXDOCID514866];Lehman,ALCOSummaryPackage(Sept.10,2007),atp.2[LBEXDOCID514867];
Lehman, ALCO Summary Package (Sept. 11, 2007), at p. 2 [LBEXDOCID 514868]; Lehman, ALCO
134

for September, October, and November 2007 were projected to be $0.05 billion, $2.15
billion and$1.75billion respectively.506Thecommitteeprojectednegativemonth end
cashcapitalpositionsfortheremainderoftheyear.507
OnthedaythatArchstoneclosed,TonucciinformedOMearathatLehmanwas
looking at being $12 [billion] short [in equity]should not really be surprised.508
Moreover, the firms cash capital projections for the end of October went negative
immediatelyafterthefirmclosedonArchstone.509
A draft presentation on the firms equity adequacy dated October 2007 was
preparedfortheExecutiveCommitteeshortlyaftertheexchangebetweenOMearaand
Tonucci.510OMearawasslatedtobethepresenter.511Thepresentationconcludedthat
the firms capital adequacy over the last five to six quarters had materially
[LBEXDOCID514871];Lehman,ALCOSummaryPackage(Sept.17,2007),atp.3[LBEXDOCID514872];
Lehman, ALCO Summary Package (Sept. 18, 2007), at p. 3 [LBEXDOCID 514873]; Lehman, ALCO
[LBEXDOCID514876];Lehman,ALCOSummaryPackage(Sept.26,2007),atp.3[LBEXDOCID514877].
506Id.
507Id.
508Email from Paolo R. Tonucci, Lehman, to Christopher M. OMeara, Lehman (Oct. 5, 2007) [LBEX
DOCID1360792].
509Lehman,ALCOSummaryPackage(Sept.4,2007),atp.2[LBEXDOCID514881].
510Lehman,EquityAdequacyPresentationtoExecutiveCommittee[Draft](Oct.26,2007)[LBEXDOCID
1698460],attachedtoemailfromAriAxelrod,Lehman,toChristopherM.OMeara,Lehman,etal.(Oct.
26,2007)[LBEXDOCID1912826].
511Email fromAriAxelrod,Lehman, toChristopherM. OMeara,Lehman,et al. (Oct.26,2007)[LBEX
DOCID1902541].
135

deteriorated.512 Lehman was at the bottom of its peer range with respect to the
regulatory requirement of a minimum 10% total capital ratio imposed by the SEC.513
The equity adequacy framework illustrated how the firms capital position decreased
froma$7.2billionsurplusinthebeginningof2006toa$42milliondeficitattheendof
the third quarter of 2007.514 The Examiner was unable to find a final version of this
presentation,andwasunabletodetermineifthepresentationeverwasgiven.Fuldsaid
that he was notaware oftheinformationcontained inthe presentation, andif he had
been,hewouldhavebeenabletoresolvethesituation.515
The deterioration of Lehmanscapital was also apparent from the decline in its
total capital ratio from 18.2% in early 2006 to 10.5% in August 2007.516 The industry
highinAugust2007was18.7%.517FromAugusttoNovember2007,Lehmanpostedthe
lowesttotalcapitalratiointheindustry.518ThefirmwasatornearitsSECimposed10%
512Ari Axelrod, Lehman, Equity Adequacy Presentation Summary Page [Draft] (Oct. 25, 2007), at p. 1
[LBEXDOCID 1696067], attached to email from Ari Axelrod, Lehman, to Christopher M. OMeara,
Lehman,etal.(Oct.26,2007)[LBEXDOCID1902541].
513Lehman,EquityAdequacyPresentationtoExecutiveCommittee[Draft](Oct.26,2007),atp.1[LBEX
DOCID1698460],attachedtoemailfromAriAxelrod,Lehman,toChristopherM.OMeara,Lehman,et
514Id.
515ExaminersInterviewofRichardS.Fuld,Jr.,Dec.9,2009,atp.5.
516Lehman, Monthly CSE Capital Reports for SEC (Mar. 2006), at p. 1 [LBEXSEC 000303]; Lehman,
Equity Adequacy Presentation to Executive Committee [Draft] (Oct. 26, 2007), at p. 5 [LBEXDOCID
1698460],attachedtoemailfromAriAxelrod,Lehman,toChristopherM.OMeara,Lehman,etal.(Oct.
26,2007)[LBEXDOCID1912826].
517EmailfromAnnaYu,Lehman,toErinM.Callan,Lehman,etal.(Dec.9,2007)[LBEXDOCID3761740].
518Lehman,CSEMethodologyImpactSummary(Apr.4,2008),atp.2[LBEXDOCID382980].
136

requirementforsixmonthsin20072008.519Onthreeseparateoccasions,Lehmanhadat
leastaconcernthatthetotalcapitalratiowouldfallbelowthe10%requirement.520
TheSECexpectedLehmantonotifyitifthetotalcapitalratiofellbeloworwas
expectedtofallbelowthe10%requirement,butLehmandidnotdoso.521Tonuccitold
theSECthatLehmanwascomfortablewithlandingclosetothe10%limitattheend
oftheyeargivenhowdifficultitistoissuerightnow.522
ThedominantcausefortherapiddeclineinLehmansequitypositionwasashift
in the firms asset mix to illiquid assets, including high yield loans, real estate, and
principal investments.523 From November 2006 to August 2007, the firms illiquid
holdingsgrewby72%,whileTier1capitalgrewbyonly26%.524
519Lehman,CSEMethodologyImpactSummary(Apr.4,2008),atp.2[LBEXDOCID382980].
520EmailfromAnnaYu,Lehman,toPaoloR.Tonucci,Lehman(Oct.3,2007)[LBEXDOCID1654567];e
mail from Anna Yu, Lehman, to undisclosed recipients (Nov. 26, 2007) [LBEXDOCID 638715]; email
fromAnnaYu,Lehman,toGeorgesAssi,Lehman,etal.(Dec.7,2007)[LBEXDOCID307968].
52117 C.F.R. 240.15c31g(e) (1) (i);17 C.F.R. 240.17i8(a) (2)(2007); The Goldman Sachs Group Inc.,
QuarterlyReportasofMay31,2008(Form10Q)(filedonJuly7,2008),atp.90(GoldmanSachs10Q
(filedonJuly7,2008))(GoldmanSachsisrequiredtonotifytheSECintheeventthattheTotalCapital
Ratio falls below 10% or is expected to do so within the next month); Merrill Lynch & Co., Inc.,
QuarterlyReportasofJune27,2008(Form10Q)(filedonAug.5,2008),atp.108(MerrillLynch10Q
(filedonAug.5,2008))(MerrillLynchisrequiredtonotifytheSECintheeventthattheTotalCapital
Ratiofallsorisexpectedtofallbelow10%);ErikR.Sirri,SEC,TestimonyConcerningLessonsLearnedin
RiskManagementOversightatFederalFinancialRegulatorsBeforetheSubcommitteeonSecurities,Insurance
andInvestmentCommitteeonBanking,HousingandUrbanAffairs,UnitedStatesSenate,Mar.19,2009
(CSEs were also required to file an early warning notice with the SEC in the event that certain
minimum thresholds, including the 10% capital ratio, were breached or were likely to be breached);
ExaminersInterviewofMatthewEichner,Nov.23,2009,atp.13.
522SEC,NotesfromMonthlyRiskMeetingwithLehman(Nov.15,2007),atp.2[LBEXSEC007467].
523Lehman,EquityAdequacyPresentationtoExecutiveCommittee[Draft](Oct.26,2007),atp.7[LBEX
DOCID1698460],attachedtoemailfromAriAxelrod,Lehman,toChristopherM.OMeara,Lehman,et
524Id.atp.6.
137

Thereafter, Lehmans cash capital and equity adequacy position temporarily
improved.Theimprovementwastheresultofseveralfactors.Foronething,theSEC
changed the method of calculating the total capital ratio, and, as a result, Lehman
pickedupseveralpercentagepointsandsavedroughly$4billionincapitalchargeson
average every month.525 In addition, Lehman was able to sell some of its leveraged
loanpositions,therebyraisingcashcapitalandreducingitsilliquidholdings.526
Originations
During this same period, midAugust 2007, Lehman decided to close BNC and
ceasesubprimeoriginationsentirely.527Theanticipatedturnintheresidentialmortgage
market still had not arrived, and management could not justify Lehmans continued
exposure to liability on the origination of subprime mortgages.528 In January 2008,
Lehmans Aurora subsidiary suspended its origination through wholesale and
525EmailfromAnnaYu,Lehman,toMartinKelly,Lehman,etal.(Feb.6,2008)[LBEXDOCID2799485].
526Lehman,ALCOSummaryPackage(Jan.31,2008),atp.2[LBEXDOCID527115].
527LehmanBrothersHoldingsInc.,PressRelease:LehmanBrothersAnnouncesClosureofBNCMortgage
(Aug. 22, 2007) [LBEXDOCID 880148]; Lehman, Subprime(r) (Sept. 6, 2007), at p. 14 [LBEXDOCID
894656];emailfromEdwardGrieb,Lehman,toChristopherM.OMeara,Lehman(Aug.22,2007)[LBEX
DOCID197143];emailfromTashaPelio,Lehman,toJasjit(Jesse)Bhattal,Lehman,etal.(Aug.22,2007)
[LBEXDOCID176893].
528ExaminersInterviewofLanaFranksHarber,Sept.23,2009,atpp.2,10,11;ExaminersInterviewof
DavidN.Sherr,Sept.25,2009,atpp.2,6,8.
138

correspondent channels, which represented the bulk of the program.529 Lehman had
curtailedtheflowofMortgageMakeroriginationsapproximatelyfivemonthsearlier.530
(g) September,October,andNovember2007Meetingsof
BoardofDirectors
Lehman had a series of Board meetings in the fall of 2007. At these meetings,
Lehmans management continued to report on the firms elevated risk profile and
concentrationofrealestateandleveragedloanrisk,butdidnotpresenttheBoardwith
additionalnegativeinformationconcerningthefirmsriskandliquidityprofile.
(i) RiskAppetiteDisclosures
AttheSeptember11,2007FinanceandRiskCommitteemeeting,theFinanceand
Risk Committee was shown a presentation disclosing that the firms average risk
appetite usage rose from $2.12 billion in November 2006 to $3.27 billion in August
2007.531Inthepresentation,theCommitteewasinformedthatwhileriskappetiteusage
had increased, Lehman still remained within its risk appetite limit.532 The Committee
529Lehman Brothers Holdings Inc., Press Release: Lehman Brothers Suspends Wholesale and
CorrespondentU.S.ResidentialMortgageOriginationActivities(Jan.17,2008)[LBEXDOCID156125].
530 Dimitrios Kritikos, Lehman, Aurora Loan Services Risk Review January 2008 (Feb. 7, 2008), at p.12
[LBEXDOCID394711].
531Lehman, Presentation on Risk, Liquidity, Capital and Balance Sheet Update to Finance and Risk
CommitteeofLehmanBoardofDirectors(Sept.11,2007),atp.2[LBEXAM067167].
532Lehman Brothers Holdings Inc., Minutes of Meeting of Financeand Risk Committee of the Board of
Directors(Sept.11,2007),atp.3[LBEXAM067018];Lehman,DailyRiskAppetiteReport(Sept.6,2007)
[LBEXDOCID1340197],attachedtoemailfromChristopherM.OMeara,Lehman,toDavidGoldfarb,
Lehman(Sept.7,2007)[LBEXDOCID1345985].
139

was informed of the recent increase in the risk appetite limit from $3.3 billion to $3.5
billion.533
AlthoughitwascorrectthatthefirmsmonthlyaverageriskappetiteforAugust
2007 was within the firms risk appetite limit, by the time of the meeting, Lehman
actuallywasoveritsnewlyincreasedlimitby$97million.534Additionally,Lehmanhad
been over the $3.5 billion limit each business day that month except for September 3,
2007.535ThereisnoevidencethattheBoardwasinformedthatArchstoneandatleast
one other bridge equity deal had been excluded from Lehmans risk appetite usage
calculation for almost three months, or that Lehman would have been over its risk
appetitelimitformuchoftheperiodsinceJune1,2007ifthosebridgeequitydealshad
beenincludedinthecalculationinatimelymanner.
When the full Board met again on October 15, 2007, OMeara disclosed that
Lehmanwasoveritsfirmwideriskappetitelimit.ButOMearadidnotwanttheBoard
to conclude that Lehman was out of bounds, so OMeara edited the standard chart
providedtotheBoardateachmeeting.536Previously,thatchartshowedthefirmsrisk
appetite usage and risk appetite limit in close proximity, so that the directors could
533 Lehman, Risk, Liquidity, Capital and Balance Sheet Update Presentation to Finance and Risk
Committee of Lehman Board of Directors with Weliksons handwritten notes (Sept. 11, 2007), at p. 25
[WGM_LBEX_02248].
534AppendixNo.9,comparingriskappetiteandVaRusageandlimits.
535Id.
140

easily seehowmuchbelow(orabove) theusagewascomparedtothelimit.537Before
theOctober2007Boardmeeting,however,OMearadirectedthatthelimitinformation
be removed from the final version of the chart.538 He explained to the Examiner that
managementwasnottroubledbybeingoverthelimitandhepreferredtoexplainthe
overagetotheBoardorallyratherthanthroughwrittenmaterials.539
In addition, OMeara informed the Board that Lehmans average daily risk
appetite usage for the prior month was $3.7 billion, $200 million above the new risk
appetitelimit,540buthedidnotdisclosethatonthedayoftheBoardmeeting,Lehmans
daily risk appetite usage was $4.269 billion, 22% (or $769 million) above the new risk
appetite limit.541 Moreover, at this October meeting, OMeara also said he told the
Board that Lehman had a higher capacity the outside edge of the amount of risk
thatLehmancouldabsorbthanitsactualriskappetitelimitandthatthecapacitywas
atleast$4.0billion.542
537Lehman, Second Quarter Financial Information Presentation to Lehman Board of Directors (June 19,
2007), at p. 6 [LBHI_SEC07940_026226]; Lehman, Estimated Third Quarter Financial Information

PresentationtoLehmanBoardofDirectors(Sept.11,2007),atp.6[LBHI_SEC07940_026288].
538Lehman,PresentationtoLehmanBoardofDirectorsonSeptember2007FinancialInformation[Draft]
(Oct.8,2007),atp.6[LBEXDOCID510227];Lehman,FinalPresentationtoLehmanBoardofDirectorson
September 2007 Financial Information (Oct. 15, 2007), at p. 6 [LBHI_SEC07940_026377]; Examiners
InterviewofChristopherM.OMeara,Sept.23,2009,atp.4.
539Id.
540Lehman,PresentationtoLehmanBoardofDirectorsonSeptember2007FinancialInformation(Oct.15,
2007),atp.6[LBHI_SEC07940_026377].
541Lehman,DailyFirmwideRiskDriver(Oct.15,2007)[LBEXDOCID147304],attachedtoemailfrom
JeffreyGoodman,Lehman,toMadelynAntoncic,Lehman,etal.(Oct.14,2007)[LBEXDOCID155737].
542ExaminersInterviewofChristopherM.OMeara,Aug.14,2009,atpp.10,12.
141

OMearadidnotinformtheBoardthatLehmangenerallyhadbeeninexcessof
its firmwide risk appetite limit since entering into the Archstone transaction in late
May 2007; OMeara attributed Lehmans limit excesses to recent changes in market
conditionsspecifically, the inabilitytosecuritize or syndicaterisksthat Lehmanhad
previouslyexpectedtobeabletodistribute543butdidnotmentionotherfactorssuch
astheadditionofArchstoneandothernewdeals.544
Many of Lehmans directors told the Examiner that this information about the
extentanddurationofanyriskappetitelimitexcesswouldhavebeenhelpfulforthem
tohavereceived.545SomedirectorsdidnotrecallknowingthatLehmanhadeverbeen
in breach of its risk appetite limits.546 Although none of the directors said that they
wouldhavechangedtheirviewshadtheyreceivedthatinformation,theydidsaythat
543ExaminersInterviewofChristopherM.OMeara,Sept.23,2009,atpp.1415;Lehman,Presentationon
Risk, Liquidity, Capital and Balance Sheet Update to Financeand Risk Committee of Lehman Board of
Directors(Sept.11,2007),atp.2[LBEXAM067167];LehmanBrothersHoldingsInc.,MinutesofMeeting
ofBoardofDirectors(Oct.15,2007),atp.6[LBHI_SEC07940_026407].
544Lehman, September 2007 Financial Information Presentation to Lehman Board of Directors with
Christopher M. OMearas handwritten notes (Oct. 15, 2007), at p. 6 [LEH_CMO_0000001]; Lehman,

September 2007 Financial Information Presentation to Lehman Board of Directors with Jeffrey A.
Weliksonshandwrittennotes(Oct.15,2007),atp.6[WGM_LBEX_00540].
545Examiners Interview of Roger Berlind, May 8, 2009, at p. 4; Examiners Interview of Dr. Henry
Kaufman,May19,2009,atp.7;ExaminersInterviewofMarshaJohnsonEvans,May22,2009,atpp.79;
Examiners Interview of John D. Macomber, Sept. 25, 2009, at p. 3; Examiners Interview of Roland A.
Hernandez,Oct.2,2009.
546Examiners Interview of Roger Berlind, May 8, 2009, at p. 4; Examiners Interview of John D.
Macomber,Sept.25,2009,atp.17;ExaminersInterviewofMarshaJohnsonEvans,May22,2009,atp.9;
ExaminersInterviewofSirChristopherGent,Oct.21,2009,atp.14;ExaminersInterviewofRolandA.
Hernandez,Oct.2,2009,atp.10.
142

theywouldhavewantedtohaveaconversationwithmanagementaboutthereasonfor
thelimitoveragesandmanagementsstrategyforresolvingthem.547
Thefollowingchartillustratesthelagbetweenthebeginningoftheriskappetite
limitoveragesandthenotificationoftheBoard.Thestraightdottedlinerepresentsthe
firmwideriskappetitelimitandthejaggedsolidlinerepresentsthefirmwideusage:
547Examiners
Interview of Roger Berlind, May 8, 2009, at p. 4; Examiners Interview of John D.
Macomber,Sept.25,2009,atp.13;ExaminersInterviewofMarshaJohnsonEvans,May22,2009,atp.7;
ExaminersInterviewofSirChristopherGent,Oct.21,2009,atp.15;ExaminersInterviewofRolandA.
Hernandez,Oct.2,2009,atp.10;ExaminersInterviewofDr.HenryKaufman,May19,2009,atp.7.
143

FirmwideRiskAppetiteUsagevs.Limit
Q2 2007 Q3 2007 Q4 2007 Q1 2008
4.5
PeriodbetweenRAexcessand Boardnotification
4.0
3.5
3.0
$inBillions
2.5
2.0
1.5
1.0
0.5
0.0
Feb28,07 May31,07 Aug31,07 Nov30,07 Feb29,08
May29,2007 Aug13,2007 Sep11, 2007 Oct15,2007

Archstone Archstoneis Boardof Boardisfirst
agreement. addedintoRA.RA Directorsistold toldabout RA
waslater thatRA"remains excess.
RAexcesses retroactively withinthe
beginsoon updatedtoreflect establishedrisk
thereafter. thecommitment limits."
sinceJune1,2007.
FirmwideUsage FirmwideLimit
Source:LehmanRisk Summary
Note:Datesmayreflect actualdate,orthefirst businessdayaftertheevent.
(ii) LeveragedLoanDisclosures
Both the Finance and Risk Committee and the full Board were apprised of
Lehmansriskexposuretohighyieldbondsandleveragedloan.548OMearadiscussed
548LehmanBrothersHoldingsInc.,MinutesofMeetingofFinanceandRiskCommitteeofLehmanBoard
ofDirectors(Sept.11,2007),atpp.12[LBEXAM067018];Lehman,Risk,Liquidity,CapitalandBalance
144

withtheCommitteethecomprehensiveriskframeworkforhighyielddebtproducts
and referred to Lehmans extensive risk controls, spanning the approval process
through postclosing.549 OMeara told the Finance and Risk Committee that Lehman
had a disciplined approach to risk mitigation through syndication, outright sales, sale
through silent partner participation, and singlename and macro hedging.550 A chart
that accompanied his presentation shows that Lehmans macro hedges reduced
LehmansHYClosedLoanNetExposurebyapproximately20%.551
TheBoardwasnotinformedthatin2007Lehmansmanagershaddecidednotto
increase the size of its macro hedges on the leveraged loans exposure to cover the
remaining 80% of the closed loans or to cover any portion of Lehmans much greater
volume of commitments because these exposures were considered potentially not
capableofbeinghedged.552(Relatedly,thereisnoevidencethatmanagementdisclosed
the extent to which Lehmans commercial real estate investments were unhedged.)553
SheetUpdatePresentationtoFinanceandRiskCommitteeofLehmanBoardofDirectors(Sept.11,2007),
at p. 13 [LBEXAM 067167]; Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors
(Sept.11,2007),atp.6[LBHI_SEC07940_026364].
Directors(Sept.11,2007),atpp.23[LBEXAM067018].
550Lehman, Risk, Liquidity, Capital and Balance Sheet Update Presentation to Finance and Risk
551Id.
552Examiners Interview of Paul Shotton, June 5, 2009, at pp. 78; Examiners Interview of Kentaro
Umezaki,June25,2009,atp.17;ExaminersInterviewofFredOrlan,Sept.21,2009,atp.6;Examiners
InterviewofRogerNagioff,Sept.30,2009,atp.13;ExaminersInterviewofAlexKirk,Jan.12,2010,atp.
9; Lehman Brothers Holdings Inc., Minutes of Meeting of Finance and Risk Committee of the Board of
Directors(Sept.11,2007),atpp.23[LBEXAM067018].
553ExaminersInterviewofMarshaJohnsonEvans,May22,2009,atpp.3,910;ExaminersInterviewof
RogerBerlind,May8,2009,atp.7.
145

Some members of Lehman management were concerned that hedging the leveraged
loanswouldbeineffectiveandcouldcreateadoublewhammysimultaneouslosses
ontheloansandthehedges.554
TheBoardwasnotinformedthattheriskappetiteusageofLehmansleveraged
loanbusinesswasalmostdoublethelimitapplicabletothatbusinessandthattheusage
had been over the limit almost continuously since July 19, 2007,555 or that Lehmans
management had approved at least 30 leveraged loans that exceeded Lehmans single
transactionlimit.556SomedirectorsbelievedthatthedecisiontoexceedLehmanshigh
yieldandsingletransactionlimitsshouldhavebeendisclosedtotheBoard.557
554ExaminersInterviewofRogerNagioff,Sept.30,2009,atpp.3,13;ExaminersInterviewofMadelyn
Antoncic,Mar.27,2009,atp.10.
555Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Sept. 11. 2007), at p. 6
[LBHI_SEC07940_263264]; Lehman, Update on Liquidity, Leveraged Loan Commitments and Mortgage

PositionsPresentationtoLehmanBoardofDirectorswithWeliksonshandwrittennotes(Sept.11,2007)
[LBHI_SEC07940_026355]; Mynor Gonzalez, Lehman, Daily Risk Appetite and VaR Report (Sept. 11,
2007) [LBEXDOCID 3296330], attached to email from Mynor Gonzalez, Lehman, to Mark Weber,
Lehman (Sept. 12, 2007) [LBEXDOCID 3295527]; Appendix No. 9, comparing risk appetite and VaR
usageversuslimits.
556Lehman, Risk, Liquidity, Capital, and Balance Sheet Update Presentation to Finance and Risk
CommitteeofLehmanBoardofDirectors(Sept.11,2007)[LBEXAM067167];LehmanBrothersHoldings
Inc.,MinutesofMeetingoftheFinanceandRiskCommitteeofBoardofDirectors(Sept.11,2007)[LBEX
AM 067018]; email from Joe Li, Lehman, to Fred Orlan, Lehman, et al. (July 25, 2007) [LBEXDOCID
2563167].
557ExaminersInterviewofDr.HenryKaufman,Sept.2,2009,atp.6(notingimportanceofconcentration
limits); Examiners Interview of John D. Macomber, Sept. 25, 2009, at pp. 6, 17 (stating that significant
excessesoughttohavebeendisclosed).
146

(iii) LeverageRatiosandBalanceSheetDisclosures
AttheseSeptember11,2007meetings,OMearaalsoreportedtotheFinanceand
Risk Committee that Lehmans net leverage ratio was in line with Lehmans peers.558
Managementspresentationregardingthenetleveragemetricnoted:
In the past, leverage was the key measure of equity adequacy. Between
2003 and 2006 we significantly reduced leverage. Low leverage was
positively viewed by rating agencies and contributed to our 2005
upgrades. In 2006 and 2007, we worked with the regulatory and rating
agenciestoimplementmoreaccurateadequacymeasures.Asaresult,we
arecomfortablewithallowingourleveragetoincrease.559
Thenewadequacymeasuresincludedameasurementforequity,theCSEcapitalratios,
andLehmansinternalequityadequacyframework.560
OMeara did not disclose the firms use of Repo 105 transactions to manage its
net leverage ratio at this Board meeting or any other, and no director asked by the
Examinereverwasawareoftheseoffbalancesheettransactions.561
558Lehman, Risk, Liquidity, Capital and Balance Sheet Update Presentation to Finance and Risk
CommitteeofLehmanBoardofDirectorswithWeliksonsHandwrittenNotes(Sept.11,2007),atpp.2,30
[WGM_LBEX_0224702340];LehmanBrothersHoldingsInc.,FinanceandRiskCommitteeMinutes(Sept.
11,2007),atpp.23[LBEXAM067018].
559Lehman, Presentation on Risk, Liquidity, Capital and Balance Sheet Update to Finance and Risk
560Id.atp.51.
561Examiners Interview of Roger Berlind, Dec. 18, 2009, at p. 4; Examiners Interview of Roland A.
Hernandez, Oct. 2, 2009, at p. 22; Examiners Interview of John D. Macomber, Sept. 25, 2009, at p. 20;
ExaminersInterviewofDr.HenryKaufman,Sept.2,2009,atp.21;ExaminersInterviewofMichaelL.
Ainslie, Dec. 22, 2009, at p. 4; Examiners Interview of Thomas Cruikshank, Oct. 8, 2009, at p. 2;
Examiners Interview of Sir. Christopher Gent, Jan. 20, 2010, at p. 4; Examiners Interview of Jerry A.
Grundhofer, Sept. 16, 2009, at p. 10; Lehman Brothers Holdings Inc., Minutes of the Board of Directors
(Sept.11,2007),atp.3[LBHI_SEC07940_026364];Lehman,BoardofDirectorsMaterialsforSept.11,2007
BoardMeeting(Sept.7,2007)[LBHI_SEC07940026282];LehmanBrothersHoldingsInc.,Minutesofthe
BoardofDirectors(Oct.15,2007),atp.6[LBHI_SEC07940_026407];Lehman,BoardofDirectorsMaterials
forOct.15,2007BoardMeeting(Oct.11,2007)[LBHI_SEC07940026371];LehmanBrothersHoldingsInc.,
147

(iv) LiquidityandCapitalDisclosures
Tonucci reported to the Boards Finance and Risk Committee that Lehman had
record levels of liquidity and cash capital surplus at the end of the third quarter of
2007.562HealsoreviewedLehmansliquiditypoolyeartodateandoverthelastfour
years, noting the conservative nature of the firms liquidity pool as compared to its
peers,which[had]beenrecognizedbytheleadingcreditratingagencies.563
The materials presented to the Board showed that Lehman had a third quarter
record liquidity pool of $36 billion (an increase from $25.7 billion at the end of the
second quarter 2007) and a cash capital position of $8.1 billion (an increase from $2.5
billion at the end of the second quarter) against a $2 billion policy minimum.564 The
materialsstatedthatLehmandidnotprojecttheneedtotapthecapitalmarketsbecause
Lehman had significant liquidity to fund these activities.565 Management similarly
emphasized to the full Board Lehmans conservative approach to funding its balance
Minutes of the Board of Directors (Nov. 8, 2007), at p. 6 [LBHI_SEC07940_026650]; Lehman, Board of

Directors Materials for Nov. 8, 2007 Board Meeting (Nov. 2, 2007) [LBHI_SEC07940026520]; see also
SectionIII.A.4ofthisReport.
Directors(Sept.11,2007),atp.3[LBEXAM067018].
563Id.
564Lehman,UpdateonLiquidity,LeveragedLoanCommitmentsandMortgagePositionsPresentationto
Lehman Board of Directors with Weliksons handwritten notes (Sept. 11, 2007), at p. 1
[LBHI_SEC07940_026355]; Lehman, Risk, Liquidity, Capital and Balance Sheet Update Presentation to
FinanceandRiskCommitteeofLehmanBoardofDirectors(Sept.11,2007),atp.31[LBEXAM067167].
565Id.
148

sheetandstrongliquiditypool,butacknowledgedthatforthelasttwomonthsliquidity
hadbeenmorechallengingtomaintain.566
Management did not tell the Board or the Finance and Risk Committee about
ALCOsconcernsaboutLehmansabilitytofunditscommitments,orthatLehmanhad
nearly stopped entering into new deals in August 2007.567 Some directors said that if
anyofLehmansseniormanagementhadconcernsaboutthefirmsfundingorcapital
adequacy,thatisclearlysomethingtheywouldhavewantedtoknow.568
OnSeptember20,2007,LehmanissuedapressreleaseannouncingthatOMeara
wouldreplaceAntoncicasLehmansGlobalHeadofRiskManagement(orCRO)asof
December1,2007.569TheExaminerdidnotfindanyevidencetosuggestthatAntoncics
replacement was related to the risk limit or risk disclosure issues that had occurred
duringthepriorthreetofourmonths.However,theSECnoteditsconcernthattherisk
566Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Sept. 11, 2007), at p. 5
[LBHI_SEC07940_026364].
567ExaminersInterviewofKentaroUmezaki,June25,2009,atpp.1617;ExaminersInterviewofRoger
Nagioff,Sept.30,2009,atpp.910;emailfromRogerNagioff,Lehman,toIanT.Lowitt,Lehman(July20,
2009)[LBEXDOCID175646];emailfromAlexKirk,Lehman,toRogerNagioff,Lehman(Aug.6,2007)
[LBEXDOCID173492];emailfromAlexKirk,Lehman,toRogerNagioff,Lehman(Aug.7,2007)[LBEX
DOCID173496].
568ExaminersInterviewofJohnD.Macomber,Sept.28,2009,atp.16;ExaminersInterviewofDr.Henry
Kaufman,Dec.22,2009(sayingitmighthavebeenappropriatetodiscloseliquidityconcernsiftheywere
morethanshortlived).
569Lehman Brothers Holdings Inc., Press Release: Lehman Brothers Announces Management Changes
(Sept.20,2007)[LBEXDOCID533362].
149

limit excesses occurred during a period when Lehmans CRO position was in
transition.570
(4) LateReactions:LehmanSlowlyExitsItsIlliquidRealEstate
Investments
Thelastquarterof2007andfirstquarterof2008fromSeptember2007through
February2008wasacrucialjunctureforLehman.Lehmansoverallbalancesheethad
grown by 37% during 2007,571 and much of the growth was concentrated in illiquid
holdingsthatLehmanwasalreadyunabletosellwithoutincurringsignificantlosses.572
As a result, without the accounting device of Repo 105 transactions, FID was already
welloveritsbalancesheetlimitofapproximately$230billionby$18billion.573Indeed,
Lehman had been over its risk limits for the prior six months.574 In hindsight, this
quarter may have been Lehmans final opportunity to take decisive action to improve
itsbalancesheetbeforethenearcollapseofBearStearnschangedtherulesoftheroad
forLehmanandallofitspeerinvestmentbanks.
BeforeBearStearnsnearcollapseinMarch2008,Lehmanhadtwobasicwaysof
reducing its leverage: (1) selling assets, to reduce the numerator in the net leverage
formula;or(2)raisingequity,toincreasethedenominatorinthenetleverageformula.
570SEC,NotesfromLehmansMonthlyRiskReviewmeeting(Oct.11,2007),atp.6[LBEXSEC007438].
571Lehman,2008FinancialPlanPresentationtoFinanceandRiskCommitteeofBoardofDirectors(Jan.
29,2008),atp.8[LBHI_SEC07940_068559].
572ExaminersInterviewofHerbertH.(Bart)McDadeIII,Sept.16,2009,atp.3;ExaminersInterviewof
TreasurySecretaryTimothyF.Geithner,Nov.24,2009,atp.7.
573AndrewJ.Morton,Notes:FirstSixtyDays(Apr.7,2008),atp.6[LBEXDOCID1734462].
150

But Lehman did not successfully take either of these tacks during the final quarter of
2007orthefirstquarterof2008:Lehmansnetbalancesheetwas$23.7billionhigherat
the end of the first quarter of 2008 than at the end of 2007.575 Lehman did not raise
substantialamountsofequityduringthisperiod.576
Lehmansfailuretosellassetssoonerwasbasedpartlyonitspreviousdecisionto
pursue a countercyclical growth strategy, which entailed a conscious acceptance of
greater risk even while Lehmans peer investment banks were curtailing their risk
taking.577 The countercyclical growth strategy continued to be reflected in Lehmans
strategyinthefirstquarterof2008.578
FuldtoldtheExaminerthathedecidedaftertheDecember2007holidayseason
to instruct his senior managers to reduce the firms balance sheet.579 However,
documentary evidence shows that Lehman did not aggressively begin to sell assets
untilthesecondquarterof2008.580
575LBHI10Q(filedonApr.9,2008),atp.70.
576Lehman,2008FinancialPlanPresentationtoFinanceandRiskCommitteeofBoardofDirectors(Jan.
29,2008),atp.16[LBHI_SEC07940_068559];ExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,at
pp.2527.
577See Lehman, 2008 Financial Plan Presentation to Finance and Risk Committee of Board of Directors
(Jan.29,2008),atp.6[LBHI_SEC07940_068559].
578Id.
579ExaminersInterviewofRichardS.Fuld,Jr.,Nov.19,2009,atp.2.
580Lehman, Commercial Real Estate Update (Mar. 25, 2008), at p. 3 [LBHI_SEC07940_127250]; Lehman,
Balance Sheet and Disclosure Scorecard For Trade Date April 21, 2008 (Apr. 22, 2008), at p. 3 [LBEX
DOCID3187588],attachedtoemailfromTalLitvin,Lehman,toHerbertH.(Bart)McDadeIII,Lehman,et
al.(Apr.22,2008)[LBEXDOCID3187333];emailfromGaryMandelblatt,Lehman,toAlexKirk,Lehman
(Jan.15,2008)[LBEXDOCID1600235];emailfromErinM.Callan,Lehman,toHerbertH.(Bart)McDade
III,Lehman,etal.(Apr.3,2008)[LBEXDOCID1538729];emailfromPaulA.Hughson,Lehman,toMark
151

Duringthefirstquarterof2008,FuldalsodecidedthatLehmanwouldnotraise
equity unless it could do so at a premium.581 While many of Lehmans competitors
enteredintostrategictransactionstoraiseequityinlate2007andearly2008,582Lehman
didnotwanttosignalweaknessbyraisingequityatadiscount,583and,unlikeitspeers,
had not yet suffered losses that might have signaled a more urgent need for such
action.
(a) Fiscal2008RiskAppetiteLimitIncrease
InOctober2007,thefirmwideriskappetiteusagecontinuedtoincrease,andfor
several days was more than $500 million over the limit; the limit excess peaked at
almost 22% of the limit amount.584Thelimitexcess waspartly the resultofLehmans
decision to enter into several significant commercial real estate and leveraged loan
transactionsinMay,June,andJuly2007,whichweregraduallybeingfundedandthus
Walsh,Lehman(Apr.1,2008)[LBEXDOCID1866761];Lehman,BalanceSheetandDisclosureScorecard
ForTradeDateAugust12,2008(Aug.13,2008),atp.7[LBEXSIPA006539].
581Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at p. 8; Examiners Interview of Jeremy
Isaacs,Oct.1,2009,atp.3.
582See,e.g.,MerrillLynch&Co.,Inc.,AnnualReportfor2007asofDec.28,2007(Form10K)(filedonFeb.
25,2008),atp.23(MerrillLynch200710K)(statingthatMerrillLynchissued$6.2billionincommon
stockduringthefourthquarterof2007,and$6.6billionofmandatoryconvertiblepreferredstockduring
thefirstquarterof2008);MorganStanley,AnnualReportfor2007asofNov.30,2007(Form10K)(filed
on Jan. 29, 2008), at pp. 17879 (Morgan Stanley 2007 10K) (stating that Morgan Stanley sold equity
units to the Chinese Investment Corporation for approximately $5.579 billion in December 2007);
Citigroup Inc., Annual Report for 2007 as of Dec.31,2007 (Form 10K)(filed on Feb.22, 2008), at p.77
(Citigroup 2007 10K) (stating that Citigroup sold $7.5 billion of equity units to the Abu Dhabi
InvestmentAuthorityonDecember3,2007);UBSAG,AnnualReportfor2007asofDec.31,2007(Form
20F) (filed on Mar. 18, 2008), at pp. 27677 (UBS AG 2007 20F) (stating that UBS issued shares
correspondingtoapproximately13.4%ofthethencurrentsharecapitalonFebruary27,2008);seeSection
III.A.3ofthisReport.
583Email from David Goldfarb, Lehman, to Richard S. Fuld, Jr., Lehman, et al. (Jan. 9, 2008)
[LBHI_SEC07940_670045].
152

increasing Lehmans risk appetite usage; partly the result of Lehmans inability to
securitize or syndicate those and other transactions; and partly the result of increased
volatilityinthemarket.585
Lehmanincreasedthefirmwideriskappetitelimitforfiscal2008.Approvalfor
the increase was given on January 14, 2008, when Lehman raised the limit from $3.5
billionto$4billion,with[the]increase[being]backdatedtoDecember3,2007.586The
limitincreasehadtheeffectofeliminatinganyfirmwidelimitexcessesfromthatdate
forward.587
To arrive at the $4 billion risk appetite limit figure, Lehmans officers made
significantchangestothelimitcalculationascomparedtoprioryearscalculations.The
Examinersfinancialadvisors calculatethatif the same assumptionsusedfor the 2007
riskappetitelimithadbeenusedtodeterminethelimitfor2008,the2008limitwould
havebeenapproximately$2.5billionratherthan$4.0billion.588
The 2008 risk appetite limit also was based on a very aggressive projected
revenue figure. Lehmans projected revenues were the starting point for setting the
limit,andperhapsthesinglemostimportantinputtotheformula.Lehmanuseda$21
585SEC,NotesfromLehmansMonthlyRiskReviewMeeting(Aug.17,2007),atp.7[LBEXSEC007383];
emailfromJeffreyGoodman,Lehman,toChristopherM.OMeara,Lehman,etal.(Dec.4,2007)[LBEX
DOCID251204].
586Lehman,MaterialforMarketRiskControlCommitteeMeeting(Jan.14,2008),atp.33[LBEXDOCID
271352], attached to email from Mark Weber, Lehman, to Paul Shotton, Lehman, et al. (Jan. 14, 2008)
[LBEXDOCID223263].
588For a more detailed explanation of the changes in the risk appetite calculation, see Appendix 10,
describingcalculationofincreased$4.0billionriskappetitelimit.
153

billionprojectedrevenuefigureincalculatingthe$4billionlimitamount.589Despitethe
difficulties in the market, this amount constituted a 9% increase over 2007 revenues.
Contemporaneousexternalanalystreportsprojected2008revenuesofonlyabout$19.2
billion a figure that would have resulted in a much lower risk appetite limit for the
year.590
(b) January2008MeetingofBoardofDirectors
OnJanuary29,2008,theFinanceandRiskCommitteeandtheentireBoardmet.
Duringthesemeetings,managementdiscussedthedifficultmarket,butbelievedthatit
presentedopportunitiesforLehmantogrow.591LehmansseniorofficerstoldtheBoard:
[The market environment] presents an opportunity for the firm to pursue a
countercyclicalgrowthstrategy,similartowhatitdidduringthe20012002downturn,
to improve its competitive position and, over time, generate superior returns for our
shareholders.592
Management provided the Finance and Risk Committee with an overview of
LehmansnetassetsandleveragelevelsandtoldtheCommitteethatLehmansbalance
589Paolo R. Tonucci, Lehman, 2008 Financial Plan Presentation (Jan. 29, 2008), at p. 1
[LBHI_SEC07940_068559].
590E.g.,DouglasSipkin,WachoviaCapitalMarkets,L.L.C.,ToughYearAheadSowingSeedsforShare
Gains(Jan.15,2008),atp.1[LBEXDOCID095883];Appendix10,describingcalculationofincreased$4.0
billionriskappetitelimit.
591Lehman,2008FinancialPlanSummary(Jan.29,2009),atp.5[LBHI_SEC07940_027374].
592Id.
154

sheet continued to grow across almost all asset classes and businesses.593 At the full
Boardmeeting,KaufmanreportedtotheBoardonLehmansbalancesheetgrowthand
Lehmans year end increase in net leverage.594 Callan discussed Lehmans target
leverageratiowiththeBoardandsaidthatitwouldcomebackdown.595
At the Finance and Risk Committee meeting, management reviewed Lehmans
monthlystresstestsandscenarioanalyses.596Stresstestsindicatedaworstcaselossof
$3.2 billion.597 Management did not inform the Committee of a new Credit Crunch
scenario that was added to Lehmans portfolio of stress testing scenarios in October
2007 that predicted the worst loss of all the scenarios, with a loss of $3.99 billion
(althoughearlydraftsofthepresentationdidincludethescenario).598
At these January meetings, Lehmans management also recommended the new
risk appetite limit to the Board.599 The directors were generally not aware or did not
Directors(Jan.29,2008),atpp.23[LBEXAM067022];Lehman,AdditionalMaterialsfortheFinanceand
RiskCommittee(Jan.29,2008),atp.3[LBEXAM067260].
594Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Jan. 29, 2008), at p.3
(LBHI_SEC07940_027446].
595Id.atp.8;Lehman,December2007PresentationtoLehmanBoardwithWeliksonshandwrittennotes
(Jan.29,2008),atp.6[WGM_LBEX_00708].
596Lehman, 2008 Financial Plan Presentation to Finance and Risk Committee of the Board of Directors
(Jan.29,2008),atp.18[LBHI_SEC07940_068559].
597Id.atp.19.
598Lehman, Monthly Risk Review Package (Oct. 11, 2007), at p. 10 [LBEXSEC 007438] (noting Lehman
added a new stress test, called the Credit Crunch which is essentially Summer 2007); Lehman, 2008
Financial Plan Presentation to Lehman Board of Directors [Draft] (Jan. 2008), at p. 5 [LBEXDOCID
384192], attached to email from Mark Weber, Lehman, to Jennifer Bale, Lehman, et al. (Jan. 16, 2008)
[LBEXDOCID306708].
599Lehman,2008FinancialPlanSummary(Jan.29,2008),atp.11[LBHI_SEC07940_027374].
155

recallanydiscussionregardingtheadjustmentsoftheriskappetitecalculation.600Two
ofthedirectorssaidthattheywouldhavewantedtoknowaboutsignificantchangesin
the methodology.601 However, Lehmans managers told the Board that the $21 billion
revenueprojectionwasveryaggressive,andtheBoardhadanextendeddiscussionof
theimpactofpotentiallylowerrevenuesonLehmansbusiness.602
(c) ExecutiveTurnover
InJanuary2008,Nagioffdecidedforpersonalreasonstoresignasglobalheadof
FID.603 In addition, that month, Alex Kirk, cochief operating officer of FID since
October2007,leftLehman.KirkagreedwithFuldthathewouldleaveLehmanatabout
thesametime.604
600 Examiners Interview of Sir Christopher Gent, Oct. 21, 2009, at p. 16; Examiners Interview of Dr.
HenryKaufman,Sept.2,2009,atp.2;ExaminersInterviewofRolandA.Hernandez,Oct.2,2009,atp.
14;ExaminersInterviewofJohnD.Macomber,Sept.25,2009,atp.18.
601 Examiners Interview of Dr. Henry Kaufman, Sept. 2, 2009, at p. 2; Examiners Interview of John
Macomber,Sept.25,2009,atp.2.
602Jeffrey A. Welikson, Lehman,Notesfrom the 2008 Financial Plan Presentation (Jan. 29,2008), at p. 1
[WGM_LBEX_03249].
603Examiners Interview of Roger Nagioff, Sept.30, 2009, at p. 20; Examiners Interview of Richard S.
Fuld, Jr., Sept.25, 2009, at p.22 (Fuld indicated that Nagioffs decision to step down was entirely
voluntary and was the result of Nagioffs frustration with his commute from London); Examiners
InterviewofSirChristopherGent,Oct.21,2009,atp.5(Gentexplainedthat,basedonconversationswith
Nagioff,hebelievedNagioffsresignationwasentirelyduetothelogisticaldisruptionofNagioffsfamily
lifeonaccountofhiscommute);ExaminersInterviewofHughE.(Skip)McGeeIII,Aug.12,2009,atp.13
(McGee denied that Nagioffs resignation had anything to do with Lehmans cessation of residential
mortgage originations, and tied Nagioffs decision to the difficulty of Nagioffs commute); Examiners
InterviewofJohnF.Akers,Apr.22,2009,atp.2(AkersexpressedthebeliefthatNagioffleftvoluntarily
and that his departure was mutual between him and management, but also noted that along with the
commute from London, difficulty also arose because Nagioff failed to meet Fulds expectations);
Examiners Interview of EricFelder, May21, 2009, at p.6 (Felder indicated that Nagioff left Lehman
voluntarily).
604TranscriptofdepositiontestimonyofAlexKirk,InreLehmanBrothersHoldingsInc.,CaseNo.0813555,
Bankr.S.D.N.Y.,Aug.31,2009,atpp.78.
156

(d) CommercialRealEstateSellOff:TooLittle,TooLate
Although Lehman ultimately took aggressive action to reduce its balance sheet
andthusitsnetleverage,Lehmansmanagementdidnotmakeafirmwidedecisionto
reducethesefiguresuntilwellafterthebeginningoftheriskappetiteandbalancesheet
limitoveragesinmid2007.Moreover,evenafterLehmansseniorofficersdirectedthe
businesslinestoreducetheirbalancesheets,ittookseveralmonthsforthereductionto
be effectuated, particularly with respect to Lehmans illiquid holdings of commercial
realestateassets.
Although the firm persistently was over its balance sheet limits, and had been
overtheriskappetitelimitsinceaboutJune1,2007,thefirstwrittenindicationthatthe
RiskCommitteeconsideredtherisklimitoveragewasinOctober2007.605OnOctober2,
2007, OMeara noted in an email that the Risk Committee agreed to temporarily
approve the Risk Appetite limit overage, due to the unusual circumstances in the
marketplacetoday/recently,especiallyconcerningLeveragedFinanceandRealEstate
businesses.606 Thus, Lehmans management decided not to reduce its risk position
aggressivelyatthattime.
Later in October, in advance of a planned conversation with the Executive
Committee,OMearaproposedformulatingspecificrecommendationsaboutwhereto
605Email from Christopher M. OMeara, Lehman, to Paul Shotton, Lehman, et al. (Oct. 2, 2007) [LBEX
DOCID155020].
606Email from Christopher M. OMeara, Lehman, to Paul Shotton, Lehman, et al. (Oct. 2, 2007) [LBEX
DOCID155020].
157

make the cuts to bring down risk appetite.607 Goodman expressed a willingness to
takesomelossestoachievethisgoal.608InaNovember2007presentationtoFuld,the
commercial real estate group recommended reducing its global balance sheet by $15
billion.609
When Erin M. Callan became CFO on December 1, 2007, one of her objectives
wastoreducebalancesheet,particularlyintheareasofresidentialandcommercialreal
estate.610 Fuld decided during the December 2007 holiday season that it was time to
pursueanaggressivereductionofLehmansriskprofile.611
Lehman did not aggressively pursue these reductions for several months,
however. According to Callan, she had discussions with Fuld and Gregory about
reducing balance sheet in January and February 2008, but didnt get traction quickly
on it.612 Between the fourth quarter of 2007 and the first quarter of 2008, Lehmans
grossandnetassetsactuallyincreasedfrom$691billionto$786billion,andfrom$373
607EmailfromJeffreyGoodman,Lehman,toMarkWeber,Lehman,etal.(Oct.22,2007)[LBEXDOCID
318367].
608Id.
609GlobalRealEstateGroup,Lehman,GlobalRealEstateUpdate(Nov.6,2007),atpp.1,2[LBEXDOCID
514264],attachedtoemailfromJeffreyGoodman,Lehman,toMadelynAntoncic,Lehman,etal.(Nov.6,
2007)[LBEXDOCID531492];emailfromJonathanCohen,Lehman,toChristopherM.OMeara,Lehman,
et al. (Nov. 3, 2007) [LBEX DOCID 523669] (indicating that Fuld was the intended audience of the
presentation).
610ExaminersInterviewofErinM.Callan,Oct.23,2009,atpp.1013.
158

billionto$397billion,respectively.613Inaddition,FIDexceededitsbalancesheetlimit
inthefourthquarterof2007by$11.17billion,withoveragesconcentratedinsecuritized
productsandrealestate.614Inthefirstquarterof2008,FIDwasoverthebalancesheet
limit by $18 billion with nearly 50% of the overages concentrated in securitized
products and real estate.615 Lehmans Treasurer at the time, Paolo Tonucci, was
comfortablewithFIDsbalancesheetoveragesinthefirstquarterof2008.616Attheend
ofthefirstquarterof2008,TonuccididnotrequireFIDtoselloffmoreassets.617
ItwasnotuntilFebruary26,2008thatGregoryinstructedWalshtogetbalance
sheetdownquickly,618andGREGsetouttoreduceitsglobalbalancesheetby$5billion
by March 18, 2008.619 Even after that, Callan told the Examiner that she pleaded with
Fuld and Gregory to reduce the balance sheet and finally persuaded them to add the
issue to the Executive Committees March 20, 2008 agenda after the near collapse of
613Lehman,Q22008Update(June18,2008),atp.5[LBEXDOCID1302959],attachedtoemailfromAnu
Jacob,Lehman,toDennisRodrigues,Lehman,etal.(July8,2008)[LBEXDOCID1326944].
614AndrewJ.Morton,Notes:FirstSixtyDays(Apr.7,2008),atp.6[LBEXDOCID1734462],attachedtoe
mailfromGaryMandelblatt,Lehman,toAndrewJ.Morton,Lehman,etal.(Apr.7,2008)[LBEXDOCID
1834937].
615Id.atp.4.
616Email from Clement Bernard, Lehman, to Andrew J. Morton, Lehman, et al. (Feb. 27, 2008) [LBEX
DOCID1849839].
617Id.
618Email from Mark A. Walsh, Lehman, to Andrew J. Morton, Lehman (Feb.26, 2008)
[LBHI_SEC07940_115814].
619EmailfromPaulA.Hughson,Lehman,toMarkGabbay,Lehman,etal.(Feb.27,2008)[LBEXDOCID
1869265] (discussing the schedule for the $5 billion reduction target); email from Paul A. Hughson,
Lehman,toMarkGabbay,Lehman,etal.(Mar.7,2008)[LBEXDOCID1723168](Hughsongivesupdate
on sales progress and asks for updates from others on their progress towards the $5 billion reduction
target).
159

Bear Stearns.620 McDade was made the firms balance sheet czar in midMarch and
was given authority to enforce firmwide balance sheet targets.621 Fuld intended to
reduceallofLehmanspositions,includingcommercialrealestateandleveragedloans
positions.622BalancesheetreductiontargetswerenotsentouttoLehmansbusinesses
untilaftertheExecutiveCommitteemeetingonMarch20,2008.623
OnMay13,2008,twoweeksbeforetheendofthesecondquarter,Callanurged
GregoryandFuldtodeliveronthebalancesheetreductionthisquarterandnotgive
anyroomtoFIDforslippage.624GREGsoverseasbusinessesinparticularwereslow
to reduce their positions in the first and second quarters of 2008,625 but GREGs U.S.
businessmetitsbalancesheetreductiontargets,despitecontinuingtoengageinsome
originations.626
SomewitnessesbelievedthatGREGwasnotaggressiveenoughinsellingoffits
portfolio, holding on to positions in a belief that the market would eventually
620ExaminersInterviewofErinM.Callan,Oct.23,2009,atpp.10,11.
621Id.atp.12;ExaminersInterviewofAndrewJ.Morton,Sept.21,2009,atp.11.
624Email from Erin M. Callan, Lehman, to Joseph Gregory, Lehman, et al. (May 13, 2008)
[LBHI_SEC07940_034732].
625ExaminersInterviewofPaulA.Hughson,Oct.28,2009,atp.5;Lehman,BalanceSheetandDisclosure
ScorecardforTradeDateJune23,2008(June24,2008),atp.10[LBEXDOCID1742000],attachedtoemail
from Michael McGarvey, Lehman, to Paul Mitrokostas, Lehman, et al. (June 25, 2008) [LBEXDOCID
1856557]; email from Paul A. Hughson, Lehman, to Kentaro Umezaki, Lehman, et al. (Oct. 2, 2007)
[LBEXDOCID 1809381]; email from Paul A. Hughson, Lehman, to Jonathan Cohen, Lehman (July 20,
2007)[LBEXDOCID1426881].
626Examiners Interview of Mark A. Walsh, Oct. 21, 2009, at pp. 1011 (stating that he and Gregory
realizedatthetimethathaltingoriginationswasnotaseasyasflippingaswitch).
160

rebound.627 In one memorandum, Lehmans Head of Global Strategy expressed the
concernthattheteamresponsibleforsellingdownthesepositionsisthesameonethat
originated them.628 But several witnesses denied there was any incentive not to sell
down the portfolio because they knew that no one in GREG would be getting a 2008
bonus.629
RegardlessofthereasonsforLehmansslowreactiontoitsoversizedcommercial
realestateholdings,thefactremainsthatLehmansbalancesheetdidnotdeclineuntil
theendofthesecondquarterof2008,afterBearStearnshadalreadynearlycollapsed.
(e) LehmansCompensationPractices
TheExaminerconsidered,inthecourseofdeterminingwhethertheofficersand
directors of Lehman breached their fiduciary duties, the impact that Lehmans
compensationpracticesmayhavehadonLehmansconductsuchastheexpansioninto
potentiallyhighlyprofitable,butriskier,linesofbusiness,asdiscussedabove.
Lehmans compensation policy was designed, in theory, to penalize excessive
risktaking.Attimes,FIDbusinessesthatexceededbalancesheetlimitsandbreached
627ExaminersInterviewofErinM.Callan,Oct.23,2009,atp.13;ExaminersInterviewofMarkWeber,
Aug.11,2009,atpp.89.
628Memorandum from Timothy Lyons, Lehman, to David Goldfarb, Lehman, Strategic Imperatives for
theFirm(July3,2008),atp.1[LBEXDOCID1377945].
629ExaminersInterviewofDavidOReilly,Oct.26,2009,atp.3;ExaminersInterviewofMarkA.Walsh,
Oct. 21, 2009, at p. 11; Examiners Interview of Kenneth Cohen, Oct. 20, 2009, at p. 11; Examiners
InterviewofAndrewJ.Morton,Sept.21,2009,atpp.1920(MortonnotesthatWalshknewbyFebruary
2008 that he would receive only a straight salary for 2008, with no bonus, thus Walsh had no
compensationbased incentive to inflate his marks). For a more detailed discussion of the effect of
Lehmansofficerscompensationstructureontheincentivetotakerisks,seeAppendix11,Compensation.
161

risk limitsfaceddiminutionoftheircompensationpool.630Atothertimes,FIDused a
Compensation Scorecard that included riskweighted metrics such as return on risk
equity and return on net balance sheet to determine compensation pool allocations.631
The FID Compensation Committee assessed performance against VaR, balance sheet
usage,andriskappetite.632
But in practice, Lehman rewarded its employees based upon revenue with
minimal attention to risk factors in setting compensation. None of these riskrelated
adjustments was applied rigorously or consistently. Ken Umezaki, then Head of FID
Strategy,notedafterafirmwidespeechbyFuld:
[T]hemajorityofthetradingbusinessesfocusisonrevenues,withbalance
sheet,risklimit,capitalorcostimplicationsbeingasecondaryconcern.633
To calculate revenue for its compensation pool, Lehman included revenue not
yetrecognizedbutrecordedbasedonmarktomarketpositions.634Intheory,therefore,
traders and business units were incented to enter into transactions for shortterm
profits,evenifthosetransactionscreatedlongtermrisksforthefirm.635
630 Examiners Interview of Kentaro Umezaki, June 25, 2009, at pp. 89; Lehman, Global Consolidated
BalanceSheet(May31,2007)[LBEXDOCID276740];emailfromKentaroUmezaki,Lehman,toKaushik
Amin,Lehman,etal.(July10,2007)[LBEXDOCID252873].
631Lehman,2004FixedIncomeDivisionCompensationScorecard(Undated)[LBEXDOCID1748807].
632Lehman,COMPMETRICSExcelSpreadsheet(Undated),atpp.19[LBEXLL1054327];Lehman,2007
FIDForecastBudgetSupportExcelSpreadsheet(Undated),atpp.111[LBEXBARCMP0000001].
633 Email from Kentaro Umezaki, Lehman, to Scott J. Freidheim, Lehman, et al. (Apr. 19, 2007) [LBEX
DOCID318475].
634ExaminersInterviewofJohnD.Macomber,Sept.25,2009,atpp.5,22;ExaminersInterviewofJames
Emmert,Oct.9,2009,atp.23.
635 See Section III.A.1.b.1.2 of this Report. The Examiner finds that Lehmans assumption of ever
increasing business risk did not come from the bottom up but rather from the top down. Similarly
162

Lehmans marktomarket accounting also incented Lehman to value
investmentsatthehighendtogeneratehighernetrevenues.Lehmanhadprocedures
tocontrolsuchvaluations,however,andinpractice,theExaminerfoundnoevidenceto
supportafindingthatanyimpropervaluationsweretakentoaffectcompensation.
AmoredetaileddescriptionofLehmanscompensationpracticesmaybefound
atAppendix11.
c) Analysis
The Examiner investigated three potential claims in connection with Lehmans
managementofitsrisks:(1)whetheranyLehmanofficerbreachedthefiduciarydutyof
caretothefirmbyassumingexcessiveriskwithrespecttoLehmansinvestments,orby
failing to follow the firms risk management policies; (2) whether any Lehman officer
breachedthefiduciarydutyofgoodfaithandcandorbynotprovidingtheBoardwith
material information concerning risk issues; and (3) whether any Lehman director
breachedthefiduciarydutyofgoodfaithtomonitorLehmansriskmanagement.
LehmansseniorofficersFuldandGregoryinparticularhadsizeableholdingsofLehmanstockand
may have been more incented to increase Lehmans longterm stock price than to generate shortterm
revenues.
163

Procedures
(a) LegalStandard
To assert a colorable duty of care claim concerning corporate conduct, the
plaintiff must first overcome the protection of the business judgment rule. Under the
traditionalbusinessjudgmentruleasitappliestodirectors,thereisapresumptionthat
inmakingabusinessdecisionthedirectorsofacorporationactedonaninformedbasis,
ingoodfaithandinthehonest beliefthattheactiontakenwasinthebestinterestsof
thecompany.636Thus,acourtwillnotsubstituteitsjudgmentforthatoftheboardif
thelattersdecisioncanbeattributedtoanyrationalbusinesspurpose.637
Thebusinessjudgmentrulehasrarelybeenappliedtoofficers.However,based
upon a recent decision by the Delaware Supreme Court638 holding that the fiduciary
duties of directors and officers are identical, the Examiner concludes that Delaware
courts will likely hold, at a minimum, that officers are protected by the business
judgment rule whenever they act under an express delegation of authority from the
Board;theDelawarecourtsarealsolikelytoholdthatofficersareprotectedbytherule
636Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954 (Del. 1985) (quoting Aronson v. Lewis, 473 A.2d
805,812(Del.1984))(internalquotationmarksomitted).
637Id. (quoting Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del. 1971)); see the discussion of Delaware
corporatefiduciarylawinAppendix1,LegalIssues.
638Gantlerv.Stephens,965A.2d695,709(Del.2009).
164

whenevertheyactwithinthescopeoftheirdiscretionevenifnotpursuanttoexpress
delegationbytheBoard.639
The Examiner concludes that the Delaware courts are likely to hold that an
officer can be stripped of the protection of the business judgment rule only in fairly
narrowcircumstancesnotpresentedhere.640
If the evidence overcomes the presumption of the business judgment rule, the
plaintiffmustthenproveaviolationofthedutyofcare.641Thestandardofprooffora
dutyofcareclaimforcorporatemisconductisgenerallydefinedasgrossnegligence.642
Gross negligence means reckless indifference to or a deliberate disregard of the
corporationsinterests,oractionswhicharewithouttheboundsofreason.643
Overcoming the business judgment rule and establishing gross negligence are
particularly difficult when a plaintiff is challenging the risktaking of a financial
institution.AsacourtapplyingDelawarelawhasrecentlynoted,takingrisksisatthe
heart of a financial institutions business, and decisions about what risks to take are
639Cf.id.(holdingthatthefiduciarydutiesofofficersanddirectorsareidentical).
640See,e.g.,McMullinv.Beran,765A.2d910,922(Del.2000);seealsoSmithv.VanGorkom,488A.2d858,872
(Del.1985),overruledonothergroundsbyGantler,965A.2dat713n.54;Aronson,473A.2dat812,overruled
onothergroundsbyBrehmv.Eisner,746A.2d244,254(Del.2000).Ryanv.Gifford,918A.2d341,354(Del.
Ch.2007);Massarov.VernitronCorp,559F.Supp.1068,1080(D.Mass.1983);OmnibankofManteev.United
S.Bank,607So.2d76,8485(Miss.1992)Cf.MillsAcquisitionCo.v.MacMillan,Inc.,559A.2d1261,1279
(Del. 1989) ([J]udicial reluctance to assess the merits of a business decision ends in the face of illicit
manipulationofaboardsdeliberativeprocessbyselfinterestedcorporatefiduciaries.).
641Unlikethedirectors,LehmansofficersarenotimmunizedbyLehmansarticlesofincorporationfrom
personal liability for breaching the duty of care. See Lehman Brothers Holdings Inc., Certificate of
Incorporation,at10.1,LimitationofLiabilityofDirectors.
642VanGorkom,488A.2dat873.
643Tomczakv.MortonThiokol,Inc.,No.7861,1990WL42607,at*12(Del.Ch.Apr.5,1990).
165

inherently protected by the business judgment rule from hindsight challenge.644
Therefore, a plaintiff asserting a breach of the duty of care by Lehmans senior
managerswouldfacesignificantburdens.
(b) Background
The Examiner finds insufficient evidence to support a claim that any Lehman
officer breached the fiduciary duty of care in connection with managing the risks
associatedwiththemoreaggressivebusinessstrategyLehmanadoptedin2006.
Asmentionedabove,Lehmansbusinessstrategyin2006and2007waspremised
onusingmoreofitsbalancesheettoincreaseitsprincipalinvestments.Inadditionto
the risks in the proprietary investments themselves, many of the firms proprietary
investments entailed a commitment by Lehman to a much larger amount of debt or
equity than Lehman ultimately expected to retain for itself. Although these bridge
equity and bridge debt transactions were risky, Lehmans management decided to
engage in these transactions because they were profitable in their own right, because
they helped Lehman participate in more and larger deals, and because they helped
Lehmantodeveloplongtermclientrelationships.
644In re Citigroup Inc. Sholder Derivative Litig., 964 A.2d 106, 126 (Del. Ch. 2009) (The essence of the
business judgment of managers and directors is deciding how the company will evaluate the tradeoff
betweenriskandreturn.Businessesandparticularlyfinancialinstitutionsmakereturnsbytakingon
risk;acompanyorinvestorthatiswillingtotakeonmoreriskcanearnahigherreturn.).
166

Lehmans officers were entitled under Delaware law to pursue this aggressive
highriskstrategy,andtheExaminerdoesnotquestiontheirbusinessdecisiontodoso;
decisionsofthistypeareatthecoreofthebusinessjudgmentrule.
Although its management was entitled to pursue a business strategy of
increasingitsprincipalinvestmentsandengaginginsubstantialbridgedebtandequity
transactions,Lehmansownpoliciesrequiredmanagementtoconsiderandanalyzethe
risks of that strategy in a systematic manner. The Examiner has found evidence that
raises questions whether Lehmans senior management disregarded Lehmans risk
managementframework,includingitsriskappetitelimits,itssingletransactionlimits,
itsstresstesting,itsbalancesheetlimits,andtheadviceoftheriskmanagers.Asone
former risk manager put it, whatever risk governance process we had in place was
ultimately not effective in protecting the Firm. . . . The function lacked sufficient
authority within the Firm. Decisionmaking was dominated by the business.645
Indeed, there is substantial evidence that after Lehman adopted a more aggressive
business strategy in 2006, its risk management policies and limits were not a major
factorinthefirmsinvestmentdecisions,eventhoughmanagementcontinuedtotellthe
645EmailfromVincentDiMassimo,Lehman,toChristopherM.OMeara,Lehman(Sept.1,2008)[LBEX
DOCID203219].
167

Board, the rating agencies, and regulators that Lehman was prudently managing risk
throughitsriskmanagementsystem.646
The evidence that Lehman disregarded its risk controls is particularly strong
withrespecttobridgeequityandbridgedebt.Inseveralimportantcontexts,Lehman
excluded bridge equity and bridge debt commitments entirely from its risk metrics.
Theseexclusionswereapparentlybasedonmanagementsassumptionthatitwouldbe
abletodistributetheequityanddebtsuccessfullytootherparties.Whenthesubprime
crisiseruptedintothecreditmarketsgenerally,thisexpectationprovedtobeerroneous.
However, the Examiner does not find that the decisions by Lehmans officers
werenotentitledtotheprotectionofthebusinessjudgmentrule.AlthoughLehmans
seniorofficerschosetodisregardindicationsfromLehmansriskmanagementsystems
that the firm was undertaking excessive risk, the Examiner did not find evidence that
Lehmans management entered into financial transactions without informing
themselvesofthebasicfactsofthetransactions,aswouldbenecessarytostripthemof
thebusinessjudgmentrulesprotectionandprovegrossnegligence.Lehmansofficers
wereentitledtosetanddecidetoexceedrisklimits,whichweremerelytoolstoassist
646 E.g., SEC, Lehman Monthly Risk Review Meeting Notes (July 19, 2007), at p. 5 [LBEXSEC 007363]
(Jeff [Goodman] told us that . . . VaR is just one measure that Lehman uses, and is more of a speed
bump/warningsignthanatrue,hardlimitthatrolefallstoRA[(i.e.riskappetite)].[.]Hesaidthat
Madelyn[Antoncic],Dave[Goldfarb],andtheexecutivecommitteetendtolookmoreatRA.Asanaside,
MadelyncameinafterJeffsexplanationandgavevirtuallythesamespeech.).
168

themin theirinvestmentdecisions,notlegalrestraintsontheirauthority. Theymade
consideredbusinessdecisionstodosobecauseofprofitmakingopportunities.
Nor does the Examiner find that Lehmans officers exceeded the scope of their
authority by pursuing an aggressive countercyclical growth strategy. Lehmans
management was entitled to calculate that the subprime crisis offered Lehman the
opportunity to become a dominant residential mortgage originator, to expand its
alreadypowerfulcommercialrealestatefranchise,andtouselargeleveragedloansasa
meanstowardsdeveloping its investmentbankingbusiness. Although managements
disclosurestotheBoardontherisksofthisstrategywerenotasdetailedorasobjective
as they might have been, the Examiner does not find that managements disclosures
were so lacking as to deprive the officers of the protection of the business judgment
rule.
Even if the business judgment rule did not apply to the officers pursuit of a
countercyclical growth strategy, the Examiner would not find gross negligence
sufficienttoestablishabreachofthedutyofcare.Grossnegligencerequiresproofthat
the officer made decisions that were irrational or reckless. Lehmans senior officers
decidedtomakebusinessdecisionsprimarilybasedontheirintuitiveunderstandingof
the markets and their evaluation of the risks and rewards of entering into certain
transactions.Their decision to use theirpracticalbusinessexperienceratherthan rely
169

oncertainquantitativerisklimitsandothermetricscannotbeconsideredirrationalor
reckless.
ThedecisionsbyLehmansmanagementmustalsobeconsideredincontext.In
manyrespects,Lehmanstransactionswerenodifferentfromthoseconductedbyother
market participants, and were, in some respects, less aggressive than those of their
competitors.Forexample,severalfinancialinstitutionssufferedcatastrophiclosseson
investmentsinCDOsandcreditdefaultswaps;Lehmanprudentlylimiteditsexposure
intheseareas.Lehmansofficerswouldarguethatananalysisoftheirmanagementof
Lehmans risks should consider the risks that Lehman prudently avoided along with
therisksthatLehmanunsuccessfullytook.
Moreover,abreachofthedutyofcareclaimwouldrelyheavilyonthetestimony
and email communications of Lehmans risk managers and financial controllers. But
riskmanagersandcontrollersarebydefinitionmoreriskaversethanrisktakersthe
business people who actually make the decisions on behalf of the enterprise. Indeed,
risk managers and controllers are naturally inclined to see limits and controls as
harder and less susceptible to judgment than businesspersons. Lehmans officers
would have a compelling argument that the risk managers opposition to various
strategiesandtransactionsmustbeconsideredinthiscontext.
170

ResidentialMortgageOrigination
TheExaminerdoesnotfindthatLehmanscountercyclicalgrowthstrategywith
respect to its residential mortgage origination gives rise to a colorable duty of care
claim. Lehmans management took significant steps to curtail and control its
origination of subprime mortgages, including discontinuing certain mortgage
programs,installingimprovedriskmanagementsystems,andreplacingmanagementof
itssubprimeoriginator.Lehmansmanagementalsosuccessfullyhedgeditssubprime
mortgage risk, at least until early 2008, and avoided some of the catastrophic
investmentsthatotherfinancialinstitutionsmadeinthemortgagemarket,forexample
inCDOs.
Lehmans management can be secondguessed, perhaps, for its decision to
continue originating AltA mortgages through its Aurora subsidiary even as it was
curtailing the origination of subprime mortgages through its BNC subsidiary, and for
failingtocurtailitssubprimemortgageoriginationsmorequickly.Asdescribedabove,
however, these business decisions were part of Lehmans strategy to benefit from a
consolidation in the mortgage origination industry. In 2007, Lehman curtailed
originationofriskiersegmentsofitsAltAproductionafteritbecameevidentthatthese
riskiersegmentswereperformingaspoorlyassubprimeloans.
Thebusinessjudgmentruleshieldsfromjudicialreviewtheforegoingdecisions
by Lehman concerning its AltA and subprime originations. The Examiner does not
171

find that Lehmans management should be deprived of that protection, or that these
businessdecisionswereirrationalorreckless.
(ii) LehmansConcentrationofRiskinItsCommercial
RealEstateBusiness
As described above, Lehman entered into large commercial real estate
transactions during the course of 2007, including transactions that left Lehman with a
substantialinvestmentinbridgeequity.Themostsignificantofthesetransactionswas
Archstone.
Lehmanenteredintothesecommercialrealestatebridgeequitytransactionsata
precarious time in the financial markets. After the onset of the subprime mortgage
crisisinDecember2006orJanuary2007,therewasariskofcontagiontothecommercial
real estate market. Lehmans officers recognized this risk but concluded that it was
manageable.647Althoughinhindsightthisconclusionwaswrong,theExaminercannot
concludethatatthetimeitwasrecklessorirrational.
Lehmans officers exercised judgment to pursue commercial real estate
opportunities,andtooverrideindicatorsfromthefirmsrisksystems.BeforeLehman
enteredintotheArchstonetransaction,LehmansRealEstategroupwasalreadynearits
risk limits. And the risk in the Archstone commitment and several contemporaneous
real estate bridge equity deals was enormous perhaps as large as or larger than
647ExaminersInterviewofRichardS.Fuld,Jr.,Sept.30,2009,atpp.1415;ExaminersInterviewofJoseph
Gregory,Nov.13,2009,atpp.78;ExaminersInterviewofMarkA.Walsh,Oct.21,2009,atpp.79.
172

Lehmansentirepreexistingrealestatebookputtogether.648Thus,itwasobviousthat
entering into Archstone and these other transactions would put Lehman well over its
real estate risk appetite limit. Several witnesses, including Jeffrey Goodman, the risk
managerprimarilyresponsibleforGREG,saidintheirinterviewsthatthecommercial
realestategroupwasnotsubjecttoitsriskappetitelimits.649Similarly,MarkWalsh,the
headofGREG,saidhewasinformedthatGREGwasallocatedexcessriskappetitefrom
otherbusinessdivisions.650
Theriskappetitelimitapplicabletoanindividualbusinesslinemaybeviewedas
atypeofconcentrationlimit.Concentrationlimitsareimportanttoensurethatafirm
does not take too much risk in a single, undiversified business or area. By exceeding
the concentrationlimits applicabletoLehmansrealestatebusiness,Lehmansofficers
tooktheriskthatthefirmwouldoverconcentrateitscapitalincommercialrealestate
investments.
648 See Mark Weber, Lehman, Chart Showing Risk Appetite Adjustment for Archstone (July 24, 2008)
[LBEXDOCID425705],attachedtoemailfromMarkWeber,Lehman,toPortfolioRiskSupport,Lehman,
et al. (July 24, 2008) [LBEXDOCID 265567] (showing that as a result of the inclusion of the Archstone
positions into the firmsrisk measurements, GREGs riskappetite usageincreasedfrom$689millionto
$1.233billion);emailfromMadelynAntoncic,Lehman,toRogerNagioff,Lehman,etal.(June29,2007)
[LBEXDOCID1478403];emailfromJeffreyGoodman,Lehman,toMarkA.Walsh,Lehman,etal.(June
29,2007)[LBEXDOCID2538925](same).
649Examiners Interview of Jeffrey Goodman, Aug. 28, 2009; Examiners Interview of David S. Lazarus,
Nov. 18, 2009, at p. 4; Examiners Interview of Paul A. Hughson, Oct. 28, 2009, at p. 4; Examiners
InterviewofKennethCohen,Oct.20,2009,atp.6;ExaminersInterviewofMarkWeber,Aug.11,2009,at
p.3.
650ExaminersInterviewofMarkWalsh,Oct.21,2009,atp.5.
173

The risk attributable to Archstone and at least one other bridge equity
transaction was excluded from Lehmans risk appetite usage calculation for almost
three months after the May 2007 commitment date for Archstone.651 These two
transactions were not included in the firms risk appetite calculation until August 13,
2007.652 After the exclusion was acknowledged in August 2007, Lehman retroactively
corrected its risk appetite figures to include the previously omitted risks.653 The
retroactive calculation shows that if these transactions had been included in the risk
appetite usage, Lehman would have been over its firmwide and real estate risk
appetitelimitsalmostcontinuouslyfromthedateoftheArchstonecommitment.
Although Lehmans decision to concentrate heavily in real estate bridge equity
wasunwiseinretrospect,andexcludingmajortransactionsfromLehmansriskusage
calculationwasabreachofriskmanagementprotocol,thefactremainsthatLehmans
management seriously considered the risks in the Archstone transaction in a series of
651MarkWeber,Lehman,ChartShowingRiskAppetiteAdjustmentforArchstone(July24,2008)[LBEX
DOCID425705],attachedtoemailfromMarkWeber,Lehman,toPortfolioRiskSupport,Lehman,etal.
(July24,2008)[LBEXDOCID265567];accordExaminersInterviewofJeffreyGoodman,Aug.28,2009;e
mailfromMarkWeber,Lehman,toLauraVecchio,Lehman,etal.(July31,2008)[LBEXDOCID264849];
Lehman, Market Risk Control Committee Meeting Agenda (Nov. 12, 2007), at p. 17 [LBEXDOCID
271334], attached to email from Mark Weber, Lehman, to Paul Shotton, Lehman, et al. (Nov. 12, 2007)
[LBEXDOCID265289].
(July 24, 2008) [LBEXDOCID 265567]; see also email from Mark Weber, Lehman, to Laura Vecchio,
Lehman,etal.(July31,2008)[LBEXDOCID264849];Lehman,MarketRiskControlCommitteeMeeting
Agenda(Nov.12,2007),atp.17[LBEXDOCID271334],attachedtoemailfromMarkWeber,Lehman,to
PaulShotton,Lehman,etal.(Nov.12,2007)[LBEXDOCID265289].
(July24,2008)[LBEXDOCID265567].
174

Executive Committee and Commitment Committee meetings over a period of weeks,
modified the transaction in several important ways to try to manage the risk, and
ultimately decided that the rewards from the transaction outweighed the risk.
Moreover, Lehmans management plainly was aware of the risk associated with the
Archstonetransactionduringthisperiod.Infact,Lehmansmanagementwasfocused
on trying to distribute the Archstone debt and equity and reduce the firms risk in
advanceoftheclosingofthattransaction.
The Examiner thus concludes that there is no colorable claim of breach of
fiduciary duty on the part of Lehmans officers. Lehman managements decision to
exceed its limit for this business and invest heavily in commercial real estate is
protected by the business judgment rule. That rule does not operate retroactively to
judge a business decision based on its ultimate failure, but instead focuses on the
reasonsformakingthatdecisionasofthetimeandinthecontextinwhichitwasmade.
The officers decision not to follow the guidance of its internal and voluntary risk
managementsystemdoesnotgiverisetoabreachofthedutyofcare.
(iii) ConcentratedInvestmentsinLeveragedLoans
As described above, Lehmans principal investment strategy also included
participating in leveraged loan transactions. This business grewspectacularly in 2006
and the first half of 2007. Many of these loans were made to private equity firms, or
sponsors, who were purchasing companies as part of leveraged buyouts. These
175

transactions were risky for Lehman because they consumed tremendous amounts of
capital, were made on terms that strongly favored the borrowers, and often involved
bridge equity or bridge debt that Lehman hoped to distribute to other financial
institutions(butwascommittedtokeepforitselfifitwasunabletodoso).
The evidence is that during the first eight months of Lehmans fiscal 2007,
Lehmans leveraged loan business, like its commercial real estate business, was not
subject to any limits. Between August 2006 and July 2007, Lehman entered into
approximately 30 leveraged loans that exceeded the single transaction limit that had
previously been adopted for these transactions, often by significant margins.654 The
chartbelowdemonstratesthemagnitudeoftheseoverages:
654JoeLi,Lehman,STLBacktestingExcelSpreadsheet(July25,2007)[LBEXDOCID2506462],attachedto
emailfromJoeLi,Lehman,toFredS.Orlan,Lehman,etal.(July25,2007)[LBEXDOCID2563167].
176

LeveragedFinanceDealswithSingleTransactionLoss(STL)inExcessofLimit1
(July2007Analysis,DealsbetweenAugust2006andJuly2007)($inMillions)
DealName Original OldFrameworkSTL NewFramework
Commitment fordealswithSTL STLfordealswith
Date2 over$250MM3 STLover$400MM3
Intelsat 2,090 1,045
Weatherford 4/30/2007 2,030 1,015
HoughtonMifflinRiverdeepGroup 7/16/2007 1,389 694
TXUCorp 2/26/2007 1,368 684
FirstDataCorporation 4/2/2007 1,203 601
AlcoaInc. 5/24/2007 1,200 600
HomeDepotSupply 6/19/2007 971 486
CDWCorporation 5/29/2007 909 455
DollarGeneral 3/1/2007 882 441
HarmanInternationalIndustries 4/25/2007 692 346
USFoodService 651 326
CVS 1/16/2007 600 300
BCE 6/29/2007 553 277
BAWAGPSK 3/1/2007 550 275
TognumAG 515 258
ProSiebenSat.1MediaAG 1/31/2007 500 250
CBSCorporation 476 238
WestCorp 465 232
IBMInternationalGroupBV 440 220
SequaCorp 6/18/2007 431 216
Tesoro 4/10/2007 431 215
AllianceData 5/31/2007 424 212
ApplebeesInternational,Inc. 7/16/2007 403 202
AllisonTransmission 5/21/2007 390 195
Dockwise 388 194
UnivisionCommunications 7/14/2006 387 193
PHHCorporation 3/15/2007 386 193
FormulaOneGroup 378 189
UnitedRentals,Inc. 7/22/2007 372 186
ThermoElectronCorp. 5/7/2006 360 180
NationalBeefPackingCo. 5/11/2007 335 168
BulgarianTelecommunications 3/28/2007 327 164
EndemolHoldings 5/11/2007 322 161
LindeMaterialHandlingGroup 293 146
PinnacleFoods 2/10/2007 277 138
TheKlocknerPentaplastGroup 276 138
GuitarCenter,Inc. 6/20/2007 263 132

Note:HighlightedcellsindicatetransactionswithSTLinexcessofthelimitconditionsdescribedbelow:
1 Table includes all deals from August 2006 to July 2007 that are in excess of $900M and also have a calculated STL of > $250M under the loss
calculationmethodologyinplaceJuly2007(SeeOldFrameworkSTLcolumn).HighlighteddealshaveanSTLinexcessoftheappliedlimitstatedin
columntitle.TransactionsinexcessoftheLimitswouldhaverequiredExecutiveCommitteeapproval(LBEXDOCID2170674).
2OriginalcommitmentindicatesearliestknowndateonwhichadealwascommittedtobyLehman,aspresentedintheLPGWeeklyReviews.
3 All deal data is from an Excel spreadsheet (LBEXDOCID 2506463) attached to a July 25, 2007 Joe Li email (LBEXDOCID 2563148) stating:
Previouslywehaveusedalosslimitof250mmto350mm.Wewouldliketoproposea400mmastheFirmsrevenuehasincreased.Inadditionto
changingthelimit,itwasproposedthatriskfactorsbeadjustedtoexcludedefaultrisk,leavingonlysystematicriskastheSingleTransactionLoss.
ThisproposedchangehadtheeffectofhalvingtheSTL(calculatedriskoftheposition),andsimultaneouslyincreasingthelimit.Itemshighlightedin
theOldFrameworkcolumnareSTLnumberscalculatedunderthemethodologyinplaceinJuly2007thatexceedthe$250Mlosslimitinplace
at the time. Highlighted items in the New Framework column represent STL numbers calculated under the proposed methodology (which
halved the STL amount) that exceed the proposed $400M Limit. Please note that a September 2007 presentation on STL (LBEXDOCID 194075)
stated that the current limit was $250 and proposed that the limit be increased to $300M. A leveraged finance risk presentation to the Executive
Committeeonemonthlaterrecommendedthatthelimitbeincreasedto$400M(LBEXDOCID569902).
177

Lehmans decision to exceed the single transaction limit proved to be unwise.
JustasLehmanwasenteringintoaparticularlylargevolumeofcommitments,Lehman
won a huge volume of deals, and the credit markets froze, causing Lehman to be left
with tremendous risk on its books. Before long, Lehmans high yield book showed a
risk appetite usage almost double the limit for those exposures an enormous
concentrationofriskinasingle,illiquidassetclass.
Asaresultofthishighvolumeofcommitments,someinLehmansmanagement
becameconcerned,asearlyasJuly2007,thatthefirmwouldnotbeabletofundallofits
commitments.AsIanLowitt,thentheCAO,wroteinanemaildatedJuly20,2007:In
caseweeverforget;thisiswhyonehasconcentrationlimitsandoverallportfoliolimits.
Marketsdoseizeup.655
Although Lehmans decision to enter into huge illiquid transactions during a
recognized credit bubble656 was unwise, the large leveraged loan transactions were
considered and approved by Lehmans Executive Committee, which was entitled to
increase or override the single transaction limit, just as it was entitled to increase or
override the risk appetite limits. Such decisions are subject to the business judgment
rule.
655EmailfromIanT.Lowitt,Lehman,toChristopherM.OMeara,Lehman(July20,2007)[LBEXDOCID
194066].
656Email from Christopher M. OMeara, Lehman, to Paulo R. Tonucci, Lehman (Apr. 6, 2007) [LBEX
DOCID1349076].
178

(iv) FirmWideRiskAppetiteExcesses
The Examiner also considered whether Lehmans handling of its overall risk
limits was a breach of the duty of care. As described above, Lehmans management
decidedtotreatthefirmsriskappetitelimitasasoftlimitratherthanasameaningful
constraintonmanagementsassumptionofrisk.
Lehmandecidedtoexceedthefirmwideriskappetitelimitatseveraljunctures.
First, though Lehman dramatically increased the limit for fiscal 2007, Lehman
nevertheless approachedthe newlimit by May2007. Lehman enteredinto Archstone
andseveralotherbridgeequitytransactionsnotwithstandingtheobviousfactthatthose
transactionswouldimmediatelyputLehmanoveritsfirmwideriskappetitelimits.657
Several months later, with Lehmans firmwide risk usage actually in excess of
the limit, Lehman decided to increase the limit again, even as one of its senior risk
managers admitted to the SEC that Lehman did not in fact have increased risktaking
capacity.658
Then,inearlyOctober2007,whenLehmansriskappetiteexcesseswereattheir
peak, at least some members of Lehmans senior management discussed the limit
breaches and decided to grant a temporary reprieve from the limits based on the
difficult conditions in the real estate and leveraged loan markets. For the most part,
658SEC,NotesfromLehmansMonthlyRiskReviewmeeting(Oct.11,2007),atp.6[LBEXSEC007438].
179

Lehman did not pursue aggressive risk reduction strategies until sometime in 2008,
particularlywithrespecttocommercialrealestate.
Rather than reduce its risk usage, Lehman cured its risk appetite overages by
increasingthefirmwideriskappetitelimityetagain.659Thereisevidencewhichraises
the question whether Lehmans risktaking capacity had in fact increased. The
increased limit amount was calculated by substantially changing the assumptions
previously used in calculating the risk appetite limit, and by using a very aggressive
2008 budgeted revenue figure. If Lehman had used the same assumptions as it had
previously used for calculating the risk appetite limit, and a more realistic revenue
figure,itwouldlikelyhaveconcludedthatitwasnecessarytoreduceitsriskappetite
limit to take account of its diminished profitability relative to its equity base. Such a
conclusion might have impelled management more urgently to sell assets, reduce the
firmsriskprofile,andreducethefirmsleverage.
AlthoughLehmansriskappetitelimitsultimatelyprovidedlittleornolimiting
functionatall,theExaminerdoesnotfindthatthedecisiontoexceedordisregardthese
limitsgivesrisetoacolorableclaimofbreachoffiduciaryduty.Theseinternallimits
wereintendedonlyforthe guidanceofLehmansownmanagement;theydidnotput
659Examiners Interview of Christopher M. OMeara, Aug. 14, 2009, at p. 10; Lehmans Material for
Market Risk Control Committee Meeting (Jan. 14, 2008), at p. 33 [LBEXDOCID 271352], attached to e
mail from Mark Weber, Lehman, to Paul Shotton, Lehman, et al. (Jan. 14, 2008) [LBEXDOCID 223263];
EstimatedThirdQuarter2007FinancialInformationPresentationtoLehmanBoardofDirectors(Sept.11,
2007),atp.6[LBHI_SEC07940_026288].
180

anylegalconstraintsonthescopeofmanagementsauthority.Andbecausebusinessin
general and investment banking in particular is an inherently risky enterprise,
Lehmansmanagementwasentitledtopursueacountercyclicalgrowthstrategybased
on its evaluation of the markets and of Lehmans business, even if that strategy
necessarily posed a risk to the firm. Moreover, Lehmans risk appetite limit overages
werereportedtotheSEC.TheExaminerdoesnotfindthatmanagementsdecisionto
increaseandthenexceedLehmansriskappetitelevelsgivesrisetoacolorableclaimfor
breachoffiduciaryduties.
(v) FirmWideBalanceSheetLimits
Lehmanalsofailedtoapplyitsbalancesheetlimitsinlate2007.Applicationof
these limits would also have restricted Lehmans risktaking. Instead, Lehman
dramaticallyincreasedthesizeofitsbalancesheet,andusedincreasinglylargevolumes
of Repo 105 transactions to create the appearance that the firms net leverage ratio
remainedwithinareasonablerangeofsuchratiosestablishedbytheratingagencies.660
(vi) StressTesting
As described above, Lehmans stress tests suffered from a significant flaw.
AlthoughLehmanmadeastrategicdecisionin2006totakemoreprincipalrisk,Lehman
did not modify its stress tests to include the risks arising from many of its principal
investments including its real estate investments other than commercial mortgage
660ForfurtherdetailregardingtheRepo105transactions,seeSectionIII.A.4ofthisReport.
181

backed securities (CMBS), its private equity investments, and, during a crucial
period, its leveraged loan commitments.661 Thus, Lehmans management pursued its
countercyclicalgrowthstrategy,includinganincreasingconcentrationofriskinilliquid
assets, without availing itself of a common risk management technique for evaluating
thepotentialrisktothefirmfromthatstrategy.
But stress tests, like risk limits, are an instrument available for use of
managementasitdeemsappropriate;Lehmansmanagementwasnotlegallyrequired
tomakebusinessdecisionsbasedontheresultsofstresstesting.662Moreover,theSEC
was aware that Lehmans stress tests excluded untraded investments and did not
question the exclusion, because historically it had been the norm to limit stress tests
only to traded positions.663 Based on these facts, the Examiner does not find that
Lehmanmanagementsuseofthestresstestsgivesrisetoacolorableclaimforabreach
ofthedutyofcare.
(vii) Summary:OfficersDutyofCare
TheExaminerreviewedextensiveevidenceconcerningLehmansseniorofficers
decisiontodisregardtheguidanceprovidedbyLehmansriskmanagementsystemas
they implemented the firms aggressive business strategy in 2006 and 2007. That
661Email from Melda Elagoz, Lehman, to Stephen Lax, Lehman, et al. (June 21, 2007) [LBEXDOCID
2546617];ExaminersInterviewofPaulShotton,Oct.16,2009,atpp.45.
662LehmanwasrequiredtoconductcertainstresstestingaspartofitsparticipationintheCSEprogram.
See17C.F.R.240.15c31(2007).
663Examiners Interview of Matthew Eichner, Nov. 23, 2009, at p. 12; Examiners Interview of Paul
Shotton,Oct.16,2009,atpp.45;ExaminersInterviewofJeffreyGoodman,Aug.28,2009.
182

evidence goes to the heart of Lehmans ultimate financial failure because the illiquid
investmentsacquiredduringthatperiodcouldnotbesoldoffsufficientlyquickly,and
Lehmans liquidity and confidence suffered as a result. When the run on Lehman
began in September 2008, Lehman lacked the liquidity to survive. Thus, Lehmans
collapse can be traced in part to Lehman managements adoption of a countercyclical
growth strategy in 2006 and 2007. Although management turned out to be wrong in
their business judgments, the evidence does not establish that managements actions
and decisions were so reckless and irrational as to give rise to a colorable claim of
breachoffiduciaryduty.
[B]usiness failure is an everpresent risk. The business judgment rule

existspreciselytoensurethatdirectorsandmanagersactingingoodfaith
maypursueriskystrategiesthatseemtopromisegreatprofit.Ifthemere
fact that a strategy turned out poorly is in itself sufficient to create an
inference that the directors who approved it breached their fiduciary
duties,thebusinessjudgmentrulewillhavebeendenudedofmuchofits
utility.664
Assumed
The Examineralsodoes notfinda colorable claim that,during theperiod from
May2007throughJanuary2008,Lehmansseniorofficersbreachedtheirdutyofcandor
with respect to their disclosures to the Board of Directors concerning Lehmans risk
664Trenwick Am. Litig. Trust v. Ernst & Young, L.L.P., 906 A.2d 168, 193 (Del. Ch. 2006), affd sub nom.
TrenwickAm.Litig.Trustv.Billett,931A.2d438(Del.2007).
183

management system. Lehmans management gave the Board regular reports
concerning the state of the firms business, including reports containing quantitative
risk,balancesheet,revenue,andothermetrics.Lehmansmanagementalsodiscussed
marketconditionsandtheirpotentialimpactonthefirmwiththeBoard.TheExaminer
didnotfindevidencethatmanagersknowinglymadefalsestatementstotheBoard.
In light of the Boards limited role in supervising the risk management of the
enterprise,andtheabsenceofauthoritymandatinggreaterdisclosuretotheBoard,the
ExaminerdoesnotbelievethattheofficershadalegaldutytoprovidetheBoardwith
additional negative information. The Examiner does not find that the evidence gives
risetoacolorableclaimforabreachofthedutyofcandor.
LehmansmanagementrepeatedlydisclosedtotheBoardthatLehmanintended
to grow its business dramatically, increase its risk profile, and embrace risk even in
declining markets. The Board undoubtedly understood and approved of Lehmans
growthstrategy.
During 2007, there were a number of instances in which management did not
provide information to the Board. For example, management did not disclose its
decision to exceed or disregard the various concentration limits applicable to the
leveraged loan business and to the commercial real estate businesses, including
184

especially the single transaction limit, contrary to representations to the Board that
managementtookstepstoavoid[]overconcentrationinanyonearea.665
In hindsight, various Board members stated that it would have been helpful to
have had more information. For example, some directors said that if the risk limit
breachesweresufficientlylargeandlonglasting; 666ifmanagementsliquidityconcerns
weremorethanasingleincursion;667oriftheexclusionsfromthestresstestingwere
sufficientlysignificant;668theywouldhavewantedtoknowaboutthesefacts.669
Ontheotherhand,theBoarddidnotexplicitlydirectmanagementtoprovideit
with this information, and there is no evidence that the Board asked questions that
managementdidnotanswer,oransweredinaccurately.Moreover,asdiscussedabove,
management was not required by any regulatory authority or by Delaware common
lawtoprovidesuchdetailedinformationtotheBoardofDirectors.
Although Lehmans management did not provide the Board with all available
informationconcerningtherisksfacedbythefirmduring2007andearly2008,thatfact
is not surprising given the Boards limited role in overseeing the firms risk
management, and the extraordinarily detailed information available to management.
665DavidGoldfarb,etal,ManagingtheFirmPresentationtoLehmanBoardofDirectors(May15,2007),at
p.20[LBHI_SEC07940_026136]
666ExaminersInterviewofRogerBerlind,May8,2009,atp.4;ExaminersInterviewofMarshaJohnson
Evans, May 22, 2009, at p. 6; Examiners Interview of Roland A. Hernandez, Oct. 2, 2009, at p. 10;
ExaminersInterviewofJohnD.Macomber,Sept.25,2009,atp.17.ExaminersInterviewofDr.Henry
Kaufman,May19,2009,atp.17.
667ExaminersInterviewofDr.HenryKaufman,Dec.22,2009.
668ExaminersInterviewofJohnD.Macomber,Sept.25,2009,atpp.6,17.
669SeeIII.A.1.bofthisReport.
185

After reviewing this evidence, the Examiner finds insufficient evidence to support a
colorable claim that Lehmans management was either grossly negligent or
intentionally deceptive in providing information to the Board concerning risk
management.
First,theExaminerhasfoundnocolorableclaimthatLehmansseniormanagers
violated their fiduciary duty of care through their handling of risk issues.
ManagementsdisclosureoftheriskappetiteexcessestotheSECsupportstheviewthat
managementdidnotbelieveitwasactingimprudently,muchlessviolatingthelaw,by
taking on a higher level of risk than was consistent with the firms preexisting risk
policiesandlimits.Underthesecircumstancesitwouldtakeverysubstantialevidence
ofmanagementsintenttomisleadtheBoardinordertolayasufficientfoundationfora
claimthatLehmansseniorofficersbreachedtheirdutyofcandor.
Establishingaviolationofthedutyofcandorwithrespecttoriskmanagementis
particularlydifficult.AstheDelawareChanceryCourtrecentlyexplainedinconnection
withdirectorsmonitoringofriskdecisionsbymanagement:Itisalmostimpossiblefor
a court, in hindsight, to determine whether the directors of a company properly
evaluatedriskandthusmadetherightbusinessdecision....Businessdecisionmakers
must operate in the real world, with imperfect information, limited resources, and an
uncertainfuture.670
670InreCitigroupInc.SholderDerivativeLitig.,964A.2d106,126(Del.Ch.2009).
186

Managementsdutyofcandorconcerningriskmanagementaddsanotherlevelof
complexity beyond the issues raised by the duty of care. Risk limits, policies, and
metricsweredesignedforusebymanagement,nottheboard.Absentexpressdirection
fromtheboardastowhatinformationconcerningriskmanagementitshouldbegiven
(and there was no such direction here), management must make the determination of
whatlevelofdetailtheboardneedstofulfillitsobligationtomonitorriskdecisions.
Applyingthestandardofproofrequiringatleastgrossnegligenceandperhaps
intentional deception to establish a breach of the duty of candor means that senior
managersmaymakeagoodfaithmistakebynotprovidingmaterialinformationtothe
board without violating their fiduciary duties. Although it can be fairly debated
whetherLehmansmanagementshouldhaveprovideditsBoardwithmoreinformation
and more timely information concerning the firms risk usage, stress test results, and
liquidity, the Examiner does not find that any mistake by management in this regard
constitutedgrossnegligenceorintentionaldeception.
187

LehmansRiskTakingActivities
(a) LehmansDirectorsareProtectedFromDutyofCare
JudgmentRule
Corporate directors duty of care is a duty of informed decision making.671 It
involves the process by which directors make business decisions, not the content of
those decisions.672 However, directors are generally afforded additional protection by
thebusinessjudgmentrule,ajudicialpresumptionthatacourtshouldnotsubstitute
its judgment for that of the board if the latters decision can be attributed to any
rationalbusinesspurpose.673
Lehman,likemanyDelawarecorporations,immunizeditsdirectorsfromclaims
ofbreachingthedutyofcare.Lehmanscertificateofincorporationprovides:
A director shall not be personally liable to the Corporation or its

stockholders for monetary damages for breach of fiduciary duty as a
director; provided that this sentence shall not eliminate or limit the
liability of a director (i) for any breach of his duty of loyalty to the
Corporationoritsstockholders,(ii)foractsoromissionsnotingoodfaith
or which involve intentional misconduct or a knowing violation of law,
(iii)underSection174of[theDelawareGeneralCorporationLaw],or(iv)
671Smithv.VanGorkom,488A.2d858,872(Del.1985),overruledonothergrounds,Gantlerv.Stephens,965
A.2d695,713n.54(Del.2009).
672InreCaremarkIntl.Inc.DerivativeLitig.,698A.2d959,967(Del.Ch.1996).
673UnocalCorp.v.MesaPetroleumCo.,493A.2d946,954(Del.1985)(quotingSinclairOilCorp.v.Levien,280
A.2d717,720(Del.1971)).ForamoredetaileddiscussionofDelawarelawgoverningcorporatedirectors
fiduciaryduties,seeAppendix1,LegalIssues.
188

foranytransactionfromwhichthedirectorderivesanimproperpersonal
benefit.674
The wording of this clause is nearly identical to that in Section 102(b)(7) of the
Delaware General Corporate Law, which authorizes a corporation to exculpate its
directors from personal liability for breaches of fiduciary duties, except in the four
exceptionsstatedinthestatute:conductviolatingthedirectorsdutyofloyalty;actsor
omissionsnotingoodfaith;intentionalmisconduct;andknowingviolationsoflaw.675Courts
uphold such a clause to protect directors from liability provided that the conduct in
question does not violate their duty of loyalty.676 In addition, Delaware protects
directors from personal liability to the extent their decisions are based on information
providedtothembymanagement.677
Therefore, Delaware has chosen to impose personal liability only on those
directorswhohavehandledtheirresponsibilityinarecklessorirrationalmanner:
Directorsdecisionsmustbereasonable,notperfect.Inthetransactional
context,[an]extremesetoffacts[is]requiredtosustainadisloyaltyclaim
premised on the notion that disinterested directors were intentionally
disregarding their duties. . . . Only if they knowingly and completely
674LehmanBrothersHoldingsInc.,CertificateofIncorporation,at10.1,LimitationofLiabilityofDirectors.
675SeeDEL.CODEANN.tit.8,102(b)(7)(2009).
676SeeStoneexrel.AmSouthBancorporationv.Ritter,911A.2d362,367(Del.2006)(Suchaprovisioncan
exculpatedirectorsfrommonetaryliabilityforabreachofthedutyofcare,butnotforconductthatisnot
ingoodfaithorabreachofthedutyofloyalty.).
677SeeDEL. CODE ANN.tit.8,141(e)(2009);seealsoBrehmv.Eisner,746A.2d244,261(Del.2000);Inre
CitigroupInc.SholderDerivativeLitig.,964A.2d106,132&n.86(Del.Ch.2009).
189

failedtoundertake their responsibilities would theybreach theirdutyof

loyalty.678
(b) LehmansDirectorsDidNotViolateTheirDutyofLoyalty
A directors duty of loyalty [e]ssentially...mandates that the best interest of
the corporationand itsshareholderstakeprecedenceoveranyinterestpossessed bya
director, officer or controlling shareholder and not shared by the stockholders
generally.679 The duty of loyalty chiefly involves situations in which directors utilize
their positions to confer special benefits onto themselves or majority stockholders.680
Thesesituationsarefrequentlyreferredtoasselfdealingorinterestedsituations.681
A director is considered interested when he will receive a personal financial benefit
fromatransactionthatisnotequallysharedbythestockholders.682Directorsarealso
consideredinterestedwheretheirmotivationsinexecutingabusinessdecisionappear
tobesubservienttotheinterestsofamajoritystockholder.683
TheExaminerhasfoundnoevidenceofselfdealingbyLehmansdirectors,and
Lehmandidnothaveamajoritystockholdinginterest.
678LyondellChem.Co.v.Ryan,970A.2d235,24344(Del.2009)(quotingInreLearCorp.SholderLitig.,967
A.2d640,65455(Del.Ch.2008)).
679Cede&Co.v.Technicolor,Inc.,634A.2d345,361(Del.1993),modifiedonothergrounds,636A.2d956(Del.
1994).
680Aronsonv.Lewis,473A.2d805,812(Del.1984),overruledonothergrounds,Brehmv.Eisner,746A.2d244,
254(Del.2000).
681Seeid.
682GlobisPartners,L.P.v.PlumtreeSoftware,Inc.,No.1577VCP,2007WL4292024,at*5(Del.Ch.Nov.30,
2007).
683See,e.g.,EmeraldPartnersv.Berlin,787A.2d85(Del.2001);Tooleyv.AXAFin.,Inc.,No.18414,2005WL
1252378,at*5(Del.Ch.May13,2005).
190

(c) LehmansDirectorsDidNotViolateTheirDutytoMonitor
UnderDelawarelaw,directorshaveafiduciarydutytomonitormanagements
compliance with corporate reporting and control systems. The Delaware Supreme
Courthasadopted theCaremarkstandardforassessingdirector oversight liability.684
Under Caremark, the fiduciary duty to monitor management is breached if (a) the
directorsutterlyfailedtoimplementanyreportingorinformationsystemorcontrols;or
(b) having implemented such a system or controls, consciously failed to monitor or
oversee its operations thus disabling themselves from being informed of risks or
problemsrequiringtheirattention.685TheDelawareSupremeCourtstressed,however,
that a director can be held liable only for a conscious failure to fulfill the oversight
function:
[I]mposition of liability requires a showing that the directors knew that

theywerenotdischargingtheirfiduciaryobligations.Wheredirectorsfail
to act in the face of a known duty to act, thereby demonstrating a
conscious disregard for their responsibilities, they breach their duty of
loyaltybyfailingtodischargethatfiduciaryobligationingoodfaith.686
(i) ApplicationofCaremarktoRiskOversight:Inre
CitigroupInc.
In the Citigroup case, the Delaware Chancery Court rejected a claim that
Citigroups current and former directors and officers had breached their fiduciary
duties by failing to properly monitor and manage the risks the Company faced from
684Stone,911A.2dat36465.
685InreCitigroupInc.SholderDerivativeLitig.,964A.2d106,123(Del.Ch.2009)(quotingStone,911A.2dat
370).
686Stone,911A.2dat370(internalcitationsomitted).
191

problems in the subprime lending market and for failing to properly disclose
Citigroupsexposuretosubprimeassets.687Thecomplaintallegedvarioustheoriesof
liabilityincludingabreachofthedutytomonitorunderCaremark.Plaintiffsbasedtheir
claimonseveralredflagsthatallegedlyshouldhavegivendefendantsnoticeofthe
problems that were brewing in the real estate and credit markets.688 Noting that the
supposed red flags amount[ed] to little more than portions of public documents that
reflected the worsening conditions in the subprime mortgage market and in the
economygenerally, theCourt foundtheallegationslegally insufficienttoshowthat
the directors were or should have been aware of any wrongdoing at the Company or
were consciously disregarding a duty somehow to prevent Citigroup from suffering
losses.689
The Court also held that a Caremark claim involving risk management must be
consistentwiththebusinessjudgmentrule:
Itisalmostimpossibleforacourt,inhindsight,todeterminewhetherthe
directorsofacompanyproperlyevaluatedriskandthusmadetheright
businessdecision.
...
To impose liability on directors for making a wrong business decision

wouldcrippletheirabilitytoearnreturnsforinvestorsbytakingbusiness
risks.690
687Citigroup,964A.2dat111.
688Id.
689Id.atp.128.
690Id.atp.126.
192

TheCourtheldthatplaintiffshadfailedtotietheCaremarkclaimtoafailureof
thecorporateriskmanagementsystem:
[P]laintiffs allegations do not even specify how the boards oversight

mechanisms were inadequate or how the director defendants knew of
theseinadequaciesandconsciouslyignoredthem.Rather,plaintiffsseem
to hope the Court will accept the conclusion that since the Company
suffered large losses, and since a properly functioning risk management
systemwouldhaveavoidedsuchlosses,thedirectorsmusthavebreached
theirfiduciarydutiesinallowingsuchlosses.691
TheCourtemphasizedthatredflagssufficienttostateaCaremarkclaimmust
gobeyondsignsinthemarketthatreflectedworseningconditionsandsuggestedthat
conditionsmaydeteriorateevenfurther....692TheCourtwasprotectiveofdirectors
facing personal liability because the risk assumed by their corporation resulted in
losses:
Oversight duties under Delaware law are not designed to subject

directors,evenexpertdirectors,topersonalliabilityforfailuretopredictthe
futureandtoproperlyevaluatebusinessrisk.693
Directors
The Examiner does not find that Lehmans directors breached their Caremark
dutytomonitormanagementscompliancewiththelaw.
First,theExaminerdoesnotfindthatthedirectorsutterlyfailedtoimplement
any reporting or information system or controls.694 As explained above, the Board
691Id.at128.
692Id.at130.
693Citigroup,964A.2dat131.
193

received regular information at every Board meeting concerning the firms risk,
liquidity, and balance sheet situation. The Board also created a Finance and Risk
Committee to receive considerably more detailed information about these topics.
Moreover,theBoardreceivedregularreportsaboutthefirmsriskmanagementsystems
and controls. The directors plainly implemented a sufficient reporting system and
controls.
Second, the Examiner does not find that the directors consciously failed to
monitor or oversee its operations thus disabling themselves from being informed of
risks or problems requiring their attention.695 As explained above, the Examiner has
notfoundcolorableclaimsthatLehmansseniorofficersbreachedtheirfiduciaryduties
through the manner in which they managed risk. To the contrary, managements
conduct is protected from liability by the business judgment rule. There is also
insufficient evidence that Lehmans management violated any legal requirements or
obligations relating to risk management. The risk limits, policies, metrics, and stress
teststhatLehmandevelopedwereintendedtobeusedinternallyanddidnotconstitute
legal obligations.Because Lehmanmanagementshandling ofrisk didnotviolate the
law,thedirectorscannotbeliableforabreachoftheirdutytomonitormanagementto
preventsuchviolations.
694Id.atp.123.
695Id.
194

Moreover, there is no evidence, as Delaware law requires, that Lehmans
directors consciously disregarded violations by Lehmans senior officers of their
fiduciary or other legal duties through their decisions concerning the amount of risk
that Lehman assumed and their management of that risk. The directors were not
presented with red flags of such misconduct. And in monitoring risk issues, the
Board justifiably relied entirely on information provided by management. Under
Delawarelaw,thedirectorsaretherebyimmunizedfrompersonalliability.696
696SeeDEL.CODEANN.tit.8,141(e)(2009).
195

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Jenner&BlockLLP
353N.ClarkStreet
Chicago,IL606543456
3122229350

919ThirdAvenue
37thFloor
NewYork,NY100223908
2128911600


VOLUME2OF9
Section III.A.2: Valuation
Section III.A.3: Survival
EXAMINERSREPORT
TABLEOFCONTENTS
(SHORTFORM)
VOLUME1
Introduction...................................................................................................................................2
I. ExecutiveSummaryoftheExaminersConclusions ......................................................15
C. DoColorableClaimsAriseFromTransfersofLBHIAffiliateAssetsTo
C. SystemsAccess..............................................................................................................33
SectionIII.A.1:Risk
b) Facts..................................................................................................................58
c) Analysis .........................................................................................................163
VOLUME2
2. Valuation ..............................................................................................................203
a) ExecutiveSummary .....................................................................................203
Portfolio .........................................................................................................215
c) SeniorManagementsInvolvementinValuation....................................241
Book................................................................................................................266
TransactionsGroup......................................................................................285
Positions.........................................................................................................356
WholeLoansPortfolio .................................................................................494
h) ExaminersAnalysisoftheValuationofLehmansRMBS
Portfolio .........................................................................................................527
i) ExaminersAnalysisoftheValuationofLehmansCDOs ....................538
j) ExaminersAnalysisoftheValuationofLehmansDerivatives
Positions.........................................................................................................568
k) ExaminersAnalysisoftheValuationofLehmansCorporate
DebtPositions ...............................................................................................583
l) ExaminersAnalysisoftheValuationofLehmansCorporate
EquitiesPositions .........................................................................................594
ii

3. LehmansSurvivalStrategiesandEfforts........................................................609
a) IntroductiontoLehmansSurvivalStrategiesandEfforts.....................609
b) LehmansActionsin2008PriortotheNearCollapseofBear
Stearns............................................................................................................622
c) ActionsandEffortsFollowingtheNearCollapseofBearStearns .......631
VOLUME3
4. Repo105................................................................................................................732
a) Repo105ExecutiveSummary.................................................................732
b) Introduction ..................................................................................................750
Transactions ..................................................................................................764
d) ATypicalRepo105Transaction ................................................................765
e) ManagingBalanceSheetandLeverage ....................................................800
EngineerPubliclyReportedFinancialResults.........................................853
g) TheMaterialityofLehmansRepo105Practice ......................................884
h) KnowledgeofLehmansRepo105ProgramattheHighestLevels
oftheFirm .....................................................................................................914
i) Ernst&YoungsKnowledgeofLehmansRepo105Program..............948
j) TheExaminersConclusions ......................................................................962
iii

VOLUME4
5. PotentialClaimsAgainstLehmansSecuredLenders .................................1066
a) IntroductionandExecutiveSummary ....................................................1066
b) LehmansDealingsWithJPMorgan ........................................................1084
c) LehmansDealingsWithCitigroup.........................................................1224
d) LehmansDealingsWithHSBC ...............................................................1303
e) LehmansDealingsWithBankofAmerica ............................................1375
f) LehmansDealingsWithBankofNewYorkMellon............................1376
g) LehmansDealingsWithStandardBank................................................1382
h) LehmansDealingsWiththeFederalReserveBankofNewYork .....1385
i) LehmansLiquidityPool...........................................................................1401
6. TheInteractionBetweenLehmanandtheGovernment..............................1482
a) Introduction ................................................................................................1482
b) TheSECsOversightofLehman ..............................................................1484
c) TheFRBNYsOversightofLehman ........................................................1494
d) TheFederalReservesOversightofLehman .........................................1502
e) TheTreasuryDepartmentsOversightofLehman ...............................1505
f) TheRelationshipoftheSECandFRBNYinMonitoring
LehmansLiquidity....................................................................................1507
MeetingsattheFRBNY .............................................................................1516
iv

ConvenedaMeetingoftheMajorWallStreetFirmsinan
AttempttoFacilitatetheRescueofLehman ..........................................1523
i) LehmansBankruptcyFiling ....................................................................1535
VOLUME5
VoidableTransfers....................................................................................................1544
1. ExecutiveSummary ..........................................................................................1544
LBHI(FirstBullet) .............................................................................................1546
3. ExaminersInvestigationofPossibleAvoidanceActions(Third,
FourthandEighthBullets)...............................................................................1570
LBHIAffiliateDirectorsandOfficers(FifthBullet) .....................................1894
(SecondBullet) ...................................................................................................1912
6. ExaminersReviewofIntercompanyTransactionsWithinThirty
DaysofLBHIsBankruptcyFiling(SeventhBullet).....................................1938
7. ExaminersAnalysisofLehmansDebttoFreddieMac..............................1951
Barclays,orFromtheLehmanALITransaction? ................................................1961
2. Facts .....................................................................................................................1965
3. WhetherAssetsofLBHIAffiliatesWereTransferredtoBarclays .............1997
4. LehmanALITransaction..................................................................................2055
5. Conclusions ........................................................................................................2063
6. BarclaysTransaction .........................................................................................2103
vi

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Section III.A.2: Valuation
TABLEOFCONTENTS
2. Valuation ..............................................................................................................203
(1) ScopeofExamination ...........................................................................210
(2) SummaryofApplicableLegalStandards..........................................212
(3) SummaryofFindingsandConclusions.............................................214
Portfolio .........................................................................................................215
(1) OverviewofLehmansCREPortfolio................................................217
(a) SummaryofPortfolio................................................................... 217
(b) OverviewofValuationofCREPortfolio................................... 220
(i) GREGLeaders ..................................................................... 220
(ii) ParticipantsintheValuationProcess............................... 220
(c) ChangesintheCREPortfoliofrom2006through2008 .......... 223
(d) PerfectStormImpactonCREValuationin2008.................. 227
(2) OutsideReviewofLehmansCREValuationProcess.....................232
(a) SEC .................................................................................................. 233
(b) Ernst&Young ............................................................................... 237
(1) SeniorManagementsGeneralRoleWithRespecttoCRE
Valuation ................................................................................................243
(2) SeniorManagementsInvolvementinValuationinthe
SecondQuarterof2008 ........................................................................245
(3) SeniorManagementsInvolvementinValuationintheThird
Quarterof2008 ......................................................................................247
(a) SeniorManagementsAccount ................................................... 248
(b) PaulHughsonsAccount ............................................................. 253
(c) OtherAccounts ............................................................................. 254
(4) ExaminersFindingsandConclusionsWithRespectto
SeniorManagementsInvolvementinCREValuation....................265
Book................................................................................................................266
(1) ExecutiveSummary..............................................................................266
(2) LehmansValuationProcessforitsCommercialBook ...................270
196

(3) ExaminersFindingsandConclusionsastothe
ReasonablenessofLehmansValuationofitsCommercial
Book ........................................................................................................274
(a) AsoftheSecondQuarterof2008 ............................................... 274
(b) AsoftheThirdQuarterof2008 .................................................. 282
(2) OverviewofLehmansPTGPortfolio................................................292
(3) EvolutionofLehmansPTGPortfolioFrom2005Through
2008..........................................................................................................296
(4) LehmansValuationProcessforItsPTGPortfolio...........................303
(a) TheRoleofTriMontintheValuationProcessfor
LehmansPTGPortfolio............................................................... 306
(i) LehmansIssueswithTriMontsData ............................. 311
(ii) LehmanChangedItsValuationMethodologyfor
ItsPTGPortfolioinLate2007............................................ 312
(b) TheRoleofLehmansPTGBusinessDeskinthe
ValuationProcessforLehmansPTGPortfolio........................ 319
TestingtheValuationofLehmansPTGPortfolio ................... 321
(d) TheInfluenceofLehmansPTGBusinessDeskuponthe
PriceTestingFunctionofLehmansProductControl
Group.............................................................................................. 326
(5) TheExaminersFindingsandConclusionsastothe
ReasonablenessofLehmansValuationofPTGPortfolio...............329
(a) LehmanDidNotMarkPTGAssetstoMarketBased
Yield ................................................................................................ 331
(b) TheEffectofNotMarkingtoMarketBasedYield .................. 337
(i) EffectofCap*105NotMarkingtoMarketBased
Yield ...................................................................................... 337
Yield ...................................................................................... 342
(iii) EffectofProductControlPriceTestingNot
MarkingtoMarketBasedYield ........................................ 349
197

(iv) EffectofModifyingTriMontsDataintheThird
Quarterof2008 .................................................................... 351
(c) ExaminersFindingsandConclusionsastotheEffectof
NotMarkingLehmansPTGPortfoliotoMarketBased
Yield ................................................................................................ 353
Positions.........................................................................................................356
(2) LehmansAcquisitionofArchstone...................................................364
(a) BackgroundonArchstone ........................................................... 364
(b) AcquisitionofArchstone ............................................................. 365
(i) AnalystReaction.................................................................. 367
(ii) LehmansSyndicationEfforts ........................................... 370
(iii) BridgeandPermanentEquityatClosing ........................ 374
(iv) CapitalStructureatClosing............................................... 375
(v) PriceFlex .............................................................................. 377
(vi) Standard&PoorsCreditRating ...................................... 380
(3) LehmansValuationofArchstone ......................................................382
(a) ValuationBetweenCommitmentandClosing......................... 386
(b) ValuationasoftheClosingDate ................................................ 388
(c) ValuationasoftheFourthQuarterof2007............................... 390
(d) ValuationIssuesDuringtheFirstQuarterof2008 .................. 391
(i) BarronsArticle.................................................................... 391
a. ArchstonesResponsetotheBarronsArticle.......... 392
b. LehmansResponsetotheBarronsArticle ............. 394
(ii) January2008ArchstoneUpdate ....................................... 396
(iii) ValuationasofFebruary29,2008..................................... 399
(iv) FirstQuarter2008EarningsCallandLenders
DiscussionRegardingModifyingtheArchstone
Strategy ................................................................................. 401
(e) ValuationIssuesDuringtheSecondQuarterof2008.............. 402
(i) March2008ArchstoneUpdate.......................................... 402
(ii) March2008Valuation......................................................... 404
(iii) April2008DowngradebyS&P ......................................... 407
198

(iv) EinhornSpeechinApril2008 ............................................ 407

(v) May2008Valuation ............................................................ 408
(vi) SecondQuarter2008EarningsConferenceCall ............. 411
a. PreparationandLehmansMethodsof
AnalyzingReasonablenessofValuationsPrior
totheCall ...................................................................... 411
b. DiscussionDuringtheSecondQuarter2008
EarningsCall................................................................. 412
(vii) LehmansRevisedPlantoSellArchstonePositions ...... 414
(f) ValuationIssuesDuringtheThirdQuarterof2008 ................ 416
(i) DiscussionAmongLendersinJuly2008 ......................... 417
(ii) August2008Valuation ....................................................... 417
(g) ProductControlsReviewofArchstoneValuations................ 418
(4) ExaminersAnalysisofLehmansValuationProcessforits
ArchstonePositions ..............................................................................419
(a) DiscountedCashFlowValuationMethod................................ 421
(i) RentGrowth......................................................................... 422
a. NetOperatingIncome................................................. 426
b. SensitivityAnalysis...................................................... 429
(ii) ExitCapitalizationRate...................................................... 431
(iii) ExitPlatformValue............................................................. 433
(iv) DiscountRate....................................................................... 436
(b) SumofthePartsMethod ............................................................. 438
(c) ComparableCompanyMethod .................................................. 440
(i) PotentialOvervaluationBasedonPrimary
ComparableCompanies..................................................... 445
(5) ExaminersAnalysisoftheReasonablenessofLehmans
ValuationofitsArchstonePositionsonaQuarterlyBasis .............446
(a) ReasonablenessasoftheFourthQuarterof2007 .................... 446
(b) ReasonablenessasoftheFirstQuarterof2008 ........................ 449
(i) BarronsArticle.................................................................... 450
(ii) DiscussionsAmongArchstone,Tishmanand
Lenders ................................................................................. 458
(iii) LehmansValuationDuringtheFirstQuarterof
2008........................................................................................ 459
199

(iv) SumoftheParts................................................................... 460

(v) DCFMethod......................................................................... 464
(vi) ExaminersFindingsandConclusionsastothe
ReasonablenessofLehmansArchstoneValuation
asoftheEndoftheFirstQuarterof2008 ........................ 466
(c) ReasonablenessasoftheSecondQuarterof2008.................... 468
(i) SecondQuarterEarningsCall ........................................... 469
(ii) SumoftheParts................................................................... 476
(iii) DCFModel ........................................................................... 477
(iv) RentGrowth......................................................................... 478
(v) ExitCapitalizationRate...................................................... 479
(vi) QuantificationofChangesinAssumptions .................... 480
(vii) ExaminersFindingsandConclusionsastothe
asoftheEndoftheSecondQuarterof2008 ................... 481
(d) ReasonablenessasoftheThirdQuarterof2008 ...................... 484
(i) SumoftheParts................................................................... 487
(ii) DCFMethod......................................................................... 488
(iii) RentGrowth......................................................................... 489
(iv) ExitCapitalizationRate...................................................... 490
(v) QuantificationofChangesinAssumptions .................... 491
asoftheEndoftheThirdQuarterof2008 ...................... 492
(1) ResidentialWholeLoansOverview ...................................................494
(2) LehmansU.S.ResidentialWholeLoansin2008 .............................497
(3) LehmansValuationProcessforitsResidentialWholeLoans .......501
(a) LehmansMay2008PriceTesting .............................................. 504
(b) LehmansAugust2008PriceTesting......................................... 515
(4) ExaminersIndependentValuationofLehmansResidential
WholeLoansPortfolio..........................................................................520
200

(5) ExaminersFindingsandConclusionsWithRespecttothe
ReasonablenessofLehmansValuationofItsResidential
WholeLoansPortfolio..........................................................................525
Portfolio .........................................................................................................527
(1) LehmansPriceTestingProcessforCDOs ........................................543
(2) PriceTestingResultsfortheSecondandThirdQuarters2008 ......551
(a) LehmansPriceTestingofitsCeagoCDOs .............................. 553
(3) ExaminersReviewofLehmansLargestU.S.ABS/CRECDO
Positions .................................................................................................562
ReasonablenessofLehmansValuationofitsCDOs .......................567
Positions.........................................................................................................568
(1) OverviewofLehmansDerivativesPositions...................................568
(2) LehmansUseofCreditSupportAnnexestoMitigate
DerivativesRisk ....................................................................................574
(3) LehmansPriceTestingofitsDerivativesPositions ........................578
DebtPositions ...............................................................................................583
(1) OverviewofLehmansCorporateDebtPositions ...........................583
(2) LehmansPriceTestingofitsCorporateDebtPositions.................585
ValuationofLehmansCorporateDebtPositions............................589
(a) RelianceonNonTrades............................................................... 590
(b) QualityControlErrorsMismatchedCompanies .................. 591
(c) NoTestingofInternalCreditRating ......................................... 592
(1) OverviewofLehmansCorporateEquitiesPositions......................594
(2) LehmansValuationProcessforitsCorporateEquities
Positions .................................................................................................596
ValuationofLehmansCorporateEquitiesPositions......................599
201

(a) ImpairedDebtwithNoEquityMarkDown ............................ 601

(b) StaticMarks ................................................................................... 603
202

2. Valuation
a) ExecutiveSummary
UnderGAAP,Lehmanwasrequiredtoreportthevalueofitsfinancialinventory
at fair value.697 Beginning in the first quarter of 2007,698 Lehman adopted SFAS 157,
which established the fair value of an asset as the price that would be received in an
orderlyhypotheticalsaleoftheasset.699
Toincreaseconsistencyandcomparabilityinfairvaluemeasurements,SFAS157
createdabroad,threelevel,fairvaluehierarchythatprioritizestheinputstovaluation
techniques used to measure fair value.700 Generally, this hierarchy gives the highest
priority to quoted prices in active markets for identical assets or liabilities (Level 1),
followedbyobservableinputsotherthanquotedprices(Level2)andthelowestpriority
to unobservable inputs (Level 3).701 To the extent that the value of an asset cannot be
determinedbyreferencetoobservabledatabasedontransactionsbetweenpartiesinthe
market,otherthandatafromdistressedsales,SFAS157requiresthereportingentityto
697Fin.AccountingStandardsBd.,SFASNo.107,1011.Inaddition,Lehmanownedpositionswithin
itsfinancialinventorythatwereclassifiedasheldforsale,whichwerereportedatthelowerofcarrying
amountorfairvalue.
698SFAS 157 became mandatory for financial statements issued for fiscal years beginning after
November15,2007,andFASBencouragedearlyadoption.Fin.AccountingStandardsBd.,SFASNo.157,
36.
699Lehman Brothers Holdings Inc., Quarterly Report as of Feb. 28, 2007 (Form 10Q)(filed on Apr. 9,
2007),atp.14(LBHI10Q(filedApr.9,2007))(WeelectedtoearlyadoptSFAS157beginninginour
2007fiscalyear....).SFAS157andfairvaluemeasurementsarediscussedfurtherinAppendix1,Legal
Issues,SectionVII.A.
700SFASNo.157,22.
701Id.at2230.
203

use its judgment to determine fair value, taking into account its view as to the
assumptionsthatmarketparticipantswoulduseinpricingtheasset.702
As the level of market activity declined in late 2007 and 2008 resulting in
valuation inputs becoming less observable and certain of Lehmans assets became
increasinglylessliquid,Lehmanprogressivelyreliedonitsjudgmenttodeterminethe
fairvalueofsuchassets.703Inlightofthedislocationofthemarketsanditsimpacton
theinformationavailabletodeterminethemarketpriceofanasset,investors,analysts
andthemediafocusedonLehmansmarktomarketvaluations.704Lehmandevoteda
702Id.at22,30.
703Examiners Interview of Abebual A. Kebede, Oct. 6, 2009, at pp. 4, 68. See Lehman, Valuation &
Control Report Fixed Income Division (Feb. 2008), at p. 27 [LBEXWGM 002260] (noting that to
compensate for the lack of sales data, [p]roduct control is having continuous discussions with Front
Office going through deals in more detail and trying to obtain market color using recent syndications,
bids,offersandanyothermarketinformation.)LehmanreportedanincreasingamountofLevel2and
Level3assetsinitsfinancialstatementsfromtheendofthefourthquarterforits2007fiscalyeartothe
endofthefirstquarterof2008.SeeLehmanBrothersHoldingsInc.,AnnualReportasofNov.30,2007
(Form10K),atp.41(filedonJan.29,2008)(LBHI200710K)(Duringthe2007fiscalyear,ourLevel3
assetsincreased,endingtheyearat13%ofFinancialInstrumentsandotherinventorypositionsowned.);
LehmanBrothersHoldingsInc.,QuarterlyReportasofFeb.29,2008(Form10Q),atp.23(filedonApr.9,
2008)[LBEXDOCID1024435](LBHI10Q(filedApr.9,2008))(showinganincreaseintheamountof
Level2andLevel3assetsonaquarteroverquarterbasisfromtheendofthe2007fiscalyear).Although
by the end of the second quarter of 2008 the aggregate amount of Lehmans financial inventory
considered Level 2 or Level 3 decreased on a quarteroverquarter basis, the majority of this decrease
occurred in the Level 2 asset category, and due to an even more substantial decrease in the amount of
Level 1 assets over the same time period, the proportion of Lehmans financial inventory that was
categorized as Level 2 and Level 3 increased on a quarteroverquarter basis. See Lehman Brothers
Holdings Inc., Quarterly Report as of May 31, 2008 (Form 10Q), at pp. 2930 (filed on July 10, 2008)
(LBHI10Q(filedJuly10,2008)).
704See Andrew Bary, ApartmentHouse Blues, Barrons, Jan. 21, 2008, available at http://online.barrons.
com/article/SB120070919702802265.html#articleTabs_panel_article%3D1 (noting that based on current

REIT prices, the value of the Archstone equity could be zero.); see also David Einhorn, Greenlight
Capital, Presentation to the Value Investing Congress, A Few Thoughts About Risk (Nov. 29, 2007)
[LBEXDOCID 2490444]; Transcript of Speech by David Einhorn, Presentation to Grants Spring
InvestmentConference,PrivateProfitsandSocializedRisk(Apr.8,2008),atp.9,availableat
204

considerablepartofitsearningscallsforthefirstandsecondquartersof2008toexplain
thevaluesithaddeterminedforawiderangeofitsassetsandthemethodologiesithad
employed in doing so.705 Notwithstanding such disclosures, it is apparent that
Lehmans valuations, or its marks, for its illiquid assets, were being questioned by
marketparticipants.706
For example, David Einhorn of Greenlight Capital, who at the time held short
positionsinLehman,statedinanApril8,2008speech:
There is good reason to question Lehmans fair value calculations. . . .

Lehmancouldhavetakenmanybillionsmoreinwritedownsthanitdid.
Lehman had large exposure to commercial real estate. . . . Lehman does
notprovideenoughtransparencyforustoevenhazardaguessastohow
they have accounted for these items. . . . I suspect that greater
transparencyonthesevaluationswouldnotinspiremarketconfidence.707
http://www.foolingsomepeople.com/main/mroom/Grants%20Conference%2004082008.pdf (last
visited Feb. 2, 2010); Transcript of Speech by David Einhorn, Presentation to Ira W. Sohn Investment
Research Conference, Accounting Ingenuity (May 21, 2008), at pp. 34, available at
http://www.foolingsomepeople.com/main/TCF%202008%20Speech.pdf.
705Transcript of Lehman Brothers Holdings Inc. Second Quarter 2008 Earnings Call (June 16, 2008);
TranscriptofLehmanBrothersHoldingsInc.FirstQuarter2008EarningsCall(March18,2008).
706JonathanWeil,LehmansGreatestValueLiesInLessonsLearned,Bloomberg.com(June11,2008),available
at http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_weil&sid=aLvc47iu_Re0
(Lehmansmarket capitalization,at $19.2 billion,is nowalmost $7 billionless than the companys$26
billionbookvalue,orassetsminusliabilities.ThatsuggeststhatthemarketbelievesLehmanhasntfully
cleaned up its balance sheet and that the worst is still to come, managements assurances
notwithstanding.).
707TranscriptofSpeechbyDavidEinhorn,PresentationtoGrantsSpringInvestmentConference,Private
Profits and Socialized Risk (Apr. 8, 2008), at p. 9, available at http://www.foolingsomepeople.

com/main/mroom/Grants%20Conference%2004082008.pdf. See also Transcript of Speech by David
Einhorn, Presentation to Ira W. Sohn Investment Research Conference, Accounting Ingenuity (May 21,
2008), at pp. 34, available at http://www.foolingsome people.com/main/ TCF%202008%20Speech.pdf
(Theissueoftheproperuseoffairvalueaccountingisntaboutstrictversuspermissiveaccounting....
The cycle has exposed the investments to be more volatile and in many cases less valuable than they
thought.Thedeclineinmarketvalueshasforcedtheseinstitutionstomakeatoughdecision.Dothey
followtherules,takethewritedownsandsuffertheconsequenceswhatevertheymaybe?Orworse,do
205

Einhorns skepticism was also reflected in the financial press. On March 20, 2008,
Portfolio.compublishedanarticletitledTheDebtShuffle,whichasked:Whatactually
happenedtoLehmansbalance sheet in thefirstquarter?Assets rose. Leveragerose.
Writedowns were suspiciously miniscule. And the company fiddled with the way it
definesakeymeasureofthefirmsnetworth.708LehmansHeadofU.S.GlobalCredit
Products, Eric Felder, forwarded this article to Ian Lowitt, Lehmans CoChief
AdministrativeOfficer,withthenote,bunchofpeoplelookingatthisarticle,towhich
Lowittreplied,[d]oesnthelp.709FirmssuchasLehmanrequiredtheconfidenceofthe
markettoassureitssourcesofshorttermfinancingthattheywouldberepaid;andthe
marketsconfidenceinLehmanwaspubliclyquestioned.710
According to the SEC, one of the reasons that the market lost confidence in
LehmanwasthatthemarkethadlittleconfidenceintheassetvaluesthatLehmanwas
reporting.711ThislackofconfidencewasevidentintheperformanceofLehmansstock
price,whichdroppedtonearhistoriclowsfollowingLehmansJune9,2008preliminary
theytaketheviewthattheycantreallyvaluetheinvestmentsinordertoavoidwritingthemdown?Or,
evenworse,dotheyclaimtofollowtheaccountingrules,butsimplylieaboutthevalues?)
708Jesse Eisinger, The Debt Shuffle: Wall Street cheered Lehmans earnings, but there are questions about its
balance sheet, Portfolio.com (Mar. 20, 2008), available at http://www.portfolio.com/newsmarkets/top

5/2008/03/20/LehmansDebtShuffle.
709See email from Eric Felder, Lehman, to Ian T. Lowitt, Lehman (Mar. 23, 2008)
[LBHI_SEC07940_625905]; email from Ian T. Lowitt, Lehman, to Eric Felder, Lehman (Mar. 23, 2008)
[LBHI_SEC07940_625905]. There is substantial evidence that the market lost a significant degree of
confidenceinLehmaninthesummerof2008.InJune2008,S&P,FitchandMoodyseachissuedratings
downgradesforLehman,andLehmansstockpriceplummetedfollowingitsearningsannouncementfor
thesecondquarterof2008.SeeSectionIII.B.3.d.2.eofthisReport.
710ExaminersInterviewofSECstaff,Aug.24,2009,atp.14.
711Id.
206

earnings announcement.712 The decline in Lehmans stock price resulted in Lehman
having a market capitalization of $19.2 billion, which was nearly $7 billion below
Lehmans book value. According to Bloomberg.coms Jonathan Weil, the decline in
stock price suggest[ed] that the market believes Lehman hasnt fully cleaned up its
balance sheet and the worst is still to come, managements assurances
notwithstanding.713
ThelackofconfidenceinLehmansvaluationswasalsoevidentinthedemands
for collateral made by Lehmans clearing banks throughout 2008 to secure risks they
assumed in connection with clearing and settling Lehmans triparty and currency
trades,andotherextensionsofcredit.714Tocontinuetheprovisionofclearingservices
and intraday credit that Lehman relied upon for daytoday operations, Lehmans
712SeeSection III.B.3.d.2.e of this Report for further discussion of the markets lack of confidence in
Lehmaninsummerof2008.Fromthebeginningof2008throughtheendofthesecondquarterof2008,
Lehmanscommonstocktradedinrangebetweenahighof$66pershareonFebruary1,2008toalowof
$31.75 on March 17, 2008, immediately after the near collapse of Bear Stearns. Starting in June 2008,
Lehmanssharepricewasapproachingits52weeklow,wouldsoonfallbelow$30pershareandwould
notagainreturntothatlevel.ThelasttimeLehmansstockhadtradedbelow$30/sharewasinSeptember
andOctober1998intheaftermathofthecollapseofLongTermCapitalManagementandtheRussian
Sovereign Debt Crisis. On June 12, 2008, Lehmans stock opened at $21.35/share, and closed at
$21.17/sharelowsthatLehmanhadnotreachedsince1996andthevolumeontradingofLehmans
sharesreachedanalltimehighofover173millionaleveloftradingthatwouldonlybeeclipsedin
Lehmans final week prior to the bankruptcy filing. All historical pricing information is publicly
availablefromsitessuchasYahoo!Finance.
713JonathanWeil,LehmansGreatestValueLiesInLessonsLearned,Bloomberg.com(June11,2008),available
at http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_weil&sid=aLvc47iu_Re0.
Notably, Robert Azerad, Lehmans Global Head of Asset and Liability Management, forwarded this
articletoPaoloTonucci,LehmansGlobalTreasurer,anddescribedthisarticleas[r]epresentativeofthe
tone of the market. Email from Robert Azerad, Lehman, to Paolo Tonucci, Lehman (June 11, 2008)
[LBHI_SEC07940_517806809]
714SeeSectionIII.A.5.ofthisReportforadiscussionofthecollateraldemandsmadebyLehmansclearing
banks.
207

clearing banks began demanding collateral.715 In response, Lehman pledged, or
attemptedtopledge,Lehmanstructuredinstruments,suchascertaincollateralizedloan
obligations, to Citigroup and JPMorgan two of its principal settlement banks.716
Citigroup rejected the assets proposed by Lehman, due to their illiquid characteristics
andtheinabilitytoestablishreliablemarksforsuchassets.717WhileJPMorganaccepted
Lehmans structured instruments, that bank demanded additional cash collateral after
conducting analyses showing that the collateral was likely not worth the par values
assignedbyLehman.718JPMorganscollateralcallwasoneofthecontributingfactorsto
theliquidityproblemsthathastenedLehmansbankruptcy.719
Further, the lack of confidence in Lehmans valuation of its CRE assets was a
principal reason why Lehman sought to shed its illiquid CRE assets in a spinoff
715See Section III.A.5. of this Report, which discusses the importance of Lehmans secured lenders in
general, and Sections III.A.5.b.d., which discuss Lehmans dealings with JPMorgan, Citigroup and
HSBC, which were three of Lehmans most important clearing and settlement banks. Each bank
requestedcollateralfromLehmaninthesummerof2008.
716See Section III.A.5.c.1.c.ii of this Report, which discusses Lehmans proposed pledge of securities to
Citi;andseealsoSectionsIII.A.5.b.1.eandIII.A.5.b.1.kofthisReportwhichdiscussesJPMorgansconcerns
withsecuritiespledgedbyLehmanascollateral.
717See Section III.A.5.c.1.c.ii of this Report, which discusses Lehmans proposed pledge of securities to
Citi.
718See Sections III.A.5.b.1.e and III.A.5.b.1.l, of this Report, which discuss JPMorgans concerns over
Lehman collateral, and certain of JPMorgans valuation analyses of Lehmans collateral. See Section
III.A.5.b.1.k of this Report, which notes that JPMorgans concerns over the value of Lehmans pledged
assets,atleastinpart,ledthebanktoaskforapledgeofcashcollateral.
719See Section III.A.6 of this Report which discusses the effect of clearing bank collateral demands on
Lehmansliquidity.
208

companythatwouldnotberequiredtoreportthefairvalueofsuchassetspursuantto
SFAS157.720
TheuncertainlyastothefairvalueofLehmansassetsalsoplayedaroleinthe
negotiationsbetweenBofAandLehmanregardingapotentialacquisitionofLehmanby
BofA.LewistoldtheExaminerthatforBofA,thequestionofwhetherornotitwasa
gooddealwasbasedentirelyonthenumbers.721BofAputtogetheradiligenceteam
atsomepointaroundSeptember10or11,2008,anditbecamequicklyapparenttothem
that, without substantial government assistance, the deal would not be beneficial to
BofA.722ThestickingpointforBofAwaswhatLewisdescribedasa$66billionholein
Lehmansvaluationofitsassets.723AlthoughLewisstatedthathedidnotthinkthatthe
assetswerecompletelyworthless,BofAdidnotwantthose$66billioninassetsatany
price,andwantedthemoffthebooks.724LewisstatedthathethoughtLehmansmarks
were out of line with BofAs.725 Once it became apparent to Lewisthat government
assistancewasnotforthcoming,BofAeffectivelyendeditsnegotiationswithLehman.726
720Examiners Interview of SEC staff, Aug. 24, 2009, at p. 14. For a discussion of SpinCo, see Section
III.A.5.c.4ofthisReport.
721ExaminersInterviewofKennethD.Lewis,Oct.9,2009,atp.4.
722Id.
723Id.atp.5.
724Id.
725Id.
726Id.atp.6.
209

(1) ScopeofExamination
To address the tasks in the Examiners Order, the Examiner evaluated the
reasonableness of Lehmans marktomarket valuations in two distinct but related
differentcontexts.TheExaminerconsideredthereasonablenessofLehmansmarkto
marketvaluationsfortworeasons.First,inconnectionwiththeExaminersanalysisas
to whether LBHI or any LBHI Affiliates were insolvent, the Examiner considered
whether there was sufficient evidence that Lehmans valuations for a particular asset
class were unreasonable such that the court could adjust, or even disregard, such
valuations in determining the solvency of these debtors. Second, where there was
sufficient evidence to demonstrate that valuations were unreasonable, the Examiner
considered whether such valuations were the product of actions of a Lehman officer
thatwouldsupportacolorableclaimofbreachoffiduciaryduty.
The Examiners inquiry into the reasonableness of Lehmans valuation focused
onLehmansU.S.assets.TheExaminerdeterminedthat,inlightofthecompositionof
the LBHI Affiliates assets, the relative inaccessibility of information regarding the
valuation and price testing of Lehmans nonU.S. assets and the time and expense
necessarytoobtainandanalyzesuchinformation,anassessmentofLehmansnonU.S.
assets was not a prudent use of resources. Accordingly, unless otherwise noted, any
referencetoanassetclassoraparticularLehmanbusinessunitinthisSectionistoU.S.
assetsoraLehmanU.S.businessunit.
210

The Examiner analyzed Lehmans valuation of the following asset categories:
commercial real estate (CRE), residential whole loans (RWLs), residential
mortgagebacked securities (RMBS), collateralized debt obligations (CDOs),
derivatives, corporate debt and corporate equity. The Examiner selected these asset
categoriesduetotherelativesizeofeachassetclassandtheriskofavaluationerrorin
light of deteriorating market conditions. Given that the primary purpose of the
valuation was to support the solvency analysis, the Examiner focused the valuation
analysis on the second and third fiscal quarters of 2008,727 except with respect to
Lehmans valuations of its Archstone positions, which are addressed beginning with
theArchstoneacquisitioninOctober2007.
Acrossallassetclasses,theassetvaluesLehmanreportedwerethosedetermined
by its business desk,subject to revision pursuant to a price testing process performed
by its Product Control Group.728 Even within a single asset class, the valuation
methodologies employed by the business desk differed, and the Product Control
727LBHIsmarketcapitalizationwasapproximately$28.1billionasoftheendofitsfirstfiscalquarteron
February29,2008.SeeLBHIForm10Q(filedApril9,2008),atp.6.TheExaminerfocusedonthedates
May 31, 2008, and August 31, 2008, because these were the last days of Lehmans second and third
quarters, respectively. While Lehman did not file a quarterly report for the third quarter of 2008, the
businessdesksdidvaluetheirpositionsandtheProductControlGroupperformedpricetestingforthis
period. In light of the primary purpose of the valuation analysis, the Examiner determinedthat it was
not a prudent use of resources to examine the reasonableness of Lehmans valuations (other than
Archstone)priortothesecondquarterof2008.WithrespecttoArchstone,giventhesubstantialanalyst
andmediafocusonthistransactionandthenatureofLehmansparticipation,theExaminerdeterminedit
wouldbeprudenttobeginthevaluationanalysiswiththeArchstoneacquisitioninthefourthquarterof
2007 toprovideappropriate context in which to consider the reasonableness of Lehmans valuations
duringlaterperiods.
728Lehman, Price Verification Policy: Global Capital Markets 2008 [Draft], at p. 4
[LBHI_SEC07940_2965994].
211

Groupspricetestingservedasastandardizedcheckonthevaluationprocess.Forthis
reason,theinvestigationfocusedontheroleplayedbytheProductControlGroupand
themethodsemployedinthepricetestingprocess.
(2) SummaryofApplicableLegalStandards
ThestandardfordeterminingthefairvalueofanassetpursuanttoSFAS157is
closely aligned with the standard courts have applied in determining the value of a
debtors assets for purposes of a solvency determination.729 The Bankruptcy Code
definesinsolventinrelevantpartasthefinancialconditionsuchthatthesumofthe
entitysdebtsisgreaterthanallofsuchentitysproperty,atafairvaluation[.]730When
assessingthefairvalueofadebtorsassets,courtsconsiderthefairmarketpriceofthe
debtorsassetsthatcouldbeobtainedifsoldinaprudentmannerwithinareasonable
periodoftimetopaythedebtorsdebts.731Inthismanner,boththeSFAS157standard
for marktomarket valuation and the courts solvency analysis are predicated on the
price that could be obtained for the asset in the marketplace as of the applicable
measurementdate.
Given that valuation is, to a great extent, a subjective exercise,732 courts have
assessedthereasonablenessofadebtorsvaluationorprojectionoffuturecashflowsin
729See Appendix 1, Legal Issues, Section VII.A, for a discussion of the applicable valuation standards
underSFAS157andforasolvencydeterminationundertheBankruptcyCode.
73011U.S.C.101(32)(A)(definitionapplicabletoentitiesotherthanapartnershipormunicipality).
731InreRoblinIndustries,Inc.,78F.3d30,35(2dCir.1996).
732InreIridiumOperatingLLC,373B.R.283,348(Bankr.S.D.N.Y.2007).
212

light ofinformationavailableatthetimethevaluationwasundertaken.AstheThird
Circuit has explained with respect to the analysis of a debtors cash flow projections,
far from hindsight or posthoc analysis, a court looks at the circumstances as they
appearedtothedebtoranddetermineswhetherthedebtorsbeliefthatafutureevent
wouldoccurwasreasonable.Thelessreasonableadebtorsbelief,themoreacourtis
justifiedinreducingtheassets(orraisingliabilities)toreflectthedebtorstruefinancial
condition at the time of the alleged transfers.733 Accordingly, the Examiner has
considered the reasonableness of Lehmans asset values in light of contemporaneous
informationavailabletoLehmanandwiththeunderstandingthatvaluationofilliquid
assetsrequirestheapplicationofconsiderablejudgment.
With respect to the fiduciary duty analysis, a corporate fiduciary would have
breached such duty if the fiduciary caused Lehman to improperly value an asset
intentionally or with conscious recklessness i.e., a state of mind approximating
actualintent,andnotmerelyaheightenedformofnegligence.734Inorderforthereto
beacolorableclaim,thefactsneedtosupportafindingthatthecorporatefiduciaryhad
thenecessaryscienter.
733Mellon Bank, N.A. v. Official Committee of Unsecured Creditors of R.M.L., Inc., 92 F.3d 139, 157 (3d Cir.
1996).
734See,e.g.,Desimonev.Barrows,924A.2d908,93435&n.89(Del.Ch.2007).SeeAppendix1,LegalIssues,
Section II, for a discussion regarding the legal standards for breach of fiduciary duty. See also South
CherryStreet,LLCv.HennesseeGroupLLC,573F.3d98,109(2dCir.2009).
213

(3) SummaryofFindingsandConclusions
The Examiner finds insufficient evidence to support a finding that Lehmans
valuations of its RWL, RMBS, CDO or derivative positions were unreasonable during
thesecondandthirdquartersof2008.AlthoughtheExamineridentifies,anddiscusses
below,certainproblematicissuesrelatedtothepricetestingoftheseassetclasses,these
problems either did not impact the ultimate asset values determined or the resulting
valuationerrorswereimmaterial.
Because an assessment of the reasonableness of Lehmans asset values for
corporate debt and corporate equity would require an expensive and time consuming
assetbyasset analysis, the Examiner determined that such an assessment was not a
prudentuseofresources.TheExaminerconsideredLehmansvaluationsofthelargest
corporate debt and corporate equity positions and identified issues that may warrant
furtherreviewbypartiesininterest.
Withrespecttocommercialrealestate,theExaminerfindsinsufficientevidence
toconcludethatLehmansvaluationsofitsCommercialportfoliowereunreasonableas
of the second and third quarters of 2008. The Examiner determines that there is
sufficientevidencetoconcludethatcertainofthePrincipalTransactionsGroup(PTG)
realestateassetswerenotreasonably valued during thesequarters. Furthermore,the
ExaminerfindssufficientevidencetosupportafindingthatLehmansvaluationsofits
214

Archstonebridgeequityinvestmentwereunreasonableasofthefirst,secondandthird
quartersof2008.735
The Examiner did not find sufficient evidence to support a colorable claim for
breachoffiduciarydutyinconnectionwithanyofLehmansvaluations.Inparticular,
inthethirdquarterof2008thereisevidencethatcertainexecutivesfeltpressuretonot
take all of the writedowns on real estate positions that they determined were
appropriate;thereissomeevidencethatthepressureactuallyresultedinunreasonable
marks. But, as the evidence is in conflict, the Examiner determines that there is
insufficient evidence to support a colorable claim that Lehmans senior management
imposedarbitrarylimitsonwritedownsofrealestatepositionsduringthatquarter.
Portfolio
This Section addresses Lehmans valuation of its CRE portfolio, principally
duringthesecondandthirdquartersof2008,736andprovidesanoverviewofLehmans
CREportfolioandLehmansvaluationprocessacrosstheCREportfolio.Inordertoput
Lehmans valuation process and decisions in context, this overview summarizes the
735Thisanalysisalsopertainstothepermanentequity(i.e.,generalpartnerinterest)whichwasvaluedat
$246 millionat closing. See Lehman, Archstone Monthly Exposure as of July 2008 revised.xls [LBEX
BARFID0013113].
736As is the case with each of the other asset classes that were the focus of the investigation as to
Lehmansvaluationofassets,theExaminerdeterminedthatitwouldnotbeaprudentuseofresourcesto
conductaninvestigationofLehmansvaluationofitsnonU.S.CREassets.WiththeexceptionofLCPI,
which owned certain European debt and Coeur Defense positions (located in Paris, France), the LBHI
AffiliatesdidnotdirectlyownmaterialCREpositionsinrespectofrealestatelocatedoutsideoftheU.S.
See Section III.B.3.c.3.a of this Report, which discusses the Examiners finding that LCPI was either
insolventorborderlinesolventduringtheperiodbeginningSeptember2007.
215

changes in Lehmans CRE portfolio beginning in 2006 and Lehmans response to the
changing market conditions throughout 2007 and 2008, including the writedowns
Lehman took in 2008. This Section concludes by addressing the SECs review of
Lehmans price verification processes for its CRE portfolio and the quarterly review
performedbyE&YofLehmansCREvaluationsin2008.
Following the overview, the Examiner discusses the role played by Lehman
senior management in the valuation process and, in particular, addresses whether
senior managers set predetermined limits on the amount of CRE writedowns for the
second and third quarters of 2008. This Report continues with an analysis of the
valuation of the CRE assets within each of Global Real Estate Groups (GREGs)
business units Commercial, Principal Transactions Group (PTG) and Bridge
Equity.737 The Report, in separate subsections, describes the assets in the PTG and
Commercial portfolios, Lehmans Archstone investments,738 the methodologies
employedbyLehmantovaluesuchassetsandtheproceduresusedtopricetestthose
values. Each subsection includes the Examiners analysis as to whether there is
737Lehman, GREG Update (Aug. 7, 2008), at p. 2 [LBHI_SEC_07940_ICP_003590]. According to this

presentation,thethreebusinessunitsofGREGwereCommercialWholeLoansandCMBS(whichwere
referred to as Commercial), PTG and Real Estate Advisory. Id. Real Estate Advisory provide[d]
comprehensive advisory and capital raising services but did not utilize [Lehmans] balance sheet,
whichmeansthatpositionsoriginatedfromthisbusinessunitwerenotownedbyLBHIorthedebtors.
Id.;seealsoLehman,RealEstateUpdatePresentationtoS&P(Oct.2007),atp.3[LBHI_SEC07940_126498].
738The Examiners analysis of the Bridge Equity units valuation focuses on Lehmans valuation of its
Archstone bridge equity position because this single position represented over 50% of the value of
Lehmansbridgeequityportfolio.
216

sufficientevidenceto support afindingthatLehmansvaluations of these assets were
unreasonable.739
(1) OverviewofLehmansCREPortfolio
(a) SummaryofPortfolio
The Commercial portfolio (Commercial Book) was comprised of debt
instruments, such as commercial mortgage loans and Commercial MortgageBacked
Securities (CMBS).740 These assets were backed by real estate properties that were
generating cash flow and Lehmans intention was to syndicate, securitize and/or sell
theseassetstoinvestorswithinafewmonthsaftertheiroriginationoracquisition.741
PTG assets were typically highly leveraged debt or equity investments in real
estate assets that Lehman intended to hold for its own account while a developer
improvedordevelopedtheunderlyingasset.742Asageneralmatter,Lehmansstrategy
739WhileLehmandidnotfileaquarterlyreportforthethirdquarterof2008,itdidvalueitsCREassets
and perform price testing for this period. Lehman publicly disclosed its preliminary third quarter
results. Lehman, Press Release: Lehman Brothers Announces Preliminary Third Quarter Results and
StrategicRestructuring[LBHI_SEC07940_028677].
740WyattdeSilva,E&Y,MemorandumtoFiles:LehmanCommercialRealEstateFAS157Adoption(Jan.
28,2008),atpp.24[EYLELBHIKEYPERS2025661];Lehman,GlobalRealEstateProductControlReal
EstateAmericasPriceVerificationPresentation[Draft](Feb.2008),atp.4[LBEXWGM916015];Lehman,
GREGUniversity:STARTAnalysts&AssociatesDeepDiveTrainingPresentation(Sept.2007),atp.50
[LBHI_SEC_07940_ICP_007982].Inaddition,Lehmanwouldsellwholeloanstoinstitutionalinvestors.
741Lehman, GREG Update (Aug. 7, 2008), at p. 2 [LBHI_SEC_07940_ICP_003590]; see also E&Y
Workpaper, Lehman Brothers Holdings Inc. 6 Month Period Ending May 31, 2008, Mortgage Capital
Team:PrincipalTransactionsP&LReview,atp.3[EYSECLBHIMCGAMX08138373](Commercials
are primarily composed of conduit and large loans with a principal exit strategy, historically of sale,
namelysecuritization.)
742Lehman, Global Real Estate Product Control Real Estate Americas Price Verification Presentation
[Draft] (Feb. 2008), at p. 4 [LBEXWGM 916018] (describing PTG assets as High Leveraged debt and
equityinvestmentsincommercialrealestateproperties).
217

was to monetize a PTG investment in connection with a sale of the underlying real
estateassetaftersuchdevelopmentorimprovementwascompleted.743
Lehman would provide bridge equity, together with debt financing, to a real
estate company in connection with its acquisition of particular properties, or to the
acquirerofarealestatecompanythroughaleveragedbuyout. 744Lehmanintendedto
sell bridge equity positions it originated over the shortterm to mediumterm to
institutionalinvestors.
As of May 31, 2008, GREG valued its global CRE portfolio at $49.3 billion,745
which consisted of $28.0 billion in the U.S., $12.5 billion in Europe and $8.9 billion in
Asia.746Asofthatdate,GREGvalueditsU.S.CREpositionsasfollows:Commercial
743WyattdeSilva,E&Y,MemorandumtoFiles:LehmanCommercialRealEstateFAS157Adoption(Jan.
28, 2008), at p. 5 [EYLELBHIKEYPERS 2025665] (Lehmans exit strategy for PTG Investments is
throughsaleoftheunderlyingassetorrefinanceofthedebt/equitypositions.);ExaminersInterviewof
AristidesKoutouvides,Nov.20,2009,atpp.78.
744Lehman, GREG University: START Analysts & Associates Deep Dive Training Presentation (Sept.
2007),atp.85[LBHI_SEC_07940_ICP_007982];Lehman,GREGApprovalPoliciesandProceduresManual
(May 2008 ed.), at 1 [LBEXOTS 000245]. See Section I.B.2.c, which discusses Lehmans strategy with
respecttobridgeequityinvestments.
745These amounts refer to Lehmans balance sheet at risk and do not include the value of certain real
estate assets held by entities (such as votinginterest entities and variableinterest entities) in which
Lehmanmadedebtandequityinvestments.LBHI10Q(filedJuly10,2008)atp.26([Lehman]considers
itself to have economic exposure only to its direct investments to these entities; the Company does not
haveeconomicexposuretothetotalunderlyingassetsintheseentities.)TheExaminerdidnotperform
aforensicreviewofLehmansaccountingrecords.LehmanreporteditsvaluationsaccordingtoGAAP
asset class (e.g., Real Estate Held for Sale) but managed its business according to business unit. The
ExamineruseddatacreatedbyLehmanintheordinarycourseinconnectionwiththisvaluationanalysis.
746Lehman, Global Real Estate Inventory Spreadsheet as of May 31, 2008 (Aug. 8, 2008) [LBEXDOCID
2077095]. The Examiners financial advisor has determined that the amounts in this spreadsheet for
Commercial Mortgages ($29.4 billion) and Real Estate Held for Sale ($10.4 billion) GAAP asset classes
reconcilewithLehmansfinancialdisclosuresinitsSECfilingforthesecondquarterof2008.LBHI10Q
(filedJuly10, 2008)at p.71. Although the Examiner haslimitedthe investigation into Lehmans CRE
218

$15.1 billion; PTG $8.5 billion; and Bridge Equity $3.1 billion.747 For assets that
weresubjecttoSFAS157,748substantiallyalloftheCommercialpositionswereclassified
asLevel2,whilethePTGandBridgeEquitypositionsweregenerallyclassifiedasLevel
3.749
As of August 31, 2008, GREG valued its global CRE portfolio at $41.3 billion,
which consisted of $23.4 billion in the United States, $10.1 billion in Europe and $7.8
billion in Asia.750 As of that date, GREG valued its U.S. CRE positions as follows:
Commercial $11.9 billion; PTG $7.8 billion; and Bridge Equity $2.8 billion.751
ForassetsthatweresubjecttoSFAS157,substantiallyalloftheCommercialpositions
portfoliototheU.S.positions,someportionsoftheReportwill,attimes,refertoGREGsglobalholdings
inordertoprovidecontext.
2077095]. GREGs assets in the U.S. also included $0.8 billion that was classified as Other. For
purposesofanalysisandpresentation,thisReportalsoreclassifies$0.4billionofSunCalpositionsfrom
PTGintotheOthercategory.
748Real Estate Held for Sale was reported at the lower of its cost basis and fair value, so therefore the
valuationanalysisisthesamefortheseassetsandFAS157forthepurposesofthisReport.
749Id.GREGreportedthefollowingamountsasofMay31,2008:Level1$57million;Level2$26.1
billion;Level3$12.8billion;RealEstateHeldforSale$10.4billion.
750Lehman,GlobalRealEstateInventorySpreadsheetasofAug.31,2008[LBEXDOCID1025119].Thee
Examiners financial advisor has determined that the combined amount in this spreadsheet for the
Commercial Mortgages and Real Estate Held for Sale asset classes ($32.6 billion) reconciles with
LehmansfinancialdisclosuresforthethirdquarterinitsSeptember10,2008pressrelease.Lehman,Press
Release: Lehman Brothers Announces Preliminary Third Quarter Results and Strategic Restructuring
(Sept.10,2008)[LBHI_SEC07940_028677].SimilartotheMay31,2008amounts,theseamountsreferto
Lehmansbalancesheetatriskanddonotincludethevalueoftheunderlyingassetsheldbyentitiesin
which Lehman had an investment interest because Lehman did not have direct economic exposure to
suchunderlyingassets.
751Id.GREGreportedthefollowingamounts:Level1$15million;Level2$20.1billion;Level3$12.5
billion;andRealEstateHeldforSale$8.7billion.GREGsassetsintheU.S.included$0.6billionthat
wasclassifiedasOther.TheExamineralsoreclassified$0.4billionofSunCalpositionsfromPTGinto
theOthercategory.
219

were classified as Level 2, while the PTG and Bridge Equity positions were generally
classifiedasLevel3.752
(b) OverviewofValuationofCREPortfolio
(i) GREGLeaders
Mark A. Walsh served as the Head of GREG and reported to the head of
LehmansFixedIncomeDivision(FID).753ServingunderWalshwereKennethCohen,
HeadofU.S.Originations,andPaulA.Hughson,HeadofCreditDistribution.754Walsh,
CohenandHughsonservedonGREGsGlobalCreditCommitteeandwereresponsible
forapprovingoriginationofCREdealsinthefirstinstance.755
(ii) ParticipantsintheValuationProcess
Aswithotherbusinessunits,theapplicableGREGbusinessunitwasresponsible
for valuing, or marking, its assets.756 The values assigned to assets are commonly
referred to as marks, and determining the value of the assets as marking the
752Id.
753ExaminersInterviewofMarkA.Walsh,Oct.21,2009,atp.4.MichaelGelbandservedasLehmans
HeadofFIDuntilMay2007,whenhewasreplacedbyRogerNagioff.Lehman,PressReleaseNaming
RogerB.NagioffGlobalHeadofFixedIncome(May2,2007)[LBEXDOCID1470086],attachedtoemail
from Monique Wise, Lehman, to Jasjit Bhattal, Lehman, et al. (May 1, 2007) [LBEXDOCID 1605828].
NagioffhimselfdepartedLehmaninJanuary2008.
755Lehman,GREGApprovalPoliciesandProceduresManual(June2006),atp.12[LBEXDOCID624251].
SeeSectionIII.A.1.b.2.b.viiiforinformationontheapprovalprocessfordealorigination.
756Theprocessformarkingbythebusinessdeskisdiscussedingreaterdetailinthesubsectionsdealing
withvaluationsofeachportfolioandtheArchstonepositions.
220

book.757ForthePTGpositions,assetmanagersvaluedthesepositionsbasedontheir
knowledge of the development of the underlying real estate asset.758 Anthony J.
Barsanti, Senior Vice President in PTG, and Aristides Koutouvides, Vice President in
PTG,werethetwoemployeesprimarilyresponsiblefordeterminingthemarksforthe
PTG assets during the period that is the subject of the Examiners review. Their
valuations were subject to review by Kenneth Cohen, Walsh and other members of
Lehmansseniormanagement.759
Commercialpositionswerevaluedbypersonnelwhomarkedthebookbasedon
their understanding of how debt was trading in the applicable market.760 Their
valuationsweresubjecttoreviewbyHughson,whoalsosupervisedthemarkingofthe
BridgeEquityassets.761
Agroupofproductcontrollerswasassignedtoconductpriceverificationforthe
CRE assets. This price verification, or price testing, process for each GREG business
unit is discussed in more detail in the applicable subsection addressing Lehmans
valuationofsuchassets.JonathanCohen,SeniorVicePresident,directlyoversawthis
757ExaminersInterviewofAbebualA.Kebede,Sept.29,2009,atp.5;ExaminersInterviewofKenneth
Cohen, Oct. 20, 2009, at p. 11; Examiners Interview of Kenneth Cohen, Jan. 21, 2010, at pp. 2, 4;
ExaminersInterviewofJonathanCohen,Jan.11,2010,atp.6.
758ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.11.
759Id.atpp.1011.
761Id.atp.10.
221

process.762 Abebual Kebede, Vice President, served under Jonathan Cohen, and was
responsible for price testing the Bridge Equity positions and supervised the three
product controllers who price tested the Commercial Book and the PTG positions.763
JenniferParkpricetestedCommercialBook,EliRabinpricetestedPTGequitypositions
andRebeccaPlattpricetestedthePTGdebtpositions.764
Asageneralmatter,theproductcontrollersperformedpricetestingonpositions
by inputting positionspecific information into spreadsheet models that produced an
outputvaluebasedoncalculationsandformulasselectedbyLehmanaspricetesting
tools.765Theproductcontrollersthencomparedthemodeloutputvaluetothebusiness
desk value to determine whether the difference between the two, referred to as the
variance, exceeded a certain threshold.766 The product controllers discussed variances
withtheappropriatebusinessdeskpersonwhoselectedthemarkinordertodetermine
762Lehman, Global Real Estate Product Control, Real Estate Americas Price Verification Presentation
[Draft](Feb.2008),atp.3[LBEXWGM916015].
763Id.;ExaminersInterviewofAbebualA.Kebede,Sept.29,2009,atp.5(KebedetoldtheExaminerthat
hisjobwastomakesurethemarksmadesense.)
[Draft](Feb.2008),atp.3[LBEXWGM916015].
765Id.atpp.610;ExaminersInterviewofAbebualA.Kebede,Sept.29,2009,atp.5.
[Draft](Feb.2008),atpp.610[LBEXWGM916015];ExaminersInterviewofAbebualA.Kebede,Sept.
29,2009,atp.6.
222

whether the business desk or valuation control value should be accepted for each
position.767
When disagreement persisted as to the variance, Product Control elevated the
issuetoKebede,andifKebedewasnotsatisfiedwiththebusinessdesksbasisforthe
marks, he would bring the dispute to Jonathan Cohens attention.768 Cohen could
further elevate the dispute up through the Product Control chain of command, to
ClementBernard,theCFOforFID,769toGerardReilly,theGlobalProductController770
andultimatelytoLehmansCFO.771TheinteractionbetweentheGREGbusinessdesks
andProductControlisdiscussedinthefollowingsubsection.
(c) ChangesintheCREPortfoliofrom2006through2008
In order to understand the difficulties Lehman encountered in valuing its CRE
positionsinthesecondandthirdquartersof2008,itisnecessarytofirstbrieflyreview
the material changes in the GREG portfolio and the real estate markets beginning in
[Draft](Feb.2008),atp.21[LBEXWGM916015];ExaminersInterviewofAbebualA.Kebede,Sept.29,
2009,atp.3.
768Examiners Interview of Abebual A. Kebede, Sept. 29, 2009, at pp. 68 (noting that prior to 2008, the
valuation control team, along with senior GREG employees, including Barsanti and Jonathan Cohen,
determinedthefinalmarksforCREassets).
769Lehman,CapitalMarketsandIBDFinanceOffsitePresentationonValuationandControlGroup(Jan.
16,2008),atp.12[LBEXWGM756817].
770ExaminersInterviewofKennethCohen,Oct.20,2009,atp.10.GerardReillypassedawayinaskiing
accidentonDecember29,2008;ChristopherM.OMeara,LehmansformerCFO,describedReillyasthe
person ultimately responsible for valuations of Level 2 and Level 3 assets. Examiners Interview of
ChristopherM.OMeara,Aug.14,2009,atp.26.
771Examiners Interview of Christopher M. OMeara, Aug. 14, 2009, at p. 26 (stating that the product
controllerswhotookresponsibilityforvaluationwereunderhisdirectionasCFO);ExaminersInterview
ofAbebualA.Kebede,Sept.29,2009atp.6.
223

2006. In 2006, Lehman decided to commit more of its balance sheet to historically
profitable businesses and to put more of Lehmans capital at risk in order to remain
competitive with other investment banks.772 That strategy included substantially
increasingitsCREinvestments.773Lehmanexecuteduponthisstrategy,reportingthat
theaggregatevalue ofits globalCREassetswas$55.2billionasofthe endof its 2007
fiscalyear,increasingfrom$28.9billionasoftheendofits2006fiscalyear.774
Over July and August 2007 Lehman personnel recognized that the market for
placinginvestmentsbackedbycommercialrealestatewasvirtuallyclosed775andthe
leveragedloansmarkethadshutdown.776Inlightoftheseevents,Lehmandecidedto
stoporiginatingnewloansintheleveragedloanandcommercialrealestatebusinesses
untiltheendofthethirdquarterof2007.777However,Lehmanhadalreadycommitted
to finance several large CRE deals that closed in October and November of 2007,
includingArchstone.
772ExaminersInterviewofKennethCohen,Oct.20,2009,atp.7.
773Id.;emailfromPaulA.Hughson,Lehman,toKentaroUmezaki,Lehman,etal.(May9,2006)[LBEX
DOCID1776281](requestingameetingwithUmezakitodiscussGlobalRealEstateRiskAppetiteand
howthenewlimitscoincidewithourplantoexpandourbusinessinAsia,Europeandourbridgeequity
globally).
774Lehman, Presentation to Moodys Investors Service, Commercial Real Estate (Feb. 13, 2008), at p. 5
[LBHI_SEC_07940_ICP_008206].
775Email from William J. Hughes, Lehman, to Alex Kirk, Lehman, et al. (July 27, 2007) [LBEXDOCID
174304].
776Email from Alex Kirk, Lehman, to Roger Nagioff, Lehman (Aug. 6, 2007) [LBEXDOCID 173492];
ExaminersInterviewofRogerNagioff,Sept.30,2009,atp.9.
224

As 2007 progressed, Lehman increased its focus on the size of its balance sheet
and its leverage.778 On November 3, 2007, Walsh emailed Roger Nagioff, Lehmans
Global Head of Fixed Income, regarding his plans to reduce the balance sheet at a
steady rate, with a target of a $45 billion GREG balance sheet on a global basis.779
GREGsNovember6,2007presentationtotheExecutiveCommitteestatedthatunder
any circumstance an estimated $15 billion reduction in global balance sheet is
warranted,andrecommendedreducingtheglobalGREGbalancesheetto$43.7billion
byMarch31,2008.780
Despitethisemphasisondeleveragingand thestatedplantoreducetheGREG
balance sheet by $15 billion, GREGs balance sheet of $55.0 billion at the end of
February 2008 was only $200 million less than the GREG balance sheet at the end of
November 2007.781 In the first quarter of 2008, Lehmans plan to reduce its balance
778See Section III.A.4.f on Repo 105/108. With respect to reducing the size of the GREG balance sheet,
Hughson told the Examiner that he and Walsh recognized the need for such reduction in May 2007.
ExaminersInterviewofPaulA.Hughson,Oct.28,2009,atpp.45;seealsoemailfromPaulA.Hughson,
Lehman,toThomasPearson,Lehman,etal.(May23,2006)[LBEXDOCID1776282].Walshpointedtothe
fallof2007aswhenheknewbalancesheetreductionwasanecessarystep.ExaminersInterviewofMark
A.Walsh,Oct.21,2009,atp.10.InSeptember2007,KentaroUmezaki,HeadofFixedIncomeStrategy,
told Hughson that a flat growth policy was being considered for GREG. See email from Kentaro
Umezaki,Lehman,toPaulA.Hughson,Lehman,etal.(Sept.24,2007)[LBEXDOCID1809381].
779Walsh broke down the target GREG balance sheet as follows: $25 billion in the United States, $10
billioninEuropeand$10billioninAsia.EmailfromMarkA.Walsh,Lehman,toRogerNagioff,Lehman
(Nov.3,2007)[LBEXDOCID175741].
780Lehman,GREGGlobalRealEstateUpdatePresentation(Nov.6,2007),atp.1[LBEXDOCID2072935];
emailfromAbebualA.Kebede,Lehman,toJonathanCohen,Lehman,etal.(Nov.4,2007)[LBEXDOCID
523669].
781Lehman,GREGUpdate(June5,2008),atp.1[LBEXDOCID1417258].
225

sheetresultedinthesaleoflessthan$400millionofCREassets.782Accordingtoformer
Lehman CFO Erin Callan, Lehman did not set balance sheet reduction targets for
businessesuntilafterBearStearnssnearcollapseinMarch2008.783
During the second quarter of 2008, Lehman publicly disclosed that it sold
approximately$8billionofCREpositions.784Despitethesecondquartersales,manyof
the largest CRE positions originated in 2007 were not sold or securitized, such that
many of these transactions remained among the 10 largest exposures on GREGs
balancesheetasofMay31,2008.785LehmanreportedthatitsglobalCREpositionsasof
782Lehman,GREGSecondQuarter2008SalesSpreadsheet(May29,2008)[LBEXDOCID4352112].The
spreadsheet shows the GREG positions that were sold since November 30, 2007. According to the
spreadsheet, during the first quarter of 2008, 13 positions were sold in the United States for $350.5
million,nopositionsweresoldinEuropeandonepositionwassoldinAsiafor$33.1million.
784TranscriptofLehmanBrothersHoldingsInc.SecondQuarter2008EarningsCall(June16,2008),atp.
12.LehmanalsoreportedtoitsAuditCommitteethatitsoldapproximately$8billionofCREpositions
duringthesecondquarterof2008.Lehman,PresentationtotheAuditCommittee:ValuationReview
2nd Quarter 2008 (July 2008), at pp. 2123 [LBHI_SEC07940_2969525]. However, for purposes of
benchmarkingitssalesduringthequartertothevaluationofitsremainingCREpositions,Lehmantold
E&Ythatitsold$5.2billionofCREassetsduringthesecondquarterof2008.E&YWorkpaper,Global
Real Estate Q208 Sales Activity, Q2.J1 GREG Sales 2nd Qtr 08 Lead.xls, at p. 30 [EYSECLBHIMC
GAMX08138412]. The Examiners financial advisor has observed that the difference in these numbers
reflectsadifferentmethodologyforcalculatingsalesforthepurposesofbenchmarkingtheremaining
positions,andthelowernumberreflectstheexclusionofapproximately$1billionofsalesinEuropethat
were sellerfinanced without recourse, over $600 million of loan payments that were characterized as
sales to the Audit Committee and over $250 million from the sale of two U.S. PTG positions that were
deemed outside the scope of the benchmarking analysis due to the unique nature of the investments.
Therewere$3.8billionofCommercialsalesintheUnitedStatesduringthesecondquarterof2008that
Lehmandeemedtoberelevantforpurposesofbenchmarkingtothevaluationofitsremainingpositions;
there were no suchsales for PTG or BridgeEquitypositions. See Lehman, GREG SecondQuarter 2008
Sales Spreadsheet (May 29, 2008) [LBEXDOCID 1139324]; Lehman, GREG Second Quarter and Third
Quarter2008SalesSpreadsheet(Aug.19,2008)[LBEXDOCID4323975].
785Ronald S. Marcus, Office of Thrift Supervision, Report of Examination (July 7, 2008), at p. 6 [LBEX
OTS000004].
226

that date had a value of approximately $50 billion.786 After accounting for total net
writedowns, the Commercial Book was valued at $15.1 billion, the PTG positions at
$8.5billionandtheBridgeEquitypositionsat$3.1billion.787
(d) PerfectStormImpactonCREValuationin2008
Theeconomiccrisisinthe2007and2008wasreferredtoasaperfectstormin
severalLehmanpresentations.788Asthedecliningmarketpersistedinthefourthquarter
of2007,LehmanconsideredtakingwritedownsonitsCREpositions.OnOctober28,
2007,WalshemailedNagiofftolethimknowthatthelastfewdaysinthemarkethave
beenuglyandcmbsisdownbig.789Asaresult,WalshreportedGREGwillbepassing
thru a significant write down on monday, and anticipated more writedowns to
come.790
786LBHI10Q(filedJuly10,2008),atp.70.TheamountofCREoftendependsonthedefinitionusedby
Lehman. Lehmans 10Q for the second quarter of 2008 listed its CRE holdings at $40 billion, but that
amountexcludedcertainrealestaterelatedcorporatedebtorcorporateequitypositions.The$50billion
totalincludesthosepositions,whichweredeterminedbytheExaminersfinancialadvisorpursuanttoa
review of Lehmans product control share drive. Unless noted otherwise, these figures represent
Lehmansnumbersasbalancesheetatrisk.Balancesheetatriskistheportionofanasset,adjustedto
marketvalue(whichtakesintoaccountthewritedowns),thatLehmanconsideredasrepresentativeofits
economicexposure.Thebalancesheetatriskisthebestindicatorforthesepurposesbecauseitlooksat
Lehmanstrueexposuretoanassetasitdoesnotincludeanythirdpartyportionthatisconsolidatedfor
accountingpurposes.
2077095]. GREGs assets in the U.S. also included $0.8 billion that was classified as Other. The
Examineralsoreclassified$0.4billionofSunCalpositionsfromPTGintotheOthercategory.
788See Lehman, GREG 2009 Strategy Executive Update Draft Presentation (June 20, 2008), at p. 1
[LBHI_SEC07940_124425]; Lehman, Global Commercial Real Estate Presentation (Aug. 6, 2008), at p. 4

[LBHI_SEC07940_302586].
789EmailfromMarkA.Walsh,Lehman,toRogerNagioff,Lehman,etal.(Oct.27,2008)[LBEXDOCID
175724].
790Id.Also,onNovember6,2007,GREGproducedforinternalcirculationaGlobalRealEstateUpdate
statingthatLehmansglobalCREassetsweremaintainingstrongprofitabilitybasedonitsconservative
227

Overthecourseof2008,LehmanwrotedownitsCREpositionsbymorethan$3
billion:
NetWritedownsbyBusinessUnit791

Q1 Q2 Q3 Total

PTG 271 302 504 1,077

BridgeEquity 72 349 265 686

Commercial 293 195 306 794

SunCal792 156 178 212 546

Total 792 1,025 1,286 3,103

The January 2008 GREG Product Control report on Global Real Estate
Markdownsprovidesausefulsummaryofthemarketconditionsatthetimeandtheir
policies and the cushion of imbedded profitability. Lehman, GREG Global Real Estate Update
Presentation (Nov.6, 2007), at p. 1 [LBEXDOCID 2072935]. The update continued: Notwithstanding
strong real estate fundamentals, transactions have slowed to a trickle due to uncertainty around
financing, valuation (stalemate), and weakening of economic forecasts. Id. The update stated that
LehmanwouldmakenetwritedownsofitsU.S.CREassetsintheamountof$825millionforfiscalyear
2007.Id.
791Lehman,GlobalRealEstate2008NetMarkDowns(Sept.5,2008)[LBEXAM346991].
792SunCal consisted of approximately 25 positions inCalifornia real estate that straddled both the PTG
andCommercialportfolios.TheExaminersfinancialadvisorhasobservedthatthefilescontainingthe
writedowns reported one number for SunCal and did not allocate it between PTG and Commercial.
Therefore,theExaminerhaspresentedSunCalseparatelyanddidnotattempttoallocatethetotalSunCal
writedownintoitsPTGandCommercialcomponents.Further,giventhatSunCalwascomprisedofas
manyas25properties(dependingonthedate),theExaminerdeterminedthatitwasnotaprudentuseof
resourcestoinvestigatethevaluationofeachSunCalposition.
228

impactonthevalueoftheCREportfolio.793Thisreportsexecutivesummarystatedin
fullasfollows:
The capital markets meltdown continued into the first quarter.

CMBS spreads have widened to alltime highs and investors have
beenstayingonthesidelines.
CMBS delinquencies are still at historic lows, but real estate is

usuallyalaggingindicator.
Many of our bank loans and PTG positions are directly related to
theresidentialhousingsector,whichisextremelytroubled.
In general, the collateral performance of our whole loan positions

has not been an issue, but the spread widening at all the debt
trancheshaveledtolowervalues.
Theinabilitytohedgeourfloatingratebookandthemezzclasses
ofourfixedrateloanshascontinuedtoresultinlosses.
The mark downs effected in January are the best estimates by the
businessandproductcontrolatthistime.
Aspartofitsongoingmethodology,theGlobalRealEstateGroup
(GREG)performedavaluationreviewoftheirentireportfolio.The
review took into consideration the continuing widening of credit
spreads,continuedsluggishnessintheresidentialmarket,andlack
ofliquidityinthemarketplace.
The Real Estate Product Control group has reviewed the mark
adjustmentsandagreeswiththeseadjustments.
The review resulted in a total markdown of $665 mn (approx.

$505mnintheUS,and$160mninEurope.
ForCMBSpositionsandloansoriginatedwiththeintentionthattheywouldbe
transformed into CMBS, the January 2008 report further stated that [w]ritedowns
793Lehman,GlobalRealEstateProductControl,GlobalRealEstateMarkdownsPresentation(Jan.2008),
atpp.12[LBEXWGM771226].
229

weretriggeredbyspreadwideningandlackofliquidity.794Forbothfloatingrateand
fixedrate loans, the [o]riginal exit plan was through syndication to institutional
investorsandthe[s]yndicationmarketissufferingfromlackofliquidityinpartdue
to marketwide inability to create liquidity through securitization of loans for sale as
CMBS positions.795 The value of PTG investments, which were primarily related to
land or condominium development/conversion, were affected by the softness of the
residential market thereby extending the absorption period and reducing sales
prices.796 With respect to Bridge Equity, the report explains that the [w]idening of
creditspreadseatsintotheequityyield,makingsyndicationatpardifficult.797
In February 2008, the Product Control Group observed that the [f]loating rate
securitization market is inactive; no deal in the market since Dec07.798 As a result,
794Id.atp.4.ThespreaddatareferencedinthisJanuary2008reportisCMBSspreaddatacontainedin
publicationssuchasCommercialMortgageAlert.Aswithspreadsproducedforothertypesofassets,the
CMBSspreadstypicallyshowthedifferencebetweentheCMBSyield(orreturnonaCMBSinvestment
divided by each month of ownership) and the yield of some benchmark asset (which is typically U.S.
treasuries)assumingthesamematuritydateforeach.Spreadsareanindicatorofanassetsrisk,asthey
showthepremium(ordiscount)aninvestorrequiresaboveandbeyondtheriskfreebenchmarkasset.
To form CMBS bonds, commercial loans are pooled and carved up into different risk baskets, or
tranches.TheCMBSspreadtrackstheyielddifferenceforinvestmentsineachtranche.Thelowerend
of the CMBS spread range features tranches containing the pooled loans with the highest risk (i.e.,
subprime loans) and the higher end of the spread range features tranches with the best credit risk or
lowestrisk(i.e.,conventionalloanstoborrowerswithgoodcredit).Awidercreditspreadindicatesthat
thelowerratedportionsofthepooledloanswillresultinloweryields,andasaresult,themarketplace
imposesahigherdiscounttothelowerratedtrancheinanyattemptedsale.Inotherwords,awidecredit
spreadindicatesthatinvestorswilleitherdemandahigherrateofreturnorareductioninpurchaseprice.
795Id.atpp.68.
796Id.atp.9.
797Id.atp.5.
798Lehman, Valuation & Control Report Fixed Income Division (Feb. 2008), at p. 27 [LBEXWGM
002238];ExaminersInterviewofAbebualA.Kebede,Oct.6,2009;FrankS.Aldridge,E&YWalkthrough
230

Lehmans ability to verify the prices for floating rate loans had become extremely
challenging.799 As the market for new issuances of CMBS deteriorated and then
eventually shut down (a trend documented in contemporaneous industry
publications),800 Lehman lost the ability to execute its traditional exit strategy for a
substantialpartofitsCommercialBook.Furthermore,Lehmanrecognizedthatthelack
ofsecuritizationsmadepricetestingparticularlydifficult.801
TemplateforConduit,LargeLoan,andCMBXPriceVerificationProcess(Nov.30,2008),atp.9[EYLE
LBHIMCGAMX08063735] (citing to E&Y Workpaper B32.4); E&Y Workpaper, B32.4 First Quarter
Management Valuation & Control Report No. 137 (Nov. 30, 2008) [EYLELBHIMCGAMX08063053]
(containing Lehmans Feb. 2008 Pricing Report with E&Ys note that it deems management review of
pricingreasonable).
799Lehman, Valuation & Control Report Fixed Income Division (Feb. 2008), at p. 27 [LBEXWGM
002260].
800Prudential Real Estate Investors, U.S. Quarterly, Oct. 2007, at p. 1, available at
http://www.irei.com/web/do/pub/research/view(Thecreditmarkettroublesthatbeganwiththecollapse
ofthesubprimemortgagemarketinFebruarycaughtupwithcommercialrealestateinthethirdquarter,
upsettingthedebtmarketsandslowingtransactionactivity.)ThequarterlyissuanceofU.S.CMBSfell
from approximate aggregate amounts of $75.83 billion in secondquarter2007, to $59.94 billion in third
quarter 2007, $33.27 billion in fourth quarter 2007, $5.90 billion in first quarter 2008, $6.24 billion in
secondquarter2008,andfinallytozerothroughouttheremainderofthe2008fiscalyear.SeeCommercial
Mortgage Alert, Summary of CMBS Issuance, Sept. 30, 2009, available at http://www.
cmalert.com/ranks.php;CommercialMortgageAlert,SummaryofCMBSIssuance,June30,2009,available
at http://www.cmalert.com/ranks.php; Commercial Mortgage Alert, Summary of CMBS Issuance, Mar.
31,2009,availableathttp://www.cmalert.com/ranks.php;CommercialMortgageAlert,SummaryofCMBS
andRealEstateCDOIssuance,Dec.31,2008,availableathttp://www.cmalert.com/ranks.php.
801TheFebruary2008Valuation&ControlReportalsostates,withrespecttotheCommercialBook,that
[s]preadspublishedinthirdpartypublicationsarestale.Lehman,Valuation&ControlReportFixed
IncomeDivision(Feb.2008),atp.27[LBEXWGM002260].Thismeantthatthereportedspreadsdidnot
reflecttherapiddeteriorationinthemarketandwereofquestionablevalueforcalculatingthediscount
rateusedtovalueCommercialpositions.CMBSyieldsobtaineddirectlyfromBloomberg.comshowthat
CMBSAAAJunioryieldsincreasedfrom6.8%onNovember30,2007to9.6%onFebruary29,2008.Over
thesameperiod,CMBSAAAMezzyieldsincreasedfrom6.3%to8.0%,CMBSAAyieldsincreasedfrom
7.2%to10.6%,CMBSAyieldsincreasedfrom8.3%to12.6%andCMBSBBByieldsincreasedfrom11.1%
to17.1%.Themovementinyieldsduringthefourthquarter2007andfirstquarter2008causedLehman
tobeconcernedthatthelagtimeforreportingmarketdatainthirdpartypublicationswouldundermine
Lehmansabilitytopricetestthemarks.ExaminersInterviewofAbebualA.Kebede,Oct.6,2009,atpp.
23,78.ThelackofsalesdatainthemarketplacealsomadeitdifficultforLehmantodeterminethefair
marketvalueofitsCREassets.Id.Tocompensateforthelackofsuchdata,theFebruary2008Valuation
231

Lehman noted the effects of the perfect storm on its CRE business in a
presentationtotheBoardofDirectorsonAugust6,2008(appearinginearlieriterations
throughout the summer),802 which detailed an [u]nprecedented [credit] spread
wideningacrossthecapitalstructure[that][d]ramaticallyreducedCMBSvolumessince
securitizationmarketsareshut,causinga[d]ichotomybetweenEquitybuyersfocused
on fundamentals and Credit buyers impacted by spread contagion.803 The spread
widening caused Lehman to hold [CRE] positions originally originated for
securitization/syndication, meaning that assets that had been liquid were now
illiquid.804
(2) OutsideReviewofLehmansCREValuationProcess
InreviewingthereasonablenessofLehmansvaluationofitsCREportfolio,the
Examiner has taken into consideration the separate reviews of Lehmans valuation
processthatwereundertakenbytheSECandErnst&Youngin2008.
&ControlReportstatedthat[p]roductcontrolishavingcontinuousdiscussionswithFrontOfficegoing
throughdealsinmoredetailandtryingtoobtainmarketcolorusingrecentsyndications,bids,offersand
any other market information. Lehman, Valuation & Control Report Fixed Income Division (Feb.
2008),atp.27[LBEXWGM002260].
802Lehman, GREG 2009 Strategy Executive Update Draft Presentation [Draft] (June 20, 2008), at p. 1
[LBHI_SEC07940_124424]
803Lehman,GlobalCommercialRealEstatePresentation(Aug.6,2008),atp.4[LBHI_SEC07940_302580]
(emphasis in original). CMBS AAA Junior spreads widened from 4.15% on May 30, 2008, to 6.95% on
August29,2008.Overthesameperiod,CMBSAAAMezzspreadswidenedfrom2.95%to4.60%,CMBS
AAspreadswidenedfrom5.65%to9.20%,CMBSAspreadswidenedfrom7.15%to13.70%andCMBS
BBBspreadswidenedfrom14.65%to21.70%.TheExaminersfinancialadvisorcompiledthisdatafrom
Bloomberg.
804Lehman,GlobalCommercialRealEstatePresentation(Aug.6,2008),atp.4[LBHI_SEC07940_302580].
232

(a) SEC
InFebruary2008theSECcommencedaspecialprojecttoreviewtheCSEsprice
verificationprocessesfortheirCREportfolios.805Lehmancooperatedwiththisprocess,
as did the four other CSE firms.806 The SEC did not produce a formal report for this
project and declined to provide the Examiner any formal conclusions produced in
connection with this project.807 However, the SEC provided the Examiner with its
informalanalysisandcommentsduringaninterview.808
TheSECsinspectionincludedareviewofthematerialsLehmanusedinitsprice
verificationprocess,andwasinitiallyfocusedonthemarksreportedasofJanuary31,
2008, and then as of February 29, 2008.809 The SEC began meeting with Lehman in
805MemorandumfromRaymondDoherty,SEC,etal.,toErikSirri,SEC,etal.,re:ScopeMemorandumfor
the Consolidated Supervised Entity (CSE) Commercial Real Estate (CRE) Price Verification
Inspections (Feb. 27, 2008), at p. 1 [LBEXWGM 001752]. An email widely circulated within Lehman
statedthat[t]heintentoftheinspectionsprogram...isfortheSECtoconductmeaningfulandfocused
inspections of the five CSE firms. Email from Laura Vecchio, Lehman, to Christopher M. OMeara,
Lehman,etal.(Jan.22,2008)[LBHI_SEC07940_068584].TheSECslettertoLehmandescribingthescope
ofthereviewstatedthatitwould:
[F]ocuson(1)gainingageneralunderstandingoftheCREproductsheldininventoryby[Lehman],
including the related hedging strategies, (2) reviewing the price verification policies and procedures to
determine if appropriate valuation controls have been designed, and (3) testing the price verification
process to ensure that the controls are operating as intended. Ultimately, the staff will compare and
contrastthevariousCRErelatedpriceverificationpoliciesandproceduresacrossthefiveCSEs.
MemorandumfromRaymondDoherty,SEC,etal.,toErikSirri,SEC,etal.,re:ScopeMemorandum
for the Consolidated Supervised Entity (CSE) Commercial Real Estate (CRE) Price Verification
Inspections(Feb.27,2008),atp.1[LBEXWGM001752]
806ExaminersInterviewofSECstaff,Aug.24,2009,atpp.34,1314.
807Id.atp.14(notingthattheSECneverreleaseditsfindingsformally).TheSECexpresseditsconcerns
informallythroughoutitsinspectionbutnoformalpresentationwasmade.
808Id.atpassim.
809Id.;LetterfromRaymondDoherty,SEC,toLauraVecchio,Lehman,re:CommercialRealEstatePrice
Verification Inspection Initial Document Request (Feb. 27, 2008), at p. 1 [LBEXWGM 001754]; email
from Thomas ODougherty, SEC, to Abebual A. Kebede, Lehman, et al. (Apr. 11, 2008)
233

February 2008 and continued these meetings throughout the spring and summer.810
Duringthefirstmeetings,theSECconductedageneralreviewoftheCREbusiness,and
the related audit and product control functions.811 Lehman addressed various topics,
including an overview of the CMBS business,812 an overview of the real estate risk
review process,813 real estate product control process,814 and the fixed income product
control process. As the inspection continued, the SEC focused on Lehmans price
verification procedures,815 price verification models816 and the valuation of particular
positions.817
[LBHI_SEC07940_2229003].TheSECheldaseriesofmeetingstoreviewinformationandaskquestions,
and the SEC typically requested materials in advance of and subsequent to a meeting. Letter from
Raymond Doherty, SEC, to Laura Vecchio, Lehman, re: Commercial Real Estate Price Verification
InspectionInitialDocumentRequest(Feb.27,2008),atpp.12[LBEXWGM001754](indicatingSECs
intenttoschedulemeetingsforaninternalauditworkpaperreview,towalkthroughthepriceverification
packageandtowalkthroughtheQuestGFSreconciliation);emailfromLauraM.Vecchio,Lehman,to
AbebualA.Kebede,Lehman,etal.(Feb.29,2008)[LBHI_SEC07940_5494331].
810In2008,theSECmetwithLehmanonFebruary78,March5,March31,May2122,June20,July3and
July16.
811Lehman, Feb. 8,2008Meeting AgendaforSECCSEInspections of Commercial Mortgage Valuations
(Jan. 29, 2008) [LBHI_SEC07940_113571], attached to email from Laura Vecchio, Lehman, to Kenneth
Cohen,Lehman,etal.(Jan.29,2008)[LBHI_SEC07940_113570].
812Lehman,AnOverviewoftheCMBSBusinessPresentationtotheSEC(Feb.8,2008),atpp.122[LBEX
WGM00057495].
813Lehman, Holistic Trading Book Migration Presentation to the SEC (Feb. 7, 2008), at pp. 132 [LBEX
DOCID3176398](addressingriskallowanceandmodelassumptions),attachedtoemailfromLauraM.
Vecchio,Lehman,toErinCallan,Lehman,etal.(Feb.8,2008)[LBEXDOCID3186259].
[Draft](Feb.2008),atpp.123[LBEXWGM91601537].
815Letter from Raymond Doherty, SEC, to Laura Vecchio, Lehman, re: Commercial Real Estate Price
Verification Inspection Initial Document Request (Feb. 27, 2008), at p. 1 [LBEXWGM 001754]; email
from Laura M. Vecchio, Lehman, to Jonathan S. Cohen, Lehman, et al. (Feb. 13, 2008)
[LBHI_SEC07940_972136] (noting that SEC has made its first followup request, asking for GREG price
verificationpoliciesandprocedures).
816EmailfromP.C.Venkatesh,SEC,toMicheleBourdeau,Lehman,etal.(Mar.19,2008)[LBEXDOCID
271655]; Letter from Raymond Doherty, SEC, to Laura Vecchio, Lehman, re: Commercial Real Estate
234

The SEC asked Lehman to provide detailed information regarding the price
verification process,includingdatarelatingtoLehmansuse ofathirdparty,TriMont
RealEstateAdvisors(TriMont),thethirdpartyservicerforPTGpositions.818TheSEC
soughtthisinformationinordertosampleCREpositionsfromallportionsofLehmans
CRE book.819 In particular, during May and June 2008 the SEC sought supporting
documentation confirming the status of $5 billion in sales of CRE positions.820 In late
Price Verification Inspection Initial Document Request (Feb. 27, 2008), at p. 1 [LBEXWGM 001754].
BaseduponthemodelinventoryLehmanprovidedit,theSECselectedasampleofmodelsdesignedto
get a broad crosssectioncore models/frameworks likely to be heavily used; models likely to have
somecomplexity,potentialsensitivitytomodelingassumptions,andsoon.
817Email from Laura M. Vecchio, Lehman, to Raymond Doherty, SEC, et al. (Feb. 21, 2008)
[LBHI_SEC07940_977936] (forwarding detailed inventory listing as of January 31, 2008 for CMBS, PTG,
andrelatedderivatives).
818Email from Thomas ODougherty, SEC, to Abebual A. Kebede, Lehman, et al. (Mar. 31, 2008)
[LBHI_SEC07940_2872557].TheSECrequestedalistofsecondquartersalesandcirclesfromwhichit
wouldselectasampleforwhichLehmanwouldbeaskedtosupplysupportingdocumentation.Email
from Thomas ODougherty, SEC, to Abebual A. Kebede, Lehman, et al. (May 27, 2008)
[LBHI_SEC07940_2906636] (requesting additional documentation based on a spreadsheet of post first
quarter sales and circles that Laura [Vecchio] provided to the SEC in the middle of April); email from
Thomas ODougherty, SEC, to Abebual A. Kebede, Lehman, et al. (June 18, 2008)
[LBHI_SEC07940_294973435] (same). Lehman provided the SEC with a document summarizing its
secondquarter2008totalselldownsasproofthatLehmanhadminimallossesonsalesandsupporting
the fact that Lehman sold assets at prices that equaled Lehmans marks. Lehman, Total Selldown
SummaryforQ208(June18,2008)[LBHI_SEC07940_1141406],attachedtoemailfromJeffreyGoodman,
Lehman,toPaulA.Hughson,Lehman,etal.(June18,2008)[LBHI_SEC07940_1141405].InaJune18,2008
emailforwarding the selldown summary to the SEC, Jeffrey Goodman, Senior Risk Manager of Fixed
IncomeRiskManagement,statedthat[w]ewouldsaythateverythingwesoldwasatthemarkshence
nogain/loss.EmailfromJeffreyGoodman,Lehman,toPaulA.Hughson,Lehman,etal.(June18,2008)
[LBHI_SEC07940_1141405]. The SEC apparently discussed the supporting documentation, which
includedsecuritiestradeconfirmations,commitmentdocumentation,andbidsforselectsecondquarter
sales, at a June 20, 2008 meeting with Kebede. Email from Thomas ODougherty, SEC, to Abebual A.
Kebede, Lehman, et al. (June 16, 2008) [LBHI_SEC07940_2946054]; email from Thomas ODougherty,
SEC,toAbebualA.Kebede,Lehman,etal.(May27,2008)[LBHI_SEC07940_2946054].
819Email from Thomas ODougherty, SEC, to Abebual A. Kebede, Lehman, et al. (May 14, 2008)
[LBHI_SEC07940_2889284].
820Id.
235

June,theSECrequestedtheArchstonepriceflexagreement,materialsrelatedtocertain
February2008marks,andfurthersupportforsecondquartersales.821
The SECs requests for material in July included questions about Lehmans
InternalRateofReturn(IRR)modelsandinformationoncreditspreads.822Followup
emailscontinueduntilearlyAugust.823TheSECwasunabletocompleteitsinspection
ofLehmanspricevaluationcontrolsbeforeLBHIsbankruptcyfiling.TheSECdidnot
provide Lehman with any formal feedback from the project or issue any formal
conclusionsrelatedtoLehman.824
The SEC did, however, identify strengths and weaknesses in Lehmans price
verificationproceduresfromtimetotimeduringtheinspection.TheSECbelievedthat
Lehmans price verification weaknesses were more pronounced than the other CSEs
because of the size of Lehmans balance sheet and the nature of its CRE business.825
Specifically,theSECrecognizedthatLehmansproductcontrolstaffwastoosmalltobe
821Email from Abebual A. Kebede, Lehman, to Thomas ODougherty, SEC, et al. (June 20, 2008)
[LBHI_SEC07940_7545309].
822Email from Thomas ODougherty, SEC, to Abebual A. Kebede, Lehman, et al. (July 7, 2008) [LBEX
DOCID697796](IreceivedtheIRRcalculationsandtheSunCalMay31stmarksfromLaura[Vecchio]on
Thursday[July3,2008].);emailfromLauraM.Vecchio,Lehman,toThomasODougherty,SEC,etal.
(July 21, 2008) [LBEXWGM 011921] (providing a response to SECs question regarding LehmanLive
spreads).
823Email from Laura M. Vecchio, Lehman, to Thomas ODougherty, SEC, et al. (Aug. 1, 2008) [LBEX
WGM011934].
824ExaminersInterviewofSECstaff,Aug.24,2009,atp.14(notingthattheSECwasunabletocomplete
CSE inspection of Lehmans price valuation controls or give Lehman formal feedback before Lehman
collapsed).
825Id.atpp.1314.
236

an effective independent check on the business desks valuations given the size and
numberofassetsintheCREportfolio.826
(b) Ernst&Young
Although E&Y audited Lehmans valuation of the CRE portfolio as part of the
2007audit,827E&Ysannual2008auditofLehmansvaluationoftheCREportfoliowas
only in its beginning stages when LBHI filed for bankruptcy.828 While E&Y had
performed quarterly reviews throughout 2008, these reviews consisted of inquiry,
observation, and analytical review and did not include substantive testing as to the
accuracy or reasonableness of Lehmans marks.829 When LBHI filed for bankruptcy,
826Id.
827E&Ys 2007 yearend audit included a comprehensive memo on CRE price testing, a memorandum
specificallyaboutPTGpositions,aspreadsheetanalyzingparticularvariancesbetweenthemarksbythe
businessdeskandvaluationcontrol,andareviewof25ofTriMontscollateralvaluations.SeeWyattde
Silva, E&Y, Memorandum to Files: Commercial Real Estate Testing Approach (Jan. 25, 2008) [EYLE
LBHIMCGAMX07 067631] (comprehensive memo); Memorandum from Nicholas McClay, E&Y, to
Files, re: U.S. PTG Analytics (Feb. 7, 2008) [EYLELBHIMCGAMX07 070778] (memorandum about
PTGpositions);E&Y,PTGYearEndSubstantiveAnalysis:ProductControlPriceVerificationVariances
(Nov.11,2007)[EYLELBHIMCGAMX0707451774)(spreadsheetanalyzingvariances);Memorandum
from Robert Martinek, E&Y, to E&Y Audit Team for Lehman Brothers, et al., re: Lehman Brothers
CommercialRealEstatePortfolio(Dec.17,2006)[EYLELBHIKEYPERS0675302](reviewof25TriMont
valuations).
828ExaminersInterviewofErnst&Young,Nov.11,2009,atpp.4,1314.Theauditprocesswas:(1)a
staff person or senior manager conducts detailed audit work; (2) the results from the audit work are
reviewed by an audit team, which formulates an initial opinion and (3) the audit work is reviewed an
additionaltwotofourtimes(theexactnumberofreviewsdependsontheriskoftheareabeingtested).
Generally,foraudittestingoftheCREportfolio,E&Ywoulddesigntesting,picktwomonthsofproduct
controlworkpaperstoreviewandconfirmthatproductcontrolwasperformingtheworkasdescribedin
thewalkthrough.E&Ywouldalsodesignatetwomonthstoretestselectpositions.Id.
829Id.atpp.34.E&Ys2008quarterlyreviewsofproductcontrolandthevaluationofLehmansCRE
portfoliofocusedonwhethertheprocess,asawhole,wasfunctioning.Id.atp.4.E&Yreviewedprice
testing files, examined variances between business desk prices and product controls prices, and
confirmed that variances deemed to be significant were resolved in accordance with Lehmans internal
procedures.Id.E&Ydidnotresolvethesevariances,butmerelyassureditselfthatdiscussionsregarding
237

some underlying testing of the CRE portfolio had begun, but no review of that work
had been performed and no initial opinions had been reached.830 Regarding CRE
specifically,E&Yhadnotyetselectedallofthepositionsitplannedtotest.831
E&Y performed walkthrough analyses as part of the annual audit process to
understand how Lehmans Product Control Group performed its independent price
verification functions.832 The purpose of the walkthroughs was to document the
significant classes of transactions, and [v]erify that [E&Y had] identified the
appropriate what could go wrongs (WCGWs) that have the potential to materially
affectrelevantfinancialstatementassertions.833Inaddition,E&Yidentifiedthedesign
and implementation of controls that Lehman had in place to internally regulate its
priceverificationprocess.834
AnE&YsWalkthroughTemplatememorandumreviewingthepriceverification
processforlargeloansandCMBSstatedthatallcomponentsoftheU.S.CREportfolio
metE&YscriteriabasedonpriceverificationdataselectedfromthemonthofFebruary
significantvarianceswereoccurringandthatproductcontrolwasultimatelycomfortablewiththefinal
mark.Id.
830ExaminersInterviewofErnst&Young,Nov.11,2009,atpp.1314.
831Id.
832Id.atp.3.
833E&Y,WalkthroughTemplate(Nov.30,2008),atpp.2,13[EYLELBHIMCGAMX08063735].The
Walkthrough Template memoranda contain three sections: the walkthrough description of the
valuation control process, an assessment of whether valuation control is segregated from other
incompatibleduties,suchasmanagement,andaconclusion.
834Id.
238

2008.835OtherdocumentsproducedbyE&Ypersonneloverthecourseof2008indicate
that E&Y did not find any material flaws with Lehmans price verification process.836
E&YpersonneltoldtheExaminerthattheconclusionsstatedinthesedocumentswere
preliminaryinnatureandtheproductofworkperformedbylowerlevelauditors,and
thereforewerenotreflectiveoftheopinionofE&Y.837
Given the prominence of Archstone and SunCal positions in 2008, E&Y had
already determined that it would be substantively testing both positions as part of its
2008 yearendaudit. E&Y separatelydocumentedits walkthroughs of thesepositions
aspartofitspreliminaryplanningforthe2008yearendaudittesting.838
An E&Y memorandum dated July 9, 2008 explained E&Ys quarterly review
valuation procedures for Archstone in the second quarter 2008.839 E&Y held multiple
835Id.atp.5.
836E&Y, Lehman Brothers Holdings Inc. Summary Review Memorandum, Consolidated Financial
StatementsQuarterendedMay31,2008(Aug.8,2008),atp.17[EYSECLBHIWP2Q08000117](Based
onourreviewofCompanysunauditedinterimconsolidatedfinancialstatementsasofandforthethree
andsixmonthperiodsendedMay31,2008,nothingcametoourattentionthatindicatesthatamaterial
modification should be made to the unaudited interim financial statements in order for them to be in
conformity with U.S. generally accepted accounting principles. Furthermore, we are not aware of any
materialmodificationthatinourjudgmentshouldbemadetothedisclosuresaboutchangesininternal
controloverfinancialreportinginorderformanagementcertificationtobeaccurateandtocomplywith
the requirements of Section 302 of the SarbanesOxley Act of 2002.); E&Y Workpaper, GREG Price
VerificationSummary,Q2J1J2J3PTGComlPricingSummary.xls,atp.1[EYSECLBHIMCGAMX
08138328](Basedontheresultsofourreview,wenotedthatsignificantpositionsappeartobevalued
withinProductControlsthresholdorwerereasonablycontemplatedandexplained.);E&YWorkpaper,
GlobalRealEstate Q208Sales Activity, Q2.J1 GREG Sales 2nd Qtr 08 Lead.xls,at p. 1 [EYSECLBHI
MCGAMX08138412](AppearsReasonable.)
837ExaminersInterviewofErnst&Young,Nov.11,2009,atp.6.
838Id.
839Memorandum from Nicholas McClay, E&Y, to Files, re: Quarterly Review Valuation Procedures for
Archstone&SunCalRealEstateInvestments(July9,2008),atp.12[EYSECLBHIDFMFIN000048].
239

meetingswithJonathanCohenandKebedetounderstandtheportfoliosofpositions,
the underlying variables and value drivers of each position, and the summary of the
methodology used to price each position in the portfolio.840 The memorandum
explains that E&Y obtained and reviewed the Archstone valuation model for
reasonableness and noted detailed data inputs and assumptions, specific calculation
scenarios,andpricesensitivitystresstestsofIRR,growthrates,caprates,development
value and timing, loan terms, and other assumptions designed to provide reasonable
ranges for position values.841 The memorandum states that, based on E&Ys
understanding of the Archstone position, Lehmans valuation assumptions and the
resultsofdiscussionswithLehmanmanagement,theprocessbywhichtheArchstone
positionsarevaluedaswellastherelatedinputs,assumptions,andcalculatedvalues
appear reasonable for the purpose of assessing reasonableness for our quarterly
review.842
Jerry Gruner, a senior manager on the E&Y Lehman audit team, told the
ExaminerthatE&YhadreceivedLehmansArchstonemodelbuthadnotreviewedthe
modeloritsinputsaspartofitsquarterlyreview.843Grunerexplainedthatheandother
E&YauditorshadscannedthroughtheArchstonemodeltoconfirmthatitlookedon
itssurfacetobeacomplexmodel....Therewerealotoftabsthatweflippedthrough
840Id.atp.1.
841Id.atp.2.
842Id.
240

as part of a high level review.844 According to Gruner, E&Y intended to review the
modelandmarksingreaterdetailduringthe2008audit,whichneveroccurred.845
William Schlich, E&Ys lead audit partner, told the Examiner that E&Y was
aware that Lehman had not sold any Archstone bridge equity and that Lehman was
generally having difficulties selling Archstone bridge equity.846 Both Schlich and
Gruner stated that they never heard any concerns from product controllers that the
unsoldbridgeequitywasimproperlymarked.847
c) SeniorManagementsInvolvementinValuation
During the second and third quarters of 2008, Lehmans senior management
intensifieditsfocusonvaluationoftheGREGportfolio.848Therehadbeenhighprofile
publiccriticismthatLehmanhadnotproperlymarkeddownitsassetvaluesthatyear.849
844Id.
845Id.
846Id.atp.4.
847Id.atp.15.
848ExaminersInterviewofClementBernard,Oct.23,2009,atp.13;ExaminersInterviewofAbebualA.
Kebede,Sept.29,2009,atp.8;ExaminersInterviewofEliRabin,Oct.21,2009,atpp.1112;Examiners
InterviewofRebeccaPlatt,Nov.2,2009,atp.10.
849See Andrew Bary, ApartmentHouse Blues, Barrons, Jan. 21, 2008, available at http://online.
barrons.com/article/SB120070919702802265.html#articleTabs_panel_article%3D1 (noting that based on

currentREITprices,thevalueoftheArchstoneequitycouldbezero.);seealsoDavidEinhorn,Greenlight
Capital, Presentation to the Value Investing Congress, A Few Thoughts About Risk (Nov. 29, 2007)
[LBEX_DOCID 2490444]; Transcript of Speech by David Einhorn, Presentation to Grants Spring
Investment Conference, Private Profits and Socialized Risk (Apr. 8, 2008), at p. 9, available at
http://www.foolingsomepeople.com/main/mroom/Grants%20Conference%2004082008.pdf.
241

Ontheotherhand,certainseniorLehmanmanagerswereconcernedthatGREGmight
havebeenoverlyaggressiveintakingwritedowns.850
Beginning in 2008, Mark A. Walsh, Head of GREG, was required to submit
proposedmarkdownstoAndrewJ.Morton,GlobalHeadofCapitalMarketsFIDor
Alex Kirk, CoCOO for FID and later, Head of Global Principal Businesses, for
approval.851ItwasWalshsunderstandingthatMortonandKirkshowedtheproposed
marks to another person, who he assumed to be Joseph M. Gregory, Lehmans
President,priortoapprovingthem.852
Whilethefirmsseniormanagementhadlegitimatereasonstobeconcernedwith
the valuation process, the potential for undue management involvement in valuation
raisestwoseriousissues.First,thatinvolvementmighthaveresultedinunreasonable
valuationsthatmustbetakenintoaccountwhendeterminingthesolvencyofLBHIand
the LBHI Affiliates in the months prior to their bankruptcy cases. Second, if senior
management intentionally caused Lehman to report materially inaccurate valuations,
850Examiners Interview of Alex Kirk, Jan. 12, 2010, at p. 14. It might seem counterintuitive that a
businessunitwhoseperformancewasatleastpartiallytiedtothevaluationofitsinvestmentswouldbe
incented to mark down those assets more than necessary. But Kenneth Cohen told the Examiner that
GREGs senior managershad alreadybeen told that they would receive no bonusesin 2008 because of
significant GREG losses already incurred; they had no incentive, therefore, to artificially prop up the
valuesofGREGassetsin2008.ExaminersInterviewofKennethCohen,Oct.20,2009,atp.11.Kirkand
otherswereconcernedthatGREGmightbeincentedtomarkdownassetsmorethanindicatedin2008to
setthestagetoshowgreaterprofitsin2009whenbonusespresumablywouldbereinstated.Id.,atp.14.
852Id.Walshhadnounderstandingastowhetherthereviewwasactuallyforapprovalofthemarksor
simplytogivemanagementnotice.Id.Therewasnooccasionwhenhisproposedmarkswerechanged
byMorton,Kirk,Gregoryoranyoneelse.Id.
242

such an action might constitute a breach of the fiduciary duty of care owed by those
officers.853
TheExaminerfindsevidencethatcertainLehmanexecutivesperceivedpressure
fromaboveinthesecondquarterof2008toartificiallylimitwritedowns,butthereisno
evidence that any caps were in fact imposed or that improper marks were knowingly
taken.Inthethirdquarterof2008,thereissimilarevidencethatcertainexecutivesfelt
pressure, and there is also some evidence that the pressure actually resulted in
improper marks. But the evidence is in conflict, and because it relates to the third
quarter it is not possible to conclude that improper marks were actually taken
Lehman,ofcourse,hadceasedoperationsbeforefinalthirdquarterfinancialstatements
were prepared. The Examiner therefore finds insufficient evidence to support the
existence of a colorable claim that Lehmans senior management imposed arbitrary
limitsonwritedownsofassetsduringthatquarter.
(1) SeniorManagementsGeneralRoleWithRespecttoCRE
Valuation
Aswithotherassetclasses,marksforLehmansCREportfolioweredetermined
by its business desks, subject to price testing performed by the Product Control
853See
Appendix 1, Legal Issues, Section II, for a discussion of corporate officers fiduciary duties.
Lehman did not file a quarterly report for the third quarter of 2008 before the commencement of the
bankruptcycases.However,duringitsthirdquarterearningscall,Lehmandidreporttoitsinvestorsand
themarketthat[o]nanetbasis,commercialwritedownsforthequartertotaled$1.6billion.Transcript
ofLehmanBrothersHoldingsInc.ThirdQuarter2008EarningsCall(Sept.10,2008),atp.9.
243

Group.854 Historically,GREGhadfullcontrolof itsmarksandwould simply givethe
headoftheFIDnoticeofthemarks.855However,during2008,theprocesschangedand
requiredWalshtosubmitGREGsproposedmarkstoMortonforapproval.856Atsome
laterpoint,approvalresponsibilityshiftedtoAlexKirk.857
WalshunderstoodthatMortonandKirkshowedGREGmarkstosomeoneelse
before they approved them; Walsh assumed it was Joseph Gregory.858 Walsh was not
clearwhethertheseniorofficersreviewedthemarkstoactuallyapprovethemorsimply
tobeinformedbeforewritedownsweretaken.859Walshstatedthat,inanyevent,there
was no occasion on which a writedown GREG proposed to take was overruled or
modified.860Likewise,WalshtoldtheExaminerthattherewasneveratimewhensenior
854Examiners Interview ofKenneth Cohen, Oct. 20, 2009,at pp. 910; Examiners Interview of Mark A.
Walsh,Oct.21,2009,atp.13.
856Id.Walshwasunabletospecifytheexactdateonwhichthischangeoccurred;however,Mortonwas
appointedheadofFIDinFebruary2008,soitmusthavebeenafterthisdate.KennethCohen,headof
U.S.OriginationsforGREG,confirmedtheprocessbywhichvaluationswereapproved,notingthatafter
GREG came up with marks, Walsh would provide them to the head of FID and that GREG would be
givenpermissiontotakewritedownsorwriteups.ExaminersInterviewofKennethCohen,Oct.20,
2009,atpp.910.
858Id.
859Id.
860Id. at p. 14. While Walsh was clear that senior management never changed marks he deemed to be
appropriate,hedidnotethatmanagementplayedanactiveroleinresolvingdisputesbetweenLehmans
tradingdesksandtheProductControlGroupastopropervaluations.WalshtoldtheExaminerthatin
late2007and2008itbecamedifficultforhimtoresolvedisagreementsastoapositionsvalue,andWalsh
wasmoreinclinedtokickitupstairsforresolutionbyMcDade,KirkorLowitt.Id.
244

management predetermined the amount of writedowns that would be taken for a
quarterorlimitedtheamountofwritedownsGREGwaspermittedtotake.861
(2) SeniorManagementsInvolvementinValuationintheSecond
Quarterof2008
Duringthesecondquarterof2008,therewasgreaterscrutinyofLehmansU.S.
CRE marks after an Executive Committee meeting in early 2008 regarding CRE
valuationsduetocommunicationproblemsbetweenWalshandMorton.862Gregory
stated that Morton thought that the CRE marks were being written down without
anyoneinforminghim,andGregorysetupthismeetingtodiscusstheneedforclearer
andmoreconsistentcommunication.863
JonathanCohen,aSeniorVicePresidentandHeadoftheGREGProductControl
Group,recalledanincidentinthesecondquarterof2008thatmadehimuncomfortable
with the degree to which senior management was involved in the valuation process.
JonathanCohenproposedtoKennethCohen,HeadofU.S.OriginationsforGREG,that
certainpositionsforwhichKennethCohenwasresponsiblebewrittendown.864These
included one PTG position and two or three Commercial positions. Jonathan Cohen
861Id. Other members of Lehmans senior management confirmed that Lehman did not place limits on
writedownsorpredeterminemarksforGREGassets.ExaminersInterviewofChristopherM.OMeara,
Aug.14,2009,atp.26;ExaminersInterviewofErinM.Callan,Oct.23,2009,atpp.2122.
862Examiners Interview of Abebual A. Kebede, Sept. 29, 2009, at p. 8; Examiners Interview of Joseph
Gregory,Nov.13,2009,atp.9;ExaminersInterviewofJonathanCohen,Jan.11,2010,atp.6.
863ExaminersInterviewofJosephGregory,Nov.13,2009,atp.9.
864ExaminersInterviewofJonathanCohen,Jan.11,2010,atp.7.
245

recalledthatKennethCohenrepliedthatIcanttakeitrightnow.865ItwasJonathan
Cohens impression that Kenneth Cohen did not have the authority to take the write
down.866
Jonathan Cohen explained that he was surprised by Kenneth Cohens reaction
andthatheraisedtheissuewiththeCFOforFID,ClementBernard,whointurnwent
toMorton.867JonathanCohenwasuncomfortablethathewasforcedtogohighupthe
chain to get approval to take the writedown, but approval was eventually given.868
JonathanCohentoldtheExaminerthatintheend,allIcandoispricetestthefront
officeownsthemarkandallIcandoisstarttheconversation.869
A similar incident was related by Anthony Barsanti, the PTG Senior Vice
PresidentresponsibleformarkingthePTGpositions.870Barsantirecountedthatduring
the second quarter valuation process, he met with Kenneth Cohen to inform him of a
listofPTGassetshewantedtowritedown.871Barsantiwantedtotakewritedownson
three positions, but Kenneth Cohen told him that hewas only allowed to write down
positions to a certain dollar value, which would not allow Barsanti to take the three
865Id.
866Id.
867Id.
868Id.
869Id.
870ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atpp.3,11.
871Id., at p. 15. As noted above, PTG refers only to U.S. PTG, and PTG assets refers only to assets
heldormanagedbyU.S.PTG.
246

writedownsidentified.872Thenextday,KennethCohencalledBarsantiandstatedthat
hecouldtakethewritedownsonthethreepositions.873
Kenneth Cohen did not recall the events described by Jonathan Cohen or
BarsantiinhisinterviewwiththeExaminer.874
WhiletheincidentsdescribedbyJonathanCohenandBarsantiestablishthatthey
perceivedpressuretocapwritedowns,thereisnoevidencethatanycapswereactually
imposed; rather, the writedowns Jonathan Cohen and Barsanti determined should
have been taken were actually taken. The Examiner finds insufficient evidence to
support theexistenceofa colorableclaimthatseniormanagement involvementled to
unreasonablevaluationsinthesecondquarterof2008.
(3) SeniorManagementsInvolvementinValuationintheThird
Quarterof2008
Similarly,theExaminerfindsinsufficientevidencetosupporttheexistenceofa
colorableclaimthatLehmanpredeterminedanetlossforGREGinthethirdquarterof
2008.875
TheExaminerwasgiventhreesomewhatdifferentbutnotentirelyconflicting
accountsoftherolethatseniormanagementplayedinthevaluationprocessforthe
872Id.
873Id.
874Examiners Interview of Kenneth Cohen, Oct. 20, 2009, at p. 11; Examiners Interview of Kenneth
Cohen,Jan.21,2010,atpp.45.
875Because of Lehmans bankruptcy, Lehmans third quarter financial statements were never formally
finalized.ThetentativeGREGgrosswritedownforthequarterwas$1.732billionandthegrosswriteup
was$0.147billion,foranetwritedownof$1.585billion.SeeLehman,GlobalRealEstate2008NetMark
Downs(Sept.5,2008)[LBEXAM346991].
247

quarter: (1) Senior managers told the Examiner, without reservation or qualification,
that there was never a predetermined limit on writedowns for any business unit;876
(2)PaulHughson,HeadofCreditDistribution,toldtheExaminerthatseniormanagers
initially attempted to impose a limit on writedowns, but GREG eventually prevailed
and was allowed to take the marks it had determined were appropriate877 and (3)
BarsantiandJonathanCohentoldtheExaminerthatanarbitrarylimitpreventedGREG
fromtakingwritedownstheydeterminedwereappropriate.878
(a) SeniorManagementsAccount
During the pressurefilled third quarter of 2008, senior management became
concernedwithlatebreakingnewsaboutproposedCREwritedowns.879
Christopher M. OMeara, Global Head of Risk Management, was asked by
Herbert H. Bart McDade, III, President and COO, and Ian Lowitt, CFO, during the
weekendofAugust23,2008,tohelpwiththethirdquarterP&Lclose.880Thingswere
chaotic and Lowitt was being pulled away for due diligence on a potential Korea
Development Bank transaction; there was a likelihood of an accelerated close and
876This position is consistent with findings by the SEC, which informed the Examiner that it did not
uncoveranyevidenceduringtheSECs2008reviewofLehmansCREpricetestingprocessthatLehman
priceditspositionstohitpredeterminedbalancesheetorearningstargets.However,itshouldbenoted
that the SEC did not examine Lehmans price testing process for the third quarter of 2008. Examiners
InterviewofSECstaff,Aug.24,2009,atp.14.
878ExaminersInterviewofJonathanCohen,Jan.11,2010,atpp.78.
880ExaminersInterviewofChristopherM.OMeara,Jan.21,2010,atp.2.
248

preliminary earnings call to address the markets concerns.881 As a former CFO,
OMeara had the stature to move the process along and get information to the
appropriatefinancegroupmorequickly.882
OMearatoldtheExaminerthathehadnodirectconversationswithMcDadeor
Lowittaboutwritedownsorhownumberswerecalculated.883Hewassimplytoldby
GerardReilly,LehmansGlobalProductController,thattherewasalreadyanestimate
oftheGREGquarterlywritedown.Herecalledthatthewritedownwasestimatedto
be $1.5 billion, but he was not sure whether this included hedges or not. Reilly told
OMearathatthe$1.5billionfigurewaspresentedtoseniormanagementandhadbeen
discussed between the Walsh team and senior management, including McDade and
others.884
However, on Monday, August 25th, OMeara heard that the third quarter real
estatewritedownmightbelarger.885Subsequenttohearingabouttheadditionalwrite
downs,OMearareceivedafax,theQ3WritedownSummary,preparedbyKenneth
Cohen and forwarded to him by Reilly, showing positionlevel estimated PTG write
downs and including two pages of handwritten notes and calculations providing an
881Id.
882Id.OMearaalsostatedthathewasnotdoinganythinginregardtofinancialreportingandwasnot
involvedinplanningfortheearningscall.Id.
883Id.
884Id.
885Id.atp.3.
249

estimatedtotalwritedownof$1.561billion.886OMearatoldtheExaminerthatheasked
Jonathan Cohen whether the numbers had changed since the presentation to senior
management, but Jonathan Cohen was not able to provide him specific information.
OMearastatedthatJonathanCohentoldhimthatheshouldcontactWalshsteamfor
moreinformationandOMearaexplainedthathewasdisappointedthatCohendidnot
knowmoreaboutthevaluationprocessatthispoint.887
In addition to this conversation with Jonathan Cohen, OMeara stated that he
hadconversationswithKennethCohen,andpossiblyWalsh,abouttheQ3Writedown
Summary.Hewastoldthatnothingsubstantivehadchanged,andthatKennethCohen
had advised that the $1.5 billion figure previously provided was the result of
rounding.888 OMeara noted that there was definitely some confusion there, and
askedthemtogobackandtakeaharderlookattheprojectedwritedown.889OMeara
emphasizedthathedidnthaveaviewonanyparticularnumber.890OMearathought
itwasfairtocharacterizethisaspushbackonthehigherwritedownsGREGwanted
to take, but that he did not have a view on what was the appropriate number.891 He
stated that he just wanted to understand why the number was higher than what had
886See email from Gerard Reilly, Lehman, to Christopher M. OMeara, Lehman, et al. (Aug. 25, 2008)
[LBHI_SEC07940_2278241];Lehman,Q3WritedownSummary[LBHI_SEC07940_2278242].
887ExaminersInterviewofChristopherOMeara,Jan.21,2010,atp.3.
888Id.
889Id.
890Id.
891Id.
250

previouslybeenpresentedtoseniormanagement.Henotedthathisresponsetohigher
writedowns could be characterized as resistance and that he thought the higher
writedownswereoverlyconservativebasedonthefactthatalowerfigurehadalready
beenprovidedbyGREGtoseniormanagement.892
OMeara stated that he thought it was possible that someone may have
interpreted something he said as imposing an inflexible limit on writedowns. He
noted that when presented with the higher writedown number he told Jonathan
Cohen, Kenneth Cohen and possibly others that this has to be 1.5, meaning that if
nothinghadchangedthenumbershouldbesameaswhathadalreadybeenpresented
toseniormanagement.893OMearaemphasizedthathethoughtGREGmanagerswere
being excessively conservative and he was simply pushing back.894 OMeara told the
ExaminerthatGREGmayhavefeltpressuredtochangethenumberasaresultofthis
questioningbutinsistedthathewasmerelytryingtounderstandthereasoningforthe
additional writedown.895 The final writedown number, according to OMeara, was
exactlywhatthebusinessunitsproposed.896
OMearas account is consistent with the recollection of Kirk. Kirk stated that
Lowitt was frustrated in late August 2008 because writedowns, particularly on
892Id.atp.4.
893Id.
894Id.
896Id.
251

Archstone, were a moving target.897 Kirk noted that Kenneth Cohen told the Finance
group late in August that GREG writedowns were going to be $1.5 billion and then
told them the next day that they were actually $1.6 billion.898 Kirk also stated that
Lowitt was concerned that GREG wanted lower valuations to set itself up for better
bonusesin2009.899Ultimately,LowittsentReillytodiscusshisconcernswithmanagers
inGREG.900
The specific position at issue was Archstone, where Hughson thought an
additional $90 to $100 million in writedowns were appropriate.901 Kirk did not think
thatthisamountwasmaterialinthecontextofa$50billionportfolio,butHughsonwas
concerned about the mark given Archstones visibility.902 Kirk instructed Kenneth
CohentodiscusstheissuewithStevenBerkenfeld,HeadoftheLegalComplianceand
Audit Division, Thomas A.Russo,ChiefLegalOfficer,andBart McDadeand believes
that theissuewas finally resolvedtoeveryonessatisfaction.903 Kirkwasclearthat he
neverheardofacapbeingsetontheamountofwritedownstaken.904
897ExaminersInterviewofAlexKirk,Jan.12,2010,atp.14.
898Id.InhisinterviewwiththeExaminer,KirkstatedthattheArchstonewritedownforthethirdquarter
was originally $1.5 billion and then changed to $1.6 billion. It is the Examiners view that this was an
accidentalmisstatementandthatKirkwasactuallyspeakingofthetotalGREGnetlossforthequarter.
The Archstone valuation writedown for the quarter was much smaller, $125 million. See Lehman, Q3
WritedownSummary,atp.36[LBHI_SEC07940_2258765].
899ExaminersInterviewofAlexKirk,Jan.12,2010,atp.14.
900Id.
901Id.
902Id.
903Id.
904Id.
252

LowitttoldtheExaminerthathehadnoroleinapprovingwritedownsandthat
senior managementhadneverimposedarbitrarylimits onthe levelof writedowns.905
Lowitt explained that Lehman had a process of forecasting likely writedowns within
assetclassesbutfrequentlythefinalwritedownsdifferedfromtheforecasts.906Hewas
clear that the forecasts were not static but would change when new information was
obtained.907
(b) PaulHughsonsAccount
HughsontoldtheExaminerthatKirkcommunicatedtoWalsh,whothenrelayed
to Hughson that you got 1.5 of marks, meaning that GREG could not take write
downsbeyond$1.5billioninthethirdquarter.908Hughsonstatedthatsomemembers
ofLehmansseniormanagement,suchasLowitt,hadchallengedGREGtoexplainwhy
thewritedownsshouldbegreaterthan$1.0billion.909Hughsonstatedthathebelieved
905ExaminersInterviewofIanT.Lowitt,Oct.28,2009,atp.39.
906Id.
907Id.
908Examiners Interview of Paul A. Hughson, Oct. 28, 2009, at p. 8. Hughsons description of having
conversations with senior management regarding the contentious third quarter marks is partially
corroboratedbyAbebualA.KebedeintheProductControlGroup.KebedestatedthatHughsontoldhim
thathewasunabletowritedowncertaincommercialrealestateassetsasmuchashewouldlikeduring
thethirdquarterof2008.ExaminersInterviewofAbebualA.Kebede,Sept.29,2009,atp.89.Kebede
couldnotrecallwhichassetswerediscussed,butthatHughsonreferredtoabunchofassets.Id.atp.9.
Kebede stated that Hughsons statement gave him suspicion that there had been an order regarding
acceptablelevelsofwritedownsforthequarter.Id.
253

that the appropriate writedowns were approximately $1.7 billion and that he argued
forwritedownsheandhisteamdeterminedwereappropriate.910
DavidOReilly,aSeniorVicePresidentinRealEstateInvestmentBanking,told
theExaminer that he overheard Hughson tellWalsh:you can tell Alex[]Kirk that if
thatsthewayhewantstomarkit,hecantalktotheSEC.911
Hughsontookprideinthefactthathehadpushedforhigherwritedownsand
thought that the $1.7 billion figure was the appropriate writedown in light of then
current market conditions. Hughson, who was directly involved in discussions with
senior management as to the third quarter writedown, took the fact that the gross
writedown ultimately taken was $1.7 billion as evidence that there was no limit on
writedownsinthethirdquarter.912
(c) OtherAccounts
WhileHughson,whowasresponsiblefordistributionofbridgeequityanddebt
positionsheldinLehmansCommercialBookandwasultimatelycontentwiththelevel
of writedowns taken in the third quarter of 2008, those responsible for marking and
pricetestingLehmansPTGbookwerenot.
910Id.
911ExaminersInterviewofDavidOReilly,Oct.26,2009,atp.2(expletivedeleted).Hughsonconfirmed
thatthisexchangeoccurred.ExaminersInterviewofPaulA.Hughson,Oct.28,2009,atp.8.
254

Historically,LehmanhadusedamethoditreferredtoasCap*105tovaluethe
collateralunderlyingPTGdebtandequitypositions.913Thismethodsimplymultiplied
the capitalization of the development by 105% to determine the collateral value.914
Whilethismethodwasdeemedaconservativeapproachwhenrealestatevalueswere
increasing,Lehmanrecognizedthatinthedownmarketoflate2007and2008itcould
produce overstated collateral values.915 Accordingly, Lehman had worked with its
primary asset manager, TriMont, to implement a new valuation model, known as an
internal rate of return (IRR) model, to value PTG collateral.916 The process was
managed by Anthony Barsanti and Aristides Koutouvides, Asset Managers in
LehmansPTGgroup.917TheIRRmodelwasintroducedonarollingbasisandbythe
thirdquarterof2008asubstantialpartofLehmansPTGbookwasvaluedusinganIRR
model.918TheswitchtotheIRRmodelresultedinlowerestimatesofcollateralvalues
than the old Cap * 105 method, and, as a consequence, indicated that material write
downswereappropriateforasignificantnumberofPTGassets.
913Examiners Interview of Anthony J. Barsanti, Oct. 15, 2009, at pp. 1213; Examiners Interview of
JonathanCohen,Jan.11,2010,atp.4.
915Id.;Lehman,Valuation&ControlReportFixedIncomeDivision(Feb.2008),atp.27[LBEXBARFID
0000058] (Current valuation methodology for land and development projects is based on cap * 105%,
whichwasaconservativeorprudentapproachisanupmarket.Givencurrentmarketconditions,this
approachmaynotbeappropriate.).
917Id.
918Id.
255

AccordingtoBarsanti,duringthethirdquarterof2008,hewantedtotake$700
million in writedowns on PTG positions.919 However, Barsanti stated that Kenneth
Cohen directed that no more than $500 million of writedowns could be taken on the
PTG portfolio during that quarter.920 Kenneth Cohen, during his interview with the
Examiner,didnotrecallanysuchexchange.921
Thesame$500millionlimitonPTGwritedownswasalsorecalledbyJonathan
Cohen,whoremembereditasonepartofa$1.585billionlimitonGREGwritedowns
generally. Jonathan Cohen stated that during a meeting with Kenneth Cohen in
KennethCohensofficeafewdaysbeforetheendofthethirdquarter,KennethCohen
told him that there was a limit of $1.585 billion for GREGs third quarter
loss.922JonathanCohenstatedthatKennethCohenexplainedthatthiswouldresultina
limit of $500 million in writedowns on PTG assets.923 During the meeting, Jonathan
CohenpointedouttoKennethCohenthatcertainwritedownshadnotbeenconsidered
in Kenneth Cohens analysis. These additional writedowns included $28 millionin
Asia, run rate GREG P&L of $20 million, and Coeur Defense and IMD Archstone
919Id.
920Id.
921ExaminersInterviewofKennethCohen,Oct.20,2009,atp.11.TheincidentdescribedbyBarsantiis
somewhat corroborated by Walsh. Barsantis proposed writedown was one part of the late breaking
newsduringthethirdquarterthatWalshdescribed.WalshstatedthatwhenBarsantiinformedhimthat
GREGs initial estimate of $1 billion in writedowns should have been increased by $700 million, this
causedMcDadeandLowitttobecomeupsetaboutgettinginformationsolateinthequarter.Examiners
InterviewofMarkA.Walsh,Oct.21,2009,atp.14.
923Id.
256

writedownsof$19million.924JonathanCohenalsostatedthatduringthismeeting,Jim
Blakemore, a Managing Director in the London office, called and wanted to take an
additional$10to$15millionofwritedownsoncertainassetsandwastoldbyKenneth
Cohenthathecouldnotdoso.925
Additionally, Jonathan Cohen told the Examiner that at one point during this
meeting OMeara joined by phone.According to Jonathan Cohen, the three discussed
additional writedowns and Jonathan Cohen was told that the number is the
number.926
Jonathan Cohen stated that during this meeting he and Kenneth Cohen
performedcalculationsandhetooknotesontheQ3WritedownSummary.927Inthetop
righthand corner of the Q3 Writedown Summary (as sent by Kenneth Cohen), the
document shows a column of figures summed to 1,585, the same number Jonathan
CohenstatedwasthelimitimposedonGREGsthird quarterwritedowns.928Thenet
924Id.
925Id.
926Id.atp.8.
927See Lehman, Q3 Writedown Summary [LBHI_SEC07940_2258765]. During their meeting, Jonathan
Cohen added additional handwritten notations to this document. Examiners Interview of Jonathan
Cohen,Jan.11,2010,atp.7.
928Examiners Interview of Jonathan Cohen, Jan. 11, 2010, at p. 7. The document also shows that the
additionoftwowriteupstothe1,585figure,oneof15relatedtoEuropeandanotherof9attributed
to Santa Monica, brought the total net writedown on the document to $1.561 billion. Lehman, Q3
WritedownSummary,atp.23[LBHI_SEC07940_2258765].
257

lossactuallydeterminedbyGREGforthequarterwas$1.585billion.929Inaddition,the
bottom of the first page of the document also shows 500 as the number assigned to
PTG for third quarter writedowns, consistent with the $500 million limit on write
downsthatbothJonathanCohenandBarsantidescribedonPTGassets.Thenetwrite
downtakenonPTGassetsforthethirdquarterwas$504million.930
The Examiner has found no evidence suggesting that the Q3 Writedown
Summary,whichwascirculatedonAugust25,2008,wasdraftedinbadfaith.Kenneth
Cohen,whodraftedthisdocument,waslikelyunawareatthetimeofthesignificantly
larger than expected writedown of PTG assets suggested by the recent switch to IRR
models.931JonathanCohentoldtheExaminerthathedidnotdiscusstheadditional$200
million PTG writedown he thought was appropriate with anyone more senior than
929Lehman, Global Real Estate 2008 Net Mark Downs, at p. 1 [LBEXAM 346991]. However, as noted
above, Lehman did not finalize its financial statements for the third quarter of 2008 and did not file a
Form10Qpriortothebankruptcy.
930Thecalculationofthisnetwritedownincludesnetwritedownsof$8milliononacategoryLehman
labeledCALand&CondosTroxler,$145milliononCALand&CondosOther,and$350million
onLandandCondos(USexcludingCA).Lehman,GlobalRealEstate2008MarkDowns,atp.1[LBEX
AM346991].ThePTGgrosswritedownforthequarterwas$555million,withawriteupof$51million,
foranetwritedownof$504million.Id.atpp.24.TheExaminersfinancialadvisorhasobservedthata
summary of writedowns in E&Ys workpapers suggests $503 million for PTG positions, but attributes
thisdifferencetorounding.SeeLehman,3QRealEstateGrossandNetMTMCashBondsSpreadsheet
(Aug.29,2008)[EYSECLBHIMCGAMX08045830].
931It should be noted that Kenneth Cohen stated that he heard sometime early in August that some
withinGREGthoughtthat$700millioninPTGwritedownswereappropriate,butthatbytheendofthe
quarter,whentheconversationwithJonathanCohenandOMearaoccurred,hethoughtthatonly$500
millioninwritedownswerebeingsuggested.ExaminersInterviewofKennethCohen,January21,2010,
atp.4.
258

himselfotherthanReilly.932Accordingly,itistheExaminersviewthatthisdocument
representedagoodfaithefforttoestimatewritedownsasofAugust25,2008.
JonathanCohenstated that hehadneverbeforeheardof a predetermined limit
onwritedowns.933However,eventhoughheknewthatsuchalimitwouldmeanthat
there were appropriate writedowns that would not be taken, Jonathan Cohen stated
thathedidnotquestionitwithKennethCohenorOMeara.934Hethoughtthathelikely
just said OK inreturn.935 When asked why he did not raise the issue during this
discussion with Kenneth Cohen and OMeara, Jonathan Cohen explained that when
someone like Chris is telling me that is the number, Im not going to bring up
somethingelse.936
When asked whether he was surprised at the limit he understood to be set,
JonathanCohenstatedthathewasnotbecauseofananalysishehaddoneforReillyin
lateJuly.937HeexplainedthatReillytoldhimthathewastryingtogetasenseofwhat
positionstheyhadtotakeawritedownonandwheretheystillhadoptions.Jonathan
Cohen stated that Reilly asked him to determine how GREG writedowns would be
allocatedunderdifferentscenariosforglobalGREGwritedowns.938Cohensaidthatat
934Id.
935Id.
938Id.
259

thattimeheunderstoodthathewasbeingaskedifwecouldonlytake$Xamountin
writedowns, what would it be?939Jonathan Cohen stated thatthistask prepared him
fortheideaofpredeterminedlevelsofwritedowns.Cohenalsostatedthatduringthe
conversation in which Reilly asked him to do this, he voiced his opinion that they
shouldtakemorewritedowns,butdidnotaskwhythelimitwasbeingsetorwhereit
was coming from.940 Cohen explained that his impression was that the directive was
comingfromaboveReilly.941
The document that Cohen prepared is titled GREG Potential Markdowns
Q308 and sets forthfour different scenarios for total GREG writedownsin the third
quarterof2008and the applicableassetlevelwritedowns under each scenario.942 The
total GREG writedowns under each scenario are $2.194 billion, $1.531 billion, $1.0
billion,and$750million.JonathanCohentoldtheExaminerthatthatthetargetwrite
downnumbersforthelasttwoscenarioswereprovidedbyReilly.943
Jonathan Cohen also stated that the writedown numbers for specific assets on
thisdocumentweremadeupnumbers,ashedidthisanalysisveryquicklyandhadto
939Id.
940Id.
941Id.
942Lehman,GREGPotentialMarkdownsasofJuly23,2008(July2008)[LBEXJC000001].Theadditional
handwritten notes on the document were made by Jonathan Cohen. Examiners Interview of Jonathan
260

meet thescenarios targets.944 For instance, he stated that the writedown number for
Archstone on this document was a completely made upnumber.945 Jonathan Cohen
explainedthattherewasalotofjugglingtogetthenumberstofitthetotalwritedown
scenariosandthatitwashardtogetdowntothesenumbersinthelasttwoscenarios.946
Jonathan Cohen told the Examiner thatit was his opinion at the time that the proper
writedownsinthethirdquarterwouldhavebeensomewherebetween$1.5billionand
$2.2 billion, which are the writedowns reflected by the first two scenarios in this
document.947 He also noted that he personally delivered the document to Reilly and
thatitwasagoodquestionwhetherReillyaskedhimnottoemailit.948
AfterhisdiscussionwithKennethCohenandOMeara,JonathanCohenworked
todeterminehowto meet the$500millionwritedowntargetforPTGassets. Heand
Kebede divided the writedowns into three tiers.949 The first tier was composed
ofwritedowns that Lehmanwould be unable tojustify not taking.950 The second and
thirdtiers were composed of potential writedowns that Jonathan Cohen determined
wereappropriate,butforwhichLehmanwouldbeabletooffersupportforadecision
944Id.
945Id.
946Id.JonathanCohenstatedthatKebedehelpedhimputthedocumenttogetherandtheyhadonlyan
hourortwoinwhichtoproducethedocument.Id.
947Id.;Lehman,GREGPotentialMarkdownsasofJuly23,2008[LBEXJC000001].
949Id.atp.9.
950Id.
261

not to implement.951 The third tier was composed of potential writedowns that
Jonathan Cohen determined they had the strongest case for not taking.952 However,
Jonathan Cohen stated that he felt that all of the writedowns in each of the tiers
shouldhavebeentaken.953ThetotalamountofthePTGwritedownsCohencalculated
foralltierswas$714 million, or $214millionoverthe limithe understood was set for
PTG.954
Ultimately, Jonathan Cohen could not identify any person he believed to be
responsibleforimposingalimitforGREGthirdquarterwritedowns.955Hestatedthat
he did notthink that Kenneth Cohen had the authority to impose such a limit on his
ownandthatitalsocouldnothavebeenWalsh.956HespeculatedthatLowitt,OMeara,
Michael Gelband, Global Head of Capital Markets, or Kirk may have had such
authority.957
Jonathan Cohen and Barsanti were the only witnesses who had direct contact
withLehmanseniormanagementonthesubjectofpossiblewritedowncaps.Butother
witnessesprovidedtheExaminerwithrelevantevidence.Kebedestatedthathefound
itdifficulttoexplainwhywritedownswerenottakenonmanyassetsduringthethird
951Id.
952Id.
953Id.
954See Lehman, untitled spreadsheet, at pp. 25 [LBHI_SEC07940_2258765]; Examiners Interview of

956Id.
957Id.
262

quarterof2008.958Healsonotedthat,contrarytowhathadpreviouslybeencustomary,
he was not involved in the final decision on writedowns in the second and third
quartersof2008.959
RebeccaPlatt,aproductcontrollerresponsibleforPTGdebtpositions,alsotold
theExaminerthatsheheardofacapontotalwritedownsforthequarter,althoughshe
did not hear of this directly from senior managers and could not recall a specific
number.960 She also stated that, in her view, product controllers Jonathan Cohen and
Kebede did not have sufficient authority to control valuations and that in many
instancestheywereoverruledbythebusinessdeskorseniormanagement.961Plattalso
explainedthatpartofherjobwasexplainingtheoutcomeofthepricetestingprocess
that is, why writedowns suggested by Product Controls models were not, in some
cases, taken. She stated that as 2008 progressed, she had increasing difficulty coming
up with justifications for not taking writedowns and that requests for writedowns
were met with increasing resistance from the business desk and/or senior
management.962 When Platt could not create a rationale for why the writedown was
nottaken,shewouldconsultwithKebede.963FortheAugust2008pricingreport,which
set forth the results of the price verification process for the last month in the third
958ExaminersInterviewofAbebualA.Kebede,Oct.6,2009,atp.5.
959Id.
960ExaminersInterviewofRebeccaPlatt,Nov.2,2009,atp.10.
961Id.
962Id.
963Id..
263

quarter,neitherKebedenorPlattcouldcreatecogentrationalestoexplainwhycertain
positionswerenotwrittendown.964KebedesuggestedthatPlattwritePCG[Product
ControlGroup]isindiscussionwithdeskregardingthisvariancewithrespecttothese
positions.965 Platt stated that, although she thought the PTG debt positions were not
reasonably marked, there was only so much [we] could do.966 Referring to the
ProductControlGroup,shestatedthattheywere,kindofsadly,thelittlepeople.967
EliRabin,theproductcontroller responsibleforPTGequitypositions,alsotold
theExaminerthatheheardrumorsthattherewasalimitontheamountofwritedowns
thatcouldbetakenonPTGpositionsinthethirdquarterof2008.968Hedidnotknow
whetherthelimitwasimposedonjustGREGorallofLehmananddidnotspecifywho
setthelimit.969
Aristides Koutouvides, who worked on the PTG business desk, stated that the
roleplayedbyseniormanagementchangedinthethirdquarterof2008.970Specifically,
he remembered that there was more pushback from senior management as to write
downs.971Koutouvidesstatedthatthelimitheunderstoodtobeinplacewasallocated
964Id.atp.11;ExaminersInterviewofAbebualA.Kebede,Oct.6,2009,atp.6.
965Lehman, Pricing Report (Aug. 2008), at pp. 1924 [LBEXBARFID 0000248]; Examiners Interview of
RebeccaPlatt,Nov.2,2009,atpp.1011;ExaminersInterviewofAbebualA.Kebede,Oct.6,2009,atpp.
56.
967Id.
968ExaminersInterviewofEliRabin,Oct.21,2009,atp.12.
969Id.
970ExaminersInterviewofAristedesKoutouvides,Nov.20,2009,atp.16.
971Id.
264

across allpositions,suchthateveryposition that he felt should bewritten downwas,
justnottotheextenthedeemedappropriate.Herecalledoneexampleinwhichheand
Barsantiwanted$500millioninwritedowns,butwereonlyallowed$450million.972He
was also unable to specify where the supposed limit on writedowns originated.
Koutouvides characterized the dialogue between the heads of the business units and
seniormanagersasexpectationsmanagementwhenitcametovaluations.973
(4) ExaminersFindingsandConclusionsWithRespecttoSenior
ManagementsInvolvementinCREValuation
The evidence is in great conflict as to whether senior management actually
attemptedtoimposeartificiallimitsonwritedownsorwhethermorejuniormanagers
misperceived management pushback as management interference. The evidence is
murky and based upon speculation as to exactly who among the senior managers
wouldhaveengagedinsuchinterferenceifinfactitoccurred.Theamountofthewrite
downsnottakenbecauseofthepossibleinterferenceapproximately$200millionina
quarter in which Lehman would report $3.9 billion of losses is of questionable
materiality. Furthermore, the actual writedowns right or wrong were never
formally reported. For all of these reasons, the Examiner concludes that the evidence
does not support the existence of colorable claims arising out of writedowns in the
thirdquarterof2008.
972Id.
973Id.
265

Book
(1) ExecutiveSummary
ThissectionoftheReportaddressesLehmansvaluationofthecommercialreal
estate assets commonly referred to as the Commercial Book. Lehmans Commercial
Book was comprised of debt instruments, such as commercial mortgage loans and
CMBS.974 Within the Commercial Book, Lehman recognized, among others, the
following asset categories: Large Loans (Fixed and Floating) and Conduit Loans, B
Notes / Mezzanine Notes, CMBS, and REIT Line of Credit (LOC). 975 These assets
werebackedbyrealestatepropertiesthatweretypicallyalreadyconstructed,operating
and generating cash flow. Lehmans expectation at the time it originated or acquired
thesepositionswasthatitwouldbeabletosyndicate,securitizeand/orsellthemwithin
a few months. This expectation caused individuals within Lehman to refer to the
CommercialBookasbeinginthemovingbusiness.976
974WyattdeSilva,E&Y,MemorandumtoFiles:LehmanCommercialRealEstateSFAS157Adoption(Jan.
28, 2008), at pp. 34 [EYLELBHIKEYPERS 2025663]. A significant portion of positions held in the
CommercialBookrelatedtoLehmansinvestmentsinArchstoneandSunCal.However,Lehmandidnot
pricetestthesepositionsaspartoftheCommercialBookpricetestingprocess.ExaminersInterviewof
JonathanCohen,Jan.11,2010,atp.10.Accordingly,thevaluationofthesepositionsisnotaddressedin
thisSection,althoughArchstoneisaddressedinSectionIII.A.2.foftheReport.
975Lehman, Real Estate Monthly Price Verification Policy and Procedures (July 16, 2008), at p. 1
[LBHI_SEC07940_1184459].
976ExaminersInterviewofJonathanCohen,Jan.11,2010,atpp.3,6.ExaminersInterviewofAnthonyJ.
Barsanti,Oct.15,2009,atp.6.ExaminersInterviewofLisaBeeson,Oct.23,2009,atp.9.Conversely,
LehmansPTGinvestments,whichwereintendedtobeheldwhiletheunderlyingrealestatewasbeing
developed,wasreferredtoasthestoragebusiness.ExaminersInterviewofAnthonyJ.Barsanti,Oct.
15,2009,atp.6.
266

As of May 31, 2008, Lehman determined that the value of its worldwide
CommercialBookwasapproximately$29.5billion,with$15.1billionintheU.S.,$10.3
billioninEurope,and$4.2billioninAsia.977AsofAugust31,2008,Lehmandetermined
the value of its worldwide Commercial Book to be approximately $24.4 billion, with
$11.9billionintheU.S.,$8.9billioninEurope,and$3.6billioninAsia.978Aswithother
asset classes, the analysis in this section focuses on Lehmans U.S. assets, as the
Examinerdeemedthetimeandexpensenecessarytoobtaininformationregardingnon
U.S.assetstobeanimprudentuseofEstateresources.979
Historically, Lehman was able to sell certain positions within the Commercial
Book shortly after origination.980 However, beginning in the latter half of 2007 and
continuing through the third quarter of 2008, the loss of liquidity due to the
deterioration of the securitization and syndication markets forced Lehman to retain
moreofitsCommercialBookassetsonitsbalancesheetatatimewhenproblemsinthe
977Lehman,GlobalRealEstateInventorySpreadsheetasofMay31,2008(August8,2008)[LBEXDOCID
2077095]. The Examiner notes that there is an immaterial difference between the value of the U.S.
CommercialBookbasedonthissource($15.1billion)ascomparedtothevalueoftheU.S.Commercial
BookpositionsreviewedbyE&Y($14.9billion)asdiscussedbelow.Inaddition,pricetestingmodelsand
internal and external Lehman presentations that have been located by the Examiner indicate slightly
differentvaluesfortheU.S.CommercialBook.TheExaminersfinancialadvisorhasconcludedthatthe
differencesamongthesesourcesmaybeduetocategorizationormarktomarketadjustments.
978Lehman,GlobalRealEstateInventorySpreadsheetasofAugust31,2008[LBEXDOCID1025119].
979As used in this Section, unless otherwise noted, the term Commercial Book refers only Lehmans
U.S.assets.
980See E&Y, Memorandum re: Conduit, Large Loan, and CMBX Price Verification Process, at p. 5 [EY
SECLBHIMCGAMx08063735].FixedRateConduitLoans&LargeLoanswerehistoricallysyndicated
everytwotothreemonths.Id.atp.5.FixedRateLoansweretypicallyheldbyLehmanfor180days.Id.
atp.6.However,theaverageholdingperiodforBNotes/MezzanineNoteswasover180days.Id.atp.
8.
267

realestatemarketwereputtingdownwardpressureonvaluations.981Asevidencedby
contemporaneous emails written by senior Lehman personnel, the markets for
investmentsbackedbycommercialrealestatewerevirtuallyclosedatthetime.982The
reductioninCMBSsecuritizationsafterthethirdquarterof2007isdemonstratedinthe
tablebelow:
LehmansCommercialSecuritizationActivitiesfromtheSecondQuarterof2006to
theSecondQuarterof2008983
In$Millions 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08
Commercial
mortgages 3,412 6,700 7,149 2,829 5,083 10,480 1,507 1,500
securitized
Quarterover
100.7% 96.4% 6.7% 60.4% 79.7% 106.2% 85.6% n/a n/a
quarterchange
Asthesecuritizationmarketdriedup,andLehmansexitstrategyfortheseassets
becameuntenable,thevalueofLehmanspositionsfell.Inthesecondquarterof2008,
Lehman took approximately $195 million in writedowns on assets within its
981Examiners Interview of Jonathan Cohen, Jan. 11, 2010, at p. 3; Diane Hinton, S&P, Liquidity
ManagementInTimesOfStress:HowTheMajorU.S.BrokerDealersFare,Nov.2007,S&PRatingsDirect,
(Nov.8,2007),atpp.23[LBHI_SEC07940_439424](Recentdisruptionsinthesubprimemarketandits
contagion effects into the leveraged finance, assetbacked commercial paper (ABCP), and CDO spaces
have substantially curtailed market liquidity.); FRBNY President Timothy Geithner, Transcript of
Remarks to The Economic Club, New York City, New York, Reducing Systemic Risk In A Dynamic
Financial System (June 9, 2008), available at http://www.newyorkfed.org/newsevents/speeches/
2008/tfg080609.html (The funding and balance sheet pressures on banks were intensified by the rapid
breakdown of securitization and structured finance markets. Banks lost the capacity to move riskier
assets off their balance sheets, at the same time they had to fund, or to prepare to fund, a range of
contingentcommitmentsoveranuncertaintimehorizon.).
982Email from William J. Hughes, Lehman, to Alex Kirk, Lehman, et al. (Jul. 27, 2007) [LBEXDOCID
174304].
983SeeLehmanBrothersHoldingsInc.,QuarterlyReportasofMay31,2007(Form10Q)(filedonJuly10,
2007),atp.27(LBHI10Q(filedJuly10,2007));LehmanBrothersHoldingsInc.,QuarterlyReportasof
August31,2007(Form10Q)(filedonOct.10,2007),atp.22(LBHI10Q(filedOct.10,2007));LBHI2007
10Katp.111(LBHI200710K);LBHI10Q(filedJuly10,2008)atp.35.
268

CommercialBook.Similarly,inthethirdquarterof2008,Lehmantookapproximately
$306 million in writedowns on its Commercial Book. Lehmans valuations of its
Commercial Book resulted in cumulative net writedowns of $958 million during the
periodbeginninginthefourthquarterof2007andendinginthethirdquarterof2008,
assetforthinthetablebelow.984
CommercialBookNetWritedownsFirstQuarter2007toThirdQuarter2008
$inmillions
1Qthru3Q07 4Q07 1Q08 2Q08 3Q08 4Q07thru3Q08
NetWriteDowns
(38) (164) (293) (195) (306) (958)
ThissectionoftheReportexamineswhetherthevalueofLehmansCommercial
Book assets, as determined by Lehman in May and August of 2008, was reasonable.
TheExaminersinvestigationhasrevealedthatthesalesdatausedbyLehmantoverify
the marks for many of its Commercial assets in the second and third quarters of 2008
may not have been sufficiently broad to be applicable to the entirety of the portfolio.
However,whilethereissomeuncertaintyastowhetherthesalesdataLehmanhadfor
thesecondandthirdquartersof2008wasrepresentativeoftheassetsremaininginits
Commercial portfolio, the data shows that Lehmans valuations at this time assumed
higheryields,andasaresultlowervalues,thanisreflectedbyactualsalesduringthe
quarter. Thus, Lehmans valuations appear reasonable in light of the available sales
984E&Y, Lehman Brothers Holdings Inc. CRE Sign P&L Q4 and YTD (November 11, 2007), at p. 2 [EY
SECLBHIMCGAMx07 071061]; E&Y, Lehman Brothers Holdings Inc. 3Q.RE.8 Gross and Net MTM
Cash Bonds 082908.xls [EYSECLBHIMCGAMX08045833]. Lehman, Global Real Estate 2008 Net
MarkDowns(Sept.5,2008)[LBEXAM346991].ThewritedownsexcludeSunCalrelatedpositions.
269

data. Furthermore, this sales data was the primarysource of information available to
Lehman,otherthantheoreticalmodelsthatrelied,inpart,upondatafromthirdparties,
to conduct price verification of these assets at the time.985 Most importantly, the asset
values ultimately determined did not fall outside of a range of reasonableness.
Accordingly, the Examiner does not find sufficient evidence to support a finding that
Lehmans valuation of its U.S. Commercial Book in the second and third quarters of
2008wasunreasonable.
(2) LehmansValuationProcessforitsCommercialBook
Aswithotherassetclasses,themarksLehmanreportedforitsCommercialBook
assetswerethosedeterminedbyitsbusinessdesk,subjecttoapriceverificationprocess
performed by its corresponding Product Control Group.986 Product Control used a
numberofmethodologies,dependingontheassetcategoryandavailableinformation,
toverifythepricinginformationprovidedbyLehmansbusinessdesk.987Forconduits
985The Examiner notes that Lehman internally recognized that its theoretical models suffered from the
useofstaledata.SeeLehman,Valuation&ControlReportFixedIncomeDivision(February2008),atp.
27[LBEXBARFID0000058].ThisreportlistedthefollowingissuefortheFloatingRateLargeLoans&
Junior Notes: Floating rate securitization market is inactive; No deal in the market since Dec07.
Spreads published in third party publications are stale; Pricing becoming extremely challenging. Id.
The proposed solution was for Product Control to work with Front Office to obtain market color on
deals that are currently in the market for syndication/sale. Id. This document also stated Product
controlishavingcontinuousdiscussionswithFrontOfficegoingthroughdealsinmoredetailandtrying
toobtainmarketcolorusingrecentsyndications,bids,offersandanyothermarketinformation.Id.
986Lehman, Price Verification Policy and Procedure 2008 [Draft] [LBHI_SEC07940_2965994]; Brian
Sciacca, et al., Lehman, HG, HY, & EMG Cash Price Testing Policy & Procedure (Jan. 24, 2007) [LBEX
BARVAL0000001].
987Lehman, Price Verification Policy and Procedure 2008 [Draft] [LBHI_SEC07940_2965994]; Brian
Sciacca, et al., Lehman, HG, HY, & EMG Cash Price Testing Policy & Procedure (Jan. 24, 2007) [LBEX
BARVAL0000001].TestingfilesfornonU.S.positionswerenotavailableandtheExaminerexpressesno
270

and large fixed rate loans, prices were historically tested in aggregate using a mock
securitizationmodel,basedonthemostrecentcomparableLehmansecuritizationdeal.
Key model inputsincludedwaterfall paymentof thebonds,termtomaturity, coupon
rateandtheLoantoValue(LTV)ratio,whichwasgenerallyderivedfromthevalue
ofthecollateralatthetimetheloanwasoriginated.988Thepresentvalueofthesubject
loan was discounted based on a weighted average yield that was estimated from a
mock securitization and/or yield spreads as published in the Commercial Mortgage
Alert (CMA).989 However, the use of this methodology became ineffective as the
securitizationmarketsclosed,causingProductControltodeemphasizetheiruseinthe
firstquarterof2008.990
Forfloatingratelargeloansandmezzanineloans,Lehmansmarksweretested
using a net present value (NPV) methodology which considered the subject loans
riskinessanditscollateralpropertyvalue.991Keymodelinputsincludedtheindividual
loansLTVratio,maturitydate,spread,couponrate,remainingpayments,anddiscount
viewofthereasonablenessofthevaluationmethodologyorultimatemarksreportedforLehmansnon
U.Scommercialrealestateassets.
988E&Y, Walkthrough Template re Conduits, Large Loan, and CMBX Price Verification Process, at p. 5
[EYSECLBHIMCGAMX08063735].
989Id.atp.8;Lehman,GlobalRealEstateProductControl,RealEstateAmericasPriceVerification(Feb.
2008),atp.10[LBEXWGM000762].
991E&Y,WalkthroughTemplatereConduits,LargeLoan,andCMBXPriceVerificationProcess,atpp.78
[EYSECLBHIMCGAMX08063735].
271

rate.992Forthediscountrate,ProductControlbasedtheircalculationonthekeymodel
inputsmentionedaboveandyieldspreaddatapublishedbyCMA.993
ForCMBS,pricesweretestedusingthirdpartypricingdatafromIDC,andother
marketsourceswhenavailable.994Productcontrollersthencomparedtheaverageofall
thirdpartypricingdataforapositiontothemarkdeterminedbythebusinessdesk.995
Finally, REIT LOC and term loans were typically price tested on an individual
basis,usingtheNPVapproachbasedonindividualloancharacteristics.996
Duringthefourthquarterof2007andthefirstquarterof2008,thelackofsalesof
Lehmans Commercial Book assets, due to the slowing pace of securitizations and
syndicationsnotedabove,meantthattherewaslimitedrelevantmarketinformationto
relyupon inperforming price testingoftheseassets.Thislackofinformationcaused
Lehman to be heavily reliant upon its theoretical pricing models for purposes of
confirmingassetvaluations.However,inthesecondandthirdquartersof2008,greater
sales activity allowed Lehmans product controllers to use sales data in addition to
models to perform price verification of the Commercial Book.997 During the second
992Id.atpp.79.
993E&Y,BNote,DiscountRateRecalculation.xls[EYSECLBHIMCGAMX08063388].
994Lehman, Global Real Estate Product Control, Real Estate Americas Price Verification (Feb. 2008), at
p.16[LBEXWGM000762].
995E&Y,WalkthroughTemplatereLiquidProductsPriceVerificationProcess,atp.7[EYSECLBHIMC
GAMX08067466].
996Lehman,GlobalRealEstateProductControl,RealEstateAmericasPriceVerification(Feb.2008),atp.
18[LBEXWGM000762].
997The increased sales activity would have also benefited the business desk as they determined the
correctmarkfortheirpositions.
272

quarterof2008,LehmanwasabletosellarangeofCommercialBookpositionsforan
aggregate price of $3.8 billion.998 Similarly, during the third quarter of 2008, Lehman
soldvariousCommercialBookpositionsforanaggregatepriceof$2.5billion.999
Thevolumeofactualsalestransactionsinthesecondandthirdquartersof2008
gave Lehmans management a higher level of confidence in the valuation process
comparedtopriorperiodswhenthelackofanymeaningfulsalesdataforcedthemto
relymostlyontheoreticalpricingmodels.1000
After the product controllers determined their test marks for a position,
variances, defined as the difference between the business desks mark and the mark
calculated by the product controller, were calculated. Lehman determined certain
variance thresholds for each asset category.1001 As with other asset classes, variances
exceeding these thresholds were resolved through discussions between business desk
and product controllers and unresolved variances were escalated to senior
management.1002
998Lehman,Q2Q3GregSalesScatterv2[LBHI_SEC07940_1234185].
999Id.
1001E&Y,Memorandumre:Conduit,LargeLoan,andCMBXPriceVerificationProcess,atp.9[EYSEC
LBHIMCGAMX08063735];E&Y,LehmanBrothersHoldingsInc.,REITPriceVerificationProcess,atp.
7 [EYSECLBHIMCGAMX080641780]; E&Y, Lehman Brothers Holdings Inc., Liquid Products Price
Verification, at p. 8 [EYSECLBHIMCGAMX08067466]; Lehman, Price Verification Policy and
Procedure2008[Draft],atp.4[LBHI_SEC07940_2965994].
1002E&Y, Lehman Brothers Holdings Inc. Price Verification P&P, Securitized Products and Valuation
Controls (March 3, 2008), at p. 23 [EYSECLBHIMCGMAX08067482]; E&Y, Lehman Brothers

HoldingsInc.PriceVerificationPolicyandProcedure2008[Draft],atp.4[LBHI_SEC07940_2965994].
273

(3) ExaminersFindingsandConclusionsastotheReasonableness
ofLehmansValuationofitsCommercialBook
In assessing the reasonableness of Lehmans marks in the second and third
quartersof2008,theExaminerreviewedvaluationanalysesprovidedbyLehmantoits
auditors, models that Lehmans product controllers used to price test the business
desksassetvaluations,anddatafromcompletedsalestransactions.
(a) AsoftheSecondQuarterof2008
In a real estate price verification presentation, the Product Control Group
summarized its price testing analysis for the second quarter of 2008.1003 The
presentationprovidedPricingCommentarythatexplainedhowtheProductControl
Group arrived at its test prices and showed the aggregate variance calculated for the
quarter. In the presentation, the Product Control Group identified a $70 million net
negative variance, equal to approximately 0.5% of Lehmans $14.5 billion Commercial
portfolio.1004AnegativevariancemeansthatLehmansmarksfortheassetstestedwere
higherthanthetestprices,suggestinganovervaluation.
Inadditiontoprovidinginformationregardingthetestpricesdeterminedforthe
Commercial Book, the Product Control presentation also contained observations on
factors impacting the pricing of each asset type.1005 The presentation noted that some
1003Lehman,RealEstatePriceVerification[Draft](July17,2008),atpp.2,3,5[LBHI_SEC07940_1169231].
1004Id. at p. 2. The Examiner notes that this presentation identified the value of the US Commercial
portfoliotobeapproximately$17.5billion,whichincluded$3.0billionofbridgeequitypositions.Forthe
purposeofCommercialBookanalysis,bridgeequitypositionswereexcludedfromtheanalysis.
1005Id.atpp.2,3,and5.
274

asset classes, specifically Archstone, benefited from price flex.1006 Price flex shifted
marktomarketlossesfromdebtpositionstoequitypositions.Apartiallyreproduced
summary of the Product Control Groups price testing analysis is shown in the table
below.
1006Id.atpp.2,5.TheArchstonedebtpositionswereincludedintheCommercialBookandthevaluation
ofthesepositionsisaddressedinSectionIII.A.4.eoftheReport,whichaddressesLehmansvaluationof
itsArchstoneBbridgeequityinvestment.
275

ProductControlsDraftPriceTestingSummaryforQ22008
U.S.Commercial1007
Legal Market Pricing

Balance Mark Value Variance PricingCommentary
FixedRate:
Significantexpsureis61%LTV,$319mnseniorloan
FirstLien 419 90.60 379 onGMbuildingmarkedat95.7,orayieldof6.7%.
Soldallof$500mnplacedintoaQ208securitization.
Apporxiamtely31%ofportfoliohaspriceflex;
remainderofbookedmarkedbasedoncomparable
BNotes/Mezz 1,021 88.50 904 (26)
spreadlevelsfromrecentsynidcation/salesactivity.
Sold$947mnduringQ208.
FloatingRate:
FullPriceflexondebt,i.e.,anylosswillbeabsorbed
Archstone 526 99.00 521 bybridgeequity.450DMassumedonmezzin
pricingbridgeequityyield.
Markedbasedonspreadsderivedorimpliedfrom
recentsyndication/salesactivityonseniorloansas
FirstLien 3,434 94.90 3,260 (12)
wellasbnotes/mezznotes.Sold$545mnduring
Q208.
Priceverifiedbasedoncomparablespreadlevelson
BNotes/Mezz(excl.Archstone) 3,516 91.90 3,230 (32) recentsyndications/salesactivity.Sold$742mn
duringQ208.
TermLoans/LOCs:
Fullpriceflex.Pricingassumptionsincorporatedin
Archstone 2,395 98.50 2,359 bridgeequity(i.e.,termloanAtoberepaidfromasset
salesandtermloanBtobesyndicated@90).
Pricedtotargetinvestoryieldof15%(exceptfor
MarbleheadandPacificPoint,whichareat12%to
accountfortheirsuperiorlocation&demographics
comparedtotherestoftheportfolio).Cashflowand
SunCal 1,944 75.60 1,470
otherprojections(lotabsorption,constructioncosts,
andsaleprice)obtainedeitherfromthirdparty
vendorshiredbyLBorthirdpartyindustry
publications.
Others(excl.ArchstoneandSunCal) 876 96.00 841 Basedonbankdebttradingmarketofsimilarcredits.
SellerfinancedtradesoriginatedinMay08atmarket
CorporateDebt 626 100.00 626
spreads.
Total(excludingSecurities) 14,757 13,590 (70)
Priceverifiedusingthirdpartysourcesandrecent
tradingactivity.Sold$1bnofalltranchesofsecurities
Securities 29,966 908 duringQ208.FloatingrateIOsmarkedatzerodue
tothelackofprepaymentprotectionandshort
duration.
Total(includingSecurities) 44,723 14,498 (70)
1007SeeLehman,RealEstatePriceVerification[Draft](July17,2008),atpp.23[LBHI_SEC07940_1169231].
Thistableexcludesbridgeequitypositionsandcollapsesthedifferenttypesofsecuritiesintoasingleline
item. The Examiner notes that the total value for U.S. Commercial assets in this draft price testing
document ($14.5 billion) is different than the final values reviewed by E&Y ($14.9 billion) and other
summaries of the Commercial Book located by the Examiner. The Examiners financial advisor has
concludedthatthesedifferencesmaybeduetocategorizationormarktomarketadjustments.
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Forthesecondquarterof2008,LehmanprovidedE&Yananalysisthatcompared
datafromsalesduringtheperiodtothecarryingvaluesoftheassetsthatremainedon
Lehmansbalancesheet.1008Theanalysiscomparedthesellingyieldsthatwereimplied
bythe prices atwhich assets weresoldduringthe quarter tothe carrying yields used
forvaluingtheportfolioasofquarterend.1009Theanalysisconcludedthattheaverage
selling yield was lower than the average carrying yield of the remaining assets; and
therefore, the prices that Lehman was achieving on actual sales were, on average,
higher than the prices at which Lehman was carrying assets in these categories on its
balance sheet.1010 However, the Examiner notes that there is great variation among
positions even within a single asset category and the applicability of a sale price to
positions still held by Lehman can only be determined by a positionspecific analysis.
Assumingthattheassetssoldwerecomparabletotheremainingassets,theCommercial
Book as of May 31, 2008, was undervalued in light of the second quarter sales data
available. Lehman relied on the sales data to support the valuation of Commercial
assetsatquarterend.1011
1008SeeE&Y,GlobalRealEstateQ208SalesActivity[EYSECLBHIMCGAMX08138412].
1009Id.
1010Id.
1011Lehman, Real Estate Price Verification [Draft] (July 17, 2008), at p. 1 [LBHI_SEC07940_1169231].
Kebede affirmed the emphasis of sales data during his interview with the Examiner. Examiners
InterviewofAbebualA.KebedeonOct.6,2009,atp.8.E&Ysworkpapersstated:Forpurposesofthe
Q2 review, the comparisons between inventory values and yields and sold values and yields appears
reasonabletosupportProductControlsassertionsofreasonable,observable,applicablesalesactivityto
supportitsfairvaluemarksasof5/30/08inadditiontoitsotherpriceverificationprocedures.Appears
Reasonable. E&Y, Global Real Estate Q208 Sales Activity, at p. 1 [EYSECLBHIMCGAMX08
277

ToevaluatetheapplicabilityofthesalesdatatothevalueofLehmansremaining
assets,theExaminerreviewedthedistributionofsalesacrosstheassetcategorieswithin
theCommercialportfolio.1012Thisanalysisissummarizedinthetablebelow.
138412].WilliamSchlichtoldtheExaminerthatE&Ysquarterlyreviewsarenotthesameastheannual
auditandthatE&Ywasstillintheplanningstagesforits2008auditwhenLehmanfiledforbankruptcy.
ExaminersInterviewofErnst&Young,Nov.11,2009,atpp.1314.
1012See E&Y, Global Real Estate Q208 Sales Activity [EYSECLBHIMCGAMX08138412]; Lehman, Q2
Q3GregSalesScatter.xls,[LBHI_SEC07940_1234185].
278

U.S.CommercialAssetClasseswithSalesDataQ22008
Carrying
Yield
SalesDuring Remaining
SellingYield on
Quarter Exposure
Remaining
Portfolio

MezzanineFloatingRate 606 2,799 8.8% 9.3%

MezzanineFixedRate 947 479 8.7% 9.4%

LargeLoansSeniorFloatingRate 545 3,575 5.9% 6.6%

BNotesFloatingRate 136 152 6.6% 9.7%

Subtotal#1 2,234 7,005 N/A N/A

SmallFixedRateMezzanine 499 379 7.5% N/A

Securities 1,018 589 N/A N/A

InterestOnly 25 319 0.0% N/A

Subtotal#2 1,542 1,287 N/A N/A

LoanstoREITs(e.g.,Archstoneand
SunCal) 4,869 N/A N/A

FloatingRateMezzanineArchstone 485 N/A N/A

BNotesFixedRate 363 N/A N/A

DerivativesMarktoMarket 893 N/A N/A

Subtotal#3 6,610 N/A N/A

Total 3,776 14,902 N/A N/A
As this table shows, Lehman was able to sell a substantial portion of assets
withincertainassetclasses,andwasunabletosellanyportionofassetsforotherasset
279

classes. The four categories for which the Examiner obtained both selling yield and
carrying yield information together account for approximately 47% of Lehmans
Commercial Book, as measured by value.1013 Within these categories, the average
carrying yield for the remaining portfolio was consistently higher than the average
selling yield.1014 The majority of asset classes without any sales data are related to
Archstonedebtpositions,whichbenefitedfrompriceflex,andSunCal.1015
While the sales data provides a degree of price transparency, many of the
transactions that were executed during the second quarter closed during the last few
daysofthequarter.1016Further,manyofthetransactionsthatclosedonthelastdayof
the quarter were seller financed (with recourse).1017 Kebede believed the terms of the
seller financing wereconsistent with market rates atthe time.1018 The Examiner is not
awareofanycontemporaneousevidencethatcontradictsKebedesbelief.
The Product Control Group used data from the sale of positions during the
quarter tovaluethe remainingpositionsbycomparing positions: (1) within thesame
deal; (2) within the same sector (i.e., office); (3) within the same geography; (4) with
1013SeeLehman,Q2Q3GregSalesScatter.xls[LBHI_SEC07940_12341851234225].
1014See E&Y, Global Real Estate Q208 Sales Activity [EYSECLBHIMCGAMX08138412]; Lehman, Q2
Q3GregSalesScatter.xls[LBHI_SEC07940_12341851234225].
1015Id. As noted, the impact of price flex on the valuation of Archstone bridge equity is discussed in
SectionIII.A.4.e.
1016E&Y,GlobalRealEstateQ208SalesActivity,atpp.110of31[EYSECLBHIMCGAMX08138412].
1017Id.Lehman,SellerFinancedPositions,atp.2[LBEXWGM763628].Becausethesellerfinancingwas
provided with recourse, in the event of a default Lehman would be permitted to seek the full
outstandingamountoftheloanfromtheborrower,notjustthecollateral.
1018ExaminersInterviewofAbebualA.Kebede,Oct.6,2009,atp.9
280

similar loantovalue ratio; and (5) with similar term to maturity.1019 For example,
Lehmansoldatrancheofthe301HowardmezzanineloanportfoliowithalowerLTV
ratiothantheremainingtranches,whichisconsistentwiththefactthattheremaining
positionsweremarkedtohigheryieldsthanthepositionssold.Thisisalsoconsistent
with the relative riskiness of each tranche the higher the LTV ratio, the riskier the
tranche.
As an additional check of the price testing process, the Examiner investigated
how Lehmans valuation models performed when compared to spreads reflected in
actualsalesdata.Areviewofavailablepricingmodelsshowedthat,whensalesdata
providing spreads was available, these spreads were manually entered by product
controllers in place of the spreads calculated by the models.1020 Among the 25
Commercial Bookpositions thattheExaminerreviewed,thispracticewasdonefor22
positions.1021 To assess the models ability to predict reasonable carrying spreads, the
Examiner replaced the spreads reflected by the sales data with Lehmans own model
calculations. A comparison of the selling spreads to the predicted spreads of the
positions examined indicates that Lehmans pricing models, on average, predicted a
1019Id.
1020TheExaminers financial advisor reviewed the majority of sold large loans and mezzanine loans
withintheLargeLoanandJuniorNotepricetestingmodels.However,sinceLehmanreportedlimited
information regarding the selling spreads for several of these sold positions, the Examiners financial
advisoronlyreviewed63.7%ofthepositionsasmeasuredbymarketvalue.
1021Lehman, Large Loans Pricing Summary (Apr. 30, 2008) [LBEXBARFID 0022055]; Lehman, Junior
Loans Pricing Summary (Apr. 30, 2008) [LBEXBARFID 0020702]; Lehman, Large Loans (PTG Model)
PricingSummary(Apr.30,2008)[LBEXBARFID0022055].
281

higher spread than the average selling spread.1022 This suggests that the price testing
processwasgenerallyconservative,producinglowermarksthanthosereflectedinthe
salesdata.
Based on the aforementioned facts and analyses, Lehmans Product Control
GrouphadsufficientsalesdataandotherinformationtoeffectivelypricetestLehmans
CommercialBookduringthesecondquarterof2008.Furthermore,theavailablesales
data suggests that Lehmans marks for these assets were conservative during the
quarter.Accordingly,theExaminerfindsthatthereisinsufficientevidencetosupporta
findingthatLehmansvaluationsofitsCommercialBookassetsinthesecondquarterof
2008wereunreasonable.
(b) AsoftheThirdQuarterof2008
TheExaminerobtainedlessinformationaboutLehmanspricetestingprocessfor
thethirdquarterof2008thanforthesecondquarter.ThisappearstobeduetoLBHIs
bankruptcy filing, which occurred just 15 days after the third quarter ended. As a
result, the Examiners financial advisor could not identify a document summarizing
Lehmans price testing process similar to the one obtained for the second quarter.
However, the process that Lehman used was generally similar to that for the second
quarterrelianceonsalesdatawhereavailableandmodelsintheabsenceofsuchdata.
1022Thepredictedspreadswereonaverage262basispointshigherthanthesellingspreads.
282

Therefore,theExaminersanalysisforthethirdquarterfollowedasimilarapproachas
wasusedforthesecondquarter.
Lehman sold approximately $2.5 billion of Commercial positions during the
thirdquarterof2008.1023Thesesalesoccurredacrossavarietyofassetclasses,asshown
inthetablebelow.Similartothesecondquarter,therewerenosalesofArchstone or
SunCalpositions.1024
ThirdQuarterU.S.CommercialBookAssetSales(ExcludingREO/Equity)
Value
AssetType
(inMillions)
LargeLoansFloatingRate 725
LargeLoansFixedRate 305
MezzanineFloatingRate 846
MezzanineFixedRate 195
BNote 144
Securities 253
Total 2,468
The majority of U.S. Commercial positions that were reviewed by the product
controllersduringthisquarterwerepricetestedintwopricingmodels:theLargeLoan
price testing model and the Junior Note price testing model.1025 Therefore, the
Examinersanalysisfocusedonthesetwopricetestingmodels.
1023Lehman, Q2 Q3 Greg Sales Scatter.xls [LBHI_SEC07940_1234185]. The $2.5 billion figure excludes
REO/Equitysales.
1024Id.
1025See
Lehman, US Real Estate Inventory vs. Pricing Reconciliation (Aug. 2008), at p. 1
[LBHI_SEC07940_3103034].Fixedrateandfloatingratelargeloansofanaggregatevalueof$6.3billion
werepricetestedintheAugustLargeLoanpricingmodel.SeeLehman,LargeLoansPricingSummary
(Aug.29,2008),atp.7[LBEXBARFID0021979].BNotes,Fixedrateandfloatingratemezzanineloansof
an aggregate value of $2.5 billion were price tested in the August Junior Loan pricing model. See
283

A review of the Large Loan Floating Rate model shows that Product Controls
review of the desks valuations for the third quarter suggested a $45 million positive
variance,or a0.7% potentialundervaluation of $6.3billion worthofpositions.1026 The
largestgroupofpositions(excludingArchstoneandSunCal)pricetestedinthismodel
was a group of $412 million of senior Hilton positions, which were benchmarked
againsttheyieldsreceivedfromthesaleofrelativelyjuniorHiltonpositionssoldduring
thequarter.
A review of the Junior Note price testing model shows that Product Controls
reviewofthedesksvaluationsforthethirdquartershowedan$87millionnetnegative
variance,orapotential3.5%overvaluationof$2.5billionworthofpositions.1027
Similartothesecondquarterreview,theExaminerfollowedthesameprocedure
to examine how Lehmans valuation models performed in the third quarter when
compared to the actual selling price/spread. The examination shows that Lehmans
pricing models,1028 on average, predicted a higher spread than the average selling
Lehman, Junior Loans Pricing Summary (Aug. 29, 2008), at p. 14 [LBEXBARFID 0021642]. These two
modelsincluded$8.8billionofthe$10.4billioninCommercialBookpositionsthatwerepricetestedasin
thethirdquarterof2008.Lehman,RealEstateAmericasPriceTestingSummary(Aug.29,2008)[LBEX
DOCID1971828].
1026SeeLehman,LargeLoansPricingSummary(Aug.29,2008)[LBEXBARFID0021979].
1027SeeLehman,JuniorLoansPricingSummary(Aug.29,2008)[LBEXBARFID0021642].
1028TheExaminerreviewedthemajorityofsoldlargeloansandmezzanineloanswithintheLargeLoan
and Junior Note price testing models. However, since Lehman reported limited information regarding
thesellingspreadsforseveralofthesesoldpositions,theExamineronlyreviewed30.6%ofthepositions
soldasmeasuredbyvalue.
284

spread,implyingthatpositionsweremarkedatlowerpricesthansimilarpositionssold
duringthethirdquarter.1029
Aswiththesecondquarter,basedontheaforementionedfactsandanalyses,the
Examiner concludes that there is insufficient evidence to support a finding that the
CommercialBookvaluationsasofthethirdquarterof2008wereunreasonable.
TransactionsGroup
Lehmans Principal Transactions Group (PTG) made debt and equity
investmentsinrealestateprojectsthatwereintendedtobeheldfortheperiodduring
which the underlying real estate was developed or improved.1030 Unlike Lehmans
Commercial Book positions, which were backed by alreadydeveloped, income
1029Thepredictedspreadswereaveraged117bpshigherthanthesellingspreads.
1030ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.4;ExaminersInterviewofMarkA.
Walsh,Oct.21,2009,atp.4.SeeLehman,GlobalRealEstateProductControl,RealEstateAmericasPrice
Verification Presentation [Draft] (Feb. 1, 2008), at p. 4 [LBEXWGM 916015]; Wyatt de Silva, E&Y,
Memorandum to Files: Commercial Real Estate FAS 157Adoption (Jan.28, 2008), at p.5 [EYLELBHI
KEYPERS 2025661]. As noted above, this Report addresses the valuation of Lehmans U.S. assets.
Accordingly,exceptasnoted,thetermPTGonlyreferstotheGREGPrincipalTransactionsGroupin
the U.S. and the investments that this group originated and managed. Additionally, the term PTG, as
used herein, excludes the SunCal development, which was technically a part of the PTG portfolio. See
Cushman&Wakefield,AppraisalofPacificaSanJuanMasterPlan(289Lots)(Oct.1,2007)[TR00031835].
LehmansinvestmentinSunCalamountedto,asofMay2008,approximately4.4%ofthebalancesheetat
riskforthePTGportfolio.Lehman,GlobalRealEstateInventorySpreadsheetasofMay31,2008(Aug.8,
2008) [LBEXDOCID 2077095]. However, Barsanti stated that PTG had limited involvement in valuing
SunCal,asthatpositionmigratedovertoHughsonsgroup.ExaminersInterviewofAnthonyJ.Barsanti,
Oct.15,2009,atp.17.JonathanCohenalsostatedthatProductControlhadnoinvolvementinvaluing
SunCal. Examiners Interview of Jonathan Cohen, Jan. 11, 2010, at p. 5. Because PTG and Product
ControlgenerallyexcludedSunCalfromthevaluationprocess,theExaminerhaslikewiseexcludedthat
assetfromconsiderationofthereasonablenessofthePTGmarks,exceptasabasisofcomparisoninone
instancebelow.
285

producingrealestateandwereintendedtobesoldtoinvestorsshortlyafterorigination,
PTG positions were not intended for nearterm sale. Instead, PTG investments were
premisedonexecutionofabusinessplan,typicallyoftwotofiveyearduration,which
oftenincludedsaleoftheunderlyingpropertyafterdevelopment.1031
Giventhisbusinessstrategy,LehmangenerallydidnotmarketPTGpositionsfor
sale, as it did Commercial Book assets. As a result, PTG positions were relatively
illiquid, even when commercial real estate values were increasing and capital was
readily available. Anthony J. Barsanti, the PTG Senior Vice President responsible for
marking the PTG positions, told the Examiner that Lehman valued these investments
through a combination of financial projections and gut feeling, due to the unique
nature of each asset and the lack of sales data regarding comparable debt and equity
positions.1032 Lehman employed valuation models incorporating assetspecific
informationandprojectingexpectedperformanceovertime.However,whilePTGasset
managersonthebusinessdeskusedthemodelsasaguide,theydidnotregardthemas
gospel.1033BarsantiandAristidesKoutouvides,thePTGVicePresidentwhoreported
to Barsanti and also valued PTG positions, made judgment calls as to whether to
modify or give weight to the model values.1034 Barsanti and Koutouvides based these
judgment calls on their experience, the collaterals performance with respect to the
1032Id.atp.11.
1033Id.
1034Id.atpp.9,1112;ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atpp.1112.
286

developments business plan, and other market data related to the collaterals
geographic region or property type that was not always accounted for in their
models.1035
Lehmanengagedathirdparty,TriMont,toproducetheassetspecificdataused
by the business desk.1036 This TriMont data was also used by the product controllers
whoseparatelypricetestedtheassetvaluesdeterminedbythebusinessdesk.
Pursuant to GAAP, and specifically SFAS 157, the PTG portfolios value was
supposedtorepresentLehmansjudgmentastothepriceatwhicheachpositioncould
besoldtoathirdpartyasofaparticularmeasurementdate,assumingthatLehmanhad
sufficientopportunitytomarketsuchinvestmentpriortothatdate.1037However,there
was disagreement between Lehman personnel about whether the PTG portfolio
reflectedthisprice.KoutouvidesandJonathanCohen,SeniorVicePresident,Headof
ProductControlGroupinGREG,toldtheExaminerthatPTGassetswerenotvaluedat
the price they could be sold to a thirdparty investor in 2008.1038 With respect to the
valuesdeterminedbyLehmanforPTGassetsduring2008,Koutouvidesstated,noone
1035Examiners Interview of Anthony J. Barsanti, Oct. 15, 2009, at. pp. 9, 1112; Examiners Interview of
1036Lehman&TriMont,AmendedandRestatedLoanServicingandAssetManagementAgreement(Sept.
1,2004),pp.1112[TR00044479].
1037ForamoredetaileddiscussionofthelegalstandardsgoverningthisReportsvaluationanalysis,see
Appendix1,LegalIssues,SectionVII.
1038Examiners Interview of Aristides Koutouvides, Nov. 20, 2009, at p. 12; Examiners Interview of
287

wouldpayyouthat.1039Infact,KoutouvidesandJonathanCohenstatedthatLehman
was not required to mark the PTG assets at the price at which an investor would
purchase such assets as of the particular measurement date.1040 In contrast, another
witness,KennethCohen,aManagingDirectorinGREGandHeadofU.S.Originations,
toldtheExaminerthatthePTGassetsweremarkedatthepricethataninvestorwould
pay to purchase the asset.1041 Barsanti, who Kenneth Cohen identified as the person
principally responsible for determining PTG marks, stated that he did not know
whetherPTGassetscouldbesoldforthepriceatwhichtheyweremarkedandstated
hehadnotthoughtaboutit.1042
The Examiners analysis of the data provided by TriMont, as well as Lehmans
useofthisinformationtoproducevaluations,supportsafindingthatLehmansprocess
forvaluingitsPTGportfoliowassystemicallyflawedbecauseLehmanprimarilyvalued
these assets based on whether the development was proceeding according to the
projects business plan and not the price a buyer would pay for the asset. This
methodologydidresult,inthefirstthreequartersof2008,inapproximately$1.1billion
in aggregate writedowns of the PTG portfolio, which was valued at approximately
1039ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atp.12.
1040Id.atpp.1112;ExaminersInterviewofJonathanCohen,Jan.11,2010,atpp.45.
1041ExaminersInterviewofKennethCohen,Jan.21,2010,atp.4.
288

$9.6 billion at the end of fiscal year 2007.1043 However, there are sufficient facts to
demonstrate that Lehman did not generally value PTG assets in light of the rates of
return(oryields)thatinvestorswouldrequiretopurchasethem.Inotherwords,the
facts support a finding that Lehman generally did not value PTG assets during these
quartersatthepricesatwhichtheycouldbesoldtoathirdpartyinvestor.
This failure to appropriately consider an investors required rate of return was
initially due to thefactthatTriMont calculatedthe valueof the underlying real estate
simplybyreferencetotheprojectscapitalization.1044ThiscalculationwascalledCap*
105,becausethecollateralvaluethemostimportantinputinthevaluationexercise1045
was calculated by multiplying the developments capitalization (i.e., outstanding
debtplusequityraised)by105%.1046
As the real estate markets deteriorated in 2007, Lehman recognized that Cap *
105 was flawed, and instructed TriMont to produce internal rate of return (IRR)
modelsforeachdevelopment.1047TheIRRmodelsweretypicallydesignedtodetermine
1043See Lehman, Global RealEstate 2008Net Mark Downs (Sept.5, 2008) [LBEXAM346991]. Lehman,
GREG(PTG)BalanceSheetPositionasofNov.30,2007(Dec.6,2007)[LBEXDOCID1374315](Nov.2007
data).
1045Examiners Interview of Jennifer Park, Sept. 10, 2009, at p. 8, Examiners Interview of Abebual A.
Kebede,Oct.13,2009,atp.6;ExaminersInterviewofEliRabin,Oct.21,2009,atpp.67.
1047The Examiner notes that the IRRmodels referenced here are not the same IRRmodels referenced
elsewhereinthisReportinthevaluationanalysisofArchstone.SeeSectionIII.A.2.fofthisReport.The
IRRmodelsusedinArchstoneassumedavalue,andthemodelderivedadiscountrate.WhileTriMonts
models could perform the same calculation, Lehman relied on TriMonts models for PTG positions to
produceavaluebasedonanassumeddiscountrateforthecollateral.
289

the value of the real estate by discounting the projected cash flows of the completed
projecttoapresentvalue.Thiswasacumbersomeandtimeconsumingprocess,butby
July2008TriMontwasabletoprovideearlyversionsoftheIRRmodelsforsubstantially
all of the PTG assets.1048 Lehman recognized that the IRR models required continued
development, and this process was projected to take many more months.1049 The
Examiner has analyzed a subset of the IRR models and determined that the models
generallyattributedadiscountratefortheequityportionofthecapitalstructurebased
onLehmansexpectedrateofreturn(i.e.,20%forlanddevelopments)and,forthedebt
portion,adiscountratebasedontheinterestrateassociatedwiththeunderlyingloans
atorigination.1050TheIRRmodelstookaweightedaveragebetweenthesetworatesto
arriveattheweightedaveragediscountratefortheproperty.1051Inthismanner,theIRR
models used a yield that did not necessarily correspond to investors required rate of
return(i.e.marketbasedinterestrates)asoftheparticularmeasurementdate.
Barsanti and Jonathan Cohen, in part by using the TriMont IRR models,
determined that it would be appropriate to write down the PTG assets by
approximately$714millionforthethirdquarterof2008.1052JonathanCohenunderstood
1049Id.
1050TriMont, TriMont Valuation Methodologies Lehman PTG and LLG CMBS Hold Assets (Apr. 28,
2008)[LBEXDOCID2089942].
1051Theweightedaveragewasbasedontheequityinvestedtodateandoutstandingdebt.
1052ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.15;ExaminersInterviewofJonathan
290

thattherewasa$500millionlimitonsuchwritedownsforthethirdquarter,1053buthe
did not inform Kenneth Cohen, Christopher M. OMeara, Global Head of Risk
Management, or anyone senior to him (other than Gerard Reilly, Global Product
Controller) that he and Barsanti had calculated proposed writedowns beyond the
perceived$500millionlimit.1054Inthismanner,approximately$214millionofthewrite
downswerenottaken.
TheExaminerfindsthereissufficientevidencetosupportafinding,forpurposes
ofasolvencyanalysis,thatcertainofLehmansPTGvaluationsasofMay31,2008and
August 31, 2008 were unreasonable. Given that there were approximately 700 PTG
positionsasofLBHIsbankruptcyfiling,1055theExaminerdeterminedthatitwasnota
prudentuseofresourcestodeterminetherangeofovervaluationforeachinvestment.
For purposes of illustration, the Examiner did analyze select positions, and describes
belowhowLehmansfailuretoproperlyconsidertheinvestorsrequiredrateofreturn
affected the valuation. Due to time constraints and lack of information that fully
capturesthenuancesofPTGpositions(orLehmansinternalprocessforvaluingmany
ofthem),theExaminersanalysisoftheseassetsdoesnotpresentanopinionastothe
1053TheExaminerconcludesthatthereisinsufficientevidencetosupportafindingthatLehmanssenior
managersintendedtoimposesuchalimit,butJonathanCohenwasunambiguousinassertingthatitwas
hisunderstandingthatsuchalimitwasinplace.ExaminersInterviewofJonathanCohen,Jan.22,2010,
atpp.23.SeeSectionIII.A.2.cofthisReport,whichdiscussesseniormanagementsprocessfordeciding
writedownsforCREassets,whichincludedPTGassets,inthesecondandthirdquartersof2008.
1055Lehman,GREGInventorySpreadsheetasofAug.31,2008(Sept.13,2008)[LBEXDOCID1025119].
291

fair value of these assets as of May or August 2008, but simply investigates the
assumptionsandpracticesLehmanusedinvaluingtheselectedPTGassetsandreaches
aconclusionastothereasonablenessofthoseassumptionsandpractices.
Inaddition,theevidencedoesnotsupporttheexistenceofacolorableclaimfora
breach of fiduciary duty related to Lehmans valuation errors, as there is insufficient
evidence to establish that any Lehman officer acted with the necessary scienter to
supportsuchaclaim.
(2) OverviewofLehmansPTGPortfolio
Lehmans PTG positions took the form of investments in both the debt and
equity of the development or improvement projects. PTG invested in real estate that
required development or improvement in order to produce the desired return on
capital.1056 Prior to the development or improvement, the underlying PTG real estate
hadeithernocashflow(i.e.,landtobedeveloped),ormateriallylesscashflowthanwas
projected to be generated upon development (i.e., conversion of rental apartment
buildings to condominiums).1057 Lehman generally planned to exit its PTG positions
when the underlying real estate project was completed, at which point the real estate
wouldbestabilizedandcouldproduceacashflowthroughleasingorsales.1058While
Lehman actively marketed Commercial Book assets for sale soon after origination,
1056ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atpp.78.
1057Id.atp.4.
1058Id.
292

Lehman usually did not market PTG assets. Development projects were typically
completedtwotofiveyearsafterLehmanprovidedthefunding(withtheaveragebeing
threeyears),atwhichtimetheunderlyingpropertywastypicallysold.1059
PTG invested in [p]roperties in markets with lack of competition for the
propertytypeorhavingsignificantbarrierstoentryduetocomplexityofthesituation
ormarketissues.1060PTGtypicallyinvestedintheconstructionofofficesorhotels,the
leasingofrentalunitsinexistingapartmentsorofficebuildings,theconversionofrental
unitsintocondominiumunits,andtheacquisitionanddevelopmentoflandforcreation
ofresidential,commercial,orresortproperties.1061
Lehman partnered with developers on PTGinvestments. Each Lehman banker
withinPTGwhooriginatedinvestmentshadrelationshipswithcertaindeveloperswith
a proven track record in a particular real estate market.1062 It was not uncommon for
Lehman to do multiple deals with a developer who had demonstrated the ability to
1059Id. See Memorandum from Sunny Galynsky, Lehman, to Kenneth Cohen, Lehman, re: Corporate
Audit Report for Real Estate: Principal Transactions Americas (Dec. 19, 2007), at p. 2 [LBEXDOCID
3570967](ThePrincipalTransactionGroupprovidesequityanddebtfundsforrealestateinvestmentin
nonstabilized assets which were scheduled to be repaid over a three to five year period. The group
engagesinoriginatingandrestructuringshorttermmezzanineloans(averagedurationof2.5years)...
.);MarkA.Walsh&KennethCohen,Lehman,AnOverviewoftheGlobalRealEstateBusiness(June6,
1060MarkA.Walsh&KennethCohen,Lehman,AnOverviewoftheGlobalRealEstateBusiness(June6,
1061Lehman,GREGUniversity:STARTTrainingAnalysts&AssociatesDeepDiveTrainingPresentation
(Sept.2007),atp.79[LBHI_SEC_07940_ICP_007982].
1062ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.7;ExaminersInterviewofAristides
Koutouvides,Nov.20,2009,atp.8.
293

successfullycompleteaproject.1063WhilecertainPTGpositionsincludedsaleortransfer
restrictions, Lehman recognized that a thirdparty investor evaluating a PTG
investmentpriortothecompletionofadevelopmentwouldneedtoconductsignificant
due diligence on the developer responsible for the project, as the profitability of the
investmentlargelydependedonthedevelopersabilitytocompletetheprojectontime
and on budget.1064 Koutouvides explained that Lehman relied on the developer to
successfully complete the project, and that the relationship between Lehman and a
developercouldbedescribedasamarriage.1065
LehmanrecognizedthatPTGinvestmentswerehigherrisk,higherreturnthan
Commercial Book investments,1066 due to the lack of stabilized cash flows and the risk
thatdevelopmentorimprovementoftheassetmightnotbeaccomplishedaccordingto
the business plan.1067 For example, a project could be delayed or derailed due to the
developers failure to timely obtain necessary zoning variances or to successfully
1064Id.atpp.4,5,17.
1066E.g.,ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.4.
1067E.g.,
Lehman, GREG Global Real Estate Update (Nov. 6, 2007), at p. 12 [LBEXWGM 771145]
(identifying key risks to include refinancing risk, residential sales, execution, and credit risk);
Lehman, GREG University: START Training Analysts & Associates Deep Dive Training Presentation
(Sept. 2007), at p. 96 [LBHI_SEC_07940_ICP_007982] (identifying CRE risks generally); Examiners
InterviewofAristidesKoutouvides,Nov.20,2009,atp.8.
294

manageaproject.1068Thedevelopersfailuretoperforminaccordancewiththebusiness
plancouldhaveamaterialeffectonthevalueofthePTGinvestment.1069
Given that the entity owning the underlying real estate was often highly
leveraged, and a PTG asset generated insufficient cash flow until the completion of
development, Lehmans expectation was that the entity would have substantial
difficulty repaying the debt at maturity unless the development was successfully
completed.1070 Similarly, execution of the business plan was crucial to obtaining
Lehmanstargetedannualrateofreturn(oryield),forexample,20%foraPTGequity
1068Email from Aristides Koutouvides, Lehman, to Anthony J. Barsanti, Lehman (May 16, 2008)
[LBHI_SEC07940_2229897]; Zev Klasewitz, Lehman, Single Asset Debt Model May 2008 Spreadsheet
(June 14, 2008), at tab Pricing, cell BK98 [LBEXLL 1985749]; Dennis Grzeskowiak, TriMont,
KnickerbockerHotelIRRModel(July1,2008),atcellF2[TR00021056];Lehman,SingleAssetDebtModel
Aug. 2008 Spreadsheet (Aug. 31, 2008), at cell BK95 [LBEXBARFID 0023236]; Lehman, Valuation &
ControlReportFixedIncomeDivision(Dec.1,2007),atp.22[LBEXWGM755798](Projectisstillin
the entitlement process; [o]verall financing package is being restructured); Examiners Interview of
AristidesKoutouvides,Nov.20,2009,atp.8.
1069Lehman,GREGGlobalRealEstateUpdate(Nov.6,2007),atp.12[LBEXWGM771145](identifying
key risks to include refinancing risk, residential sales, execution, and credit risk); Examiners
InterviewofAristidesKoutouvides,Nov.20,2009,atp.8.
1070Examiners Interview of Anthony J. Barsanti, Oct. 15, 2009, at pp. 5, 12. Additionally, if the
development failed, Lehman could foreclose on the real estate and attempt to salvage value from the
assetbyrevisingthebusinessplan,whichcouldincludepartneringwithanewdeveloperorsellingthe
property. When Lehman foreclosed and took ownership, the asset became Real Estate Owned or
REO. Lehman, Corporate Audit Dept. Entity Control Evaluation for Commercial Real Estate
Mezzanine & Equity (Jan. 4, 2006), at p. 2 [LBHI_SEC_07940_ICP_010891]; Memorandum from Robert
Martinek,E&Y,toE&YAuditTeamforLehmanBrothers,re:LehmanBrothersCommercialRealEstate
Portfolio (Dec. 17, 2006), at p. 5 [EYLELBHIKEYPERS 0675302] (noting that Lehman foreclosed on a
borrowerandcategorizedthenoteasanREO).
295

investment in land developments.1071 Either way, as Barsanti told the Examiner, [i]f
youcouldnotexecuteyourplanyouredead.1072
(3) EvolutionofLehmansPTGPortfolioFrom2005Through2008
AsLehmanexecuteditsgrowthstrategyduring2006and2007,thePTGportfolio
grew larger in size and the average position became riskier. Beginning in November
2006,thePTGbookbalancesheetincreasedsubstantially,asillustratedbythefollowing
graph.1073
U.S. PTG Balance Sheet Value at Risk over Time

$10,000
$9,000
$8,000
$7,000
USD Millions
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$-
FY 2002 FY 2003 FY 2004 FY 2005 FY 2006 FY 2007

1071Examiners Interview ofAnthony J. Barsanti, Oct.15,2009,at pp. 5, 12. According to Koutouvides,
this 20% rate for equity approximated Lehmans expected rate of return for underwriting a deal.
ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atp.7.
1073See Lehman, Balance Sheet Trend and Profit & Loss Spreadsheet (Sept. 14, 2007) [LBEXDOCID
2504119](20022006data);Lehman,GREG(PTG)BalanceSheetPositionasofNov.30,2007(Dec.6,2007)
[LBEXDOCID 1374315] (Nov. 2007 data); Lehman, Global Real Estate Group (PTG) Balance Sheet
Position as of Aug. 31, 2007 (Sept. 7, 2007) [LBEXDOCID 1639856] (Aug. 2007 data); Lehman, GREG
(PTG) Balance Sheet Position as of Feb. 29, 2008 (Mar. 5, 2008) [LBEXDOCID 1374362] (Feb. 2008);
Lehman,GREG(PTG)BalanceSheetPositionasofMay31,2008(June4,2008)[LBEXDOCID1639939]
(May 2008 data); GREG (PTG) Balance Sheet Position as of Aug. 31, 2008 (Sept. 4, 2008) [LBEXDOCID
4418520](Aug.2008data).
296

Afterremainingrelativelyconstantfrom2002to2005,thePTGbalancesheetgrew57%
betweenfiscalyear2005andfiscalyear2007,orfrom$6.1billioninfiscalyear2005,to
$6.9billioninfiscalyear2006,andto$9.6billioninfiscalyear2007.
During this period, the composition of the PTG portfolio also changed in ways
that made the portfolio more risky.1074 The increasing level of risk associated with
Lehmans PTG investments was largely the result of three factors: (1) an increased
focusonlanddevelopmentprojects;(2)afocusonCaliforniaandotherboommarkets;
and (3) a greater proportion of equity investments. Each of these factors is discussed
below.
Inregardtothefirstfactor,landdevelopments,Lehmandeterminedthatcertain
types of PTG investments, such as office building upgrades, no longer provided the
returnsthebusinessrequiredduetocompetitionfromotherinvestorswhowerewilling
to accept lower returns.1075 In order to obtain the targeted return on investment, PTG
redirecteditsfocustodevelopingland,particularlyforresidentialdevelopment.1076
1076Lehman, GREG, Americas Portfolio as of June 30, 2008 (July 19, 2008), at p. 4
[LBHI_SEC07940_241063] (stating that PTGs largest exposure is in land); Examiners Interview of
AnthonyJ.Barsanti,Oct.15,2009,atp.5;ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,
atp.8.Asnoted,LehmansSunCalpositionsarenotincludedinthisanalysisandwouldinflatethetotal
valueofthePTGportfolioifincluded.However,theExaminernotesthatSunCalisanotherexampleof
thistrend.See,e.g.,Cushman&Wakefield,AppraisalofPacificaSanJuanMasterPlan(289Lots)(Oct.1,
2007)[TR00031835].
297

For example, Lehmans investment in Heritage Fields, PTGs largest position,
representing approximately 6% of the PTG portfolio as of May 2008, involved the
creationofanewresidentialcommunityonthesiteofadecommissionedMarineCorps
basenearIrvine,California.1077TheHeritageFieldsdeveloperproposedthepreparation
of parcels to be subdivided between builders of a planned community that included
4,895residentialunits,alongwithparks,agolfcourse,educationalfacilities,amedical
office, and commercial space.1078 Lehman provided $500 million in first lien financing
for Heritage Fields in December 2005 and provided an additional $275 million of
financinginJune2007.1079
The PTG portfolios increasing concentration of land developments, such as
Heritage Fields, increased the overall risk profile of the portfolio. Land carries more
risk than all other property types and is the most volatile in terms of value.1080 As a
1077See TriMont, Heritage Fields El Toro LLC IRR Model (May 1, 2008) [LBEXBARFID 0026891]; Zev
Klasewitz,Lehman,SingleAssetDebtModelMay2008Spreadsheet(June14,2008)[LBEXLL1985749].
LehmandidnotinvestdirectlyinthehomebuildingforHeritageFields.Instead,Lehmaninvestedinthe
sponsor,LNRPropertyCorp.,thatwastopreparetheinfrastructureandprovideenvironmentalcleanup
in order to deliver the land parcels that would be subdivided between builders. Memorandum from
BrentBossung,etal.,Lehman,toLBHIInvestmentCommittee,re:LoanProposalforHeritageFields,LLC
(July1,2005),atpp.3,69[LBEXAM193357].
1078Cushman & Wakefield, Heritage Fields MasterPlan SelfContained Appraisal Report Vol. I (July 1,
2007),atp.8[LBEXDOCID2501688];Lehman,RealEstateDealSummaries:Top50AssetReviews(Sept.
13,2008),attab8[CSSEC00003929].
1079Lehman, Real Estate Deal Summaries: Top 50 Asset Reviews (Sept. 13, 2008), at tab 8 [CSSEC
00003929];TriMont,HeritageFieldsElToroLLCIRRModel(May1,2008)[LBEXBARFID0026891].
1080See Stuart M. Saft, 7 Comm. Real Estate Forms 3d 22.2 (Nov. 2009) (The biggest risk of an
investmentinundevelopedanddevelopinglandisthevirtualimpossibilityofpredictingthedirectionof
growthandtheeverincreasingcostofholdingthelandforfuturedevelopment....Anotherproblemis
determining the sales price of raw land due to the fact that, unlike securities, there is no established
market, which makes determining comparable sales impossible.); John D. Hastie, Real Estate
298

generalmatter,landisonlyprojectedtoappreciateifitisentitled,meaningthatthe
developer has obtained the various zoning and environmental approvals to construct
thedevelopment.1081 Theriskassociatedwithinvestmentsin landisthat approvals to
construct the development might not be obtained, or might be obtained only after
significantdelay.1082Furthermore,giventhetimerequiredtoobtainsuchapprovalsand
tothenbuildthephysicalstructures,thereisthepossibilityofsignificantchangesinthe
real estate market during the development period. For example, when Lehman first
provided financing to Heritage Fields in December 2005, the expectation was that the
landentitlementswouldbeobtainedinDecember2006,constructionofimprovements
would follow over the course of several years, and sales would continue through
2013.1083
In addition, the PTG portfolio was particularly concentrated in California land
development.TherisingvalueofalltypesofCaliforniapropertythroughoutthe2000s
(particularlyin2005and2006),1084combinedwithlowinterestrates,perceivedconsumer
Acquisition,DevelopmentandDispositionfromtheDevelopersPerspective,SR001ALIABA1,3(2009)
(That cost [of land acquisition] customarily includes raw land cost, the cost of providing utility and
othergovernmentalservicestotheland,thecostsofobtainingzoning,useandenvironmentalapprovals,
thecostofcreatingaccesstoandwithinthedevelopment,thecostofcuringtitledefectsandtheinterest
expenseorreturnoninvestmentchargedtothecarryingperiodpriortodevelopment.).
1082Id.
1083MemorandumfromBrentBossung,Lehman,etal.,toLBHIInvestmentCommittee,re:LoanProposal
forHeritageFields,LLC(July1,2005)atpp.3,69[LBEXAM193357].
1084SeeMoodys/REALCommercialPropertyPriceIndex,http://mit.edu/cre/research/credl/rca.html;Fed.
Housing Fin. Agency, House Price Index for California (CASTHPI), http://research.stlouisfed.org/fred2
/series/CASTHPI(showingapeakinhousepricesin2005and2006).
299

demand for housing, available liquidity, and Lehmans recent track record of success,
made raw California land an attractive PTG investment to Lehman during this
period.1085 As of the end of the second quarter of 2007, California land development
represented17.6%ofthebalancesheetatriskinthePTGportfolio.1086
Finally, Lehmans risk exposure also increased as it took equity stakes in
developments.1087Forfiscalyear2004,PTGequitymadeupapproximately26%ofthe
PTGportfolio,increasingto34%in2005and2006.1088During2007,Lehmantooknoteof
thesofteningmarketandrealizedthatthePTGportfoliowastooconcentratedinland
development and in equity positions.1089 Koutouvides noted that the market was
dropping like a stone.1090 Kenneth Cohen stopped approving, and originators
stopped submitting, deals where Lehman was not sufficiently senior in the capital
structure(i.e.,firstliendebtinsteadofequity),therebyreducingtheriskprofile.1091
1085ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.5.ApresentationgivenbyPaulA.
HughsonoutlinesseveraladvantageousaspectsoftheCaliforniamarket.PaulA.Hughson,Lehman,The
Search for Yield Alternative Real Estate Investment Opportunities (June 20, 2006) [LBEXDOCID
1745526].
1086Lehman, Portfolio Characteristics Americas (Principal Investments and CMBS Retained Positions)
Spreadsheet as of May 31, 2007 (Oct. 23, 2007) [LBEXDOCID 2501412]. SunCal is not included in this
percentage.
1087ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atpp.5,8.
1088Ketaki Chakrabarti, Lehman, Real Estate Balance Sheet Trends Spreadsheet (Apr. 18, 2007) [LBEX
DOCID 1419729]; Melissa Sullivan, Lehman, Bridge Equity Spreadsheet (July 5, 2007) [LBEXDOCID
3604474].
Koutouvides,Nov.20,2009,atp.9.SeeEmailfromJeffreyGoodman,Lehman,toAnthonyJ.Barsanti,
Lehman (Jan. 3, 2007) [LBEXDOCID 249993] (discussing deteriorating homebuilding market in
CaliforniaandforwardingarticlewithaprettynegativeviewofCAland).
300

At the end of fiscal year 2007, despite further growth in the PTG portfolio, the
proportionofequityinvestmentshaddecreasedslightlyto30%ofthePTGportfolio.1092
Lehman originated fewer PTG positions during the last quarter of 2007, a trend that
continuedinto2008.1093Inaddition,LehmanwrotedownthevalueofPTGinvestments
by$137millioninthefourthquarterof2007andby$271millioninthefirstquarterof
2008.1094 Lehman wrote down PTG assets by $302 million in the second quarter of
2008.1095
As of the end of the second quarter of 2008, Lehman held 741 positions in the
PTGportfolio.Lehmanvaluedthesepositionsat$8.5billionwithanaverageposition
1092Lehman, GREG (PTG) Balance Sheet Position as of Nov. 30, 2007 (Dec. 6, 2007) [LBEXDOCID
1374315].
1093Laura M. Vecchio, Lehman, FAS 144 Face_Basis Spreadsheet (July 14, 2008) [LBEXDOCID 587401].
Lehmanoriginated52positionsinthefourthquarterof2007,40inthefirstquarterof2008,and19inthe
secondquarterof2008.Id.
1094Lehman,GlobalRealEstate2008NetMarkDowns(Sept.5,2008)[LBEXAM346991].Thenetfigures
subtractLehmanswriteupsonPTGassetsfromthewritedowns.Althoughnetwritedownstypically
include the offset from hedging, the Examiners financial advisor has observed that Lehman did not
effectivelyhedgePTGpositionsduringthisperiod.ExaminersInterviewofAristidesKoutouvides,Nov.
20,2009,atp.9.Thegrosswritedownfiguresare$137millioninfourthquarter2007and$318millionin
firstquarter2008.LehmandidnotwriteupPTGassetsinfourthquarter2007,butdidwriteupcertain
PTGassetsby$47millioninfirstquarter2008(principally,TroxlerSpringMountainRanch).Lehman,
GlobalRealEstate2008NetMarkDowns(Sept.5,2008)[LBEXAM346991].
1095Lehmans gross writedown for second quarter 2008 was $316 million, with a $13 million writeup.
Lehman,GlobalRealEstate2008NetMarkDowns(Sept.5,2008)[LBEXAM346991].
301

sizeof$11million.1096Atthattime,thePTGportfoliofeaturedthefollowingproperty
types:1097
Balance Sheet Value at Risk by

Property Type
# of
Property Type
Other
Retail
Positions
3.3%
Office 1.5%
10.5% Condo 146
Condo Hotel 46
21.7%
Industrial 27
Multi
family Land 210
12.1% Hotel Multifamily 103
17.0%
Office 128
Land
32.9% Industrial
Other 64
1.1% Retail 17
Total 741
Approximately33%oftheoverallportfolio,or210positions,waslandfordevelopment,
with condominium developments and conversions comprising the second largest
category.
The size of the PTG portfolio decreased slightly between the second and third
quartersof2008,from741positionsvaluedat$8.5billionto690positionsvaluedat$7.8
1096Lehman, Real Estate Price Verification Presentation [Draft] (July 17, 2008), at p. 3
[LBHI_SEC07940_1169231]. The U.S. PTG portfolio accounted for 60.3% of the total PTG portfolio in
termsofbalancesheetatrisk.TheremainingPTGpositionswereheldintheAsiaandEuropeportfolios.
Id.
1097Lehman,GlobalRealEstateInventorySpreadsheetasofMay31,2008(Aug.8,2008)[LBEXDOCID
2077095].ThecategoryLandwaslabeledLand/SingleFamilybyLehmanininternalpresentations.
Basedonalimitedreviewofunderlyingpositions,theExaminersfinancialadvisorhasobservedthatthis
categoryonlycontainslanddevelopmentassets.
302

billion.1098Thisdecreasewasprimarilydrivenbya$504millionnetwritedowninthe
thirdquarter.1099
By 2008, Lehman had slowed the pace of new originations, but still held many
relatively risky positions originated during the upmarket of 20042007. These
positions, especially equity positions in land development projects, proved difficult to
accuratelyvaluethroughout2008,asisdiscussedbelow.
(4) LehmansValuationProcessforItsPTGPortfolio
Determining the fair value of any asset, especially illiquid assets such as PTG
debt and equity positions, requires the party performing the valuation to exercise
judgmentastoavarietyofcriteriathatapotentialpurchaserwouldconsider.1100These
criteriainclude,amongothers,theamountoffutureexpectedcashflowsexpectedfrom
theassetandaninvestorswillingnesstoaccepttheriskthattheassetwillnotproduce
thesecashflows.1101Thesecriteriaarereflectedinthetwocomponentsofthemarkto
marketvaluationprocess:markingtocreditandmarkingtoyield.1102
1098Id.;
Lehman, GREG Inventory Spreadsheet as of Aug. 31, 2008 (Sept. 13, 2008) [LBEXDOCID
1025119]. The SunCal positions are excluded from this calculation. The Examiners financial advisor
observedthatthedatainLehmansPTGfilesdonotincludethebasisforapositionbeingremovedfrom
thePTGportfolio(otherthansalestothirdparties).
1099Lehman,GlobalRealEstate2008NetMarkDowns(Sept.5,2008)[LBEXAM346991].TheExaminer
notesthatasummaryofwritedownsinE&Ysworkpaperssuggests$503millionforPTGpositions.The
differenceisduetorounding.SeeLehman,3QRealEstateGrossandNetMTMCashBondsSpreadsheet
(Aug.29,2008)[EYSECLBHIMCGAMX08045830].
1100SeeAppendix1,LegalIssues,SectionVII.A,foramoredetaileddiscussionofthelegalstandardfor
determiningfairvaluepursuanttoSFAS157.
1101Futureexpectedcashflowsrefertotheweightedaverageofprojectedcashflowprojectionsadjusted
for the probability that the cash flow will materialize. For example, if there were two cash flow
projections,(1)a50%chancethatcashflowwillbe$10and(2)a50%chancethatcashflowwillbe$20in
303

InthecontextofLehmansPTGportfolio,markingtocreditreferstorecognition
of changes in the amount and/or timing of the future expected cash flows from the
properties underlying the PTG positions (the collateral).1103 In terms of marking a
PTGasset,markingtocreditincludestherecognitionofachangedcollateralvaluedue
toanychangeinthebusinessplanthatchangedtheamountofcashflowsthecollateral
was expected to generate and/or the time period in which the expected cash flows
would be received.1104 Thus, marking to credit takes into account the changed
circumstancesoftheparticularassetinquestion.
In contrast, marking to yield takes into account changes in broader market
conditions affecting the value of an asset even if the circumstances of the asset itself
havenotchanged.Yieldsometimesreferredtoasarateofreturnordiscountrate
is the discount rate used to determine the present value of the future expected cash
flows, accounting for the risk that the asset will not perform as expected. As an
Year1,theexpectedcashflowforYear1is$15,whichiscomputedasfollows:(50%*$10)+(50%*$20)=
$15.
1102ThetermsmarkingtocreditandmarkingtoyieldwereusedbyvariousLehmanpersonnelwho
wereresponsibleforthevaluationofPTGassets.E.g.,ExaminersInterviewofAbebualA.Kebede,Sept.
29,2009,atp.6;ExaminersInterviewofEliRabin,Oct.21,2009,atp.7;ExaminersInterviewofAristides
Koutouvides,Nov.20,2009,atp.18.Forexample,inreviewingtheproposedPTGwritedownsforthe
thirdquarterof2008,KennethCohenmadenotesonadocumentstatingwhetherthereasonforthewrite
down was Credit or Yield. Kenneth Cohen, Lehman, Q3 Writedown Fax (Aug. 25, 2008)
[LBHI_SEC07940_2278242].
1104Markingtocreditwouldresultinanincreaseinvalueifthechangeinthebusinessplanresultedinan
increase in expected cash flows and/or accelerated the time period in which the expected cash flows
wouldbereceived.
304

investors willingness to accept the risk associated with an asset decreases, the yield
demandedtopurchasetheassetincreasesandthepurchasepricegoesdown.
ForthevaluationofequitypositionsinthePTGportfolio,yieldisrelevantforthe
determination of the value of the underlying collateral. For the loans and debt
instruments in the PTG portfolio, yield is relevant for the same purpose, but also for
determiningthediscountraterequiredforvaluingthedebtinvestmentsthatarebacked
by the collateral.1105 Both discount rates adjust value to account for the risk that the
expected cash flows will not materialize, but one is in relation to the cash flows
producedbytheunderlyingcollateralandtheothertothecashflowsproducedbythe
debtinstrument.
Inshort,markingto marketisintegraltotheconceptoffairvalue.Markingto
credit involves adjusting the value for deterioration (or appreciation) of future cash
flows expected from the investment. Marking to marketbased yield involves
discounting the cash flows expected based on a rate of return that is required by
investorsasofthevaluationdate.
1105Foranexampleofadiscountrateusedinvaluingtheunderlyingrealestatecollateral,seeTriMont,
AssetStatusReportforHeritageFieldsElToroLLC(July1,2008),attabNPV[LBEXBARFID0027112].
Foranexampleofadiscountrateusedinvaluingthedebtinvestmentsthatwerebackedbythecollateral,
see Zev Klasewitz, Lehman, Single Asset Debt Model May 2008 Spreadsheet (June 14, 2008), at tab
matrix(new)[LBEXLL1985749].
305

(a) TheRoleofTriMontintheValuationProcessfor
LehmansPTGPortfolio
LehmansvaluationprocessforitsPTGPortfoliobeganwithTriMontproviding
assetspecific information to the PTG business desk and Product Control. On the
businessdesk,BarsantiandKoutouvidesusedthatinformation,supplementedbytheir
knowledge of the status of the development and local market conditions, to value the
PTG positions.1106 ProductControl entered theTriMontdata and otherdata into their
modelstopricetestthevaluationsdeterminedbythebusinessdesk.1107
PTG outsourced a substantial part of the loan servicing and asset management
functions to TriMont, its primary asset servicer.1108 Given the substantial number and
geographicdiversityofPTGpositions,itwasmorecosteffectiveforTriMonttoprovide
theseservicesthantouseLehmanpersonnel.1109AsofMay2008,TriMontservicedover
90%ofLehmansPTGassets.1110
1106Examiners Interview of Anthony J. Barsanti, Oct. 15, 2009, at pp. 9, 1112; Examiners Interview of
1107Lehman,GlobalRealEstateProductControl,RealEstateAmericasPriceVerificationPresentationto
theSEC(Feb.1,2008),atp.5[LBEXWGM916015];ExaminersInterviewofEliRabin,Oct.21,2009,atp.
8;ExaminersInterviewofRebeccaPlatt,Nov.2,2009,atp.5.
1,2004),atpp.1112[TR00044479].
Koutouvides,Nov.20,2009,atpp.8,910.
1110SeeZevKlasewitz,Lehman,SingleAssetDebtModelMay2008Spreadsheet(June14,2008)[LBEXLL
1985749]; Zev Klasewitz, Lehman, Single Family Debt Model May 2008 Spreadsheet (June 14, 2008)
[LBEXLL1985605];Lehman,SingleFamilyEquityModelMay2008Spreadsheet(May31,2008)[LBEX
LL 1985924]; Lehman, Strategic Equity Model May 2008 Spreadsheet (May 31, 2008) [LBEXBARSOX
0000594]; Zev Klasewitz, Lehman, Single Family REO Model May 2008 Spreadsheet (June 13, 2008)
[LBEXLL 1985887]; Lehman, Strategic REO Model May 2008 Spreadsheet (May 31, 2008) [LBEXLL
1985926].
306

TriMontservicedloans,handledinsuranceissuesfortheunderlyingrealestate,
dealtwiththeadministrativeaspectsoffundingborrowingsforconstruction,anddealt
withthelocaldeveloperonaregularbasisregardingoperationalissues.1111Withrespect
tothevaluationprocess,TriMontprovidedLehmanwithpropertyleveldata,aswellas
data regarding overall value of the development and the status of the project.1112
Barsanti and Koutouvides relied on this information to value the PTG positions.1113
Koutouvides had daytoday responsibility for working with TriMont.1114 Lehmans
policy was to not disclose its marks to TriMont, thus ensuring that TriMont provided
datafreefromtheinfluenceofLehmansvaluationofitsinvestments.1115
1, 2004), at pp. 1112 [TR00044479]; Examiners Interview of Anthony J. Barsanti, Oct. 15, 2009, at p. 9.
PCCP,LLC,servicedasmallernumberofassetsthatareirrelevanttothisanalysis.Lehman,GlobalReal
EstateProductControl,RealEstateAmericasPriceVerificationPresentationtotheSEC(Feb.1,2008),at
p.5[LBEXWGM916015];ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.10.
1112ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atpp.10,14.Aspartofthe2007audit,
E&Yinternallycirculatedareviewof25positions.MemorandumfromRobertMartinek,E&Y,toE&Y
AuditTeamforLehmanBrothers,etal.,re:LehmanBrothersCommercialRealEstatePortfolio(Jan.24,
2007),atp.1[EYLELBHIWPHC000397].TriMontprovidedvaluationdataforallofthesepositions,
andthereviewconcludesforallofthemthatTriMontprovidedavaluationestimatewithintheexpected
rangeofprobablevaluessupportedbythemarket.Id.atpp.3,5,79,11,13,15,1718,20,22,2425,27,
29,30,32,3435,37.
Koutouvides,Nov.20,2009,atpp.10,14.
Koutouvides,Nov.20,2009,atpp.10,14;Lehman,GREG,IntroductiontoAssetManagement(Sept.11,
2007),atp.3[LBEXLL2746736](describingTriMontas[i]dentify[ing]deals,propertytypes,sponsors
and/ormarketstofocusassetmanagereffortsand[d]evelop[ing]anddeliver[ing]efficientreportingto
[Lehman] at the deal and portfolio level (projected deal P&L, IRR returns, annual valuations, expected
payoffs,etc.).
307

The value of the underlying real estate the collateral value was the most
important piece of information for purposes of valuation.1116 For each asset, TriMont
provided a collateral value eight months after Lehman made its investment, and
annuallythereafter.1117LehmantypicallydidnotchangeaPTGvaluationfrompar(i.e.,
100% of the investment or the funded amount) unless there was a triggering event,
suchasafailureofthebusinessplanthatreducedthecollateralvalueprovidedtoPTG
byTriMont1118
ThedatafilesproducedbyTriMontforthesecondquarterof2008categorizethe
collateralvaluation methodsin avariety ofways,butasthedata wasincomplete, the
Examinersfinancialadvisoridentifiedthemethodusedtovaluecollateralfor473ofthe
741positions(or64%ofthePTGportfolio).1119Amongthese473positions,thevaluation
1116Examiners Interview of Jennifer Park, Sept. 10, 2009, at p. 8, Examiners Interview of Abebual A.
Kebede,Oct.13,2009,atp.6;ExaminersInterviewofEliRabin,Oct.21,2009,atpp.67.
1,2004),atp.23.[TR00044479].InJuly2008,TriMontagreedtoreducethistothreemonthsafterclosing.
TriMont, TriMont Valuation Methodologies for Lehman Brothers PTG and LLG Assets: General
Guidelines(July1,2008)[LBHI_SEC07940_1201683].TriMontlistedboththecurrentvalue,whichwas
the present value of the asset, and the stabilized value, which was the anticipated value of the asset
afterthedevelopmentprojectwascompletedandtheassetwasgeneratingsufficientoperatingrevenue.
ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atpp.10,12.
1118ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.10.KoutouvidesconfirmedBarsantis
statement,sayingtherehadtobeacatalystforthevaluetochange.ExaminersInterviewofAristides
Koutouvides,Nov.20,2009,atpp.1011.
1119TriMont, TriMont Valuation Methodologies for Lehman Brothers PTG and LLG Assets: General
Guidelines(July1,2008)[LBHI_SEC07940_1201683].ForexamplesoftheTriMontexportspreadsheets,
seetheMay2008TriMontexportspreadsheetfordebtpositions,TriMont,DebtExportasofMay5,2008
(June 2, 2008) [LBEXAM 262026], and the May 2008 TriMont export spreadsheet for equity positions.
TriMont,EquityExportasofMay5,2008(June2,2008)[LBEXAM262362].
308

method usedbyTriMontcan beseparatedintotwo general categories: historical cost
basedvaluationmethodsandmarketbasedmethods.
Thehistoricalcostbasedvaluationmethodswereusedforatleast228positions,
or about 30% of the positions in the PTG portfolio in the second quarter of 2008.1120
Thesemethodsreliedprimarilyoncapitalizationofthedevelopment,alongwithsome
multiplier,tocalculatecollateralvalues.1121Cap*105wasthemethodusedforthevast
majorityofthesepositions,althoughvariationsofthecapitalizationmethodwerealso
used.1122
The marketbased methods were used for at least 245 positions, or 33% of the
positions in the PTG portfolio in the second quarter of 2008.1123 These categories
includedIRRmodels(80positions),aswellasothermethodsthatincorporatedmarket
basedassumptions.1124However,theTriMontspreadsheetscontainlittleexplanationfor
severalofthesemethods.Forsomecategories,suchaspurchaseoffer(17positions),
themethodappearstobeselfexplanatory,buttheTriMontfilesrefertofactsthatwere
1120Cap*105wasusedfor225ofthesepositionsandCap*100for3positions.
1121Duetolimitationsinthedata,theExaminerhasnotdeterminedwhyanyofthevariantsofCap*105
were used instead of Cap * 105, but all of them appear to be equivalent in using historical costbased
approachesinvaluingcollateralandnotincludinganymarketdata.
1122TriMont,DebtExportasofMay5,2008(June2,2008)[LBEXAM262026];TriMont,EquityExportas
ofMay5,2008(June2,2008)[LBEXAM262362].
1124The full list of categories includes: purchase offer, IRR, expected sale price, market prices, sellout
calculation,paidoff,propertysold,andcaprate.ForexamplesoftheTriMontexportspreadsheets,see
the May 2008 TriMont export spreadsheet for debt positions, TriMont, Debt Export as of May 5, 2008
(June 2, 2008) [LBEXAM 262026], and the May 2008 TriMont export spreadsheet for equity positions.
TriMont,EquityExportasofMay5,2008(June2,2008)[LBEXAM262362].
309

not documented in the files.1125 For other categories, such as one for sellout
developments (95 positions),1126 the TriMont files simply note a sellout calculation
was performed, but provide very little additional information.1127 The Examiners
financial advisor has observed that most of these methods appear to rely on market
based assumptions, but there is insufficient information for the Examiner to evaluate
theinputsTriMontusedorthebasisforthecollateralvaluecalculated.
However, one particular marketbased method for calculating collateral value
wasthefocusofPTGandTriMontduringthistimethediscountedcashflowmethod
that served as the basis for IRR models. As described below, Lehman and TriMont
wereintheprocessofincorporatingIRRmodelsthroughout2007and2008.Becauseof
the increased use of IRR models, and the effect that this switch had on Lehmans
valuation of PTG assets, the Examiner has focused on this method in evaluating the
reasonableness of Lehmans PTG valuations during the second and third quarters of
2008.
1125For example, for purchase offer, the Examiners financial advisor has observed no evidence
showingthetermsofanyofferfromaninvestororhowthatwasusedtovaluethecollateral.
1126A sellout development is a real estate development in which the business plan is to sell off
individualunitsofthepropertyratherthanthepropertyasawhole.
310

(i) LehmansIssueswithTriMontsData
AccordingtoseveralLehmanwitnesses,itwascommonplaceforTriMontsdata
toincludeerrors.1128KoutouvidestoldtheExaminerthatTriMonthadweakcontrols
forvaluinglanddevelopmentassets.1129Whenthedataindicatedthatapositionmight
need to be remarked, it was sometimes caused by an error.1130 The errors were
substantial and extensive enough that Koutouvides spent much of his time fixing
TriMontserrors.1131Koutouvidesnotedthat,despiteinstructingTriMonttofixdataas
to an asset in one month, the same problem would often reappear the next month.1132
During the period in which TriMont was providing IRR models, Koutouvides
1128ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atpp.1314;ExaminersInterviewofEli
Rabin, Oct. 21, 2009, at p. 8; Examiners Interview of Rebecca Platt, Nov. 2, 2009, at p. 5; Examiners
Interview of Aristides Koutouvides, Nov. 20, 2009, at p. 13. See Lehman, Business Requirements
Document(Full)forGREGTriMontExportFile[Draft](Oct.29,2007),atp.7[LBEXDOCID3501542]
(In the current system, Trimont has not modeled the exit date as a function to factor the changes in
marketcondition.Thechangesinmarketconditionmayresultinrepaymentdelaysandhencetheexit
date may change.); email from Anthony J. Barsanti, Lehman, to Britt Payne, TriMont (July 25, 2007)
[LBEXDOCID 2291650] (Barsanti responding I thought so to Paynes message that the value for
AnnapolisJunctionat100%ofcapitalizationisoverstatedanditsawriteoff);emailfromEliRabin,
Lehman, to Aristides Koutouvides, Lehman (Dec. 12, 2007) [LBEXDOCID 1639358] (According to the
[TriMont]export,thispropertyhasalreadybeensold.IknowthisisstillanactivepositionontheBS,soI
know something is incorrect.). Because of the errors, Koutouvides considered the stabilized value
reportedbyTriMonttobeuseless.ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atp.
15.
Rebecca Platt, Nov. 2, 2009, at p. 5. Platt stated that, on occasion, a position would have a value that
madeabsolutelynosense.Forexample,thepositionshouldhavebeenmakingmoneybutwasnot.Platt
statedthatshewouldassumethatTriMontsdatawasflawed,suchasthattherewasawrongmaturity
datethatthrewoffthecashflows,ratherthanconcludethatthepositionneededtoberemarked.Id.
1132Id. According to Koutouvides, PTG hired him in late 2006 in part to improve TriMonts data
reporting.Koutouvidesstatedthat,eventhoughhehadnopriorrealestateexperience,PTGhiredhim
from Lehmans corporate division because of his experience overhauling Lehmans IT system and
infrastructure.Id.atp.6.
311

characterized several meetings with TriMont as screaming matches, where he and
BarsantiexpressedfrustrationatTriMontsinabilitytoprovideaccuratedata.1133
In Koutouvides view, TriMont asset managers varied widely in ability, and
some had become too close to the developers, such that the asset managers were not
reporting on deteriorating local market conditions, preferring instead to rely on the
developers assurances that the project would be a success.1134 Koutouvides recalled
that, on at least one occasion, his concern that the TriMont asset managers were not
obtaining credible data as to the status of the project and local market conditions
resulted in his telling TriMonts asset managers to stop feeding me bullshit. I dont
believeyou.1135
Barsanti disagreed with Koutouvides opinion that TriMont provided high
valuations,butheconfirmedthatthereweremanyinstanceswherePTGhadtoinstruct
TriMonttocorrectthedata.1136
(ii) LehmanChangedItsValuationMethodologyforIts
PTGPortfolioinLate2007
As noted, until 2007 Lehmans primary method for valuing the collateral
underlying its PTG positions was the Cap * 105 method. Cap * 105 calculated the
1133Id.atp.14.
1134Id.
1135Id.
1136Examiners Interview of Anthony J. Barsanti, Oct. 15, 2009, at pp. 1314. Barsanti stated that, in his
view, TriMont had a conservative view towards valuation. Id. Barsanti also stressed throughout his
interviewwiththeExaminerthedifficultyofvaluingPTGassetswithoutsalesdatatogiveanindication
ofvalue.Id.atp.11.
312

current capitalization of the underlying property (i.e., outstanding debt plus equity
investedtodate),andthenmultipliedthisnumberby105%toestimatethevalueofthe
collateral as of the specific valuation date.1137 The additional 5% represented the
presumedappreciationofthecollateral.
By late 2007, Lehman had determined that Cap * 105 was not an appropriate
methodologyfordeterminingcollateralvalue.1138Inanupwardtrendingmarket,Cap*
105tendstoundervaluecollateralwhenappreciationoccursataratehigherthan5%.1139
Kebede,VicePresidentinProductControl,statedthatCap*105wasawaytorestrain
value inflation when the markets were going crazy.1140 Despite pressure from
auditorsandotherbusinessunits,PTGspolicywastonotwriteuppositionsuntilthe
businessplanwassubstantiallyexecutedandrealizationofgainswasimminent.1141
Whenrealestatevaluesbegantodeclinein2007,Cap*105startedtoovervalue
PTGcollateral.1142BecauseCap*105simplycalculatedcurrentcapitalizationandadded
1137Adealstotalcapitalizationincludesalloutstandingdebtsuchasloanprincipalandequityasof
thevaluationdate,includingborrowersequityand/orinvestedcapital.
AristidesKoutouvides,Nov.20,2009,atp.15.SeeemailfromEdDziadul,RealComFinancialPartners
LLC, to Dennis Grzeskowiak, TriMont, et al. (Mar. 23, 2008) [LBEXDOCID 2293586] (noting that
TriMontscollateralvaluationmethodologymadecurrentvalueworthless).
1139See,e.g.,Lehman,Valuation&ControlReportFixedIncomeDivision(Dec.1,2008),atp.27[LBEX
WGM755798](Currentvaluationmethodologyforlanddevelopmentprojectsisbasedoncap*105%,
whichwasaconservativeorprudentapproach[in]anupmarket.).
1140ExaminersInterviewofAbebualA.Kebede,Oct.6,2009,atp.4;ExaminersInterviewofAnthonyJ.
Barsanti,Oct.15,2009,atp.10.
Koutouvides,Nov.20,2009,atp.11.BarsantistatedthatthispolicycamedirectlyfromKennethCohen
andMarkA.Walsh.ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.10.
1142ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atpp.1213.
313

a 5% premium, it could never capture deterioration of collateral value that could
happen through, for example, marketwide declines in property values. Product
Controldeterminedbytheendof2007thatalthoughCap*105wasaconservativeor
prudent approach [in] an upmarket . . . [g]iven current market conditions, this
approachmaynotbeappropriate.1143
Inearly2007,PTGbegantoenactaplantochangeTriMontsprovisionofasset
leveldata.1144ThisoverhaulinthereportingsystemwasintendedtorequireTriMontto
providesupportforassumptionsaboutassetsandtobemoreresponsivetomarketplace
changes.1145Aspartofthatoverhaul,PTGdecidedthatCap*105wasnotgoingtocut
it, and planned to have TriMonts calculation of collateral value move to a more
marketbasedmethodology.1146PTGandTriMontreferredtothenewmodelsbasedon
thismethodologyasIRRmodels.
BarsantiandKoutouvidespreferredIRRmodelstoCap*105becausethemodels
hadtheabilitytovaluecollateralunderadiscountedcashflowmethod,whichBarsanti
and Koutouvides considered to be the best method for valuing collateral for PTG
1143See,e.g.,Lehman,Valuation&ControlReportFixedIncomeDivision(Dec.1,2007),atp.27[LBEX
WGM755798].
314

positions.1147 Under the discounted cash flow method, an IRR model calculated the
currentvalueofcollateralbydeterminingtheNetPresentValue(NPV)ofallmonthly
discounted Net Cash Flows (NCF).1148 As a first step, the IRR model calculated the
NCF produced by the asset by taking monthly expected revenue and subtracting
monthlyexpectedexpenses.1149Tothisresult,theIRRmodelappliedadiscountrateto
produce the NPV of the NCF. In order to reflect fair value, the discount rate should
reflect, for both equity and debt investments, the yield an investor would require to
purchase theproperty. However,Lehmangenerally attributeda discount rate for the
equity portion of the capital structure based on Lehmans expected rate of return (i.e.
20% for land developments) and, for debt, a discount rate based on the interest rate
associatedwiththeunderlyingloansatorigination.1150TheIRRmodelstookaweighted
1147Id.;
Examiners Interview of Aristides Koutouvides, Nov. 20, 2009, at pp. 4, 15. The Examiners
financial advisor has observed that IRR models are a flexible tool for valuing collateral and do not
necessarilyusethediscountedcashflowmethodforeveryvaluation.However,theprimaryreasonPTG
requiredTriMonttouseIRRmodelswasthattheyperformedadiscountedcashflowanalysis.Id.
2008)[LBEXDOCID2089942].Thecashflowsinthiscalculationincludedthecashflowsexpectedtobe
generatedbythepropertythatwouldbeavailablefordistributiontoallinvestors.
1149ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.14.Revenuesconsistedofallofthe
income that the investors in the property expected to generate from the time of investment through
executionoftheexitstrategy.Asof2007,therevenuesforPTGassetstypicallywerethesalesrevenue
once the project was completed (i.e., sale of a hotel), but sometimes the asset generated revenue in the
formofrent,portionsofadevelopmentsold,orotherpaymentsbeforeitssale.Expensescouldinclude
anythingtheinvestorsexpectedtopayindevelopmentcosts(i.e.,entitlingland,construction),financing
costs(i.e.,loanfees,interests),orotherindirectcosts(i.e.,administrativefees,marketing).
2008)[LBEXDOCID2089942].
315

averagebetweenthesetworatestoarriveattheweightedaveragediscountrateforthe
property.1151
Instead of referring just to what Lehman and the other investors paid for the
positiontoreflectcurrentvalue,IRRmodelshadtheadvantageofincorporatingfuture
events(projectedrevenuesandexpenses)intothepresentvalue,andthendiscounting
thatvalueinrecognitionoftheriskthattheinvestmentmightnotbesuccessful.Cap*
105 incorporated no discount for risk, and therefore, generally produced higher
collateralvaluesthanIRRmodelsinadownwardtrendingmarket.1152
The IRR models were implemented on a rolling basis and the models were
calibrated after they were put into use.1153 TriMont started implementing the IRR
models in California in 2007, as valuation of California land developments was a
primarysourceofconcernforPTG.1154KoutouvidesandBarsantiworkedcloselywith
TriMontinimplementingtheIRRmodels,andKoutouvidesstatedthatinMarch2007
hewasonaplaneallthetimetovisitTriMont.1155
1151Theweightedaveragewasbasedontheoutstandingdebtandtheequityinvestedtodate.
1153Examiners Interview of Aristides Koutouvides, Nov. 20, 2009, at p. 15. Koutouvides managed the
process of acquiring the models, reviewing them with Barsanti, and following up with TriMont to fix
errorsinthedata.Id.atp.10.
1155ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atp.14.SeeemailfromLoriGiesler,
TriMont, to Chris W. Warren, Lehman (Jan. 21, 2007) [LBEXDOCID 3606437]. Barsanti occasionally
joinedKoutouvidesonthesetrips.SeeemailfromDennisGrzeskowiak,TriMont,toJimHill,TriMont,et
al.(Mar.7,2008)[LBEXDOCID2293369].
316

TherolloutofIRRmodelsexperiencedmanydelays,andTriMontmissedseveral
deadlinesin2007and2008,causingmorefrustrationforPTG.1156Forexample,afterone
misseddeadline,BarsantistatedinaMarch2007emailthat[a]sthemarketcontinues
tosoften,IcanttellyouhowmuchwedependontheseIRRstomarkourposition.1157
Over a year later, on March 23, 2008, an email sent to TriMont by a PTG consultant
indicatedthattheCap*105method,whichwasstillwidelyinuse,wasworthless.1158
In Product Controls Valuation & Control Reports, the same comment appears
unchanged over a series of months, stating that TriMont was developing IRR models
and walking away from cap * 105% methodology.1159 Because of the delays,
1156SeeemailfromDennisGrzeskowiak,TriMont,toJimHill,TriMont,etal.(Mar.7,2008)[LBEXDOCID
2293367](TheyarerefusingtofundtheMonteSerenodrawrequestuntiltheIRRmodelisupdatedto
reflect the current scenario.); email from Aristides Koutouvides, Lehman, to Anthony J. Barsanti,
Lehman(Mar.7,2008)[LBEXDOCID2293369]([T]hey[TriMont]needtoupdatethemodelaccurately
beforethefinalnumbercanbedetermined.);emailfromDennisGrzeskowiak,TriMont,toEdDziadul,
RealComFinancialPartnersLLC(Mar.23,2008)[LBEXDOCID2293586](containinganemailexchange
revealing Dziaduls concern as to why Current Value . . . determined by discounting the Remaining
ValuetotheExitDatewasnotbeingapplieduniversallyandGrzeskowiaksresponsethat[t]hattiesto
TriMonts current valuation methodology . . . were working on revising that policy). Barsanti stated
that many times he was laying the hammer down on TriMont because of its delays, which made
updatingthecollateralvalueslumpy.ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.
13.
1157Email from Anthony J. Barsanti, Lehman, to Lori Giesler, TriMont, et al. (Mar. 13, 2007) [LBEX
DOCID2290789].
1158Email from Ed Dziadul, RealCom Financial Partners LLC, to Dennis Grzeskowiak, TriMont, et al.
(Mar.23,2008)[LBEXDOCID2293586].DziadulwasaformerPTGemployeelocatedinCaliforniawho,
afterleavingLehman,assistedwithTriMontsimplementationofIRRmodels.ExaminersInterviewof
AnthonyJ.Barsanti,Oct.15,2009,atp.13.
1159Lehman, Valuation & Control Report Fixed Income Division (June 2008), at p. 29 [LBEXWGM
370046]; Lehman, Valuation & Control Report Fixed Income Division (July 1, 2008), at p. 29 [LBEX
WGM790236];Lehman,Valuation&ControlReportFixedIncomeDivision(Aug.2008),atp.29[LBEX
BARFID0000260].SeealsoemailfromBrianBarry,Lehman,toJeffreyGoodman,Lehman,etal.(June19,
2008) [LBHI_SEC07940_2234984] (Within the last 6+/ months, a change to the methodology (for
valuations)wasimplementedbyTrimont(attherequestofProdControl&thebusiness).Trimonthas
317

KoutouvidesstatedthatheoftenstillreliedoncollateralvaluesbasedonCap*105in
markingpositions,asitwastheonlyavailableinformation.1160
As noted, TriMonts data provided to Lehman did not contain the information
necessarytoidentifythemethodsusedtovaluethecollateralforeachPTGposition.1161
However, in May 2008, at least 228 PTG positions still relied on some variant of the
capitalizationmethod(suchasCap*100andCap*105)tovaluetheircollateral.1162This
representedroughlyathirdofthePTGportfolio.TheExaminersfinancialadvisorhas
identified IRR models for 80 PTG positions in the second quarter of 2008.1163 By July
2008,thattotalforIRRmodelsfoundincreasedto292.Duetolimitationsinthedata,
the Examiners financial advisor has identified only 105 positions that switched from
Cap*105toIRRmodelsbetweenMayandJulyof2008.1164BarsantiandKoutouvides
madetremendousprogressinimplementingthesechanges,itisjustaquestionofhowmuchhasactually
madeittotheexportwereceive.Withthatsaid,Trimontisactivelyupdatingcurrentvalues.);TriMont,
TriMont Valuation Methodologies Lehman PTG and LLG CMBS Hold Assets (Apr. 28, 2008) [LBEX
DOCID2089942](replacing105%ofcapmethodologywith[l]esserof100%ofTotalCaportheNPVof
allmonthlyNCFs).
1161The Examiner determined that it would not be a prudent use of resources to interview numerous
TriMontassetmanagerstodetermineiftheycouldrecallinformationthatwasnotsetforthinthereports
providedtoLehman.
ofMay5,2008(June2,2008)[LBEXAM262362];TriMont,DebtExportasofJuly5,2008(Aug.1,2008)
[LBEXAM 267134]; TriMont, Equity Export as of July 5, 2008 (Aug. 4, 2008) [LBEXAM 267510]. The
Examinersfinancialadvisorhasidentified153positionsthattransitionedfromCap*105(oritsvariants)
toadifferentvaluationmethod,buthasnotidentifiedwhatthatnewmethodwasfor75positions.There
318

assertedthat,byJuly2008,TriMonthadimplementeduseofIRRmodelsforallofthe
land deals managed by its California office (which had approximately 100 positions)
and80%ofthosemanagedbyitslargerAtlantaoffice.1165
(b) TheRoleofLehmansPTGBusinessDeskintheValuation
ProcessforLehmansPTGPortfolio
Since PTG assets were risky, illiquid, mediumtolong term investments, the
business desk had a difficult time valuing them, particularly during a market
downturn.1166 Under the classification scheme established by SFAS 157, which
categorizes assets based on the degree of certainty the valuation process can provide,
almost all PTG assets were classified as Level 3, whose values are the most subjective
becausetheydependonunobservableinputs.1167
Consistentwiththeunobservablenatureofthevaluationinputs,theExaminers
financialadvisorhasobservedthatLehmansrecordsdonotindicatethedirectrelation
between the collateral values provided by TriMont and the business desks mark.
is a high likelihood that there were more than 105 positions that transitioned from Cap * 105 to IRR
modelsinJuly2008.
AristidesKoutouvides,Nov.20,2009,atpp.89,13.
1167Fin.AccountingStandardsBd.,FairValueMeasurements,SFASNo.157,2122,24(2006);Lehman,
GlobalRealEstateInventorySpreadsheetasofMay31,2008(Aug.8,2008)[LBEXDOCID2077095].As
ofMay31,2008,PTGheldnoLevel1assets,6Level2assets,and380Level3assets.Lehman,GlobalReal
EstateInventorySpreadsheetasofMay31,2008(Aug.8,2008)[LBEXDOCID2077095].Theremainder
ofPTGassetswereConsolidatedassetsandnotsubjecttoSFAS157.SeeLehmanBrothersHoldings
Inc.,PressRelease:LehmanBrothersReportsFirstQuarterResults(Mar.18,2008),atp.14[CITILBHI
EXAM00078274];ConsolidationofVariableInterestEntities,InterpretationofFin.AccountingStandards
No.46(Fin.AccountingStandardsBd.2003).
319

Lehmans asset managers, Barsanti and Koutouvides, routinely had to look beyond
TriMonts data and refer to the business plans and submarket data for a particular
propertytype,andthenexerciseindependentjudgmentastohowmuchthecollaterals
current value, as determined by the information provided by TriMont, should inform
themark.1168AlthoughPTGsrecordssetforththestatusofeachproject,includingany
problems that the development was experiencing, they do not describe how Lehman
employed its judgment to translate such problems into a writedown of a particular
amountforthecorrespondingPTGasset.1169
KoutouvidesdescribedhisvaluationprocessascastinganetwithTriMontsdata
to identify outliers and closely observing those positions to determine which ones
neededtoberemarked.1170AccordingtoKoutouvides,Lehmanspolicyforrevaluinga
positionwasthattherehadtobeacatalystforthevaluetochange,suchasafailureof
thebusinessplan.1171Koutouvidesfocusedonhardertovaluelandandcondominium
positions.1172 Notably, 99% of writedowns taken on the PTG portfolio during 2008
relatedtopositionswithlandorcondominiumsascollateral.1173Whenthereliabilityof
1168ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atpp.9,11,1314.
1169Forexample,theExaminersfinancialadvisorhasobservedthatTriMontsIRRmodelsandLehmans
price testing files do not indicate how exactly the business desk used this information to mark the
portfolio or write down assets. See, e.g., TriMont, Asset Status Report for Heritage Fields El Toro LLC
(July 1, 2008) [LBEXBARFID 0027112]; Lehman, Valuation & Control Report Fixed Income Division
(May2008),atp.22[LBHI_SEC07940_2554301].
1171Id.atpp.1011.
1172Id.atp.12.
1173Lehman,GlobalRealEstate2008NetMarkDowns(Sept.5,2008)[LBEXAM346991].
320

TriMonts method for calculating collateral values improved through the shift to IRR
models,BarsantiandKoutouvidesreliedonthosevaluesmorefrequently,butnothing
TriMontprovidedwastakenasgospelbythebusinessdesk.1174
TestingtheValuationofLehmansPTGPortfolio
Separate from the marking process of the PTG business desk, the Product
Control Group performed an independent price verification of the PTG marks.
JonathanCohenoversawProductControlsvaluationandpricetesting,andAbebualA.
Kebede worked under him and had daytoday oversight of the Product Control
staff.1175DirectedbyKebede,twojuniorproductcontrollersranmodelstogeneratetest
pricesforPTGpositions.1176EliRabinperformedpricetestingonallPTGpositionsuntil
early2008,whenLehmanhiredRebeccaPlatttopricetestthePTGdebtpositions.1177
Product Control performed the price testing process for a given month at the
beginning of the following month and performed its most thorough price testing at
quarterend.1178Topricetest,productcontrollersfedcollateralvaluesandotherinputs
theSEC(Feb.1,2008),atp.3[LBEXWGM916015].
1177Id.; Examiners Interview of Eli Rabin, Oct. 21, 2009, at p. 4; Examiners Interview of Rebecca Platt,
Nov.2,2009,atp.4.IncludedinthepricetestingforPTGequitywerethepositionsonwhichLehman
foreclosed and recategorized as real estate owned. Lehman, Real Estate Monthly Price Verification
PolicyandProcedures(July16,2008),atp.12[LBEXDOCID1454682].
[LBHI_SEC07940_1169231] (Price Verification is performed on a monthly basis); Lehman, Real Estate

MonthlyPriceVerificationPolicyandProcedures(July16,2008),atp.11[LBEXDOCID1454682](The
321

intotheir modelstoproduceamodelpriceforthedebtorequityposition,whichwas
comparedwiththebusinessdesksvalue.Thedifferencebetweenthetwowastermeda
variance.1179
Rabin and Platt used the same assetspecific data that TriMont provided to the
business desk.1180 They generally applied the collateral values provided by TriMont,
whether they were based on Cap * 105 or IRR models.1181 However, Rabin told the
Examiner that both of his superiors in the Product Control Group and business desk
personnel sometimes instructed him to disregard the current value provided by the
models.1182 Product Control knew that Cap * 105 caused inaccurate valuations of
collateral, but those collateral values were still used in the absence of IRR models.1183
PlatttoldtheExaminerthatsheobservedasuddendropincollateralvaluesacrossthe
PTGdebtbookwhenmoreIRRmodelswereincorporatedinJuly2008.1184Inaddition,
quarterly analysis is a much more detailed analysis of pricing variances resulting from the routine
monthlyprocess.);ExaminersInterviewofEliRabin,Oct.21,2009,atp.5.
1179ExaminersInterviewofAbebualA.Kebede,Sept.29,2009,atp.5.
theSEC(Feb.1,2008),atp.5[LBEXWGM916015];ExaminersInterviewofEliRabin,Oct.21,2009,atp.
8;ExaminersInterviewofRebeccaPlatt,Nov.2,2009,atp.5.RabinandPlattcouldcontactTriMonton
theirowntodiscussthedata.See,e.g.,emailfromHardingBrannon,TriMont,toRebeccaPlatt,Lehman
(Mar.13,2008)[LBEXDOCID1802324].
1181ExaminersInterviewofEliRabin,Oct.21,2009,atp.8;ExaminersInterviewofRebeccaPlatt,Nov.2,
2009,atp.5.
1183ExaminersInterviewofAbebualA.Kebede,Oct.6,2009,atp.7;ExaminersInterviewofEliRabin,
Oct. 21, 2009, at p. 7. Rabin stated that the Cap * 105 pricing methodology often caused his price
verificationmodelstosuggestthatthevaluesofaPTGpositionshouldbewrittenup,evenwhenRabin
hadspecificknowledgethattheunderlyingdealwasnotperformingwell.ExaminersInterviewofEli
Rabin,Oct.21,2009,atp.7.
322

the price testing results at this time showed that the marks overvalued the PTG debt
book.1185
ThepricetestingmodelsforPTGdebtusedmarketdatatoapplyadiscountrate
(or yield) to account for the marketbased risk of an investment in the debt of that
property type. The risk level was in part determined by the LoantoValue ratio
(LTV),whichistheratioofthevalueoftheoutstandingdebtdividedbythevalueof
thecollateral.AfterdeterminingtheLTVofadebtposition,PlattreferredtotheReal
EstateFinance&Investmentsnewsletter,whichprovideddiscountratesbasedonLTV
andpropertytype.1186Plattthenappliedtheappropriatediscountratetodeterminethe
presentvalueofthedebtposition.1187
Topricetestequitypositions,1188Rabinsmodelsperformedawaterfallanalysis
tocheckthemarks,whichisaprocessthatexaminesthedistributionofproceedsfroma
hypothetical sale of the collateral.1189 In the waterfall analysis any outstanding debt is
1185Id.atpp.7,1011.
1186Email from Rebecca Platt, Lehman, to Abebual A. Kebede, Lehman (June 16, 2008)
[LBHI_SEC07940_2945503]; Examiners Interview of Rebecca Platt, Nov. 2, 2009, at p. 8. The property
typeswereresidential,apartments,retail,malls,stripandpowercenters,industrial,multitenant,office,
CBD,suburban,andhotel.SeeInstitutionalInvestors,Inc.,RealEstateFin.&Inv.Newsl.,May26,2008,
at p. 7 [LBHI_SEC07940_2945508]; Lehman, Global Real Estate Product Control, Real Estate Americas
PriceVerificationPresentationtotheSEC(Feb.1,2008),atp.6[LBEXWGM916015].
1187Examiners Interview of Rebecca Platt, Nov. 2, 2009, at p. 8. There were additional, more technical
stepsinthisprocess,wherethepresentvaluecalculatedbythemodelwascomparedtootherbenchmark
values,suchasthevalueofproceedsfromthecollateralinaliquidationscenario,andthelowestnumber
after these comparisons became the model output. Lehman, Global Real Estate Product Control, Real
EstateAmericasPriceVerificationPresentationtotheSEC(Feb.1,2008),atp.6[LBEXWGM916015].
1188PTGREOpositionsweretestedwith asimilarprocessasthatforPTGequity.Lehman,RealEstate
MonthlyPriceVerificationPolicyandProcedures(July16,2008),atp.12[LBEXDOCID1454682].
323

assumed to be paid out first, with equity holders entitled to the remaining proceeds
subjecttothetermsofanyshareholderagreements.1190
As noted, after Product Control calculated the model price for a debt or equity
position, this price was compared to the business desks mark to determine the
variance.Lehmanspolicywasthat[v]ariancesoutsidethresholdsarediscussedwith
the business for potential mark adjustments.1191 In the PTG debt and equity models,
the threshold for an overvaluation variance was $2 million and the threshold for an
undervaluation variance was $5 million.1192 If Rabin and Platt were unable to resolve
the variance with the business desk, the issue was escalated to Kebede and Jonathan
Cohen, who could then, if necessary, direct these valuation issues to Lehmans senior
managers.1193
1190Id. at p. 6. The models assumed distribution of cash flows in the following order: (1) pay off full
amountofdebt;(2)distributiontoownersforaccumulatedpreferredreturns;(3)distributiontoowners
for return of capital; and (4) distribution to owners for split of any remaining profit according to their
profit and loss sharing ratios. Lehman, Real Estate Monthly Price Verification Policy and Procedures
(July16,2008),atp.12[LBEXDOCID1454682];Lehman,GlobalRealEstateProductControl,RealEstate
AmericasPriceVerificationPresentationtotheSEC(Feb.1,2008),atp.8[LBEXWGM916015].
theSEC(Feb.1,2008),atpp.6,8[LBEXWGM916015].
1192ForanexampleofsuchthresholdsinthePTGdebtpricetestingmodels,seeformulaincellBF4onthe
PricingtabofLehmansSingleAssetDebtModelfromMay2008.ZevKlasewitz,Lehman,SingleAsset
DebtModelMay2008Spreadsheet(June14,2008),attabPricing,cellBF4[LBEXLL1985749].Foran
exampleofsuchthresholdsinthePTGequitypricetestingmodels,seeExcelsfilterfunctionappliedto
column BA on the Valuation tab of Single Family Equity Pricing Model from June 2008. Lehman,
Single Family Equity Model June 2008 Spreadsheet (June 30, 2008), at tab Valuation [LBEXBARFID
0023444].
1193See, e.g., email from Rebecca Platt, Lehman, to Abebual A. Kebede, Lehman (June 18, 2008)
[LBHI_SEC07940_2949726] (stating that she wanted to discuss the comment [for positions that had
pricing variances] with[Kebede] because they[were] foreclosures); Examiners Interview of Eli Rabin,
Oct.21,2009,atp.4;ExaminersInterviewofRebeccaPlatt,Nov.2,2009,atpp.5,1011.
324

As a result of this escalation and resolution process, the positions for which
variances exceeded the given threshold were either remarked or resolved.1194 If
remarked,thebusinessdeskloweredorraiseditsmarkinlightoftheProductControl
testprice.1195Ifresolved,thebusinessdesksmarkwouldremainthesameandProduct
Controlprovidedanexplanationforwhythepositionwasnotremarked.1196Thegoalof
theexplanation,notedinProductControlsmonthly Valuation&ControlReport,was
toprovideinformationnotcapturedbythemodelsthatjustifieddisregardingthemodel
priceandmaintainingthedeskmark.1197
PlattandKebedetoldtheExaminerthattheyoftenhaddifficultyexplainingwhy
positionswerenotremarkedandthatinthesesituationstheycameupwithformulaic
explanations.1198Asaresult,Plattstatedthatmanyoftheexplanationssheprovidedfor
not changing the marks in the PTG debt pricing models were not meaningful and
contained many form responses, such as Based on discussions with the business,
1194Lehman,GlobalRealEstateProductControl,RealEstateAmericas,PriceVerificationPresentationto
theSEC(Feb.1,2008),atp.21[LBEXWGM916015];Lehman,RealEstatePriceVerificationPresentation
[Draft](July17,2008),atp.1[LBHI_SEC07940_1169231].
[LBHI_SEC07940_1169231].
1196Id.
1197Id.;Lehman,GlobalRealEstateProductControl,RealEstateAmericasPriceVerificationPresentation
totheSEC(Feb.1,2008),atp.21[LBEXWGM916015];ExaminersInterviewofAbebualA.Kebede,Oct.
6,2009,atp.5;ExaminersInterviewofRebeccaPlatt,Nov.2,2009,atpp.1011.
1198Examiners Interview of Abebual A. Kebede, Oct. 6, 2009, at pp. 1011 (noting that he wrote
explanationsformarksandthatheagreedwithsomeofthem);ExaminersInterviewofRebeccaPlatt,
Nov.2,2009,atp.4.
325

position is marked appropriately and continue to monitor.1199 Kebede confirmed
that no writedown was taken for many of the positions for which a significant price
testing variance was determined in the third quarter of 2008.1200 Kebede stated that,
althoughtherewasavalidexplanationfornotwritingdownsomeofthesepositions,he
wroteoroversawthewritingofseveralformresponseshedidnotactuallyagreewith
thatwereonlywrittentocomeupwithsomething.1201
(d) TheInfluenceofLehmansPTGBusinessDeskuponthe
PriceTestingFunctionofLehmansProductControlGroup
SeveralwitnessesgaveconflictingstatementsastowhetherProductControlhad
the ability to effectively provide an independent check on the business desk marks.
Walsh told the Examiner that Product Control existed on an independent track and
couldnotbefrozenoutofthevaluationprocess.1202KennethCohenalsostatedthat
ProductControlranonaparalleltrack,andcameupwithitsownnumbersrunning
its own models.1203 Kenneth Cohen stated that the business desk had no control over
ProductControlandthat,ifthebusinessdeskcouldnotconvinceProductControlthat
1199See e.g., Lehman, Valuation & Control Report Fixed Income Division (May 2008), at p. 22
[LBHI_SEC07940_2554301](noting,withrespecttoCalwestandtheNashvillePortfolio,that[b]asedon
discussionwith[the]desk....Nomarkdownsuggested);Lehman,Valuation&ControlReportFixed
IncomeDivision(July2008),atpp.2223[LBEXWGM790236](stating,withrespecttoseveralpositions
for which no writedown was taken, including Whitworth Estates Senior, [i]n discussion with the
business); Lehman, Valuation & Control Report Fixed Income Division (Aug. 2008), at pp. 2223
[LBEXBARFID 0000260] (stating, with respect to Whitworth Estates Senior Whole, [b]ased on
discussionswiththebusiness,positionismarkedappropriately);ExaminersInterviewofRebeccaPlatt,
Nov.2,2009,atpp.1011.
1201Id.;ExaminersInterviewofRebeccaPlatt,Nov.2,2009,atpp.1011.
1203ExaminersInterviewofKennethCohen,Oct.20,2009,atp.10.
326

anumberwascorrect,ProductControlcouldelevatetheissue,allthewayuptoReilly
ifnecessary.1204
Koutouvides considered the Product Control process to be credible, but stated
thatiftherewasadifferenceofopinionbetweenProductControlandthebusinessdesk
regarding valuation ofaPTGasset(which Koutouvides estimated ashappening three
times a month), the mark did not change.1205 Koutouvides confirmed that he did not
take a suggested writedown from Product Control unless he was convinced that the
price testing model was correct.1206 With the market fluctuation in 2008, Koutouvides
statedhewasreluctanttoremarkapositiononlybasedonpricetestinguntilhecould
see where the asset was trending after another quarter.1207 The process resulted in
staggered writedowns, where a lag existed between identification of a trend and the
resultingwritedown.1208
Jonathan Cohen described Product Control as compromised by a lack of
information, and stated that Product Control often took the business desks word on
1204Id.
1205ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atpp.1617.
1206Id.
1207Lehman, Valuation & Control Report Fixed Income Division (Aug. 2008), at pp. 2123 [LBEX
BARFID0000260];ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atpp.1617.
1208Examiners Interview of Aristides Koutouvides, Nov. 20, 2009, at pp. 1617. As an illustrative
example,ifthemodelsuggesteda$20millionwritedownandifLehmanbelievedthattherewasa60%
chancethatawritedownwasappropriate,Lehmanwouldtakea$12millionwritedown($20million*
60%=$12million).Insomeinstances,Lehmanwouldwaitaquartertoseewhathappenedbeforetaking
the$12millionwritedown.
327

valuation issues.1209 For example, Jonathan Cohen pointed out that Product Control
used the same discount rate for collateral that the business desk used (e.g., 20% for
equityinvestmentsinlanddevelopments).1210
Kebedestatedthattheformcommentsheusedtoexplainwhyapositionwas
notremarked,suchasbasedondiscussionswiththebusiness,indicatedthathecould
not think of anything else to explain as the reason for keeping the current mark and
that,insomecases,hemaynothaveactuallyagreedwiththecomment.1211Certaine
mailsconfirmthatKebedesworkwastosomeextentinfluencedbythePTGbusiness
desk. On August 30, 2008, Koutouvides emailed Kebede stating that Anthony
[Barsanti]andIhavegivenyouguidanceontheseniordealsthatwefeelwereincorrect.
Pleasemakethechangesandletusknowhowthischangedthetotal.1212
Rabin also stated that, in most matters, he deferred to the judgment of
Koutouvides on the business desk, given Koutouvides familiarity with the valuation
modelsandtheunderlyingbusinessfundamentalsofeachposition.1213
Plattstatedthatdespitethefactthathermodelsproducedlargeovervaluations
inthethirdquarterof2008(whichshestatedwasaftertheintegrationofasignificant
1212Emailfrom Aristides Koutouvides, Lehman, to Abebual A. Kebede, Lehman (Aug. 30, 2008)
[LBHI_SEC07940_212040]. See also email from Abebual A. Kebede, Lehman, to Anthony J. Barsanti,
Lehman,etal.(Aug.27,2008)[LBEXDOCID4449124](KebedeaskingBarsantinotalargenumber[$1.4
million],shouldwelooktoawriteoff?).
328

number of IRR models), writedowns were not taken for many PTG assets.1214 Platt
stated that Lehman didnotpay much attentiontoherthirdquarter2008pricetesting
results, characterizing the Product Control Group as, kind of sadly, the little
people.1215
(5) TheExaminersFindingsandConclusionsastothe
ReasonablenessofLehmansValuationofPTGPortfolio
TheExaminerfindssufficientevidencetosupportadeterminationthatLehman
did not appropriately consider marketbased yield when valuing PTG assets in the
secondandthirdquartersof2008.WhiletheExaminerrecognizesthatthevaluationof
illiquidassetsrequiresjudgmentandthatthereisawiderangeofreasonablevaluations
foranyparticularasset,Lehmanssystemicfailuretoincorporateamarketbasedyield
generallyresultedinanovervaluationofPTGassets.Accordingly,theExaminerfinds
that there is sufficient evidence to support a finding, for purposes of a solvency
analysis, that the values Lehman determined for certain of these assets were
unreasonable.
The evidence supports a finding that, as real estate markets deteriorated and
investorsincreasedtheirrequiredratesofreturn,Lehmanwasunabletoquicklyreplace
Cap * 105 with a valuation methodology that employed marketbased yields.
Furthermore,evenwhenLehmandidimplementavaluationmethodologythatapplied
1214ExaminersInterviewofRebeccaPlatt,Nov.2,2009,atpp.7,1011.
1215Id.atp.11.
329

a yield IRR models the yields reflected the weighted average of the contractual
interestratefordebtatoriginationandLehmansexpectedrateofreturnforequity(i.e.
20%forlanddevelopments),ratherthanmarketbasedrates.
TheExaminerdoesnotfindsufficientevidencethatLehmansfailuretoemploy
appropriateyieldsforPTGassetsduringthesecondandthirdquarterof2008supports
afindingthatanyLehmanofficersbreachedtheirfiduciaryduties.1216Althoughthereis
sufficient evidence to demonstrate that the valuation methodology for PTG assets did
notrelyonmarketbasedassumptions,thereisinsufficientevidencetodemonstratethat
any Lehmanofficeracted withanintentto produceincorrectvaluesorconductedthe
valuation process in a reckless manner. While Lehmans staffing was inadequate to
comprehensivelyvalueortestthesignificantnumberofpositionsinthePTGportfolio,
and there was also questionable judgment in the selection of yields, the valuation
determinedbyLehmandidnotresultfromactions(oromissions)thatwouldsupporta
claimofabreachoffiduciaryduty.
TheExaminerhasdeterminedthatitwouldnotbeaprudentuseofresourcesto
perform an independent valuation of every PTG asset by selecting the marketbased
yield that would have been applicable in the second and third quarters of 2008. The
uniquenessandilliquidityofPTGassets,combinedwiththevolatile2008market,create
1216SeeAppendix1,LegalIssues,SectionII,foramoredetaileddiscussionofthelegalstandardgoverning
aclaimofbreachoffiduciaryduty.
330

ahighriskoferrorforanyportfoliowideestimateofmarketbasedyield.1217Insteadof
attempting to cast a wide net, the Examiner has made observations about PTGs
applicationofyieldgenerallyandhasinvestigatedselectpositionsingreaterdetail,as
discussedbelow.1218
(a) LehmanDidNotMarkPTGAssetstoMarketBasedYield
Former Lehman personnel provided conflicting statements as to whether PTG
assets were valued at the price at which the asset could be sold, and in particular,
whetherthevaluationtookintoaccountthemarketbasedyieldthatwouldberequired
byaninvestorinlightofthencurrentmarketconditions.However,thestatementsof
those most deeply involved in the process of valuing PTG assets, as well as the
documentary evidence, provide sufficient evidence to support a finding that Lehman
didnotmarkitsPTGassetstomarketbasedyieldinthesecondandthird quartersof
2008.
Mark Walsh, head of GREG, did not indicate to the Examiner whether PTG
assets were marked at a price at which they could be sold, but stated that Lehman
1217This is especially true in that the Examiners financial advisor has had limited time to review
LehmansfilesonPTGassetsandhashadlimiteddatamadeavailableduringthediscoveryprocess.The
Examiners financial advisor did not find sufficiently detailed information to value many PTG assets.
Severalwitnesseswerealsounabletorememberanythingrelatedtothevaluationofspecificassets.See,
e.g.,ExaminersInterviewofAbebualA.Kebede,Oct.6,2009,atp.5;ExaminersInterviewofEliRabin,
Oct. 21, 2009, at pp. 9, 1112; Examiners Interview of Rebecca Platt, Nov. 2, 2009, at pp. 7, 9, 1011;
Examiners Interview of Aristides Koutouvides, Nov. 20, 2009, at p. 18 (providing very few details on
HeritageFields).
1218The chief criteria for selecting the assets (or groups of assets) analyzed below is whether the
Examiners financial advisor received sufficient information to issue a conclusion as to the valuation
processfortheseassetsinthesecondandthirdquartersof2008.
331

always marked CRE assets to both credit and yield, although he conceded that it
became difficult to mark to marketbased yield as market conditions deteriorated
during2008.1219Walshalsostatedthathewasnotnormallyinvolvedinvaluationissues
and that Barsanti and Kenneth Cohen were more knowledgeable about PTG
valuation.1220
Kenneth Cohen told the Examiner that PTG assets were marked to the price at
whichtheassetscouldbesoldtoaninvestor.1221Hestatedthatmarkingtobothcredit
and marketbased yield were components of PTGs valuation process.1222 Kenneth
Cohen described the PTG approach as markingtomodel but was clear that the
model price was intended to incorporate Lehmans best judgment as to the market
basedyieldandreflectthepriceatwhichtheassetcouldbesold.1223Healsostatedthat
awritedownbasedoncreditshouldalsoencapsulatetheeffectofchangestomarket
basedyieldaswell.1224However,KennethCohenalsostatedthatdeterminingthePTG
markswasprimarilyBarsantisjob.1225
1220Id.
1221ExaminersInterviewofKennethCohen,Jan.21,2010,atp.4.
1222Id.
1223Id.HemaintainedthispositionevenashedescribedPTGsvaluationprocessasbasedonmarkto
model,whichimpliesthatLehmanvaluedpositionsbyselectingitsownassumptionsandinputsforthe
model.Id.
1224Id. Jonathan Cohen also said that where a notation in a Lehman document indicated that a write
down was made due to credit, yield was also taken into account. Examiners Interview of Jonathan
1225Examiners Interview of Kenneth Cohen, Jan. 21, 2010, at p. 2. Kenneth Cohen could not recall the
specifics of any particular discussion regarding PTG marks and, in particular, did not remember the
332

Barsanti told the Examiner that Lehman was probably not marking to yield,
andinsteadwouldmarkPTGassetsbasedmoreonagutfeelingaboutthepositionin
relation to the market.1226 Barsanti, who both Walsh and Kenneth Cohen identified as
the person principally responsible for determining PTG marks, stated that he did not
knowwhetherPTGassetscouldbesoldforthepriceatwhichtheyweremarkedand
stated he had not thought about it.1227 As discussed below, Barsantis statement is
consistentwiththeExaminersfindingthatPTGassetsweregenerallymarkedinlight
of whether the development was proceeding according to plan, and not according to
thereturnthataninvestorwouldrequiretopurchasetheposition.
Koutouvides, who reported to Barsanti, spent substantially all of his time
workingonvaluingPTGassets.1228KoutouvidesstatedthatthePTGbusinessdeskdid
notmarktomarketbasedyieldinthesecondandthirdquartersof2008,explainingthat
thedesksassetvaluationsdidnotreflectwhatabuyerwouldpayfortheassetsonthe
openmarketatthattime.1229KoutouvidesstatedthatLehmansvaluesforassetsdidnot
equal the prices at which they could be sold on the market and noted, regarding
valuationmethodologiesusedbyPTG.Id.Asdiscussedherein,theuseofIRRmodelsinplaceofCap*
105todeterminecollateralvalueswasaprincipaldriverbehindtheapproximately$214millioninwrite
downsthatwereproposedbutnottakeninthethirdquarterof2008.ExaminersInterviewofJonathan
1227Id.
1229Id.atpp.1112.Hestatedthatonlyassetsmarkedforcreditimpairmentweretaken.Id.
333

Lehmans marks, no one would pay you that.1230 He stated that any sale of illiquid
PTGassetswouldbesteeplydiscounted,duetothemanyuniquefactorsrelatedtothe
development of the underlying real estate.1231 These factors included the uncertainty
surrounding the process of entitling the property and the relationship with the
developerwhowasresponsibleforthedaytodaymanagementoftheproject.
KoutouvidesalsostatedthatLehmandidnotoriginatepositionsatthecarrying
yieldsusedin2008,meaningLehmanwouldnotenterintoinvestmentsattheyieldsit
usedtovalueitspositions.1232Ineffect,by2008Lehmanrequiredahigherrateofreturn
when making a new investment than it would use when marking an equivalent
positionthatwasalreadyincludedinthePTGportfolio.
However,Koutouvidesstatedthatdespitenotmarkingtoyield,theassetswere
markedatfairmarketvalue.1233AccordingtoKoutouvides,theselectionofyieldwas
largelyimmaterialbecauseitwouldnotmakemuchdifferenceovertheshortduration
oftheloansassociatedwithPTGdebtpositions.1234Koutouvidesalsopointedtothetwo
tofiveyearsthatLehmantypicallyheldPTGassets,arguingthatitwasinappropriateto
focusonthevalueoftheinvestmentinthecurrentmarketenvironmentwhenLehman
1230Id.atp.12.
1231Id.
1232Id.atp.3.
1233Id.
at pp. 1112; Lehman, Q3 Firmwide Q&A Summary [Draft] (Sept. 2008), at p. 43
[LBHI_SEC07940_743659](notinggenerallythattheassetsintheCREportfolioweresubjecttofairvalue
(marktomarket)accounting).
334

hadnointentiontosellthepositioninthenearfuture.1235Koutouvidesexplainedthat,
although a sudden decline in values could have a huge effect on the value of the
property, the value of a PTG asset did not strictly correlate with market trends.1236
KoutouvidesdismissedtheargumentthatPTGassetsshouldhavebeenmarkedbased
onlyonmacroeconomictrendsobservedinthe2008market.1237
JonathanCohentoldtheExaminerthatitwasfairtosaythat,inthesecondand
thirdquartersof2008,thePTGportfoliowasgenerallynotmarkedatpricesatwhich
the assets could be sold.1238 Jonathan Cohen stated that, due to the large pricing
variances between sellers and buyers in the market at that time, many buyers were
offering what he thought of as fire sale prices.1239 He expressed the view that PTG
wasnotrequiredtomarkitsassetsatthesefiresaleprices.Specifically,hepointedto
asignificantnumberofpositionsthatwerecarriedat90%ofparvalueandstatedthat
awillingbuyerwasnotgoingtopaythat.1240
With respect to the valuation of PTG assets in the second quarter of 2008,
JonathanCohennotedthattheCap*105methodprovidednowaytomarktocreditor
1235Id. at p. 11. See Lehman, Q3 Firmwide Q&A Summary [Draft] (Sept. 2008), at p. 43
[LBHI_SEC07940_743659](noting generally for assets in the CREportfolio that a separate entity REI
GlobalwouldbeabletomanageassetswithalongertimehorizonthanLehmanwouldhaveinthe
currentmarketenvironment).
1237Id.
1239Id.
1240Id.
335

yield.1241Hestatedthatduringthistime,PTGassetsweregenerallymarkedtotheyield
thatwasincorporatedintoLehmansplanfortheinvestment,andthatassetswereonly
written down when PTG had specific information that a project was experiencing
difficulties.1242
WhenTriMontprovidedmoreIRRmodelsinthethirdquarterof2008,Jonathan
Cohen stated thatPTG was thenableto marktomarketbased yield.1243Cohenstated
thatheneverconsideredmarkingtomarketbasedyieldaconcernuntilthistime,when
the IRR models were producing materially lower collateral valuations, and in turn
indicating materially lower values for PTG assets.1244 Cohen identified approximately
$714millionofPTGwritedownsforthequarter,andonlyapproximately$504million
ofsuchwritedownsweretaken.1245
The documentary evidence also supports Cohens assertion that Lehman
generallymarkedforcreditandnotyield.AdocumentlistingLehmansthirdquarter
2008 writedowns shows that 93% of those writedowns were based on credit
impairment, with only the remaining 7% related to yield.1246 Although both Jonathan
1241Id.atpp.45.
1243Id.;ExaminersInterviewofJonathanCohen,Jan,11,2010,atpp.45.
1244Examiners Interview of Jonathan Cohen, Jan. 11, 2010, at p. 5; Examiners Interview of Jonathan
1245ExaminersInterviewofJonathanCohen,Jan.11,2010,atp.9;Lehman,GlobalRealEstate12008,Net
MarkDowns(Sept.5,2008)[LBEXAM34699].
1246JonathanCohen,Lehman,Q3WritedownsSpreadsheet(Aug.2008)[LBHI_SEC07940_2258789].The
Examiner has not found any comparable analyses that allocated writedowns to credit or yield for the
PTGwritedownsinthesecondquarterof2008.
336

CohenandKennethCohenstatedthatamarkforcreditimpairmentwouldnecessarily
take into account yield impairment, Jonathan Cohen stated that the rationale given in
thedocumentwastheprimaryreasonforthewritedown.1247
(b) TheEffectofNotMarkingtoMarketBasedYield
(i) EffectofCap*105NotMarkingtoMarketBasedYield
The Examiner has investigated the impact of the switch from the Cap * 105
method to IRR models between the second and third quarters of 2008 and concludes
that the large drop in collateral values between those quarters provides sufficient
evidence to support a finding that collateral values, and thus PTG asset values, were
overvaluedinthesecondquarterof2008.
JonathanCohenacknowledgedthatCap*105couldnotbeusedformarkingto
marketbased yield.1248 As described, Cap * 105 had no marketbased inputs and was
incapable of marking collateral to either credit or yield; it simply computed collateral
value by multiplying the developments current capital structure (reflecting all
outstandingdebtplusequityinvestedtodate)by105%.Cap*105appliednodiscount
anddidnotcalculatecashflows.TheExaminersfinancialadvisorhasobservedthat,as
ofMay2008,historicalcostbasedapproaches(suchasCap*100andCap*105)were
stillusedforcollateralvaluationforatleast228positions,whichwasathirdofthePTG
1248Examiners Interview of Jonathan Cohen, Jan. 11,2010, at pp.45;Examiners Interview of Jonathan
337

portfolio in the second quarter of 2008.1249 The Examiners financial advisor has
identifiedonly54positionsvaluedbythehistoricalcostbasedapproachasofJuly2008,
orlessthan10%ofthePTGportfolio.1250ThisdoesnotmeanthatLehmancarriedthese
positions at the amount of its investment. Lehman did write down assets for credit
based on assetspecific conclusions that, regardless of the Cap * 105 calculation, there
wasdeteriorationofthecollateralvalue.However,thehighproportionofPTGassets
withcollateralvaluesdeterminedbytheCap*105methodinthesecondquarterof2008
isanindicationthatLehmandidnotrelyonreasonablecollateralvaluesinmarkingthe
PTGportfolio.
The large effect of Cap * 105 on collateral values can be observed in Platts
descriptionofherpricetestingpracticesduring2008.Asnotedabove,Plattstatedthat
whenmoreIRRmodelswereaddedtoLehmanssysteminJuly2008,thecurrentvalues
forcollateralinhermodelsdroppedsignificantlyandhermodelsproducedanoutput
suggesting the PTG debt portfolio was significantly overvalued.1251 The Examiner
[LBEXAM267134];TriMont,EquityExportasofJuly5,2008(Aug.4,2008)[LBEXAM267510].
338

investigatedandconfirmedthatLehmanscollateralvaluesdroppedsubstantiallywhen
PTGmovedawayfromCap*105.1252
The Examiners financial advisor identified 153 PTG positions that used a
historicalcostbasedvaluationmethod(Cap*105orCap*100)inthesecondquarterof
2008,andthentransitionedtoadifferentvaluationmethodinJuly2008.1253These153
positions represented a $3.1 billion value in the second quarter of 2008, or
approximately 36% of the PTG portfolio by value. After a significant number of IRR
models were incorporated into the price testing process in July 2008, the collateral
values for these 153 positions dropped by 20% when compared to the second quarter
values.1254
Due to limitations in the data, the Examiners financial advisor has confirmed
that105ofthesepositionstransitionedfromCap*105toIRRmodelsbetweenMayand
July2008,althoughitispossiblethatothersdidsoaswell.TheMay2008pricetesting
models suggested that the marks for these 105 positions were undervalued by $192
Examinersfinancialadvisorfoundthat228positionswerevaluedusingCap*105,butduetolimitations
inthedata,wasnotabletoconfirmhowcollateralfortheother75positionswerevaluedinthirdquarter
2008.
339

million.1255Aftertheswitchtocalculatingcollateralvaluesforthese105positionswith
IRR models,the price testingresultsuggestedthatthe marksforthese same positions
were overvalued by $298 million as of July 31, 2008, and $90 million as of August 31,
2008.1256
Both the PTG business desk and Product Control knew that Cap * 105 led to
unreasonable valuations in a downward trending market if strictly applied.1257
Although the Examiner has not found any direct evidence to explain exactly how the
business desk used the collateral values based on Cap * 105 in marking the PTG
Portfolio,BarsantiandKoutouvideseachstatedthattheyusedindependentjudgment,
including a judgment that positions with collateral values calculated by Cap * 105
1255For the full set of 153 positions with collateral values based on a historical cost valuation
methodology, the Examiners financial advisor observed that price testing model suggested a $271
million undervaluation of the marks as of May 2008. TriMont, Debt Export as of May 5, 2008 (June 2,
2008) [LBEXAM 262026]; TriMont, Equity Export as of May 5, 2008 (June 2, 2008) [LBEXAM 262362];
Zev Klasewitz, Lehman, Single Asset Debt Model May 2008 Spreadsheet (June 14, 2008) [LBEXLL
[LBEXLL 1985605]; Single Family Equity Model May 2008 Spreadsheet (May 31, 2008) [LBEXLL
1985924]; Lehman, Strategic Equity Model May 2008 Spreadsheet (May 31, 2008) [LBEXBARSOX
1985926].
1256TriMont,DebtExportasofJuly5,2008(Aug.1,2008)[LBEXAM267134];TriMont,EquityExportas
ofJuly5,2008(Aug.4,2008)[LBEXAM267510];TriMont,DebtExportasofAug.5,2008(Sept.2,2008)
[LBEXAM 273310]; TriMont, Equity Export as of Aug. 5, 2008 (Sept. 2, 2008) [LBEXAM 273058]. The
Examiners financial advisor observed that the lower overvaluation figure in August 2008 is primarily
duetoProductControlsmodificationsofthecurrentvaluesbasedonIRRmodels,discussedbelow,that
occurredwhentheprincipalcollateralvaluationmethodologyswitchedtoIRRmodels.
1257E.g., Examiners Interview of Abebual A. Kebede, Oct. 6, 2009, at p. 7; Examiners Interview of
AnthonyJ.Barsanti,Oct.15,2009,atp.13;ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,
atp.15;emailfromEdDziadul,RealComFinancialPartnersLLC,toDennisGrzeskowiak,TriMont,etal.
(Mar.23,2008)[LBEXDOCID2293586](describingCap*105asworthless).
340

neededtobewrittendown.1258However,collateralvaluewasthemostimportantdata
point for valuing PTG positions, and there is no indication that Barsanti and
Koutouvides used some other method for calculating collateral values when they did
notuseTriMontsvaluebasedonCap*105.1259
Theevidenceissufficienttosupportafindingthatcollateralvaluescalculatedby
Cap * 105 were inflated, and this method calculated collateral values for at least one
third of the PTG portfolio.1260 The large drop in collateral values that occurred when
PTGmovedawayfromCap*105providessufficientevidencetosupportafinding,for
purposes of a solvency analysis, that certain marks in the PTG portfolio were not
reasonableassessmentsoffairvalueasofthesecondquarterof2008.
1260The Examiners financial advisor analyzed data from TriMont export files from May 2008 and July
2008.TriMont,DebtExportasofMay5,2008(June2,2008)[LBEXAM262026];TriMont,EquityExport
asofMay5,2008(June2,2008)[LBEXAM262362];TriMont,DebtExportasofJuly5,2008(Aug.1,2008)
Examiners financial advisor also analyzed data from pricing files from May 2008 and July 2008. Zev
Klasewitz,Lehman,SingleAssetDebtModelMay2008Spreadsheet(June14,2008)[LBEXLL1985749];
Zev Klasewitz, Lehman, Single Family Debt Model May 2008 Spreadsheet (June 14, 2008) [LBEXLL
1985605];Lehman,SingleFamilyEquityModelMay2008Spreadsheet(May31,2008)[LBEXLL1985924];
Lehman, Strategic Equity Model May 2008 Spreadsheet (May 31, 2008) [LBEXBARSOX 0000594]; Zev
Klasewitz,Lehman,SingleFamilyREOModelMay2008Spreadsheet(June13,2008)[LBEXLL1985887];
Lehman,StrategicREOModelMay2008Spreadsheet(May31,2008)[LBEXLL1985926];Lehman,Single
Family Debt Model July 2008 Spreadsheet (July 31, 2008) [LBEXBARFID 0022574]; Lehman, Strategic
REO Model July 2008 Spreadsheet (July 31, 2008) [LBEXBARFID 0024563]; Lehman, Strategic Equity
ModelJuly2008Spreadsheet(July31,2008)[LBEXBARFID0012795];Lehman,SingleFamilyREOModel
July 2008 Spreadsheet (July 31, 2008) [LBEXBARFID 0024208]; Lehman, Single Asset Debt Model July
2008Spreadsheet(July31,2008)[LBEXBARFID0023120];Lehman,SingleFamilyEquityModelJuly2008
Spreadsheet(July31,2008)[LBEXBARFID0023610].
341

Yield
IRR models, in discounting projected cash flows, offered a more reasonable
method of valuing collateral than Cap * 105. However, even when Lehman did
implementIRR modelsthatapplied ayield, thesemodels didnot basetheir yields on
marketbased interest rates.1261 Both Koutouvides and Jonathan Cohen stated that the
yields selected were based on Lehmans expected rate of return at origination, rather
thantherateofreturnthatatypicalmarketinvestorwouldrequire.1262
The Examiner has investigated select positions to determine whether TriMonts
IRRmodelsusedayieldcomparabletothatappliedtootherpositionsorprovidedby
other marketdata sources, such as an appraisal. This analysis has focused on the
property type identified by witnesses as being of greatest concern to PTG asset
managerslanddevelopments.
ThediscountratethatTriMontusedintheIRRmodelstodeterminethecurrent
collateralvalueofanassetwastheweightedaverageofthediscountratesoftheequity
anddebtpositionsatorigination,asdiscussedabove.1263
1261Examiners Interview of Jonathan Cohen, Jan. 11,2010, at pp.45;Examiners Interview of Jonathan
Cohen, Jan. 22, 2010, at pp. 34. Although Jonathan Cohen also stated that he discussed the issue of
markingtomarketbasedyieldwithReilly,theExaminerhasfoundnoevidencethatanysuchdiscussion
endedupaffectingthemarks.ExaminersInterviewofJonathanCohen,Jan.11,2010,atp.5.
1262ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atpp.7,1112.ExaminersInterview
ofJonathanCohen,Jan.11,2010,atp.5.
1263See, e.g., TriMont, Asset Status Report for Heritage Fields El Toro LLC (July 1, 2008), at tab NPV
[LBEXBARFID0027112].Inthismannerthediscountwasaweightedaveragecostofcapital,weighted
342

Since the cost of debt and cost of equity were based on rates as of deal
origination, they remained static regardless of how the market participants risk
assessment changed throughout the investments lifetime.1264 Therefore, the discount
ratesusedinIRRmodelswerenotmarketbased,asthediscountratedidnotmaterially
change if the markets changing assessment of risk resulted in demand for a higher
yield.
HeritageFieldsprovidesanexampleofapositionthatLehmanvaluedusingIRR
modelsthatcontainedadiscountrateforcollateralthatwasmateriallylowerthanthat
producedbyathirdparty,Cushman&Wakefield(C&W).InaJuly2007appraisalof
HeritageFieldsthatwasprovidedtoLehman,C&Wnoted18%asthediscountratefor
the collateral,1265 and in an April 2008 appraisal, that discount rate was 21%.1266
Meanwhile,TriMontusedan8.23%discountrateinitsMay2008IRRmodeland11.98%
rate in its July 2008 IRR model.1267 In the face of this discrepancy, TriMont did not
increase the discount rate to be more in line with the April 2008 C&W appraisal, but
in this case by the current outstanding debt and all paidin equity (which may be different than the
capitalstructureatorigination).
1264Again,Cap*105didnotapplyadiscountratetocollateralvalues.TheExamineralsonotesthatthe
capital structure could change over time due to amortization of debt or equity raises, which would
impacttheweightedaveragediscountrate.
1265Cushman & Wakefield, Heritage Fields MasterPlan SelfContained Appraisal Report Vol. I (July 1,
2007), at pp. 34041 [LBEXDOCID 2501688]. This discount rate was characterized by C&W as an
unleveragedcost of equity, and the Examinersfinancial advisor observed that this is consistent with a
weightedaveragecostofcapitalratewithonlyequityinthecapitalstructure.Id.
1266Cushman&Wakefield,HeritageFieldsMasterPlanSummaryAppraisalReport(Apr.1,2008),atp.
61[LBEXDOCID2096020].ThediscountrateselectedbyC&Wassumedanunleveragedposition.
1267TriMont, Heritage Fields El Toro LLC IRR Model (May 1, 2008), at tab NPV [LBEXBARFID
0026891]; TriMont, Asset Status Report for Heritage Fields El Toro LLC (July 1, 2008), at tab NPV
[LBEXBARFID0027112].
343

rather, in its July 2008 model, TriMont lowered the projected cash flows of the
development.1268 Through this change, the collateral value TriMont produced in July
2008 for Heritage Fields, $797 million, was close to C&Ws collateral value for April
2008,$790million.1269EventhoughTriMontadjustedthecashflowandcameupwitha
similar collateral value, the large gap between the discount rates indicates that
TriMontsIRRmodelsincludeddiscountratesthatweretoolow.
InordertoinvestigatewhetherthediscountratesusedintheIRRmodelswere
consistentlylowerthanthoseobtainedfromothersources,theExaminercomparedthe
discount rate that C&W used for Heritage Fields as a benchmark to measure the
discount rates used for other similar properties. Heritage Fields was a land
development with a sellout component, meaning it was a real estate development
wherethebusinessplanwastoselloffindividualunitsofthepropertyratherthanthe
property as a whole.1270 Sellouts were typically the most risky form of land
1268SeeTriMont,AssetStatusReportforHeritageFieldsElToroLLC(July1,2008),attabNPV[LBEX
BARFID 0027112]. For example, absorption the amount of time it takes to sellout all lots was
assumedbyTriMonttobecompleteby2013intheMaydataandthatwasextendedto2015intheJuly
data.TriMont,HeritageFieldsElToroLLCIRRModel(May1,2008),attabCFDeal,cellBO4[LBEX
BARFID 0026891]; TriMont, Asset Status Report for Heritage Fields El Toro LLC (July 1, 2008) [LBEX
BARFID0027112].
1269TriMont,AssetStatusReportforHeritageFieldsElToroLLC(July1,2008)[LBEXBARFID0027112].
1270Id.Forexample,inalanddevelopment,thedeveloperwillfirstpurchaseaplotofland,thensecure
entitlement (approvals to build), put in infrastructure (such as grading, roads, utilities, etc.), and
subdivide the plot into individual lots. The developer will then sell the individual lots to merchant
builderswhowillconstructhomesonthelots.Whenallthelotshavebeensold,theprojectissoldout.
ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.4.
344

development, because they involved overseeing a development to completion and
holdingontotheassetwhileitwassoldpiecebypiece.1271
Forthepurposeofthiscomparison,theExaminerincludedonlythosepositions
for which IRR models were used to estimate the collateral values. The Examiners
financial advisor identified three applicable land development sellout properties
meetingthesecriteria.1272Belowisacomparisonofthecollateralvaluescalculatedusing
TriMontsdiscountratesforthesepropertieswiththecollateralvaluescalculatedbythe
Examiners financial advisor using the C&W April 2008 discount rate for Heritage
Fields.
Collateral Value
C&W Heritage % Difference in
TriMont TriMont Using C&W
Property Name Fields Discount Collateral
Discount Rate Collateral Value Heritage Fields
Rate Values
Discount Rate
(A) (B) (B)/(A)-1
1 West Bay Club Development 10.9% 81,185,918 21.0% 74,636,592 -8.1%
2 PlazaCorp 1.Berkley 7.3% 72,699,971 21.0% 50,205,769 -30.9%
3 Laurel Cove 12.2% 53,917,607 21.0% 40,298,467 -25.3%
Average 10.1% 69,267,832 21.0% 55,046,943 -20.5%
1271SeeTonySevelka,SubdivisionDevelopment:Risk,Profit,andDeveloperSurveys,AppraisalJ.242,24252
(Summer 2004), available at http://www.entrepreneur.com/tradejournals/article/120353039_2.html (noting

generally that [l]and in a raw state . . . carries the highest level of overall development risk and that
landmayberipeforresidentialdevelopment...butthequestionremainsastowhetherthedeveloper
willbeabletoselltheproposedfinishedlots).
1272These were West Bay Club Development, PlazaCorp1.Berkley, and Laurel Cove. TriMont, Asset
Status Report for West Bay Club Development (July 1, 2008), at tab NPV [LBEXBARFID 0030164];
TriMont, Asset Status Report for PlazaCorp1.Berkley (Aug. 1, 2008), at tab NPV [LBEXBARFID
0029074]; TriMont, Asset Status Report for Laurel Cove (July 1, 2008), at tab NPV [LBEXBARFID
0028845].
345

Thethreepropertiesfeaturediscountratesthatweremateriallylowerthanthediscount
rateusedbyC&WinitsApril2008appraisalofHeritageFields.1273Ifthediscountrate
intheApril2008C&WappraisalofHeritageFieldswereappliedtothesepositions,the
collateralvaluesofthesepropertieswoulddropbyanaverageof20%.
An additional benchmark by which the Examiners financial advisor measured
the discount rates Lehman used to value the collateral of these three properties is the
discount rates used to value its SunCal collateral. SunCal consisted of investments in
California land development projects.1274 Lehman used a 15% weighted average
discount rate for the majority of the SunCal properties.1275 As shown above, the
discountratesforallthreePTGlanddevelopmentpropertieswerelowerthan15%.
The C&W appraisals for Heritage Fields also illustrate how Lehmans discount
rates did not respond to market changes. C&Ws two appraisals for Heritage Fields
were performed in two different years when, according to Koutouvides, the market
1273The discount rates used by TriMont were different due to differences in the cost of debt and the
weightsofdebtversusequityinthecapitalstack.TriMontusedthesamecostofequityforeachposition,
though it would likely have been more appropriate to use a cost of equity commensurate with the
leverage.
1274See,e.g.,Cushman&Wakefield,AppraisalofPacificaSanJuanMasterPlan(289Lots)(Oct.1,2007)
[TR00031835].
1275ExaminersInterviewofPaulA.Hughson,Oct.28,2009,atp.9.TheSunCalpositionswerevalued
based on projections that were influenced by third parties and a discount rate determined by Lehman.
Hughson stated that he was the person who determined the 15% unleveraged discount rate for the
majorityofthepositions.Id.The15%unleverageddiscountwasbasedontheassumptionofa2/3debt,
1/3 equity capital structure post restructuring with a cost of debt of 10% and cost of equity of 25%.
Hughsonstatedthatthisdiscountrateassumptionwassupportedbyassetsalesintheregion.Id.
346

was dropping like a stone.1276 Therefore, the increase in the discount rates between
C&Ws two appraisals 3% is likely to have been the result of marketbased
activity.1277ThisassumptionisconsistentwithLehmansownpracticesinvaluingnon
PTG positions. In valuing Lehmans bridge equity position in Archstone, Lehman
increaseditsdiscountratefromapproximately12%inMay2007to15%bythesecond
quarter of 2008.1278 This approximately 3% increase in the Archstone discount rate
reflects Lehmans recognition that marketbased yields were increasing as the market
conditionsdeterioratedforstabilizedassets.Inaccordancewiththehigherrisk,higher
returnnatureofthePTGinvestments,1279theExaminersfinancialadvisorhasobserved
thatitisreasonabletoexpectthatthemarketyieldforhigherrisk,nonstabilizedassets
wouldincreaseatasimilarorhigherratethanforstabilizedassets(e.g.Archstone)ina
1277TheExaminernotesthatitisalsopossiblethatthedifferenceindiscountratesmaysuggestspecific
problemswiththeHeritageFieldssunderlyingcollateral.
1278Memorandum from Mark A. Walsh, Lehman, et al., to LBHI Bridge Loan Committee & Investment
Committee, re: Debt and Equity Financing Commitment Proposal for the Potential Acquisition of
ArchstoneSmith(May16,2007),atp.9[LBEXDOCID1674960].Lehman,$23.4billiondebtandequity
financing commitment in connection with the potential acquisition of ArchstoneSmith by Lehman
Brothers and Tishman Speyer Properties, May 16, 2007 [LBEXDOCID 1674960]. The commitment
documentsidentifyanIRRforArchstonebridgeequityof12.1%.Thisrateincludedthecostofcapitalas
well as Lehmans expected return from the investment. Therefore, the Examiners financial advisor
observesthat,strictlyspeaking,thecostofcapitalalonewouldbelessthan12.1%.EmailfromWebster
Neighbor, Lehman, to Paul A. Hughson, Lehman, et al. (June 14, 2008) [LBEXDOCID 1865693]; email
from Paul A. Hughson, Lehman, to Webster Neighbor, Lehman, et al. (June 15, 2008) [LBEXDOCID
1865693]; emailfrom Webster Neighbor, Lehman, to Paul A. Hughson, Lehman (Sept.12,2008) [LBEX
DOCID2903130].
1279E.g.,ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atp.4.
347

downward trending market.1280 Instead, the IRR models for PTG assets incorporated
debt and equity discount rates that were incapable of responding to market changes.
Theserateswereequaltotheapplicabledevelopmentsratesfordebtandequityasof
theoriginationoftheinvestment.
Koutouvides told the Examiner that the choice of discount rate for both the
collateral and debtpositions did notmatter asmuchfor PTGpositionsbecauseof the
shorttermmaturitydateofmanyoftheloans.1281Koutouvidesstatementwasbasedon
theobservationthatthedifferenceinyieldbetweenwhatLehmanusedinitsvaluation
and what a market participant would require in a sale did not have much time to
compoundforashorttermdebtposition.
Koutouvides argument that the particular yield used is insignificant must be
evaluated on a positionbyposition basis. If the position has less leverage (and
consequently a lower LTV ratio) and a shorter term maturity for the debt, then it is
possiblethatthechangescausedbythediscountratemightnothaveamaterialeffect
onvalue.However,alongertermdebtposition,suchastheHeritageFieldsposition,
wouldhaveamuchlongertimeforthedifferenceinyieldtocompound,resultingina
1280Foroneofthethreelanddevelopments,WestBayClubDevelopment,Lehmandidtakeawritedown
of$24millioninAugust2008,afterthepositionwasvaluedat$76.5millioninJuly.Lehman,GlobalReal
Estate 2008 Net Mark Downs (Sept. 5, 2008), at tab Position & Monthly Detail, cell M148 [LBEXAM
346991] However, Lehman did not write down the other two positions, and the use of a possibly
incorrectdiscountrateforallthreepropertiesissufficientevidencetosupportafindingthatTriMonts
IRR models produced discount rates used in the valuation process that were lower than the market
supported.
1281Id.atp.3.
348

bigger difference in values. If the development has significant leverage and the debt
hasalongermaturitydateforthedebt,thenthechangestothediscountratecanhavea
significanteffectonvalue.
The PTG portfolio featured many positions that were highly leveraged debt
positionsorequitypositionsthatwouldbeaffectedbyachangeincollateralvalues.1282
BarsantiandKoutouvideswouldtogethermarkthePTGportfolio,positionbyposition,
usingTriMontsdataasmodifiedbytheirjudgment.1283Thedecreaseof20%or15%in
collateral value, as in the examples above, is sufficient evidence to support a finding
thatthePTGbusinessdeskwas,atleastinpart,basingvaluationsondatathatincluded
highercollateralvaluesthanthemarketthensupported,evenafterthetransitiontoIRR
models.
(iii) EffectofProductControlPriceTestingNotMarkingto
MarketBasedYield
AccordingtoBarsantiandKoutouvides,thePTGbusinessdesklackednecessary
resources.1284 Barsanti and Koutouvides were primarily responsible for valuing 700
positions in the book, and Koutouvides spent much of his time addressing TriMonts
errors.1285 Although, in theory, Lehman intended Product Control to serve as an
1282Lehman Brothers, Global Real Estate Product Control Real Estate Americas Price Verification
Presentation[Draft](Feb.2008),atp.4[LBEXWGM916018](describingPTGassetsasHighLeveraged
debtandequityinvestmentsincommercialrealestateproperties).
1283ExaminersInterviewofAnthonyJ.Barsanti,Oct.15,2009,atpp.11,1314.
1284Id.;ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atpp.10,13.ExaminersInterview
ofSECstaff,Aug.24,2009,atpp.1415.
349

independent check on the business desk marks, it suffered from a similar lack of
resources.1286 According to Jonathan Cohen, product controllers were not given
sufficientinformationtoproperlytestvalues.1287WithoutaneffectiveProductControl
process,theriskofmisstatingthevalueofPTGassetsrisessignificantly.
Above all, Product Control had no effective method for using marketbased
yieldstotestthemarksforPTGassets.ThiswaslargelyduetothefactthattheProduct
Controlpricetestingprocessreliedheavilyoninputfromthebusinessdeskand,inthis
manner,wasnottrulyindependent.ProductControlusedthesamecollateralvaluesas
thoseprovidedbyTriMonttothebusinessdesk.1288Cap*105inarguablyfailedtotake
marketbased yields into account and thus caused overvaluation of collateral in the
secondquarterof2008.Asnotedabove,theIRRmodelsthatbecamemoreprevalentin
the third quarter of 2008 also did not use a marketbased yield for determining
collateral value.1289 Additionally, Product Control would defer to the business desks
1286ExaminersInterviewofJonathanCohen,Jan.11,2010,atp.5;ExaminersInterviewofRebeccaPlatt,
Nov. 2,2009, at pp. 4, 7. The SEC also reached aninformal conclusion that Lehmans Product Control
staffwastoosmalltobeaneffectiveindependentcheckonthebusinessdesksvaluationsgiventhesize
andnumberofassetsintheCREportfolio.ExaminersInterviewofSECstaff,Aug.24,2009,atpp.34,
1314
1287ExaminersInterviewofJonathanCohen,Jan.11,2010,atp.5.Additionally,JonathanCohennoted
that, without certain necessary information, Product Control could not effectively employ the models
availabletoit.Id.
1289In testing certain PTG debt positions, Product Control applied a discount rate based on the rates
published in the Real Estate Investment & Finance newsletter. Examiners Interview of Abebual A.
Kebede, Sept. 29, 2009, at p. 8; Examiners Interview of Abebual A. Kebede, Oct. 6, 2009, at p. 8;
Examiners Interview of Abebual A. Kebede, Oct. 13, 2009, at p. 7. The Examiners financial advisor
conducted a review of the spreads used by Product Control to calculate the debt discount rate and
determinedthatthespreadsusedinthesecondquarterof2008didnotreflectcurrentmarketdata.
350

judgment as to when to replace or modify the collateral values provided by TriMont
andusethebusinessdeskscollateralvaluesinstead.1290
(iv) EffectofModifyingTriMontsDataintheThird
Quarterof2008
According to Jonathan Cohen, the switch to IRR models in the third quarter of
2008 enabled PTG to mark positions to marketbased yield.1291 This suggests that
TriMontsIRRmodelsmateriallyimprovedLehmansvaluationstoaccountformarket
basedyields.However,inmanyinstancesinthethirdquarterof2008,PTGmodified
the collateral values provided by TriMont, elected to not give weight to other
information suggesting that a position should be remarked, or was not persuaded by
price testing results showing a large overvaluation after lower collateral values were
incorporated into the price testing models. These facts provide further evidence that
Lehmandidnotmakeaconcertedefforttomarktomarketbasedyieldandthatitwas
notmerelythelackofIRRmodelsinthesecondquarterof2008thatpreventedLehman
frommarkingPTGassetstomarketbasedyield.
ThereissufficientevidencetosupportafindingthatthePTGbusinessdeskused
its judgment to conclude that it should not use many of the values produced by
TriMont when it was replacing Cap * 105 with IRR models. Among the positions for
1290E.g., email from Aristides Koutouvides, Lehman, to Abebual A. Kebede, Lehman (Aug. 30, 2008)
[LBHI_SEC07940_212040];ExaminersInterviewofEliRabin,Oct.21,2009,atp.8;ExaminersInterview
ofPaulA.Hughson,Oct.28,2009,atp.7;ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,
atpp.1617;ExaminersInterviewofJonathanCohen,Jan.11,2010,atp.5.
351

which the Examiners financial advisor has observed that TriMonts collateral values
weremodified,Lehmansubstitutedahighercollateralvaluefor14ofthe18positions
(or 78%) in May 2008,1292 and 38 of the 40 positions (or 95%) in August 2008.1293 The
magnitude of the departure from TriMonts collateral values also materially increased
from May to August. In May 2008, the collateral values used by Lehman for these
positions were, in aggregate, $636 million higher than TriMonts collateral values.1294
However, in August 2008, Lehmans collateral values were $1.7 billion higher than
TriMonts collateral values.1295 The Examiners financial advisor calculated that, had
1985926].
1293See Lehman, Single Asset Debt Model Aug. 2008 Spreadsheet (Aug. 31, 2008) [LBEXBARFID
0023236]; Lehman, Single Family Debt Model Aug. 2008 Spreadsheet (Aug. 31, 2008) [LBEXBARFID
0022749]; Lehman, Single Family Equity Model Aug. 2008 Spreadsheet (Aug. 31, 2008) [LBEXBARFID
0023801]; Lehman, Strategic Equity Model Aug. 2008 Spreadsheet (Aug. 31, 2008) [LBEXBARFID
0012946]; Lehman, Single Family REO Model Aug. 2008 Spreadsheet (Aug. 31, 2008) [LBEXBARFID
0024249];Lehman,StrategicREOModelAug.2008Spreadsheet(Aug.31,2008)[LBEXBARFID0024594].
The specificvaluation methodology for many of these positionsis unknown,although the data reflects
thatonlyoneofthesepositionswasvaluedinAugust2008usingacapitalizationmethod.
1985926].
352

LehmanemployedTriMontscollateralvalues,thepricetestinginAugust2008would
have indicated a $671 million overvaluation for these positions.1296 Instead, after
Lehman used its own collateral values, the price testing indicated only a $56 million
overvaluation.1297
(c) ExaminersFindingsandConclusionsastotheEffectof
NotMarkingLehmansPTGPortfoliotoMarketBased
Yield
AsasubstantialpartofthePTGportfoliowasnotvaluedbasedonmarketbased
yield,theExaminerconcludesthatthereissufficientevidencetosupportafindingthat
certain PTG assets were unreasonably valued, for purposes of a solvency analysis,
duringthesecondandthirdquartersof2008.
Koutouvides and Jonathan Cohen told the Examiner that the PTG marks
representedfairvalue.1298Accordingtothesewitnesses,PTGwasnotrequiredtomark
these illiquid assets, backed by nonstabilized real estate, at prices they could sell for
1298ExaminersInterviewofAristidesKoutouvides,Nov.20,2009,atpp.1112;ExaminersInterviewof
JonathanCohen,Jan.11,2010,atp.5;ExaminersInterviewofJonathanCohen,Jan.22,2010,atp.4.
353

duringasharpmarketdownturn.Koutouvides,whowasclosesttothetechnicaldetails
ofthebusinessdesksvaluationofPTGassets,toldtheExaminerthatLehmanmadeno
attempttomarkPTGassetstomarketbasedyieldduringthesecondandthirdquarters
of2008.1299KoutouvidesandJonathanCohenassertedthatLehmansintentiontohold
theseassetsaslongterminvestmentsmeantthattheassetvaluesshouldnotbesubject
to shortterm fluctuations in the market. Lehmans logic (as represented in these
witnessstatements)wasthatsellingPTGassetswasverydifficult,andLehmandidnot
wanttosellPTGassetsatsteeplydiscountedprices.JonathanCohenassertedthatany
sale of PTG assets at this time was a fire sale, and Lehman had a policy against
valuingassetsbasedondistressedsales.1300
Lehman did not originate PTG positions with the intention of selling half
developedproperties,andtheuniquefeaturesofeachproject,aswellasthemarriage
betweenLehmanandthedeveloper,madeitdifficultforathirdpartytoassesstherisks
inherentinanunfinishedproject.However,markingassetsatfairvalue(whetherfor
purposes of solvency or SFAS 157) is not overridden by the fact that Lehman did not
markettheunderlyingpropertyuntiltheprojectwasnearlycomplete.1301
1300Examiners Interview of Jonathan Cohen, Jan. 11, 2010, at p. 5; Examiners Interview of Jonathan
1301Fin.AccountingStandardsBd.,DeterminingFairValueWhentheVolumeandLevelofActivityfor
theAssetorLiabilityHaveSignificantlyDecreasedandIdentifyingTransactionsThatAreNotOrderly,
StaffPositionNo.1574,2(2009)(Fairvalueisthepricethatwouldbereceivedtosellanassetorpaid
totransferaliabilityinanorderlytransaction(thatis,notaforcedliquidationordistressedsale)between
354

The definition of fair value under SFAS 157 relies on a transaction with typical
marketingperiods.1302Thisisanobjectivedefinition,allowingforthemarketingperiod
toextendforanappropriateperiodoftime.
TheExaminersconclusionsthatthereissufficientevidencetosupportafinding
that certain PTG positions were unreasonably valued during the second and third
quarters of 2008 does not extend to all of Lehmans PTG positions. As described, the
process of valuing PTG positions requires assetspecific information and an
investigationofthecircumstancesandcurrentstateofadevelopmentproject.Forthe
purposeofperformingasolvencyanalysis,acourtcoulddiscountthePTGassetvalues
reportedbyLehmanonacasebycasebasisafteraconsiderationofthespecificassetsin
question.
Asnoted,althoughthereissufficientevidencetodemonstratethatthevaluation
methodology for PTG assets did not rely on marketbased assumptions, there is
insufficientevidencetosupportacolorableclaimthatanyLehmanofficeractedwithan
intent to produce incorrect values or conducted the valuation process in a reckless
manner.Theerrorsinvaluationdidnotresultfromactions(oromissions)thatwould
supportaclaimofabreachoffiduciaryduty.1303
market participants at the measurement date under current market conditions). For a more detailed
discussionofthelegalstandardforfairvaluemeasurements,seeAppendix1,LegalIssues,SectionVII.
1302SeeAppendix1,LegalIssues,SectionVII.A.
1303For a more detailed discussion of the standard governing a claim of breach of fiduciary duty, see
Appendix1,LegalIssues,SectionII.
355

Positions
This section of the Report addresses Lehmans valuations of its Archstone
positions.
Lehman,togetherwithTishmanSpeyer,agreedtoacquireArchstone,apublicly
traded Real Estate Investment Trust (REIT), on May 29, 2007 (the Commitment
Date). The transaction closed on October 5, 2007 (the Closing Date). Lehman
fundedapproximately$5.4billionofthe$23.6billionpurchaseprice,makingArchstone
Lehmanslargestcommercialrealestateinvestment.
Aftertheacquisitionwasannounced,analystsopinedthatLehmanandTishman
Speyer had negotiated a favorable price. However, as the stock prices of Archstones
publicly traded peers began to decline over the summer and early fall of 2007, a
Citigroup analyst suggested that Archstones enterprise value had declined to a level
wheretheArchstoneacquirerswouldbebetteroffpayingthe$1.5billionbreakupfee
insteadofcompletingthetransaction.1304
Lehman initially projected that its Archstone investments would generate in
excess of $1.3 billion in profits over 10 years. This projection was based on the
following assumptions: (1) Archstone would sell certain properties for $8.9 billion
1304Citigroup,ArchstoneSmithTrust:CouldtheBuyerCutTheirLossesandWalkAway?(July26,2007),
atp.1[LBEXDOCID1192001].
356

contemporaneouslywiththeclosing,therebyreducingLehmansexposureandrisk;(2)
Archstonesprojecteddebttoenterpriseratioofover80%atclosingwouldbereduced
shortlythereaftertoapproximately70%pursuanttoa$1.9billionequityoffering;(3)the
promotefeatureembeddedinLehmansgeneralpartnerinterest(whichitreferredtoas
permanent equity) would result in that equity interest receiving enhanced returns;
and (4) Lehman would syndicate onehalf of its Archstone debt and limited partner
interests(whichitreferredtoasbridgeequity)withintwoweeksofclosingandthe
remainderduringthefollowingsixmonths.
TheassumptionssupportingLehmansinitialprofitprojectionwerenotrealized:
(1)Archstone sold only $1.4 billion of properties contemporaneously with the closing;
(2)Archstonedidnotexecuteapostclosingequityoffering;(3)byMarch2008,Lehman
determined that the promote feature would not provide enhanced returns; and
(4)Lehmandidnotsyndicateamaterialpartofeitherits$2.3billionArchstoneentity
leveldebtoritsbridgeequitybeforeLBHIfiledforbankruptcy.AlsoasoftheClosing
Date, the lenders, including Lehman, only syndicated $71 million of bridge equity,
which represented 1.5% of the aggregate $4.6 billion bridge equity commitment.1305
1305The
lending group received expressions of interests from D.E. Shaw and Abu Dhabi Investment
Authority, but these investors ultimately chose not to participate in the Archstone transaction. Email
fromMikeMazzei,Barclays,toMarkWalsh,Lehman(Nov.19,2007)[LBEXDOCID1787730].TheAbu
Dhabi Investment Authority expressed an interest in acquiring $250 to $550 million of bridge equity.
Memorandum from Coburn Packard, Lehman, and Arash Dilmanian, Lehman, to Brett Bossung,
Lehman, and Mark Newman, Lehman, Archstone Acquisition Update (Sept. 17, 2007), at p. 4 [LBEX
DOCID2073832].Lehmansold$50milliontotheIrvineCompany,$20milliontoConsolidatedInvestor
Group, and $1 million to Larry Cohen, a high net worth individual associated with Tishman Speyer.
357

However, Lehman and its financing partners were able to reduce their aggregate
exposure by over $8 billion through the placement of Archstone mortgage debt with
Fannie Mae and Freddie Mac at the closing. After the closing, Lehman, BofA and
Barclays did not syndicate any bridge equity and only syndicated $43 million of term
loans.1306
Archstonewasahighlyleveragedcompanywith76%loantoenterprisevalueas
of the Closing Date.1307 Lehmans approximately $2.2 billion of entitylevel debt was
structurally subordinate to over $12.0 billion of Archstone assetlevel debt, and its
approximately $2.4 billion of equity was subordinate to approximately $17 billion of
debt. Given Archstones leverage, a small decline in Archstones enterprise value
would result in a materially larger decrease in the fair value of Lehmans equity
interest.Conversely,asmallincreaseinArchstonesenterprisevaluewouldresultina
materiallylargerincreaseinthefairvalueofthatinvestment.1308
Lehman, Archstone Smith Multifamily JV Debt and Equity Redemption Schedule (Jan. 3, 2008), at
Redemptions tab [LBEXDOCID 2502413], attached to email from Keith Cyrus, Lehman, to Paul A.
Hughson,Lehman,etal.(Jan.3,2008)[LBEXDOCID2646616].
1306Lehman, Pro Forma Capitalization Company Balance Sheet (May 30, 2008), at p. 2 [LBEXDOCID
4329013]attachedtoemailfromRachelHamilton,Lehman,toPaulA.Hughson,Lehman,et.al.(May31,
2008)[LBEXDOCID4329012].
1307The76%ratioassumesthepurchasepricewasrepresentativeoffairvalueasoftheClosingDate.
1308The Examiners financial advisor calculated that Lehmans $2.4 billion Archstone equity investment
wouldbereducedby$1billioninvalueifArchstonesenterprisevaluedeclinedbyapproximately10%.
358

AsoftheClosingDate,LehmanwrotedownthevalueofitsArchstonepositions
by$230million,theaggregateamountofunderwriting,structuringandM&Aadvisory
feesitreceivedinconnectionwiththeacquisition.1309
AJanuary2008BarronsarticlesuggestedArchstonehadnoequityvaluebased
on an analysis of the decline in the stock prices of Archstones publicly traded peers
sincetheClosingDate.1310Thelenders,includingLehman,wereunabletosyndicateany
of their Archstone positions during the first quarter of 2008, and Archstone faced a
tighteningliquiditysituationdueto,amongotherthings,itsinabilitytoexecuteitsplan
to sell properties to reduce the acquisition debt. Lehman did not take any valuation
relatedwritedownsduringthefirstquarterof2008.
During the second quarter of 2008, the lenders, including Lehman, were still
unabletosyndicateArchstonedebt,andover$1billionofpotentialArchstoneproperty
salesfellthroughafterBearStearnssnearcollapse.Archstonecontinuedtofaceatight
liquiditysituation,andbythistimeLehmanrecognizedthatapartmentbuildingvalues
weregenerallydeclining.InlateMarch2008,basedonanupdatedvaluationanalysis,
Lehman wrote down $200 million on its bridge equity position and $50 million on its
permanentequityposition.1311
1309Lehman,ArchstoneOriginationFeesMarkedintoPosition,atp.1[LBEXBARFID0024639].
1310Andrew Bary, ApartmentHouse Blues, Barrons, Jan. 21, 2008, at p. 1, available at

http://online.barrons.com/article/SB120070919702802265.html#articleTabs_panel_article%3D1.
1311Lehman,GlobalRealEstate2008MarkDowns,atp.8[LBEXBARFID0013162].
359

LehmancontinuedtoconductananalysisofthevalueofitsArchstonepositions,
resultinginanadditional$90millionwritedownonitsbridgeequityand$10million
on its permanent equity in May 2008.1312 At this time, Lehman realized it would not
meetitssyndicationgoalsforArchstoneandchangedtheestimatedcompletionofthe
syndication program from October 2008 to fiscal year 2010. Lehmans May 2008
valuation determination was based on its judgment that Archstone debt and bridge
equity positions would be more marketable in the future after Archstone deleveraged
by using the proceeds of property sales to satisfy part of the acquisition debt, and
restructured certain of its remaining debt. In August 2008, Lehman took its final
Archstonewritedownof$110milliononitsbridgeequitypositionand$15millionon
itspermanentequityposition.1313
In assessing the reasonableness of Lehmans valuations of its Archstone equity,
the Examiner recognizes that this investment was an illiquid asset, and Lehmans
valuationsnecessarilyreliedonunobservableinputs.Inlightoftheabsenceofdirectly
applicablemarketdata,acourtcouldfindthatthereareawiderangeofvaluationsthat
would be reasonable. In conducting the analysis, the Examiner only considered
contemporaneous information that was available to Lehman, and is cognizant of the
1312Id.
360

standard that courts apply in assessing the reasonableness of a debtors valuation
judgmentsforpurposesofasolvencyanalysis.1314
The evidence does not support a finding that Lehmans valuations of its
Archstone equity positions as of the fourth quarter of 2007 were unreasonable.
However,thereissufficientevidencetosupportafindingthatLehmansvaluationsfor
its Archstone equity positions were unreasonable beginning as of the end of the first
quarterof2008,andcontinuingthroughtheendofthethirdquarterof2008.1315
TheExaminersdeterminationastoLehmansfirstquartervaluationisbasedon
thedeteriorationinArchstonesprojectedfundamentals(e.g.,netoperatingincome,rent
growthratesandcapitalizationrates)thatoccurredbetweentheCommitmentDateand
theendoffirstquarterof2008.TheevidencesupportsafindingthatLehmansmodels
employedunreasonablyoptimisticassumptionsthatweregenerallybasedonLehmans
assumptionswhenitcommittedtoparticipateintheArchstoneacquisitioninMay2007.
Notwithstanding the substantial data available to Lehman regarding the deterioration
of such fundamentals, Lehman did not revise the assumptions that supported its
valuation. The evidence supports a finding that Lehmans valuation of its Archstone
equity was overstated, for purposes of a solvency analysis, by $200 million to $450
1314See Appendix 1, Legal Issues,SectionVII, fora full discussion of relevant legalissues pertaining to
valuation.
1315TheExaminersfinancialadvisorquantifiedtheamountoftheindicativeovervaluationofLehmans
bridgeandpermanentequitypositionsassumingthepromotefeaturewasturnedoff,whichisconsistent
with Lehmans valuation analysis as of March 2008, and therefore the bridge and permanent equity
wouldhavethesamemarks.
361

millionasoftheendofthefirstquarterof2008.Giventhatthevaluationofanilliquid
asset requires judgment, the Examiner determined that it is appropriate to express a
range as to which there is sufficient evidence to support a finding that Lehmans
Archstoneequityvaluationswereoverstatedforpurposesofasolvencyanalysis.
Lehman wrote down its Archstone investment by over $350 million during the
secondquarterof2008.1316However,theExaminerfindsthatthereissufficientevidence
to support a finding that Lehmans cumulative writedowns did not fully reflect the
decline in the value of Archstone equity, in light of the deterioration of the
fundamentalssupportingtheassumptionsinLehmansArchstonemodel.Theevidence
supportsafindingthatLehmansvaluationofitsArchstoneequitywasoverstated,for
purposes of a solvency analysis, by $200 million to $500 million as of the end of the
secondquarterof2008.
Lehman wrote down its Archstone investment by approximately $125 million
duringthethirdquarterof2008.1317Aswiththepriorquarter,theExaminerfindsthere
is sufficient evidence to support a finding that Lehmans cumulative writedowns did
not fully reflect the deterioration in the value of Archstone equity during this period.
TheExaminerfindsthatthereissufficientevidencetosupportafindingthatLehmans
Archstoneequityvaluationwasoverstated,forpurposesofasolvencyanalysis,by$140
to$400millionasoftheendofthethirdquarterof2008.
1316Lehman,GlobalRealEstate2008MarkDowns,atp.8[LBHI_SEC07940_7620384].
1317Id.atp.12.
362

The Examiner also considered Product Controls role in the price testing of the
Archstone valuations. Jonathan Cohen, the senior GREG product controller, told the
Examiner that Product Control was not provided with the data underlying the
assumptions and inputs used in the Archstone model that supported the business
desks valuations.1318 Cohen told the Examiner that Product Control did not have the
resources or capabilities to adequately review the Archstone business desks
valuations.1319Cohenacknowledgedthathedeferredtothebusinessdesksvaluationof
LehmansArchstonepositionsbecauseCohenconsideredthedeskpersonneltobemore
knowledgeable about that investment.1320 The Examiner finds that there is sufficient
evidencetosupportafindingthatLehmansProductControlGroupdidnotserveasan
effectiveindependentcheckonLehmansvaluationofitsArchstonepositions.
AlthoughthereissufficientevidencetodemonstratethatLehmansvaluationsof
its Archstone equity positions were unreasonable for purposes of a solvency analysis
beginning as of the end of the first quarter of 2008, there is insufficient evidence to
support a colorable claim that any Lehman officer acted with an intent to produce
incorrect values, or conducted the valuation process in a reckless manner. Lehmans
valuationsofitsArchstonepositionswerenottheproductofactions(oromissions)that
wouldsupportaclaimofabreachoffiduciaryduty.
1319Id.
1320Id.
363

(2) LehmansAcquisitionofArchstone
(a) BackgroundonArchstone
PriortotheacquisitioninOctober2007,ArchstonewasapubliclytradedREIT.1321
It was engaged primarily in the acquisition, development, redevelopment, operation
andlongtermownershipofhighriseandgardenapartmentcommunitiesindesirable,
highbarriertoentrymarkets.1322Archstonesstrategywastofocusonitscoremarkets,
characterized by: (1) protected locations with high barriers to entry; (2) expensive
singlefamilyhomeprices;and(3)astrong,diversifiedeconomicbasewithsignificant
employmentgrowthpotential.1323Archstonesportfolioofpropertiesincludedhighend
apartment buildings in metropolitan areas such as New York, Washington, D.C., San
Francisco, Seattle and Boston.1324 As of December 31, 2007, Archstone owned 154
apartment communities, representing 46,566 units, including units under
construction.1325 Prior to the acquisition, Archstone was the second largest publicly
traded apartment REIT in the U.S., as measured by market capitalization1326 and
enterprisevalue.1327
1321Archstone,AnnualReportfor2007asofDec.31,2007(Form10K)(filedonApr.1,2008),atp.3.
1322Id.atp.9.
1323Id.
1324Id.atpp.910.
1325Id.atp.20.
1326Market capitalization refers to the total market value of a companys outstanding shares, which is
calculatedbymultiplyingthenumberofsharesoutstandingbythestockpricepershare.
1327Lehman,PresentationtoTishmanSpeyer,ProjectEasyLivingDiscussion/ValuationMaterials[Draft]
(May21,2007),atp.8[LBEXDOCID1695374].Enterprisevaluereferstothetotalvalueofthebusiness,
takingintoaccountmarketcapitalization,outstandingdebt,cashavailableandotherassets.
364

(b) AcquisitionofArchstone
Lehman and Tishman Speyer sponsored the purchase as a joint venture and
negotiations to acquire Archstone evolved throughout May 2007. The first offer price
was $64.00/share on May 2, 2007. This offer was reduced to $60.00/share on May 23,
2007.Thefinalofferof$60.75/sharewasagreedtoonMay29,2007(theCommitment
Date),andpubliclyannouncedonthesameday.1328Thedecreasefromtheinitialoffer
priceoccurredbecause:(1)duediligencerevealedtheexistenceofcertaintaxprotection
agreements that impaired the value of some Archstone properties; (2) due diligence
indicated that the yields on Archstones developments were lower than Lehman and
TishmanSpeyerexpected;and(3)developmentsinthecapitalmarkets.1329Accordingto
aMay18,2007memoprovidedtoLehmansInvestmentCommittee,Lehmanprojected
it would earn in excess of $1.3 billion in profit over 10 years on its Archstone
investment.1330
Based on the terms of the commitment, Archstones capital structure was
projected to have (broadly speaking) three separate components: assetlevel debt,
1328Lehman,TransactionTimelineprovidedtotheNewYorkStockExchange(June20,2007),atpp.45
[LBEXDOCID 2139993]; Archstone, Current Report as of Aug. 17, 2007 (Form 8K) (filed on Aug. 20,
2007),atp.14.
1329Lehman, Transaction Timeline provided to the New York Stock Exchange (June 20, 2007), at p. 4
[LBEXDOCID 2139993]; email from Steven R. Hash, Lehman, to David S. Lazarus, Lehman (May 23,
2007)[LBEXDOCID1863672].
1330MemorandumfromMarkA.Walsh,etal.,toExec.CommitteeoftheLBHIBd.ofDirectors,re:$23.4
billiondebtandequityfinancingcommitmentinconnectionwiththepotentialacquisitionofArchstone
SmithTrust(May18,2007),atp.3[LBEXDOCID1722291];ExaminersInterviewofMarkA.Walsh,Oct.
21,2009,atp.9.
365

entitylevel debt and equity. The assetlevel debt which Lehman referred to as
mortgage, mezzanine and assumed debt would be secured by mortgages on
Archstonesproperties.1331Conversely,termloanswouldbeunsecuredobligationsand
were therefore categorized as entitylevel debt.1332 The equity was split into two
categoriesbridgeequityandpermanentequity.WhentheArchstonedealclosedon
October5,2007(theClosingDate),theassetleveldebtwassecuredbymortgageson
Archstones properties and was comprised of $9.5 billion of first lien mortgage debt,
$1.1 billion of mezzanine mortgage debt and $1.4 billion of existing mortgage debt
(referredtointhetablebelowasassumeddebt).1333Archstonehad$4.6billionofbridge
equityand$500millionofpermanentequity.1334
Thepurchaseprice(aftertakingintoaccountassumedliabilitiesandtransactions
costs)was$23.6billion.1335InconnectionwiththeclosingoftheArchstoneacquisition,
$1.4 billion of properties from Archstones portfolio were sold and the proceeds were
usedtorepayacquisitiondebt.1336This,ineffect,reducedArchstonesenterprisevalue
1331Lehman, Easy Living Q2 Model Risk (June 15, 2008), at all property level debt tab [LBEXDOCID
4456413].
1332Lehman categorized the debt as entitylevel debt. Entitylevel debt is structurally subordinate to
assetleveldebtbecausetheproceedsofanassetsalewouldfirstpayoffassetleveldebt,andthenany
remainingproceedswouldgotowardentityleveldebt.
1333Lehman,Archstone:FinancialSummary(June14,2008),atp.5[LBEXDOCID012476].
1334Id.
1335Lehman,EasyLivingModelRisk(June15,2008)attabS&UcellM51[LBEXDOCID4456413].
1336Lehman,ArchstoneQ22008Update(June12,2008),atp.10[LBEXDOCID2929329].The$1.4billion
resultedinthesaleofa90%interestintheseproperties;Archstoneretainedtheremaining10%interestin
thesepropertiespostclosing.
366

from $23.6 billion to $22.2 billion as of the Closing Date.1337 The following sets forth
Archstonesinitialcapitalization:
ArchstoneInitialCapitalization1338
$inmillions
Lehman Total Lehman% Security %ofLehman
$Amount $Amount ofSecurity %ofTotal Investment
MortgageDebt 272 9,529 3% 43% 5%
MezzanineDebt 506 1,097 46% 5% 9%
AssumedDebt 0 1,391 0% 6% 0%
TermLoans 2,253 4,764 47% 21% 42%
PreferredEquity 0 292 0% 1% 0%
TotalDebtandPreferredEquity 3,031 17,073 18% 77% 56%
BridgeEquity 2,142 4,600 47% 21% 40%

PermanentEquity 246 500 49% 2% 5%
TotalEquity 2,388 5,100 47% 23% 44%
TotalCapitalization 5,419 22,173 24% 100% 100%
(i) AnalystReaction
Industry analysts initially perceived that Lehman and Tishman Speyer had
agreed to acquire Archstone at a favorable price.1339 The Wall Street Journal reported
that[i]nvestorsandanalystsreactedcoollytoTishmanSpeyerPropertiesandLehman
1337Lehman, Archstone July 2008 Update (July 29, 2008), at p. 4 [LBHI_SEC07940_ICP_008533]. The
sources and uses tab in each of the two models that the Examiners financial advisor reviewed
Lehman, Bridge Equity Discounting Sensitivity (Mar. 17, 2008) [LBEXDOCID 1626080] and Lehman,
EasyLivingModelRisk(June15,2008)[LBEXDOCID4456413]showatotalsourcesnumberof$23.6
billion being adjusted down by $1.42 billion due to 90% Sale: OC/SD JV (sale of properties in the
OrangeCountry/SanDiegoarea).Thetotalproceedsfromthesalewere$1.578billion(seecellO42ofthe
S&Utabinthemodels),butbecauseArchstoneowned90%oftheproperties,itreceived$1.42billion(i.e.,
0.9 * 1.578 billion). The sale price was $23.6 billion, less property sales of $1.4 billion, equaling $22.2
billion.InanalysesofitsinvestmentinArchstonepostclosing,Lehmanrepeatedlyreferredtoaninitial
enterprisevalue(orinitialcapitalization)of$22.2billion.
1339Email from Steven Fiscler, Lehman, to Edwin Mejia, Lehman, et al. (May 30, 2007) [LBEXDOCID
2786297].
367

Brothers Holdings Inc.s bid for apartment giant ArchstoneSmith Trust, saying the
offeristoolowgiventherecentpricinginthecommercialrealestateworld.1340
Analyst sentiment changed shortly thereafter. A Wall Street Journal article,
Alltel, Archstone Investors Get Credit Willies, published in early July 2007 and
circulated in an email1341 from Jonathan Cohen to Keith Cyrus, a Vice President in
GREGs Bridge Equity unit, specifically mentioned Archstone and reported that [a]
fewprivateequityfirmsmaybegettingacaseofbuyersremorse.Thegapbetweenthe
offeringpriceandthecurrentsharepriceinanumberoflargeagreeduponleveraged
buyouts is swelling. That indicates a fear on the part of merger investors that the
privateequity acquirers may end up walking away from the deals or negotiating a
lower price.1342 An article published in the Wall Street Journal on August 1, 2007,
whichwascirculatedbyChristopherOMeara(thenCFO)inanemailtoGerardReilly
(Global Product Controller), David Goldfarb (Global Head of Strategic Partnerships,
PrincipalInvesting,andRisk),IanLowitt(thenCoChiefAdministrativeOfficer),Paolo
1340AlexFrangos,ArchstoneBidGetsCoolReply:TishmanSpeyersOfferIsSeenAsTooLowGiventhe
Pricing In Commercial Real Estate, Wall St. J., May 30, 2007, at p. B9, attached to email from Steven
Fiscler, Lehman, to Edwin Mejia, Lehman, et al. (May 30, 2007) [LBEXDOCID 2786297]. A number of
shareholderderivativeactionswerebroughtinstateandfederalcourtalleging,amongotherthings,that
ArchstonestrusteesviolatedtheirfiduciarydutiestoshareholdersinapprovingArchstonesacquisition.
Thestatecourtcaseswereconsolidatedintoonecaseinstatecourt.Theconsolidatedactioneventually
settled,andthedismissalofthefederalactionwaspartofthatagreement.
1341EmailfromJonathanCohen,Lehman,toKeithCyrus,Lehman(July3,2007)[LBEXDOCID1437297].
1342Posting of Dana Cimilluca to Deal Journal, http://blogs.wsj.com/deals/2007/07/02/alltelarchstone
investorsgetcreditwillies(July2,2007,9:55EST).
368

Tonucci (Global Treasurer) and Edward Grieb (then Global Financial Controller),1343
observed that a credit crunch was causing buyers to pull out of certain markets
altogether or to demand sharply higher yields.1344 Thearticle suggested that Lehman
might find it advantageous to cancel the acquisition and pay Archstone a $1.5 billion
breakupfee.1345AWallStreetJournalarticlepublishedonAugust18,2007alsonoted
that it might make sense for Lehman to cancel the Archstone deal rather than try to
swallowallthatdebt.1346Whenaskedinacontemporaneousemailifthiswasagood
assessmentofthesituation,JonathanCohenrespondedthatitwasspoton.1347
1343Email from Christopher M. OMeara, Lehman, to David Goldfarb, Lehman, et al. (Aug. 1, 2007)
[LBEXDOCID210157].
1344RyanChittum&KembaJ.Dunham,CreditCrunchtakesitsToll:CommercialRealEstateFeelstheEffectsof
Fewer Buyers for Pooled Mortgage Securities, Wall St. J., Aug. 1, 2007, at p. B11, attached to email from
Christopher M. OMeara, Lehman, to David Goldfarb, Lehman, et al. (July 31, 2007) [LBEXDOCID
210157] (Lowcost loans with lenient terms have propelled the commercialrealestate market to what
many feared was an unsustainable level. . . . In the past few weeks, though, nervous buyers of these
commercial securities have pulled out of the market altogether or demanded sharply higher yields,
fearingthatmanytransactionsaretoorisky....Investorsarefrettingoverthecommercialsectordespite
strong fundamentals because they see similarities to problems that led to the crash of the subprime
residentialmortgagemarket.).
1345Id.(citingCitigroup,ArchstoneSmithTrust:CouldtheBuyerCutTheirLossesandWalkAway?(July
26, 2007), at p. 1 [LBEXDOCID 1192001]) (A report Friday from Citigroup analyst Jonathan Litt
speculated that Lehman might find it advantageous to cancel the deal and pay ArchstoneSmith a $1.5
billionbreakupfeeratherthanholdingthedebtinvolvedinthedeal.).Thearticleincorrectlyreported
thatLehmanwasresponsibleforpayingtheentirebreakupfree,asopposedtotheArchstoneacquirers.
1346Alex Frangos, If It Actually Happens, Wall St. J., Aug. 18, 2007, at p. A2. The article notes that
ArchstonesshareholderswereexpectedtosignoffonthedealonAugust21,2007,andthat[t]hings
lookeddifferentwhenthedealwasannouncedinMay.Shareholderscomplainedthenthattheprice,at
$60.75 a share, was too low as buildings were still trading at record prices. . . . Given how realestate
stockshavesunksinceMay,thebuyoutpricenowseemsasteal.Nonetheless,somesayitmightmake
more sense for the buyers to cancel the deal and pay as much as $1.5 billion in termination fees to
ArchstoneSmith,ratherthantrytoswallowallthatdebt.
1347Email from Jonathan Cohen, Lehman, to Kenneth Lobo, Lehman (Aug. 20, 2007) [LBEXDOCID
4320989].
369

(ii) LehmansSyndicationEfforts
Afterafinancialinstitutionagreestoprovidefinancingtoaborrower(suchasin
connection with an acquisition), it can seek to sell all or a portion of that debt to
institutionalinvestorspriortothedateonwhichitiscontractuallyobligatedtoprovide
such financing. The sale of such debt to other financial institutions or investors is
commonlyreferredtoassyndication.1348ThistermwasalsousedbyLehmantoreferto
theprojectedsaleofitsArchstonebridgeequityposition.
Lehmans initial plan as of early May 2007 was to syndicate 50% of Lehmans
Archstonedebtandbridgeequitypositionstootherbankswithinonetotwoweeksof
the Commitment Date.1349 Lehman also projected that Archstone would enter into
agreements prior to closing to sell $9.2 billion of properties at closing, and Archstone
would use the proceeds to immediately repay a portion of the acquisition financing
provided by Lehman and its partner banks.1350 Lehman was highly confident that it
wouldbeabletosyndicateanadditional$9to$11billionofdebtbeforetheclosing,in
partbecauseoftheunlimitedpriceflexthatwasastandardfeatureinitsdebtwhere
1348BarryBobrowetal.,ThePrimaryMarket,inTheHandbookofLoansSyndications&Trading155,159160
(AllisonTaylorandAliciaSansoneeds.2007).
1349Memorandum from Mark A. Walsh, Lehman, to Exec. Committee of LBHI Board of Directors, re:
$21.3 billion debt and equity financing commitment in connection with the potential acquisition of
ArchstoneSmith by Lehman Brothers and Tishman Speyer Properties (May 7, 2007), at p. 4 [LBEX
DOCID147230].
1350Id.
370

it provided bridge equity.1351 Price flex, which is addressed in greater detail below, is
designedtoallowtheoriginatinglendertosyndicatethedebtwithoutsufferingaloss.
Inlightofthisplan,Lehmanprojectedthatitwouldonlyhavetofund$2billionto$6
billionatclosing.1352Withintwotothreeweeksofclosing,Lehmanplannedtosell50%
of its remaining Archstone mezzanine debt1353 and bridge equity positions, with the
remainderbeingsoldoverthefollowingsixmonths.1354Lehmandeterminedthatthere
was substantial institutional demand for the Archstone bridge equity, based on its
conclusionthatthisequitywasadirectinvestmentinhighquality,cashflowgenerating
realestateassets.1355
Given the potential size of the Archstone investment, Lehman brought BofA to
theacquisition,andontheCommitmentDateeachinstitutionagreedtoprovidehalfof
thedebtfinancingandtopurchasehalfofthebridgeequity.1356BofA,however,didnot
p.2[LBEXDOCID200792].
p.2[LBEXDOCID200792],attachedtoemailfromPaoloTonucci,Lehman,toChristopherM.OMeara,
1353As discussed below, mezzanine debt in the context of Archstone refers to assetlevel debt that is
subordinatetothefirstmortgagedebt.
1355Id.atp.1.
1356Lehman, Term Sheet (Bridge Equity) Project Easy Living (May 28, 2007) [LBEXDOCID 1624526];
ExaminersInterviewofMarkA.Walsh,Oct.21,2009,atp.8.
371

purchaseapermanentequityposition.1357OnJune11,2007,Barclaysagreedtopurchase
15%ofthedebtand15%ofthebridgeequity,andonJuly2,2007,agreedtoincreaseits
participationto25%ofboththedebtandthebridgeequity.1358Barclayscommitments
came out of BofAs share and did not affect Lehmans potential exposure to
Archstone.1359 As of July 2, 2007, commitments for debt (excluding mortgage and
assumed debt) and bridge equity were as follows: Lehman 47%, BofA 28%, and
Barclays25%.1360
OnJuly27,2007,MarkA.Walsh,HeadofGREG,reportedthattheinstitutional
market for investments backed by commercial real estate was virtually closed.1361
Also on July 27, D.E. Shaw informed Lehman that its risk committee had rejected a
proposedacquisitionofaportionofArchstonesbridgeequitygiventheselloffinthe
reit market and the volatility of the credit markets.1362 Lehmans Treasury personnel
becameconcernedthat,asaresultofthemarketimplosion,itmightbenecessaryto
1357Memorandum from Lehman to Commitment Committee, Lehman, et al., re: $18.3 billion debt and
equityfinancingcommitmentinconnectionwiththepotentialacquisitionofArchstoneSmithTrust(May
22,2007),atp.9[LBEXBARFID0011582].
1358CompareLetterfromScottM.Weiner,Barclays,toLehmanandBankofAmerica,re:ArchstoneJoint
Equity Commitment Letter (June 11, 2007), at p. 1 [LBEXDOCID 2073685] (redline showing execution
copy) with Letter from Michael Mazzei, President, Barclays, to Lehman and Bank of America, re: Debt
SyndicationCommitmentLetter(July2,2007),atp.2[LBEXDOCID1451573](redlineshowingexecution
copy).
1359ExaminersInterviewofMarkA.Walsh,Oct.21,2009,atpp.89.
1360Lehman, Project Easy Living Debt Funding Detail (Oct. 5, 2007), at Summary tab [LBEXDOCID
598184].PriortoJuly2,2007,LehmanandBofAadjustedtheamountsoftheirrespectivedebtandbridge
equitycommitmentsassetforthabove.
1361EmailfromWilliamHughes,Lehman,toAlexKirk,Lehman(July27,2007)[LBEXDOCID174304].
1362Email fromMark A.Walsh, Lehman,to Ian T. Lowitt, Lehman, et al.(July27,2007)[LBEXDOCID
155079].
372

provide$9billioninfundingfortheArchstonetransaction,ratherthanthepreviously
budgeted$6.8billion.1363
OnSeptember5,2007,FreddieMacagreedtopurchaseapproximately$1billion
of Archstone mortgage debt in connection with the closing of the acquisition.1364 On
September 17, 2007, Fannie Mae committed to purchase $7.1 billion of Archstone
mortgage debt.1365 Walsh and Lisa Beeson, Head of Real Estate Mergers and
Acquisitions in Lehmans Investment Banking Division, told the Examiner that the
Archstone acquisition would not have closed without this financing.1366 Walsh and
BeesontoldtheExaminerthatFannieMaesandFreddieMacsdecisionconfirmedthe
underlyingsoundnessoftheacquisition.1367
Asoftheclosing,Lehman,BofAandBarclayshadsyndicatedonly$71millionof
bridge equity, which represented 1.5% of the aggregate $4.6 billion bridge equity
1363Email from Jonathan Cohen, Lehman, to Christopher M. OMeara, Lehman, et al. (July 27, 2007)
[LBEXDOCID1904232].
1364SeeLehmanandFreddieMac,ArchstoneSmithHoldcoFloatingRatePoolTermSheet(Sept.5,2007),
at p. 1 [LBEXDOCID 4452813]; Lehman and Freddie Mac, Archstone Smith Sellco Floating Rate Pool
TermSheet(Sept.5,2007),atp.1[LBEXDOCID4452811].
1365Letter from Larry J. Kravetz, Lehman, to Fannie Mae, re: Lehman loan to Entities controlled by
TishmanSpeyerandLehmanBrothers(Sept.17,2007),atp.2[LBEXDOCID2704241].
1366ExaminersInterviewofMarkA.Walsh,Oct.22,2009,atp.9;ExaminersInterviewofLisaBeeson,
Oct.23,2009,atp.6.
1367Id.TheFreddieMacandFannieMaecommitmentswereallocatedproratatoLehman(47%),BofA
(28%)andBarclays(25%).Lehman,ProjectEasyLivingDebtFundingDetail(Oct.5,2007),atSummary
tab[LBEXDOCID598184].
373

commitment.1368 After the closing, Lehman, BofA and Barclays did not syndicate any
bridgeequityandonlysyndicated$43millionoftermloans.1369
(iii) BridgeandPermanentEquityatClosing
Atclosing,Lehmanpaid$2.1billionforbridgeequity,anditsplanwastosellthe
entire position over the short to mediumterm to institutional investors.1370 Lehman
also acquired a $250 million permanent equity position, which was held by its
Investment Management Division (IMD).1371 As noted above, the Archstone bridge
equity referred to a limited partner interest while permanent equity referred to a
generalpartnerinterest.Thegeneralpartnerinterestbenefitedfromapromotefeature
1368Thelending group received expressions of interest from D.E. Shaw and Abu Dhabi Investment
Authority, but these investors ultimately chose not to participate in the Archstone transaction. Email
from Mike Mazzei, Barclays, to Mark A. Walsh, Lehman (Nov. 19, 2007) [LBEXDOCID 1787730]. The
AbuDhabiInvestmentAuthorityexpressedaninterestinacquiring$250to$550millionofbridgeequity.
Memorandum from Coburn Packard, Lehman, and Arash Dilmanian, Lehman, to Brett Bossung,
Lehman, and Mark Newman, Lehman, Archstone Acquisition Update (Sept. 17, 2007), at p. 4 [LBEX
DOCID2073832].Lehmansold$50milliontotheIrvineCompany,$20milliontoConsolidatedInvestor
Group, and $1 million to Larry Cohen, a high net worth individual associated with Tishman Speyer.
Lehman, Archstone Smith Multifamily JV Debt and Equity Redemption Schedule (Jan. 3, 2008), at
Redemptions tab [LBEXDOCID 2502413], attached to email from Keith Cyrus, Lehman, to Paul A.
Hughson,Lehman,etal.(Jan.3,2008)[LBEXDOCID2646616].
1369Lehman, Pro Forma Capitalization Company Balance Sheet (May 30, 2008), at p. 2 [LBEXDOCID
4329013]attachedtoemailfromRachelHamilton,Lehman,toPaulA.Hughson,Lehman,et.al.(May31,
2008)[LBEXDOCID4329012].
1370Email from Jonathan Cohen, Lehman, to Clement Bernard, Lehman (Mar. 3, 2008)
[LBHI_SEC07940_984508]. See Section III.A.1.b.1.a of this Report, which discusses in more detail
Lehmansstrategywithrespecttobridgeequityinvestments.
1371EmailfromJeffreyGoodman,Lehman,toDonaldE.Petrow,Lehman(Jan.28,2008)[LBEXDOCID
3753206].
374

thatprovidedforthegeneralpartnerstoreceiveenhanceddistributionsof20%oncethe
limitedpartnershadreceivedarateofreturnonequityof8%peryear.1372
(iv) CapitalStructureatClosing
Asdiscussedabove,asoftheClosingDate,LehmanownedArchstonemortgage
debt, mezzanine debt, term loans, bridge equity and permanent equity. The
overwhelmingmajorityofLehmanspositions(86%)fellintotwocategories:termloans
(42%) and bridge/permanent equity (44%).1373 Therefore, 86% of Lehmans investment
wassubordinatedtooverhalf(54%)ofArchstonescapitalstructure.1374Thisplacement
inthecapitalstructureexposedLehmanparticularlyitsequitypositionstotherisk
of significant impairment and the potential of material gain in the value of its
investmentsifArchstonesenterprisevaluedeclinedorincreasedovertime.
The Archstone equity positions were subordinated to over threequarters (77%)
oftheinitialcapitalstructure.1375Asaresult,adeclineinenterprisevalueoflessthan
25%wouldresultin acompletelossinthevalueof theequity.The effectof leverage
1372Tishman Speyer, Lehman, and Bank of America, Term Sheet (Bridge Equity): Project Easy Living
(May 30, 2007), at pp. 56 [LBEXDOCID 1624527]; Memorandum from Lehman to Exec. Committee of
LBHI Bd. of Directors, re: $23.4 billion debt and equity financing commitment in connection with the
potentialacquisitionofArchstoneSmithTrust(May18,2007),atp.5[LBEXDOCID1722291].Ageneral
partner would no longer benefit from the promote fees in the event of failed syndication. Id. Failed
Syndicationisdefinedas:IfthesyndicationofallofLehmansequityinterestintheJointVenturehas
notbeencompletedpriortotheendoftheSyndicationPeriod,then(i)suchsyndicationshallbedeemed
aFailedSyndication;(ii)Lehmanshallbeentitledtoassumesolecontroloverthesyndicationandshall
bepermittedtosellitsequitypositiontoanyinvestorinLehmanssolediscretion;and(iii)Lehmanshall
havethesoleauthoritytoreduceoreliminatethepromoteandadministrativefeesotherwisepayableto
Sponsor.Id.
1374Id.
1375Thisfigurewascomputedas$17billionofdebtdividedby$22billionoftotalcapital.
375

works in the other direction as well, as a less than 25% increase in enterprise value
resultsina100%increaseinthevalueoftheequity.
The Examiners investigation included a solvency analysis of the LBHI
Affiliates.1376 Accordingly, the Examiner ascertained whether debtors owned any
Archstoneinvestmentpositions.Asshowninthetablebelow,LCPI,anLBHIAffiliate,
owned $1.6 billion of Archstone entitylevel debt as of May 2008. While bridge and
permanentequitywerenotdirectlyownedbyanLBHIAffiliateorLBHI,anychangein
thevalueofsuchinvestmentswouldaffectLBHIssolvency.1377
LegalEntityOwnershipofArchstonePositionsasofMay20081378
Company Item(s)Held Par %ofTotal

Value Archstone
Investment
LehmanBrothers Mortgageand $680 15%
Holdings,Inc. assetleveldebt million
LehmanCommercial Revolverand $1.6 34%
Paper,Inc. termloans billion
Luxembourg Trading TermBloans $793.5 17%
Finance million
PropertyAsset Bridgeequity $1.609 34%
Management,Inc. billion

1376SeeSectionIII.B.3.coftheReportforfurtherdetails.
1377ThisfindingisbasedontheGFSdata.SeeLehman,ReconciliationDataMay2008(June13,2008),at
Sheet1tab[LBEXLL1104843].
1378Id.
The GFS data does not split out IMD investments and thus the table does not include the
permanentequity.
376

AsofAugust2008,LuxembourgTradingFinancehadtransferred$600millionin
principalamountofTermLoanBtoLuxembourgResidentialPropertiesLoanFinance
S.a.r.l.,anLBHIAffiliate.1379
(v) PriceFlex
The debt positions held by these LBHI Affiliates were covered by price flex.1380
Price flex, as a general matter, is a mechanism that facilitates syndication or sale of a
loanbytheinitiallenderwithoutthelenderincurringaloss.1381Asamechanicalmatter,
priceflexmaypermittheinitiallendertoincreasetheinterestratetoattractbuyersof
the debt (in which case the borrower is required to pay its lenders a higher interest
rate),orrequiretheborrowertoreimbursetheinitiallenderforanylossitmaysufferas
aresultofsyndicatingorsellingthedebttoathirdpartyatapricelessthanpar.1382
Lehman, BofA and Barclays (the Archstone Lenders) entered into a certain
SideLetter,datedOctober5,2007(asamendedpursuanttothatcertainletteragreement
between Archstone and the Archstone Lenders, dated November 27, 2007, the
Archstone Side Letter), that set forth the price flex terms and conditions.1383 The
Archstone Side Letter provided that after March 24, 2008, the Archstone Lenders had
the right to require Archstone to amend the pricing of the applicable loans (including
1379Lehman,ReconciliationDataAugust2008(Sept.17,2008)[LBEXLL1104812].
1380Archstone,SideLetteragreement(Oct.5,2007),atpp.12[LBEXWGM007973].
1381Barry Bobrow et al., The Primary Market, in The Handbook of Loans Syndications & Trading 155, 175
(AllisonTaylorandAliciaSansoneeds.2007).
1382ExaminersInterviewofClementBernard,Oct.23,2009,atpp.1516.Priceflexagreementsaresubject
tothetermsagreeduponamongthelendersandtheborrower.
1383Archstone,SideLetteragreement(Oct.5,2007),atp.2[LBEXWGM007973].
377

the spread or margin) or fees in order to achieve a successful syndication of such
loans.1384PriortoMarch24,2008,theArchstoneLenderscouldmakesuchchangesonly
with Archstones consent.1385 In the event that the Archstone Lenders sold Archstone
loansatadiscountinaccordancewiththetermsoftheArchstoneSideLetter,Archstone
was obligated to reimburse the Archstone Lenders for such loss, which would be
satisfiedfromanescrowaccountheldatBofA(EscrowAccount).1386
TheEscrowAccountwasinitiallyfundedwith$39million,andtheamountheld
intheaccountwasintendedtoequalthepotentiallossthattheArchstoneLenderscould
sufferbasedonthemarketpriceoftheunsoldArchstonedebt.1387BofAwasobligatedto
mark to market such debt on the first day of each month, and Archstone was to
promptly deposit any additional amount required as a result of such mark.1388 The
onlydepositmadepriortoLBHIsbankruptcyfilingwasmadeonFebruary29,2008,in
theamountof$33million.1389Theaccountsbalancewasapproximately$74millionas
1384Id.
1385Id.WithrespecttotheTermLoanA,priortoMarch24,2008,theArchstoneLenderswerepermitted
toincreasethepredefaultinterestrateonTermLoanAtoaspecifiedlevel,andwerenotpermittedto
sell or syndicate more than $1.5 billion of the Term A Loans prior to such date without Archstones
consent.Id.PriortoMarch25,2008,theArchstonelenderswerepermittedtoincreasethepricingofthe
Mezzanine Loans by no more than 50 basis points over the spreads and indices referred to in the
ArchstoneSideLetter.Id.
1386Id.atpp.56.
1387Id.atp.5.
1388Id.atpp.56.
1389BofA,ProjectEZLivingOIDReserveFundMoneyMarketSavings(Feb.29,2008),atpp.56[LBEX
BofA000001].
378

ofthebeginningofAugust2008,whichincludedinterestearnedonthebalance.1390No
withdrawalsfromtheaccountweremadepriortoLBHIsbankruptcyfiling.1391
InthecaseofArchstone,thebridgeequityholderswerethesameinstitutionsas
the debt holders, and therefore, any sales of loans for less than par would necessarily
impact the value of their equity positions. Lehman viewed price flex as effectively
requiringequitytoguaranteethevalueofthedebt.1392
Asthepurposeandfunctionofpriceflexistopermittheinitiallendertosellthe
debt to a third party without suffering a loss, and the Examiner found that there was
sufficient equity value after accounting for the effect of overvaluations to finance the
cost of price flex, the Examiner did not find sufficient evidence to support a
determinationthatLehmansvaluationofitsArchstonedebtpositionscoveredbyprice
flexwasunreasonable.1393
1390BofA,Transactions for account: Bank of America as Administrative Agent Archstone Operating

TrustExpenseReserveEscrowAccount(July20,2009),atp.1[LBEXBofA000007].
1391TheExaminer,whiletakingintoaccounttheBofAmarksthatwerereflectedintheArchstoneEscrow
AccountsbalanceforpurposesofassessingthereasonablenessofLehmansvaluations,determinedthat
itwasnotaprudentuseofresourcestoexamineBofAsvaluationoftheArchstoneloans.
1392Examiners Interview of Clement Bernard, Oct. 23, 2009, at p. 15; Examiners Interview of Paul A.
Hughson,Dec.21,2009,atp.3;ExaminersInterviewofAbebualA.Kebede,Oct.6,2009,atp.8.
1393ThedebtpositionssubjecttopriceflexweregenerallycarriedbyLehmanat99%offundedvalue,and
Lehmansconclusionastoanylossofvalueofthesedebtpositionswasincorporatedintothebridgeand
equity positions. The Examiner did not investigate the reasonableness of Lehmans reporting of
individualunitsofaccount(i.e.,therecordingofthelossinvalueondebtpositionsinthedebtposition
thatincurredthelossortheequitypositionthatfundedthelossinvalueondebtpositions).
379

(vi) Standard&PoorsCreditRating
On September 26, 2007, S&P announced its expected ratings for Archstones
acquisition debt.1394 S&P gave the proposed $5.1 billion secured credit facility a BB
rating with a recovery rating of 4.1395 S&P also announced that its Archstone ratings
remainedonCreditWatch1396withnegativeimplicationsandthatitexpectedtolowerits
corporatecreditratingtoBBfromBBB+iftheacquisitionclosedasproposed.1397S&P
explained that the expected downgrade was due to the more aggressive financial
profile, weak debt protections (measures to insure payment of debt), and the risk
associatedwithArchstonesplantoincreasedevelopment.1398S&Pconcludedthatthese
weaknesses were partly offset by good quality and above average historical
operating performance of Archstones portfolio and that Archstones management
teamwasremaininginplace.1399
1394S&P, ArchstoneSmith Trust Ratings Remain on Watch Neg; $5.1 Billion Credit Facility Rated BB
(Sept.26,2007), at p. 1[LBEXDOCID1711704], attached to emailfrom Francis X. Gilhool, Lehman, to

PaulA.Hughson,Lehman,etal.(Sept.26,2007)[LBEXDOCID1854830].
1395Id.ABBratingimpliesthatthecompanyislessvulnerableintheneartermbutfacesmajorongoing
uncertainties due to adverse business, financial and economic conditions. S&Ps Credit Ratings
DefinitionsandFAQs,http://www.standardandpoors.com/ratings/definitionsandfaqs/en/us(lastvisited
Jan.27,2010).Arecoveryratingof4denotesanexpectationofaverage(i.e.30%50%)recoveryinthe
event of default. S&Ps Ratings Definitions, http://www.standardandpoors.com/ratings/articles/en/us/
?assetID=1245200953923(lastvisitedJan.27,2010).
1396ThecreditratingswereplacedonCreditWatchwithnegativeimplicationsshortlyaftertheagreement
toacquireArchstonehadbeenpubliclyannounced.CreditWatchisanindicatorofapotentialchangein
a rating (up or down) based on recent events. In the current case, S&P indicated that the proposed
privatizationofArchstonewouldlikelyresultinadowngradeofArchstonesrating.
1397S&P, ArchstoneSmith Trust Ratings Remain on Watch Neg; $5.1 Billion Credit Facility Rated BB
(Sept.26,2007),atp.1[LBEXDOCID1711704].
1398Id.
1399Id.
380

S&Pnotedthatthepurchasepriceimplieda4%capitalizationrate1400andthatan
increaseincapitalizationratestoamoreconservative7%wouldreduceArchstones
equity value to zero.1401 S&P also observed that the plan to reduce Archstones debt
overtimewasheavilyreliantonassetsales,whichcanbeunpredictableandopined
thatweexpectthefutureenvironmentformultifamilyassetsalesandpricingtobeless
robustthanitiscurrently.1402
OnOctober9,2007,aftertheclosingoftheacquisition,S&Pformallyloweredits
corporate rating on Archstone to BB.1403 S&P justified its rating based on several
observations:1404
Archstones risk profile had increased given the heightened

constructionandleaseupriskinherentinnewdevelopment.
[E]xpected yields on new development would be negatively

affected if the recent moderation in rents and NOI [net operating
income] growth continues, or measurably deteriorates if the
economyfallsintoarecession.
Archstonesliquidity positionwascurrentlysufficient tomeetits

capital needs but the business plan relied heavily on the
generationofaggressiveassetsaleproceeds.
S&Pconcludedthattheoutlookwasstableandthatitwouldlowertherating
ifitappearsthatthecompanywillbeunabletoachievesufficientassetsalestorepay
1400SeeSectionIII.A.2.f.4.a.iiofthisReportforadiscussionandanalysisofexitcapitalizationrates.
1401Id.
1402Id.Acapitalizationrateistheratioofincometovalue.Asvalueisthedenominator,thehigherthe
capitalizationrate,thelowerthevalueoftherealestateasset.
1403S&P,VariousRatingActionsTakenOnArchstoneSmithOperatingTrustAfterCloseofMerger(Oct.
9,2007),atp.2.
1404Id.atp.3.
381

the bank debt and alleviate the debt burden, or if the company is unable to pull back
developmentactivityiftheoperatingenvironmentdeteriorates.1405
(3) LehmansValuationofArchstone
AftertheArchstoneacquisition,Lehmanheld$5.4billioninArchstonepositions
$3.0 billion of debt and $2.4 billion of equity.1406 These amounts are referred to as
LehmansfundedexposurebecausetheyrepresenttheamountthatLehmaninvested,
net of any repayments of debt by Archstone.1407 By August 31, 2008, this funded
exposurewasreducedby$423millionduetoArchstonesrepaymentofdebt.1408The
followingtablesetsforthLehmansfundedexposureonamonthlybasis:
1405Id.
1406Lehman,ArchstoneMonthlyExpensesasofJuly08(July2008),atp.1[LBEXBARFID0013113].
1407AsArchstonedidnotpurchaseanyofitsownequity,thefundedamountsforbridgeorpermanent
equitydidnotchange.
1408Lehman, Archstone Monthly Expenses as of July 08 (July 2008), at p. 1 [LBHIBARFID 0013113];
Lehman,TopGlobalRealEstateExposures(Aug.31,2008),atp.12[LBHI_SEC07940_ICP_002615].The
$423 million reduction is computed by subtracting exposure of $4.975 billion as of August 2008 from
$5.398billionasofOctober2007.
382

ArchstoneFundedExposurebyMonth($million,Oct.07Aug.08)1409
Oct Nov Dec Jan Feb Mar Apr May June July Aug
TermLoanA&B 2,232 2,220 2,153 2,090 2,045 1,977 1,975 1,963 1,927 1,893 1,980
DevelopmentLoan 236 217 195 200 200 200 200 194 194 132 N/A
Revolver 0 0 0 211 211 158 203 237 184 114 141
MezzanineLoan 542 542 542 529 529 529 527 527 527 496 466
BridgeEquity 2,142 2,142 2,142 2,142 2,142 2,142 2,142 2,142 2,142 2,142 2,142
PermanentEquity 246 246 246 246 246 246 246 246 246 246 246
Total 5,398 5,367 5,278 5,418 5,373 5,252 5,293 5,309 5,220 5,023 4,975
Asoftheclosingdate,LehmanwrotedownitsArchstonepositionsinanamount
equal to $230 million of fees it received in connection with the acquisition.1410
Thereafter, Lehman took three valuationrelated writedowns on its Archstone
positions.1411AttheendofMarch2008,Lehmantooka$200millionwritedownonthe
bridge equity and a $50 million writedown on permanent equity.1412 In May 2008,
Lehmantooka$90millionwritedownonbridgeequityanda$10millionwritedown
on permanent equity.1413 Finally, in August 2008, Lehman took a $110 million write
down on bridge equity and a $15 million writedown on permanent equity.1414
Lehmansbasisfortakingthesewritedownsisdiscussedbelow.
BeginningonNovember15,2007,LehmanwrotedownitsArchstonepositionin
amountsequaltothedifferencebetweentheratethatLehmanchargedGREGforuseof
1409Lehman,Archstone Monthly Expenses as of July 08 (July 2008), at p. 1 [LBHIBARFID 0013113];

Lehman,TopGlobalRealEstateExposures(Aug.31,2008),atp.12[LBHI_SEC07940_ICP_002615].
1411Lehman,GlobalRealEstate2008MarkDowns,atpp.10,21[LBEXBARFID0013162].
1413Lehman,ArchstoneMonthlyExpensesasofJuly08(July2008),atp.1[LBHIBARFID0013113].
1414Id.
383

the balance sheet to finance Archstone debt positions, and the higher rate of interest
Lehman charged Archstone on these debt positions.1415 This difference is called the
excesscarry.1416JonathanCohentoldtheExaminerthatPaulHughson,GREGsHeadof
Credit Distribution, decided to use excess carry to reduce the bridge equity mark,
becauseHughsondidnotwanttoshowprofitsonArchstonepositions.1417
The first chart below shows Lehmans Archstone marks by month, and the
secondchartshowsthecorrespondingvaluationofArchstonepositionsbymonth:
LehmansArchstoneMarksbyMonth($million,Oct.07Aug.08)1418
TermLoanA&B 99.0 99.0 98.9 98.9 98.9 98.8 98.9 98.8 98.8 99.2 98.2
DevelopmentLoan 99.2 99.1 99.0 98.5 96.0 95.5 95.5 94.3 94.3 91.3 N/A
Revolver N/A N/A N/A 99.1 99.1 98.1 98.5 99.2 98.9 99.0 99.3
MezzanineLoan 98.9 98.9 98.9 98.9 98.9 98.8 98.9 98.8 98.8 99.0 98.9
BridgeEquity 90.7 90.5 90.2 89.6 89.6 79.9 79.6 75.1 74.9 74.6 69.0
PermanentEquity 100.0 100.0 100.0 100.0 100.0 79.9 79.6 75.1 74.9 74.6 69.1
WeightedAverageMark 95.7 95.6 95.5 95.3 95.1 90.1 90.1 88.0 87.7 87.2 84.3
LehmansValuationofArchstonePositions($million,Oct.07Aug.08)1419
TermLoanA&B 2,210 2,197 2,130 2,067 2,022 1,953 1,954 1,940 1,903 1,877 1,944
DevelopmentLoan 234 215 193 197 192 191 191 183 183 121 N/A
Revolver 0 0 0 209 209 155 200 235 182 113 140
MezzanineLoan 536 536 536 523 523 522 521 521 521 491 461
BridgeEquity 1,942 1,939 1,933 1,919 1,919 1,712 1,706 1,609 1,604 1,597 1,477
PermanentEquity 246 246 246 246 246 197 196 185 184 184 170
Total 5,168 5,133 5,038 5,161 5,111 4,730 4,768 4,672 4,577 4,382 4,192
1416Id.
1417Id.

384

Areviewoftheweightedaveragemarkismoreinstructivethanthemarkonany
single position (e.g., for the bridge equity or permanent equity), because it reflects
LehmansdeterminationastothevalueofallofitsArchstoneholdingsintheaggregate.
For example, an assessment of Lehmans bridge equity or permanent equity marks,
viewed in isolation, would fail to separate the change in value due to the price flex
mechanism,whichresultedintheequityabsorbinganylossofvalueofthedebt.
As of closing, Lehman valued its debt positions at approximately 99, its bridge
equityatapproximately91anditspermanentequityat100.1420Atclosing,theweighted
average mark across Lehmans Archstone portfolio was approximately 96, which
indicatesLehmanconcludedthatitsentireinvestmentwasworthapproximately96%of
whatitpaid.
LehmansweightedaverageArchstonemarkdeclinedslightlybetweenOctober
2007 and February 2008 from 95.7 to 95.1 due to application of the excess carry to
reducethemarks.Theweightedaveragemarkdeclinedto90.1inMarch,to88.0inMay
and to 84.3 in August 2008 as Lehman took the writedowns described above and
continuedtoapplyexcesscarrytoreducethemarks.
1420Lehman,Archstone Monthly Expenses as of July 08 (July 2008), at p. 1 [LBHIBARFID 0013113];

Lehman, Top Global Real Estate Exposures (Aug. 31, 2008), at p. 12 [LBHI_SEC07940_ICP_002615].
Lehmandidnottakeawritedownonitscommitmentpriortoclosing.Seethefollowingsection,which
discussesLehmansArchstonevaluationpriortoclosing.
385

(a) ValuationBetweenCommitmentandClosing
This section discusses Lehmans process with respect to the valuation of its
commitmenttofinancetheArchstoneacquisition.Financialaccountingrulesrequired
LehmantomarkitsArchstonecommitmentstomarket.1421Thatis,evenbeforeclosing,
Lehmanwasrequiredtodeterminethevalueofitscommitmentstoprovidefinancing
andpurchasedebt.1422
OnAugust22,2008,GerardReilly,theHeadProductController,askedAbebual
A.Kebede,GREGsVicePresidentofValuationControl,toputamemotogetheron
the valuation of the Archstone commitment, as this will get a lot of focus.1423 The
Examiner did not locate any evidence that demonstrated or suggested that Lehman
engagedinanysystematicefforttovalueitsArchstonecommitmentspriortothisdate.
Kebede emailed Hughson on August 22, 2007 to obtain Archstone
information.1424 Kebede wrote that Hughsons colleagues were hesitant to give him
anydetails,andKebedeaskedHughsonfordetails/supporttoperformtherequired
1421Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 133,
AccountingforDerivativeInstrumentsandHedgingActivities(June1998),17.
1423Email from Gerard Reilly, Lehman, to Abebual A. Kebede, Lehman, et al. (Aug. 21, 2007) [LBEX
DOCID 2723016]. In an email to Reilly on August 21, 2007, Kebede wrote: Further to your query
regardingtheMTM[marktomarket]ofourcommitmentonArchstoneIspokewiththedealmanagers
thisafternoon....EmailfromAbebualA.Kebede,Lehman,toGerardReilly,Lehman,etal.(Aug.21,
2007)[LBEXDOCID2723016].
1424EmailfromJonathanCohen,Lehman,toAbebualA.Kebede,Lehman(Aug.22,2007)[LBEXDOCID
2689684].
386

analysisandfortheunderwritingmodel.1425HughsonsreplydidnotaddressKebedes
request for additional information.1426 Instead, Hughson responded that as the
Archstonedebtbenefitedfrompriceflex,therewasnoneedtovaluethedebt,andthat
the bridge equity would initially be marked at 96.1427 Jonathan Cohens oneword
responsetothisemailtrailwas[u]nreal.1428JonathanCohentoldtheExaminerthat
his response referred to Hughsons failure to respond to Kebedes request for
information.1429
OnAugust23,2007,KebedesentJonathanCohenamemohedescribedasafirst
attempt on the Archstone valuation review.1430 Kebedes valuation memo observed
that while only a minimal amount of bridge equity had been syndicated, the
businessbelievedthatthemarksonthebridgeequitywereappropriatebecausethe
yieldsimpliedbythemodelLehmanusedtoassessthetransactionwereinlinewith
currentmarketyieldsforsimilarinvestments.1431
1425Id.
1426Id.
1427Id.
1428Id.
1430EmailfromAbebualA.Kebede,Lehman,toJonathanCohen,Lehman(Aug.23,2007)[LBEXDOCID
2689696].KebedeinformedJonathanCohen:Wewillneedtoupdatetheconclusiononcewedecideon
themarks.Id.TheExaminerdidnotlocateanyupdatedvaluationmemo,andJonathanCohendidnot
recallanysuchupdatebeingundertaken.
1431Lehman,ArchstoneSmithValuationUpdate(Aug.23,2007),atp.2[LBEXBARFID0011579].
387

(b) ValuationasoftheClosingDate
Asoftheclosingdate,Lehmanmarkedallofitsdebtpositionsat99,itsbridge
equityat91anditspermanentequityat100.1432Thesewritedownswereequaltothe
$230millioninunderwriting,structuringandM&AadvisoryfeesLehmanreceivedin
connectionwiththeacquisition.1433Lehmanallocatedthefeesasfollows:
AllocationofFeestoInitialArchstoneMarks1434
Debt FeesAllocatedtoMark ResultingMark

TermLoanA (11.4) 99.0%
TermLoanB (11.0) 99.0%
DevelopmentLoan (2.4) 99.0%
MezzanineLoan (5.4) 99.0%
Revolver (3.5) 99.0%
BridgeEquity (199.5) 90.7%
Total (233.0)1435
HughsontoldtheExaminerthatthefeeswereappliedtothemarksbasedonthe
stateofthedebtandequitymarketsandthatthesemarkswereapprovedbyOMeara
andTonucci.1436
1434Id.Lehmanspolicywastomarkbridgeequityfees(typically4%)intothebasisforitsbridgeequity
positions (thus reducing the mark). Lehman, Global Real Estate Mark Downs (Feb. 1, 2008), at p. 5
[LBEXDOCID514139].
1435TheExaminernotesthataccordingtoLehmansrecords(andasisdiscussedthroughoutthisSection),
Lehman received $233 million of fees related to the Archstone transaction. However, when marking
down Archstone to reflect fees, Lehman took a markdown of $230 million. This difference $3 million
differenceisimmaterialandrepresentslessthan0.1%ofLehmansArchstoneinvestment.
1436ExaminersInterviewofPaulA.Hughson,Dec.21,2009,atp.3.
388

OnOctober4,2007,thedaybeforetheclosing,JonathanCohenemailedReillyas
to the status of the loan syndication: The term loan syndication is not going so well.
No orders yet and it seems the investors want better pricing. Tishman is reluctant to
accept the discount as it will impact equity.1437 Reilly replied, [w]hat would be the
logic in not marking down the term loan?1438 Jonathan Cohen replied that the term
loans were guaranteed to make a 1% profit,1439 and the implied yields on the bridge
equity investment remained within a reasonable range notwithstanding that, due to
priceflex,equitywouldincurlossesinvaluethat,absentpriceflex,wouldbeincurred
bythedebt.1440
On October 9, 2007, Jonathan Cohen, responding to an email asking about
Hughsons views on where Archstone debt should be marked, wrote that Hughson
thinks99,butifthefirmwantshimtomarkitatwherewecouldclear,thenmaybeat
96.1441
1437Email from Jonathan Cohen, Lehman, to Gerard Reilly, Lehman (Oct. 4, 2007) [LBEXDOCID
1722336].
1438Id.
1439Lehmanconsideredthatitwouldmakea1%profitonthedebtbecauseithadallocatedfeesequaling
1%oftheprincipalamountofitsArchstonedebttosuchdebtandconcludedthatitwouldnotsuffera
lossonthesaleorsyndicationofsuchdebtduetopriceflex.Id.
1440Id.JonathanCohenalsoinformedReillythatHughsontoldhimthere[a]pparentlywasawritten
documentwherebyweagreedNOTtosellthetermloanatreducedprices.JonathanCohentoldReilly
that this meant there was an agreement to not sell into the depressed market. Email from Jonathan
Cohen,Lehman,toGerardReilly,Lehman(Oct.5,2007)[LBEXDOCID2723114].
1441Email from Jonathan Cohen, Lehman, to Derek Schneider, Lehman (Oct. 9, 2007) [LBEXDOCID
2802572].
389

(c) ValuationasoftheFourthQuarterof20071442
The Examiner did not locate any formal valuation analyses undertaken by
LehmantovaluetheArchstonepositionsasofNovember30,2007,theendofLehmans
fiscal year. Hughson, for example, did not recall any specific events that would have
caused the need to change Archstones valuation between October 5, 2007, and
November30,2007.1443Hughson,JonathanCohenandWebsterNeighbor,whoworked
intheBridgeEquityunitandoperatedtheArchstonecashflowmodelthatwasusedto
mark the bridge equity position, could not recall any specific discussion or analyses
regardingthevaluationoftheArchstonepositionasofNovember2007.1444
E&Y completed a yearend audit of LBHIs financials for the period ending
November30,2007.1445WilliamSchlich,E&Ysleadauditpartner,andJerryGruner,a
senior manager on E&Ys Lehman audit team, told the Examiner that in the
approximately twomonth period following the close of the Archstone deal, E&Y
concluded that the best indication of the fair market value of Lehmans equity
investment in Archstone was the price Lehman paid to acquire those positions.1446
Schlich and Gruner told the Examiner that BofAs and Barclays participation in the
1442LehmansfourthquartercoveredSeptember1,2007,throughNovember30,2007.
1444Id.;ExaminersInterviewofJonathanCohen,Jan.11,2010,atp.10;ExaminersInterviewofWebster
Neighbor,Nov.17,2009,atp.3.
1445Lehman,Exhibit23.01,atp.255,attachedtoLBHI200710K.E&Ysworkpapersdidnotincludeany
formalanalysisoftheArchstonepositions.
1446ExaminersInterviewofErnst&Young,Nov.11,2009,atpp.45.
390

same transactionwithsimilarterms servedas another indication that a November 30,
2007valuationbasedontheclosingpriceonOctober5,2007,wasreasonable.1447
(d) ValuationIssuesDuringtheFirstQuarterof20081448
(i) BarronsArticle
On January 21, 2008, Barrons published an article titled Apartment House
BluesthatquestionedthevalueofArchstonesequity.1449Accordingtothearticle,the
Archstone transaction could prove disastrous for Wall Street firms and other equity
investors.1450ThearticlenotedthatArchstonehadaheavyloadofdebtalmostfive
timestheamountofAvalonBay,acomparablepubliclytradedREIT.1451Inlightofthe
30%declineinthesharepricesofREITssinceOctober2007,thearticlestatedthatWall
Street was concerned . . . that rent increases will slow, even in relatively strong
markets, and that Archstone was a classic example of a good company with a bad
balancesheet....[T]hevalueofArchstoneequitycouldbezero.1452Thispotentialloss
ofallequityvaluewaspremisedonanobservationthattheimpliedcapitalizationrates
for REITs, based on current stock prices, had risen to an average of 7%, and even the
1447Id.atp.5.
1448LehmansfirstquartercoveredDecember1,2007,throughFebruary29,2008.
1449AndrewBary,ApartmentHouseBlues,Barrons,Jan.21,2008,atp.1,availableathttp://online.barrons.
com/article/SB120070919702802265.html#articleTabs_panel_article%3D1.
1450Id.
1451Id.
1452Id.atpp.12.
391

highly regarded AvalonBay1453 REIT had an implied capitalization rate of 6.3%.1454
(Thevalueofrealestateisinverselyrelatedtochangesincapitalizationrateallother
factors being equal, an increase in capitalization rates results in decrease in value.)1455
To estimate an enterprise value for Archstone, the article applied a 6% capitalization
ratetoanoptimistic$850millionofnetoperatingincomeforthisyeartoarriveat$14
billion,whichwaslowerthanthefacevalueofArchstonesdebt;thiswouldimplya
wipeoutofthe$5billionofequity.1456Thearticlefurthernotedthattheuseofa5.5%
capitalization rate, which it considered to be aggressive, still results in no equity
value.1457
a. ArchstonesResponsetotheBarronsArticle
On January 19, 2008, the Friday before Barrons piece was published, R. Scot
Sellers, Archstones CEO, wrote an email to Lehman, Tishman Speyer and Archstone
personnel, to set forth a compilation of talking points that should be helpful in
addressing many of the allegations in the article.1458 In this email, Sellers made the
followingarguments:
1453AsdiscussedbelowintheComparableCompaniesportionoftheAnalysissection,Lehmandeemed
AvalonBaytobeoneofthethreeprimarycompstoArchstone.
1455ShannonP.Pratt&RogerJ.Grabowski,CostofCapital:ApplicationsandExamples564(3ded.2008).
1457Id.
1458Email from R. Scot Sellers, Archstone, to David Augarten, Tishman Speyer, et. al. (Jan. 19, 2008)
[LBHI_SEC07940_111678].JonathanCohentoldtheExaminerthatLehmanknewthearticlewasgoingto
392

Publicmarketsarenotgoodpredictorsofrealestatevalues;1459
Valuesascribedbypublicmarketsarenottransactionable;1460
Replacementcostsareagoodindicatorofvalue;1461
Weakeningsinglefamilyhomemarketswillincreaserentgrowth;1462
Archstoneassetsaremoredesirablethanotherrealestateassets;1463
The article missed the value of Archstones platform and development

franchise.1464
bepublishedandthattheauthordidnotwanttoincorporateArchstonesandLehmansviewastovalue.
ExaminersInterviewofJonathanCohen,Jan.11,2010,atp.10.
[LBHI_SEC07940_111678]. The principle mistake in the article is the assumption that public market
sharepricesareinany[way]predictiveofrealestatevalues,orrepresentanefficientmarket.Sellers
goes on to argue how wrong the public market gets valuations and even directionality from time to
timeandcitesexampleswhereArchstoneboughtbackitsownstockatlargediscountstothevalueof
the assets when there was a period of illiquidity. He also cited Archstones solid operating
fundamentals.Id.
1460Id. Using a comparison of public market pricing to value our portfolio may seem intuitive to
someone who doesnt understand public markets well, but it is flawed for several reasons. First, you
simply could not purchase these companies today at anywhere close to current share prices. As
support, Sellers cites an example where Archstone was rebuffed in its attempt to acquire another REIT
during the last cycle with a cash offer at a material premium to the existing stock price. He further
statesthatpubliclytradedREITssuchasAvalonBayandEquityResidentialweretradingat35%to50%
belowreplacementcostandthatreplacementcostswereunlikelytocomedownmuch,ifatall,dueto
thetremendousdemandforrawmaterialsfromlargeconstructioninitiativesaroundtheworldandthat
landpriceswithinArchstonesmarketswereunlikelytochangemucheither.Id.
1461Id. Replacement costs are an especially important benchmark in supplyconstrained markets,
becauseofthedifficultyofaddingnewsupply.Bydefinition,asdemandincreasesinthesemarkets,it
canonlybemetbydevelopingnewunitsatreplacementcosts,whichinturnrequiresrentsthatproduce
amarketrateofreturnonthesecosts.Id.Replacementcostreferstothecosttoreplaceanasset,suchas
abuilding,atthecostthatonewouldincurtoday,whichmaybedifferentfromthefairmarketvalueof
theasset.Id.
1462Id. Sellers states that fundamentals for apartments were expected to become stronger due to the
deterioratingfundamentalsfornewsinglefamilyhomes(i.e.,peoplewillbemorelikelytorentthanbuy).
Id.
1463Id.Investorsplaceaveryhighvalueontheabilitytoacquirethesetypesof[Archstones]assets,at
anypointintherealestatecycle.Weareinaperiodofmorelimitedtransactionalvolumetoday,but
there is still significant demand to purchase the assets we own at very attractive prices, and we will
continuetoconsummatetransactionswithqualifiedbuyersandpartnersaswemoveforward.Id.
393

Sellersclosedtheemailbystatingthatthiswasatimetoacquiregreatassetsat
attractiveprices,becausehedidnotanticipateseeingalotofdistressinthemarkets,
duetothestrongoperatingfundamentalsinourbusinessandheexpectedthatinterest
rateswouldcomedown.1465
b. LehmansResponsetotheBarronsArticle
Lehman personnel met with representatives from Tishman Speyer, BofA and
BarclaysovertheweekendofJanuary19,2008,todiscusstheBarronsarticle.1466While
Lehman,BofAandBarclaysdecidednottoissueaformalresponse,Lehmananalyzed
public company information, compiled data on recent Archstone asset sales and
comparableassetsales,andreviewedArchstonesbusinessplan.1467
InaJanuary21,2009email,oneoftheLehmanparticipantsinthemeetingwrote
tohiscolleaguesthattheimpliedcapitalizationratesofpubliclytradedREITswerenot
representativeofthe companysportfolio. Thatbeingsaid, ifweactuallythought the
1464Id.Privaterealestateinvestorsunderstandthetremendousvalueofthisplatform/franchise,andare
willingtopayforit...butthepublicmarketsdontgetthisforsomereason.Sellersstatesthatboth
ArchstoneandAvalonBaywereabletoconsistent[ly]createvalueinsupplyconstrainedmarketsover
thecourseofmanyyearsyetpublicmarketinvestorshaveneverbeenwillingtorecognizethis.Id.
1465Id.
1466EmailfromScottA.Levin,Lehman,toStevenR.Hash,Lehman,etal.(Jan.21,2008)[LBEXDOCID
1488801].
1467Id.LehmanalsoidentifiedthefollowingassetsthattheBarronsarticledidnotappeartoincorporate
into its analysis: assets held for sale, development pipeline, platform value in Germany, ground leases
andotherassets.Id.
394

appropriate cap rate for the companys assets was 6.0%, there would not be much
equityvalueinthecompany(pleasedonotsharethatinformation).1468
ShortlyaftertheBarronsarticlewaspublished,JonathanCohensentanemailto
Donald E. Petrow, a Senior Vice President and Global Head of Real Estate Risk
Management,inwhichhewrote:Theissueisobviouslynowthatthepublicthinksthe
equitycouldbeworthlessandwearesittingatapriceof90whiletheIMDpermequity
positionisatpar.Ifwearegoodattheseprices,[]theonusisonustosupportthatwith
currentinfo.1469
A rebuttal to the Barrons article was presented to Lehmans Executive
CommitteeonJanuary22,2008.1470Therebuttalstatedthattheactualfactscontradict
theBarronsthesisandmadethefollowingarguments:1471
The 10 most recent trades in Archstones market occurred at an average

capitalization rate of 4.6%, which was significantly lower than the
capitalizationratesof6%andabovediscussedintheBarronsarticle;1472
1468Id. In the email, Levin notes that Archstone created models that illustrated that public markets
undervalue REITs compared to private markets and cap rates for institutional quality apartment
buildingsinhighbarriertoentrymarketshavemovedrelativelylittle.Tosupporttheseobservations,
Levinexplainedthat:
Archstonescomparablesweretradingatlessthanthevalueoftheindividualrealestateassets;
AfocusoncapitalizationratesignoresArchstonesnonrealestateassets,suchasdevelopmentassets;
Archstonescapitalizationrateswouldholdsteadyduetotheportfolioshighqualityassets;and
Apartmentbuildingsaremorestableinvestmentscomparedtootherrealestate.Id.
1469Email from Jonathan Cohen, Lehman, to Donald E. Petrow, Lehman (Jan. 22, 2008) [LBEXDOCID
1468672].
1470Email from Jonathan Cohen, Lehman, to RE Control US, Lehman (Jan. 22, 2008) [LBEXDOCID
1587277].
1471Lehman,ArchstoneASNTalkingPoints(Jan.22,2008),atp.1[LBEXDOCID1625626].
1472Id.
395

ArchstonerecentlysoldtwoassetsoutofitsWashington,D.C.portfolioata
capitalizationrateof4.1%;1473
Underlyingfundamentalswerestrong(asevidencedbyactualandprojected
rentgrowthof5%);1474
The stock market was valuing apartment REITs as if they were worth 30%
belowtheirnetassetvalue.Lehmannotedthatthepublicmarketoftenhas
thesepricinganomalies;1475
Barrons gave zero value for the company as a platform and its
developmentpipelineandlookedonlyatadraconianviewofassetvalue.1476
OnJanuary22,2008,afterreceivingtherebuttalargumentsthatwerepresentedtothe
ExecutiveCommittee,JonathanCohenwroteinanemailthattheBarronsarticlewas
[n]otArmageddonasoriginallythought.1477
(ii) January2008ArchstoneUpdate
In January 2008, Tishman Speyer provided a memo titled Archstone Business
PlanandSyndicationUpdate,toLehman,BofAandBarclays.1478Thememooutlineda
plantorampupArchstonesdispositionprogramin2008bydeleveragingArchstone
onanacceleratedbasisandgeneratingnetsalesproceedstopaydowntheTermLoanA
1473Id.
1474Id.Therebuttalalsoprovidedreasonswhyassetpricingremainedrelativelystrong,whichincluded:
a)Agenciescontinuetofinanceactively(lowtreasuryrates);b)Fewerrentersmovingtoownedhousing
becauseofcreditcrunch(albeitsomeforsalehousingoverhanginrentalpool;[and]c)Pricingofstand
alone assets will never stray too far from replacement cost before local developers buy. This is an
importantfactandcanlargelyexplainthedifferencebetweenwherestockstradeversusassetvalue.
1475Id.
1476Id.
1477EmailfromJonathanCohen,Lehman,toGaryJ.Fox,Lehman(Jan.22,2008)[LBEXDOCID1587278].
1478Memorandum from David Augarten, Tishman Speyer, et al., to R. Scot Sellers, Archstone, et al.,
ArchstoneBusinessPlanandSyndicationUpdate(Jan.30,2008),atp.1[LBEXDOCID1696101].
396

on an accelerated schedule.1479 The lenders were asked to delay the syndication of
TermLoanAforaperiodoftimetoallowtheCompanyampletimetoexecutethePlan
beforeanyadditionalOID[originalissuediscount]wasincurred.1480
Lehman,BofAandBarclaysmettodiscussArchstonesbusinessplanonorabout
January 30, 2008.1481 The successful execution of an accelerated disposition plan was
viewed as a critical first step to solving many of the problems faced by the equity
holders and lenders today.1482 Tishman Speyer described the problems that the
lendersandequityholdersfacedasfollows:
We still have $4.5 billion of equity left to syndicate and have lost
momentum with most of the large investors who were interested in the
deal.1483
There is no urgency for investors to invest in the deal today given the
amountofequitylefttosyndicate(i.e.thereisplentyofsupply).1484
InvestorsareconcernedthattheCompanyisnotworthwhatwepaidforit
becausecaprateshavecreptupwardsinmostmarkets.Althoughtherecent
1479Id.
1480Id. Original issue discount refers to the reduction in the value of loans that must be incurred to
effectuateatransactionbetweenawillingbuyerandwillingseller(includingtheborrowerandtheinitial
lender).FrankK.Reilly&KeithC.Brown,InvestmentAnalysisandPortfolioManagement528(6thed.2000).
For example, OID of 1% would result in a lender advancing $99 and holding a claim of $100 for
repaymentofprincipal.OIDgenerallyreferstothedifferencebetweenthestatedprincipalamountofa
debtinstrument(i.e.,theprincipalthattheborrowermustrepay)andtheamountthatthelenderactually
advanced. Id. However, in this instance, the term appears to refer to the discount at which the debt
wouldneedtobesoldbythelenderstoathirdpartyinvestor.
1481Memorandum from David Augarten, Tishman Speyer, et al., to R. Scot Sellers, Archstone, et al., re:
1482Id.
1483Id.
1484Id.
397

Barrons article grossly overstated the increase in cap rates, it still did not
helpinvestorperceptionofthevalueoftheCompany.1485
The current deal model shows returns that were well below the targeted
returns.1486Atthetime,themodelassumedtheentityleveldebtwasworth
97centsonthedollarandthateach$100millionreductioninthevalueofthe
entitylevel debt reduced the equity returns by 19 basis points (due to the
featuresofthepriceflexagreement).1487
The capital structure was not fixed due to the inability to syndicate the
entitylevel debt.1488 It was difficult to syndicate the debt due to the high
level of debt and the inability of the operating business to service its debt
obligations.1489
The lenders wanted to syndicate the term loan as quickly as possible, but
Archstone was still viewed as a risky credit with leverage at 76% (of
acquisition cost) and an operating business that was not covering its debt
service.1490
Archstone was hampered by an overleveraged balance sheet and had

limitedliquiditytofunditsexistingdevelopmentpipelineandtoinvestin
new business opportunities unless it [could] sell assets and refresh its
Revolvercapacityovertime.1491
The Tishman Speyer memo explains that to fix these problems, Archstone
must find ways to increase the value of company and improve its liquidity.1492
Tishman Speyer proposed that one way of achieving this goal for Archstone was to
allocatemorecapitaltohigherreturningdevelopmentandvalueaddedinvestments
1485Id.
1486Id.
1487Id.
1488Id.
1489Id.
1490Id.
1491Id.
1492Id.atp.2.
398

while selling certain of its core portfolio apartment complexes.1493 While it would be
challengingtoachieveallofthesegoalsinthenearterm,achievementofthesegoals
would make the equity and debt much more saleable.1494 The memo further notes
thattherewereveryfewapartmentassetsalessincethefall,whichmadeithardto
precisely estimate value in most markets.1495 According to Tishman Speyer, the
Archstoneassetsthatwerebeingmarkedwereexpectedtobesoldatvalues10%below
recent appraisals and 9% below the values that were the basis for underwriting the
acquisition.1496
(iii) ValuationasofFebruary29,2008
Lehmandidnottakeanyvaluationrelatedwritedownsduringthefirstquarter
of2008,endingFebruary29.1497OnFebruary2,2008,JonathanCohennoted:Fornow,I
thinkwearestillgoodatour90mark[referringtothebridgeequitymark].Willlikely
revisit,buttheonlyplaceitgoesissouth.1498
InaMarch3,2008emailtoClementBernard,theCFOofFID,JonathanCohen
explained that the methodology used by Lehman to value its bridge equity positions,
1493Id.
1494Id.
1495Id.atp.3.
1496Id.
1497JonathanCohenrespondedtoaquestionregardingfirstquartermarkdownsthattherewas[n]othing
thruP&L.Weusedmaybe15mmorsofromexcesscarryonthetermandmezzloanstomarkequity.
We never show that in the mark down summary. Email from Jonathan Cohen, Lehman, to Clement
Bernard,Lehman(June8,2008)[LBEXDOCID4320133].
1498Email from Jonathan Cohen, Lehman, to Robert Shaw, Lehman (Feb. 7, 2008) [LBEXDOCID
2801006].
399

including Archstone, in February 2008 was generally based on initial capitalization
structure on day 1, which also includes assumptions of the projected entity level cash
flowsandestimatedyieldsthatwewouldsellthebridgeequitytoinvestors....Sinceit
wasalwaysexpectedtobecarriedshortterm,therewasneverarobustanalysisputin
placeattheindependentservicertovaluetheequity....Thatsaid,theseinvestments
areactivelymonitoredfromthebusinessside(PaulHughson)toseeifthereisanyyield
impairmenttotheultimateequityinvestor.1499
Jonathan Cohen gave a presentation to the head of FID, Andrew J. Morton, in
March2008todiscussProductControlsreviewofthereasonablenessofLehmansfirst
quarter Archstone valuations.1500 The presentation materials include an overview of
how Lehman conducted bridge equity valuations, and set forth the internal rate of
return1501 (IRR) that was implied by Lehmans Archstone mark.1502 The presentation
materialsforthemeetingwithMortonnotethefollowing:1503
1499Email from Jonathan Cohen, Lehman, to Clement Bernard, Lehman (Mar. 3, 2008) [LBEXDOCID
1721456].
1500EmailfromJonathanCohen,Lehman,toAndrewJ.Morton,Lehman(Mar.13,2008)[LBEXDOCID
1437587](discussingtheseissuesfurther).
1501The internal rate of return is the discount rate that equates the series of cash flows to an initial
investment.SeeAppendix12,ValuationArchstone,foranillustrativeexampleofLehmansIRRmodel.
1502Id.
1503AbebualA.Kebede,Lehman,RealEstateInventoryValuation(Mar.10,2008)[LBEXDOCID1707877],
attachedtoemailfromAbebualA.Kebede,Lehman,toClementBernard,Lehman,etal.(Mar.10,2008)
[LBEXDOCID1854362].
400

Thepricingmethodologyforbridgeequitypositionsisdescribedasgauging
theyieldatwhichArchstonepositionswouldbepalatabletotargetinvestors
giventheoriginationassumptions.1504
Thevaluationneedstobebasedonthecollateralvaluesbecausesyndication
hasstalled.1505
Concerns specific to Archstone bridge equity include increases in

capitalizationratesandthepresenceofpriceflexonthedebt.1506
Hughson and Neighbor did not recall creating any documents that described
their methodology or analysis to support not taking any valuationrelated Archstone
writedowns in the first quarter.1507 Jonathan Cohen told the Examiner that Product
ControldidnotperformadequateanalysisregardingtheFebruary2008mark.1508
(iv) FirstQuarter2008EarningsCallandLenders
DiscussionRegardingModifyingtheArchstone
Strategy
DuringLehmansfirstquarter2008earningscallonMarch18,2008,ErinCallan,
CFO of Lehman, stated: With respect to Archstone, I want to make a comment here
againintheinterestoftransparencyaheadofquestions,wecurrentlyhold2.3billionof
1504Id.atSummarytab.
1505Id.atIssuestab.
1506Id.atMajorconcernstab.Priceflexwaslistedasabridgeequityvaluationconcern,becauseithada
negativeimpactonvaluationoftheequitypriceflextransferredlossofvalueofthedebttothebridge
equity.
1507Examiners Interview of Paul A. Hughson, Dec. 21, 2009, at p. 3; Examiners Interview of Webster
Neighbor, Nov. 17, 2009, at p. 3. However, Lehman appears to have prepared a sensitivity analysis
shortlyafterthefirstquarterended,asitwasbasedonaversionofthemodelusedtoassessLehmans
investment in Archstone as of March 3, 2008, as well as the underlying DCF model as of early March
2008. Jeffrey Wechsler, Lehman, Bridge Equity Discounting Sensitivity (Mar. 4, 2008) [LBEXDOCID
1391229],attachedtoemailfromJeffreyWechsler,Lehman,toJonathanCohen,Lehman(Mar.4,2008)
[LBEXDOCID1468681];Lehman,BridgeEquityDiscountingSensitivity(Mar.17,2008),atDiscounting
Sens.tab[LBEXDOCID1626080].
401

thenoninvestmentgradedebtrelatedtothattransactionand2.2billionofequity,both
currently carried materially below par. We are actively delevering that company
throughassetdispositionsatattractivelevelsandimprovingtheirfinancialprofile.1509
Atthattime,LehmanmarkedallofitsArchstonedebtpositionsat99(withthe
exceptionofthedevelopmentloanat96),bridgeequityat90,anditspermanentequity
at100,foraweightedaveragemarkforitsportfolioof95.1.Aspreviouslydiscussed,
thereductioninthe markthroughFebruary2008wasattributabletomarkingthefees
andexcesscarryintothebridgeequityposition.JonathanCohentoldtheExaminerthat
he was not consulted before this earnings call and that he would not have used the
word material.1510 Hughson told the Examiner that he agreed with Callans
characterizationastowhereLehmanwasmarkingitsArchstonepositions,becausethe
mark on the overall positions implied a 5% belowfundedamount mark for debt and
equitypositions.1511
(e) ValuationIssuesDuringtheSecondQuarterof20081512
(i) March2008ArchstoneUpdate
AccordingtotheTishmanSpeyerMarch2008ArchstoneUpdate,itbecamevery
difficult for Archstone to sell assets as market participants became decidedly more
1509FinalTranscriptofLehmanBrothersHoldingsInc.FirstQuarter2008EarningsCall(Mar.18,2008),at
p.6.
1512LehmanssecondquarterstartedonMarch1,2008,andendedMay31,2008.
402

cautious.1513Thememoreportsthat[a]llofthelargedealsthatweweretryingtoput
togetherearlierthisyearhavebeenunsuccessfultodate.1514Over$1billionofpotential
asset sales that were in negotiations fell apart after Bear Stearnss near collapse.1515
Tishman Speyer expectedit tobe challenging for Archstoneto sellassetsuntil such
timeasmarketconditionsstabilized.1516
Inresponsetothisdifficultenvironment,theproposedrevisedassetdisposition
plancallsforawillingnesstoacceptslightlylowerpricesifnecessary,inthenearterm,
to free up some liquidity and for the marketing of some of Archstones trophy
properties.1517Theassetsthatweremarketedatthistimeweredeterminedtobeworth
13% less than their appraised values.1518 The implications of this determination are
explainedintheanalysissectionbelow.
In response to concerns that Archstones liquidity situation was worsening due
tothecostofservicingtheacquisitiondebt,Archstonestartedtoreduceitsinvestment
in capital expenditures.1519 Tishman Speyer projected that, as a result of Archstones
inabilitytoexecuteontheassetsaleprogram,Archstonewouldrunoutofliquidityin
1513Memorandum from David Augarten, Tishman Speyer, et al., to R. Scot Sellers, Archstone, et al., re:
ArchstoneUpdate(Mar.24,2008),atp.1[LBEXDOCID2932586].
1514Id.
1515Id.
1516Id.
1517Id.atp.2.
1518Id.
1519Id.
403

four months (July 2008) if Archstone did not sell assets.1520 Tishman Speyer reported
thatArchstonesmanagementwasintheprocessofreviewingitsdevelopmentplan
to assess what projects should be pursued, renegotiated or cancelled and that
Archstonespeerswerealsoscalingbackdevelopmentplansintheshortterm.1521
(ii) March2008Valuation
On March 11, Product Control asked the bridge equity desk for a sensitivity
analysis based on the model that the desk used to value the Archstone position.1522
Product Control received the underlying model, as well as the sensitivity analysis, on
March17.1523
Discussionsregardingapotential$200millionwritedownonArchstonebridge
equity appear to have begun in midMarch 2008.1524 Jonathan Cohen reported to
Bernard on March 20, 2008 that the bridge equity desk was running numbers and
stressing cap rates, and the preliminary view was that a writedown of $200 million
couldbetakenbytheendofthemonth.1525Animpetusforthispotentialwritedown
was the aforementioned $1 billion of potential asset sales that did not close in the
1520Id.
1521Id.atp.4.
1522Email from Jonathan Cohen, Lehman, to Jeffrey Wechsler, Lehman, et al. (Mar. 11, 2008) [LBEX
DOCID1468690].JonathanCohenaskedforasensitivityanalysisthatshowedamarkaslowas60.Id.
1523Email from Jeffrey Wechsler, Lehman, to Jonathan Cohen, Lehman (Mar. 17, 2008) [LBEXDOCID
4310701].
1524Email from Jonathan Cohen, Lehman, to Clement Bernard, Lehman, et al. (Mar. 20, 2008) [LBEX
DOCID1854627].
1525Id.
404

aftermathofBearStearnssnearcollapse.1526JonathanCohentoldtheExaminerthatby
thistime,Archstonesbridgeequitywasessentiallyhung,meaningthatitwasbeing
heldonLehmansbooksasopposedtobeingsoldtoinvestors.1527
Lehmanultimatelytooka$200millionwritedownonitsbridgeequityanda$50
million writedown on its permanent equity in March 2008.1528 As illustrated in the
previous table titled Lehmans Archstone Marks by Month, the resulting mark for
both positions after the writedown was 80% of funded value (or a mark of 80). In
arrivingatthisvaluation,LehmandeterminedthatTermLoanAwasworth100cents
onthedollarwhileTermLoanBandtheRevolverwereworth90centsonthedollar.1529
LehmanssensitivityanalysisshowedthatLehmanprojectedaninternalrateofreturn
(IRR) on its equity investment of 16.5% employing the exit capitalization rate used
whenLehmandecidedtoparticipateintheacquisition,and14.6%assuminga50basis
points decrease in that exit capitalization rate.1530 The Examiners financial advisor
observed that this analysis shows that Lehmans lower valuation for its Archstone
positions was based on Lehmans determination that either the risk associated with
1526Id.
1529Email from Lonnie Rothbort, Lehman, to Jonathan Cohen, Lehman (May 16, 2007) [LBEXDOCID
1438381];Lehman,BridgeEquityDiscountingSensitivity(Apr.1,2008),atp.1[LBEXDOCID1432509],
attached to email from Jonathan Cohen, Lehman, to Lonnie Rothbort, Lehman (May 16, 2008) [LBEX
DOCID1567463].
1530Lehman,ArchstoneQ22008Update(June12,2008),atp.15[LBEXDOCID2929329].
405

Archstonegeneratingitsprojectedcashflowsincreasedoritwasappropriatetoreduce
theprojectedcashflows.
According to a presentation created by Lehmans Product Control Group, the
Marchwritedownwastakenbasedonthefollowingrationale:1531
Buyerswalkedawayfrom$1billioninpropertysales;
Increaseincaprate(widenedexitcapratesby50bps);
Increasedpremiumtoinvestorsuntilcompanyisdeleveredthroughasset
sales;1532
Nocurrentcashoncashreturnforequityinvestors;and
Liquidity.
Hughson told the Examiner that he agreed with the writedown in March, but
did not necessarily agree with the statements in the Product Control presentation.1533
Hughsonstatedthathisteamconsideredeverythingthatwashappeningatthetime
andincorporateditintothemodelinmarkingArchstonepositions.1534Hughsonstated
that his team marked the positions to the current state of play in the market,
includingexitcapitalizationrates,andtheteamsmarksreflectedhisbestjudgmentas
tothevalueoftheArchstonepositionsatthattime.1535
1531Lehman,GlobalRealEstateProductControl,RealEstateAmericasPotentialWritedowns(May2008),
atp.80[LBHI_SEC07940_2258765].
1532ThisreflectstheincreasedrisktoequityholdersuntilthesignificantdebtonArchstonesbookswas
reducedthroughpropertysales.
1534Id.
1535Id.
406

(iii) April2008DowngradebyS&P
InApril2008,S&PlowereditscorporatecreditratingforArchstonefromBBto
B,changeditsoutlooktonegativeandthenwithdrewtheratings.1536Therationalefor
thedowngradewasthemorechallengingcreditenvironment,whichhasslowedasset
salesand couldhinder[Archstones]abilitytodisposeofassetsinasprofitableand
timelyafashionasithadinitiallyconsidered.1537
A contemporaneous email exchange between product controllers Jonathan
Cohen and Bernard discusses the potential consequence of S&P downgrade to the
value of Lehmans positions.1538 In an email dated April 29, 2008, Jonathan Cohen
wrote to Bernard that he doubted the rating change changes investors perception
because the debt had the benefit of priceflex and the equity valuation assumed Term
LoanBcouldbesoldat90centsonthedollar.1539
(iv) EinhornSpeechinApril2008
OnApril8,2008,DavidEinhorn,PresidentofthehedgefundGreenlightCapital,
gave a speech before the Grants Spring Investment Conference that questioned
1536S&P,TishmanSpeyer,ArchstoneSmith,AndRelatedEntityRatingsLowered,ThenWithdrawn(Apr.
28,2008),atp.1[LBHI_SEC07940_120171].Lehmanreceivednoticeofthependingdowngradebeforeit
wasmadepublic.TherewasadialoguewithinLehmanregardingthepotentialtochangeS&Psdecision
regardingthedowngradeortokeepitfrombecomingpublic.EmailfromFrancisX.Gilhool,Lehman,to
JohnJ.Niebuhr,Lehman,etal.(Apr.25,2008)[LBHI_SEC07940_120164].
1537Id.
1538Email from Clement Bernard, Lehman, to Jonathan Cohen, Lehman (Apr. 29, 2008) [LBEXDOCID
1488843].
1539Id.JonathanCohenarguedthebelowparpriceof90alreadytookintoaccountthedecreaseincredit
quality.
407

Lehmans valuations of Archstone.1540 Einhorn observed that Archstones comparable
companiestradingpriceshadfallen2030%sincetheArchstonedealwasannounced.
Einhorn concluded that the high leverage in the privatized ArchstoneSmith would
suggesttheneedforamultibilliondollarwritedown.1541
(v) May2008Valuation
Unlike previous quarters, a substantial number of materials were prepared as
part of the May valuation process in anticipation of the second quarter close. This
Sectionfirstaddressesthematerialspreparedaspartofthevaluationprocess,andthen
addressesthematerialspreparedinadvanceoftheearningscall.Initssecondquarter
earnings call, Lehman discussed its equity valuation and the methodology it used to
markitsinvestment.
On May 16, 2008, Bridge Equity personnel provided an update on the recent
activity around Archstone and included a discussion of Lehmans valuation
methodology (May 16 Archstone Update).1542 The valuation methodology consisted
of three components: a discounted cash flow analysis, an analysis based on the
implications of the sale of assets from Archstones core portfolio and a comparison of
1540DavidEinhorn,PresentationtoGrantsSpringInvestmentConference:PrivateProfitsandSocialized
Risk(Apr.8,2008),availableathttp://www.foolingsomepeople.com/main/mroom/Grants%20Conference%
2004082008.pdf.
1541Id.
1542Memorandum from Keith Cyrus, Lehman, et al., to Donald E. Petrow, Lehman, et al., re: Archstone
Update(May16,2008),atp.1[LBEXDOCID1416761].
408

Lehmans valuation of Archstone to the value of Archstones publicly traded peers
basedontheirstockprices.1543
The discounted cash flow analysis, which is described in further detail below,
was based on various underwriting scenarios.1544 The required rate of return for an
investment in Archstones equity was viewed as similar to the returns provided by
coreplusfunds,whichLehmandeterminedrangedfrom12%to15%.1545
The May 16 Archstone Update does not include any analysis of Archstones
sales,butitincludesalistingofsalesaccomplishmentsthatreportsthecompanyhad
sold$1.9billionofassetsandthatithad$496millionofassetsundercontract.1546The
May16ArchstoneUpdatenotesthatArchstonewasgenerallysellingitslowerquality
assets and that Archstone was perceived to be a distressed seller.1547 Lehman
determined that Archstones liquidity position and overall markets would improve
overtime.1548
TheanalysiscomparingLehmansvaluationofArchstonetothevalueofoneof
itspeerswasbasedonvaluationanalysespublishedbyathirdpartyresearchfirmthat
1543Id.atp.3[LBEXDOCID1416761];Lehman,ArchstoneUpdate2008(May16,2008),atpp.414[LBEX
DOCID1488847].
1544Inthemodel,theprimarysensitivityanalysiswasperformedonthetimingofassetsalesandtheexit
capitalizationrateappliedtothelongtermholdportfolio.Id.
1545Memorandum from Keith Cyrus, Lehman, et al., to Donald E. Petrow, Lehman, et al., re: Archstone
1546Lehman,ArchstoneUpdate2008(May16,2008),atp.1[LBEXDOCID1488847].
1547Memorandum from Keith Cyrus, Lehman, et al., to Donald E. Petrow, Lehman, et al., Archstone
1548Id.
409

Lehman frequently referenced. The May 16 Archstone Update notes that the
capitalization rate a thirdparty research firm applied to AvalonBay, which was
generallyviewedastheclosestcomparablecompanytoArchstone,washigherthanthe
capitalization rate Lehman used for Archstone.1549 This analysis also included a
comparison of Lehmans marks over time on Archstone equity to changes in equity
valueofArchstonespeerssincetheCommitmentDate.1550
On May 27, 2008, Lehmans Product Control Group presented its view of the
Archstone sensitivity analysis to Lehmans CFO, Callan.1551 This analysis suggested a
range of additional writedowns ranging from $78 million to $615 million.1552 As
Lehman had already taken $436 million of writedowns, the highest potential write
down of $615 million would result in total writedowns of over $1 billion. Kebede
participated in this meeting and recalled being disturbed by Callans reaction upon
beingtoldthatthecumulativeArchstonewritedowncouldbegreaterthan$1billion
Callandidnotaskanyquestionsandonlywrotesomethinginhernotebook.1553Kebede
1549Lehman,ArchstoneUpdate2008(May16,2008),atp.9[LBEXDOCID1488847].
1550Id.
1551Lehman, Real Estate Product Control Update (May 27, 2008), at p. 1 [LBEXDOCID 4344653] (the
presentationtoCallan).
1552The current valuation model, per Lehmans Product Control Group, used a 5.62% rent growth
assumptionand an18% internal rate of return. Lehman,Real Estate ProductControl Update (May 27,
2008), at p. 6 [LBEXDOCID 4344653] (presented to Callan). The sensitivity analysis stressed the rent
growthassumptionfrom100to200basispointsandtheIRRassumptionfrom18%to20%.Thisanalysis
suggested a range of incremental writedowns between $78 million (no stress on the rent growth rate
assumption and an IRR of 19%) to $615 million (200 basis points decrease in the rent growth rate
assumptionandanIRRof20%).Id.
410

told the Examiner that he expected that the CFO, upon hearing such a report, would
have asked at least a few questions in order to understand the basis of the possible
writedown.1554
Lehmantookanadditional$100millionwritedowninitsArchstonepositionsin
May 2008, which reduced the bridge equity mark to 75 and the overall value of
Lehmans Archstone positions to 88% of funded value.1555 E&Y reviewed Archstones
marksaspartofitsquarterlyevaluation,andconcludedthattheprocessbywhichthe
Archstone . . . positions are valued as well as the related inputs, assumptions, and
calculatedvaluesappearreasonableforthepurposeofassessingreasonablenessforour
quarterlyreview.1556
(vi) SecondQuarter2008EarningsConferenceCall
a. PreparationandLehmansMethodsofAnalyzing
ReasonablenessofValuationsPriortotheCall
In advance of the second quarter 2008 earnings call, GREG prepared a
presentation(referredtobyLehmanastheQ2Book)thatsetsforthseveralmethods
of analysis used by Lehman to assess the reasonableness of reported Archstone
1554Id.
1556MemorandumfromNicholasMcClay,Ernst&Young,toFiles,Ernst&Young,re:QuarterlyReview
Valuation Procedures for Archstone & SunCal Real Estate Investments (July 9, 2008), at p. 2 [EYSEC
LBHIDFMFIN000048].SeeSectionIII.A.2.b.2.bforadetaileddiscussionofE&Ysreview.
411

valuationsasofMay2008.1557Thepresentationillustrateshowthemarkof75forbridge
equitywasdeterminedand includesthefollowingmethods,whicharedetailedinthe
ExaminersanalysisofLehmansArchstonevaluationsbelow:1558
ValuationofArchstonebasedonsumoftheparts;
ComparisonofArchstonesfundamentalstoitspeergroup;
AnalysisofsalesofArchstonesapartmentcomplexes;
Comparison of Lehmans valuation of its Archstone equity investment

relativetothechangeinvalueofArchstonespubliclytradedpeers.1559
b. DiscussionDuringtheSecondQuarter2008
EarningsCall
DuringLehmans2008secondquarterearningscall,LowittdiscussedLehmans
valuation of its Archstone equity investment and the methodology that was used to
determine such value.1560 Lowitt stated: We have arrived at Archstones enterprise
value primarily using a discounted cash value analysis, which supports a midteens
1557Lehman,ArchstoneUpdateQ22008(June12,2008),atpp.13[LBEXDOCID2902980],attachedto
emailfromWebsterNeighbor,Lehman,toBrettBossung,Lehman,etal.(June12,2008)[LBEXDOCID
2902980];ExaminersInterviewofWebsterNeighbor,Nov.17,2009,atp.5.
1558Lehman, Archstone Q2 2008 Update (June 12, 2008), at p. 15 [LBEXDOCID 2929329]. The May 30,
2008 mark implied an IRR of 16.9% under the scenario that stressed the exit capitalization rate by 100
basispoints.TheimpliedIRRwasfurtherreducedtoapproximately15%bystressingtheexitplatform
valuebetween$500millionand$1billion.EmailfromWebsterNeighbor,Lehman,toPaulA.Hughson,
Lehman, et al. (June 14, 2008) [LBEXDOCID 1865693]. An email exchange between Neighbor and
Hughson explains some of the other sensitivity analyses that were considered. Combinations of
assumptionsthatresultedina15%IRRincluded:(1)75basispointincreaseintheexitcapitalizationrate
and25basispointdecreaseinrentgrowthrate,(2)50basispointincreaseintheexitcapitalizationrate
and75basispointdecreaseinrentgrowthrate,and(3)25basispointincreaseintheexitcapitalization
rateand125basispointincreaseinrentgrowth.Id.
1559Unlike the analysis discussed in the prior section, this analysis took into account the effect of
Archstoneslargedebtinitscapitalstructure.
1560Final Transcript of Lehman Brothers Holdings Inc. Second Quarter Earnings Call (June 16, 2008), at
pp.1314.
412

IRR.1561 He explained that, We crosschecked that using a number of different
methodologies, including sum of the parts, replacement costs and recent comparable
transactions based on both cap rates and price per unit, the most important including
assetsalesfromtheArchstoneportfolio.1562Lowittprovidedfurtherdetailsregarding
Archstonesassetsales:
Archstone sold approximately $2 billion of assets todate and was under

contractorinactivenegotiationtosellanadditional$2billion;
The $4 billion in transactions were at an average capitalization rate in the

mid4%range;and
ManyoftheassetsthatwerebeingsoldwereidentifiedbyArchstoneasnon
core or nonstrategic and in certain cases did not represent the highest
qualityassetsinArchstonesportfolio.1563
Lowitt explained that Lehmans valuation reflect[s] the companys business
planofonlysellingenoughassetstoreducedebttoatargetedlevelandtocontinueto
increasevaluethroughitsdevelopment,assetmanagement,andrevenueenhancement
programs, which have and continue to be very successful. In that context, we have
assumedthatcapitalizationrateswillbemorethan100BPS[basispoints]higherwhen
the properties are sold than when the transaction was entered into. Based on this
analysis,weareverycomfortablewithourcurrentArchstonemark.1564
1561Id.atp.14.
1562Id.
1563Id.
1564Id.
413

HughsontoldtheExaminerthathereceivedcomplaintsfromBarclaysandBofA
when the 75 equity mark was publicly disclosed, because it was lower than the mark
theywereusingfortheirownArchstoneequitypositions.1565TheExaminersfinancial
advisorobservedthatthecostofpricefleximpliedbyLehmansmarkwashigherthan
thecostof pricefleximpliedbythebalanceoftheEscrowAccountasofFebruary29,
2008.1566
(vii) LehmansRevisedPlantoSellArchstonePositions
InMay2008,Lehmanacknowledgedthatitwouldnotmeetitsdebtandbridge
equitysyndicationgoalsandgeneratednewprojections.1567Lehmansinitialplanwasto
syndicatealldebtandbridgeequitywhileretainingonlypermanentequity.1568Lehman
initially projected it would meet these goals by October 2008, as illustrated by the
followinggraph:
1566BofA,
Transactions for Bank of America as Administrative Agent Archstone Operating Trust
Expense Reserve Escrow Account (July 20, 2009), at p. 1 [LBEXBofA 000007]; Lehman, Easy Living Q2
ModelRisk(June15,2008),atSourcesandUsestab[LBEXDOCID4456413].
1567Lehman,ArchstoneSmithTrust(May21,2008),atp.1[LBEXDOCID019129]
1568Lehman,Standard&PoorsRealEstateUpdate(Oct.10,2008),atp.19[LBEXDOCID514267].
414

LehmansPlanatClosingtoReduceitsArchstoneExposure1569
Lehman Brothers Share of Archstone-Smith Distribution

($ in billions) Current
25 $24.3 1 Position
20
$12.8 Forecast for Forecast for Forecast for Dec - Foreca st for
Partners Share
Oct 07 Dec 07 March 08 March - Oct 08
15
$3.3
10 $0.9 $0.7
$11.5 $0.8 $0.7 $0.5
Fannie Mae
Freddie Mac
$0.2 $1.9
5 Asset Sales Assumed Debt / $2.0
Bank Loan Mezz Loan Development $0.5
Preferred Equity
Syndication Syndication Loan Repayment Bank Loan
0 Phase I Syndication Bridge Equity Final Equity
___________________________ Phase II (1) Syndication Hold
1. Includes share of $750 million revolver commitment.
By May 2008, Lehman updated its plan, reflecting a determination that
Archstone would need to sell assets to satisfy debt and thereby reduce leverage.1570
LehmanpushedthegoalsithadexpectedtomeetbyOctober2008tofiscalyear2010.1571
AssetforthinthefollowingLehmangraph,Lehmanacknowledgeditwouldstillhold
approximately$5.0billion(notional)ofArchstonedebtandequityattheendofthe2008
fiscalyear.1572
1569Id.
1570Lehman, ArchstoneSmith Trust (May 21, 2008), at p. 1 [LBEXDOCID 019129], attached to email
fromPaulA.Hughson,Lehman,toPaoloR.Tonucci,Lehman(May21,2008)[LBEXDOCID074037].
1571Lehman,ArchstoneSmithTrust(May21,2008),atp.1[LBEXDOCID019129].
1572Id.
415

LehmansMay2008PlantoReduceitsArchstoneExposure1573
Lehman Brothers Share of Archstone-Smith Distribution

($ in BN)
$24.31 Current Forecast
25 Position Q4 08
$5.4 billion $4.8 billion
20
Forecast for Forecast for Forecast Forecast
$12.8 Partners Share
Q2-Q3 08 Q4 08 FY 09 FY 10
15
$5.7
10
$11.5
$0.4 $0.3 $0.1 $0.2 $0.5 $2.5
5 Asset Sales / Asset Sales /
Debt Placed Refinancings Bank Loan Development Bank Loan Mezz Loan $1.3
Repayment Loan Repayment Repayment Syndication
$0.5
at Close Post-Closing Bank Loan /
0 Bridge Equity Remainder of Final Equity
___________________________ Syndication Bank Loan / Hold
1. Includes share of $750 million revolver commitment. Bridge Equity
2. Asset sales, debt placement, assumed debt, and refinancings are net proceeds at Lehman share. to Syndicate

(f) ValuationIssuesDuringtheThirdQuarterof20081574
AfterrelativelysmallreductionsinthemarksreflectingexcesscarryinJuneand
July 2008, Lehman took its final significant Archstone writedown in August 2008,
reducingbridgeequityby$110millionandpermanentequityby$15million.1575Kebede
toldtheExaminerthatthiswritedownwaslargerthanhethoughtwaswarranted,and
he did not know why the writedown was taken.1576 An email exchange between
NeighborandHughsonincludedtheanalysisandtheunderlyingassumptionsusedto
arriveatthe$110millionwritedown,andisdiscussedintheExaminersanalysisofthe
reasonablenessofLehmansArchstonemarks.1577
1573Id.
1574LehmansthirdquartercoveredJune1,2008,throughAugust31,2008.
1577In an email to Hughson on September 12, 2008, Neighbor wrote that that the August mark was
calculated using a stressed rental growth compound annual growth rate (CAGR) of 4.9% and an
increasedexitcapitalizationrateof5.57%.Theplatformvalueremainedunchangedat$2billion.Email
fromWebsterNeighbor,Lehman,toPaulA.Hughson,Lehman(Sept.12,2008)[LBEXDOCID2903130].
NeighbortoldtheExaminerthathedidnotrecallwhethervaluationworkoccurredinthethirdquarterof
2008inparticular,andhedidnotrecallwhethertherewasathirdquarterArchstonewritedownof$110
416

(i) DiscussionAmongLendersinJuly2008
The discussions among lenders in July 2008 covered the topics addressed in
previousmonths,includingprogressonassetsales,thecurrentliquiditysituationand
plansregardingdevelopmentopportunities.1578AsofJuly9,2008,Archstonehadsold
approximately $1.5 billion assets that were on average 12% below the originally
appraisedvalue.1579Archstoneprojectedthatitwouldhaveenoughliquiditytooperate
through the end of the year.1580 Archstone continued to invest in development
opportunities but had difficulty finding joint venture deals that resulted in attractive
proposals.1581
(ii) August2008Valuation
Asdescribedabove,Lehmantookanadditionalwritedownof$110millioninits
bridge equity and $15 million in its permanent equity in August 2008.1582 The
ExaminersfinancialadvisorreviewedthemodelthatLehmanusedforitsAugust2008
Archstonevaluation,asdiscussedbelow.1583
million on bridge equity and $15 million on permanent equity. Examiners Interview of Webster
Neighbor,Nov.17,2009,atp.3.Neighboralsodidnotrecallwhethertherewasanythingunusualinthe
Archstonevaluationprocessinthirdquarter2008(orthefirstorsecondquartersof2008).Id.
1578Memorandum from David Augarten, Tishman Speyer, et al., to Mark Walsh, Lehman, et al., re:
ArchstoneBankMeetingAgenda(July9,2008),atpp.12[LBEXDOCID1746835].
1579Id.atp.2.
1580Id.
1581Id.atp.1.
1582Lehman,TopGlobalRealEstateExposures(Aug.31,2008),atp.12[LBHI_SEC07940_ICP_002615].
1583ItappearsthatNeighboradjustedtoamoreconservativeCAGRof4.90%fromthebasecaseof5.62%.
Email from Webster Neighbor, Lehman, to Paul A. Hughson, Lehman (Sept. 12, 2008) [LBEXDOCID
2903130].Neighboralsoincreasedtheexitcapitalizationrateassumptiontoanaverageof5.57%,which
wasalsomoreconservativethanthebasecaseof4.82%.1583Neighborlefttheplatformvalueat$2billion,
417

(g) ProductControlsReviewofArchstoneValuations
JonathanCohentoldtheExaminerthatLehmansProductControlGroupdidnt
domuchtopricetestArchstonein2007orearly2008,andthegroupdidnotlookat
theplatformvalueinthemodeluntilthesecondorthirdquarterof2008.1584According
to Cohen, the product controllers did not receive adequate information to test the
businessdesksvaluations,andtheProductControlGroupdidnothaveitsownmodel
or the required knowledge to test the assumptions (i.e., rent growth rates) underlying
the valuations.1585 Cohen did not recall discussing the model with the business desk
priortoMarch2008.1586AbebualKebede,whenshownthemodelandaskedtoexplain
how it worked, said that the Examiner should speak with Neighbor.1587 Cohen stated
that he never saw anything supporting certain assumptions that Lehman used when
determining its Archstone valuations (e.g., a capitalization rate of 4.1%).1588 Cohen
stated that prior to the first quarter 2008 earnings call, he did not review alternative
which resulted in a writedown of $110 million for Archstone bridge equity in August. For the third
quarter,LehmanassumedatargetIRRof15.59%.EmailfromWebsterNeighbor,Lehman,toAbebualA.
Kebede, Lehman, et al. (Sept. 11, 2008) [LBEXDOCID 1861565]. These assumptions are all reviewed
belowintheanalysissection.
1585Id.TheArchstonebridgeequitypositionwasincludedinpricetestingfilesforPTGequitypositions.
ExaminersInterviewofEliRabin,Oct.21,2009,atp.9.However,thatmodelwasnotusedtopricetest
the Archstone positions. Lehman, Real Estate Product Control Update (May 27, 2008), at p. 115
[LBHI_SEC07940_2258765].
1586Id.
1587ExaminersinterviewofAbebualA.Kebede,Oct.13,2009,atp.11.
418

methodologiesthatwouldserveaschecksontheIRRmodeldiscussedonthecall,and
Cohenwasnotsureifanyonebelowhimdidthiseither.1589
In view of the foregoing, the Examiner finds that there is sufficient evidence to
support a finding that the Product Control Group did not serve as an effective,
independentcheckonLehmansvaluationofitsArchstonepositions.
(4) ExaminersAnalysisofLehmansValuationProcessforits
ArchstonePositions
This Section of the Report sets forth the Examiners analysis of the
reasonablenessofLehmansvaluationsofitsArchstonepositions,asoftheendofeach
quarter, and beginning with the fourth quarter of 2007. As the valuation of illiquid
assetsrequiresjudgment,theExaminerrecognizesthattherearearangeofreasonable
determinations regarding the appropriate valuation inputs, and therefore a
correspondingrangeofreasonablevaluationoutputs.
As discussed above, Lehman recorded the following values for its Archstone
positionsaftertheOctober5,2007closing:$5.13billionattheendoffourthquarter2007
(95.6%offundedamount);$5.11billionattheendoffirstquarter2008(95.1%offunded
amount);$4.67billionattheendofsecondquarter2008(88.0%offundedamount);and
$4.19billionattheendofthirdquarter2008(84.3%offundedamount).1590
1589Id.
1590SeeChart,LehmansValuationofArchstonePositions(U.S.$million,Oct07Aug08),atpage1ofthis
Report.Lehman,ArchstoneMonthlyExpensesasofJuly08(July2008),atp.1[LBHIBARFID0013113];
419

Lehman used various methods over time to determine or benchmark the
valuationofitsArchstonepositions.Inordertoprovidetheappropriatecontextforthe
valuation analysis, this Section begins with a discussion of the methods Lehman
employedin2007and2008tovalueitsArchstonepositions.Thesemethodsincluded:
(i)DiscountedCashFlow(DCF);(ii)valuationofArchstonesindividualassets(Sum
of Parts); and (iii) an analysis based on the value of publicly traded comparable
companies (Comparable Company). Although Lehman did not consistently utilize
these methods in valuing its positions between October 2007 and the end of the third
quarter of 2008, the Examiners financial advisor considered each approach for each
periodinordertoconductaconsistentreview.
The following discussion of these methods, and, in particular, the information
andassumptionsusedtodeterminevaluepursuanttotheoperationofthesemethods,
issetforthtoestablishafoundationfortheanalysisbytheExaminersfinancialadvisor
of Lehmans valuations of its Archstone positions. Accordingly, while the following
SectionconsidersthecomponentpartsofthesemethodsasappliedbyLehman,itdoes
not address the reasonableness of the valuations themselves. That analysis, which is
undertakenonaquarterbyquarterbasis,followsthereafter.
420

(a) DiscountedCashFlowValuationMethod
The DCF model was the primary methodology Lehman used to value its
Archstone positions.1591 Lehmans valuation model was not strictly a DCF model.
Instead of calculating a value, Lehmans model stipulates a value, solves for the
discount rate and then assesses the reasonableness of that discount rate.1592 Lehman
referredtothisapproachastheInternalRateofReturnMethod(IRRMethod).1593The
Examiners financial advisor determinedthat LehmansIRRMethodwas areasonable
methodologybecauseboththetraditionalDCFmodelandLehmansIRRMethodarrive
atthesamevalueifthesameassumptionsareused.1594Accordingly,thisSectionuses
thetermsDCFmodelandIRRMethodinterchangeably.
The DCF model determines the value of an asset by reducing future expected
cashflowstotheirpresentvaluebyapplyingadiscountrate.1595Inthismanner,thetwo
keycomponentsintheDCFmodelarefutureexpectedcashflowsandthediscountrate.
Thechangeinthevalueofanassetispositivelycorrelatedwiththechangeinexpected
1591LowittstatedthattheDCFmodelwasLehmansprimaryvaluationmethodforvaluingitsArchstone
positionsduringLehmanssecondquarter2008earnings.FinalTranscriptofLehmanBrothersHoldings
Inc. Second Quarter Earnings Call (June 16, 2008), at p. 14 [LBHI_FIN 0007]; Examiners Interview of
AbebualA.Kebede,Sept.29,2009,atp.3.
1592Lehman,ProjectEasyLiving:TishmanSpeyerArchstoneSmithMultifamilyJV,LP(Mar.17,2008)
[LBEXDOCID 1626080]; Lehman, Easy Living Q2 Model Risk (June 15, 2008), at CFDetail tab [LBEX
DOCID4456413].
1594SeeAppendix12,ValuationArchstone.
1595Aswath Damodaran, Corporate Finance, Theory and Practice 750 (2nd ed. 2001); Eugene F. Brigham &
JoelF.Houston,FundamentalsofFinancialManagement395(8thed.1998).
421

cashflowsi.e.,anincreaseinfutureexpectedcashflowsresultsinanincreaseinvalue,
and a decrease in expected future cash flows results in a decrease in value.1596
Conversely, the change in value of an asset is negatively correlated with a change in
discountratei.e.,adecreaseinthediscountrateresultsinanincreaseinvalue,andan
increase in the discount rate results in a decrease in value.1597 Consequently, the
Examiners financial advisors analysis of Lehmans DCF Method focused on both
Lehmansdeterminationsforexpectedfuturecashflowsandthediscountrate.
ThefutureexpectedcashflowsLehmanusedinitsDCFMethodwerebasedona
number of different assumptions,1598 but three in particular drove the results: rent
growth,exitcapitalizationratesandexitplatformvalue.1599Giventheirimportance,the
Examinersfinancialadvisorfocusedonthesethreefactors.
(i) RentGrowth
The rent growth assumption refers to the expectation that the rent Archstone
charged its tenants would increase over time.1600 Lehmans valuation analysis
incorporated a projection of rent growth for each individual property within
1596Id.
1597Id.
[LBEXDOCID1626080].
1599Lehman,ArchstoneQ22008Update(June12,2008),atpp.1617[LBEXDOCID2929329].
[LBEXDOCID1626080];Lehman,EasyLivingQ2ModelRisk(June15,2008)[LBEXDOCID4456413].
422

Archstonesportfolio.1601Therentgrowthratesfortheindividualapartmentcomplexes
were combined to arrive at a weighted average growth rate for the entire portfolio.1602
Lehman also performed a sensitivity analysis during the second and third quarters of
2008totesthowlowerprojectedgrowthratesacrossmanyoftheapartmentcomplexes
wouldaffecttheportfoliosvalue.1603TheExaminersfinancialadvisorsanalysisofthe
rentgrowthassumptionfocusedonthissensitivitytest.
Lehmans base case DCF analysis projected rent for apartment complexes
expected to be held through the year 2014 to increase at a compound annual growth
rate(CAGR)duringtheperiodbeginning2008andendingin2014.1604Lehmansfirst
quarter 2008 DCF model used a CAGR of 5.72%, the second quarter model decreased
the CAGR to 5.62% and the third quarter model further decreased the CAGR to
4.90%.1605ACAGRof5.62%meansrentwasprojectedtoincreaseonaverage5.62%per
yearacrosstheportfolioofassetsexpectedtobeheldthrough2014.
1601Lehman,ProjectEasyLiving:TishmanSpeyerArchstoneSmithMultifamilyJV,LP(Mar.17,2008),
at Drivers tab [LBEXDOCID 1626080]; Lehman, Easy Living Q2 Model Risk (June 15, 2008), at Drivers
tab[LBEXDOCID4456413].
1602Id.
1603Lehman, Archstone Q22008 Update (June12,2008), at p. 17[LBEXDOCID 2929329]; Lehman,Real
EstateProductControlUpdate(May27,2008),atp.115[LBHI_SEC07940_2258765];Lehman,Archstone
SensitivityAnalysis082208(Sept.12,2008)[LBEXDOCID2852318],attachedtoemailfromWebster
Neighbor,Lehman,toPaulA.Hughson,Lehman(Sept.12,2008)[LBEXDOCID2903130].
1604In Lehmans DCF model, the projection period was from 2008 to 2014. The DCF model includes a
projectionperiodoverwhichspecificcashflowsareestimated,andaterminalperiodthatassignsavalue
basedonexpectedfuturecashflowsaftertheexpectedprojectionperiod.
[LBEXDOCID 1626080]; Lehman, Easy Living Q2 Model Risk (June 15, 2008), at Drivers tab [LBEX
DOCID 4456413]; Lehman, Archstone Sensitivity Analysis 082208 (Sept. 12, 2008) [LBEXDOCID
2852318], attached to email from Webster Neighbor, Lehman, to Paul A. Hughson, Lehman (Sept. 12,
423

In December 2007, Bridge Equity personnel were taking a fresh look at rental
growthrates.1606Thedatasuchpersonnelcollectedillustratedthatthelongtermrental
growthratesLehmanusedinitsDCFanalysiswere1.9to3.5percentagepointshigher
than thirdparty rent growth projections for apartments within Archstones primary
markets.1607Toputthisinperspective,ifthethirdpartyprojectedrentgrowthratefor
one of Archstones primary markets was 2.0%, Lehmans DCF model projected rent
growthratesforArchstonepropertiesinthatmarketofbetween3.9%and5.5%.1608On
average,thedifferencebetweenLehmansassumptionsandthirdpartyprojectionsfor
Archstonesprimarymarketswas2.9%.1609KeithCyrus,aVicePresidentintheBridge
Equitygroup,observedinaJanuary4emailthatArchstonesassetsshouldgenerally
exceedthemarketaverage,butIwanttomakesureourassumptionsarestillsoundin
light of recent market conditions.1610 In an email dated February 6, 2008, Kenneth
Siebers, a Tishman Speyer employee, wrote to Cyrus: We have made it very clear in
2008) [LBEXDOCID 2903130]. The Examinersfinancial advisor notes that these growth rates are base
case figures used in the first quarter and second quarter valuations. As discussed below, Lehman
consideredlowerrentgrowthrateassumptionsinitssecondquarter2008valuation.
1606Email from Keith Cyrus, Lehman, to Kevin Siebers, Tishman Speyer, et al. (Jan. 4, 2008)
[TSREV00003176].
1607Lehman, Archstone (Jan. 4, 2008), at p. 1 [TSREV00003177], attached to email from Keith Cyrus,
Lehman,toKevinSiebers,TishmanSpeyer,etal.(Jan.4,2008)[TSREV00003176].
1608Thelowendoftherange(3.9%)wascomputedbyadding2.0%with1.9%.Thehighendoftherange
(5.5%)wascomputedbyadding2.0%with3.5%.
1609Id.
1610Email from Keith Cyrus, Lehman, to Kevin Siebers, Tishman Speyer, et al. (Jan. 4, 2008)
[TSREV00003176].
424

every analysis that the growth rates have not been updated.1611 Consistent with
Siebersemail,therewasnomaterialchangeintherentgrowthratesusedinLehmans
DCFmodelthroughMarch31,2008.
Webster Neighbor also compared the rent growth rates used in Lehmans DCF
analysis to thirdparty projections in an email to Jonathan Cohen and other product
controllersonApril1,2008.1612Thiscomparisonshowedthattheprojectedrentgrowth
rate Lehman used in its DCF analysis continued to be approximately 3 percentage
pointshigherthanwhatthemodelreferredtoasthirdpartyprojectionsforproperties
in the same markets.1613 Neighbors email described Lehmans rent growth
assumptions as generally consistent with this 10year historical average for properties
withinArchstonesprimarymarkets.1614
The Examiners financial advisor observed, however, that within Lehmans
secondquarterDCFmodel,therewasasensitivityanalysisthat indicatedthemodels
base case rent growth rate of 5.62% was 1.25 percentage points higher than what the
modelreferredtoasthe10yearhistoricalaverageof4.37%.1615ThethirdquarterDCF
1611Emailfrom Kevin Siebers, Tishman Speyer, to Keith Cyrus, Lehman, et al. (Feb. 6, 2008)
[TSREV00003335].
1612Lehman,SpotValueVariance:TishmanSpeyerArchstoneSmithMultifamilyFund(Apr.1,2008),
at Market Data tab [LBEXDOCID 1525380], attached to email from Webster Neighbor, Lehman, to
JonathanCohen,Lehman,etal.(Apr.1,2008)[LBEXDOCID1468705].
1613Id.
1614Id.
1615Lehman,EasyLivingQ2ModelRisk(June15,2008)[LBEXDOCID4456413].Thismodelcontained
RentGrowthRateSensitivities.Oneofthesensitivitieswaslabeled10YearHistoricalAvg.The10
YearHistoricalAvgwas125basispointslowerthanthebasecaseforallofArchstonesmarkets.
425

modelsbasecaserentgrowthof4.90%wascloserto,butstillhigherthan,the10year
historicalaverage.1616
a. NetOperatingIncome
TherentgrowthassumptionwasoneofmanyassumptionsLehmanusedinits
DCF calculation to arrive at the projected revenue for each Archstone property; the
analysis also included assumptions for various types of expenses.1617 The DCF model
projectedfutureexpensesandsubtractedthesefromfutureexpectedrevenuetoarrive
at projected net operating income (NOI) for each Archstone property.1618 NOI
representsthebottomlineoroperatingprofitsgeneratedbyabusinessentityandisa
fundamentaldriverofcashflowsintheDCFMethod.
The materials presented to Lehmans Commitment Committee in May 2007
regardingthepotentialArchstoneacquisitionsetforthactualandprojectedNOIgrowth
1616TheExaminersfinancialadvisoridentifiedthethirdquarterbasecaserentalgrowthratesetforthin
Lehmansthirdquartermodel.LehmansEasyLivingcorporatethirdquartermodel(Aug.22,2008),at
Driverstab[LBEXDOCID3119444].Lehmansthirdquartermodel,unlikethesecondquartermodel,did
notincludeanactivecomparisontothe10yearhistoricalaverage.Id.TheExaminersfinancialadvisor
determinedthat,asthe10yearhistoricalrentalgrowthwouldnothavemateriallychangedbetweenthe
second quarter and third quarter of 2008, the financial advisor used the 10year historical average that
wassetforthinLehmanssecondquartermodelforpurposesofassessingthethirdquartermodelsbase
caserentalgrowthrate.
DOCID 4456413]. The chart shows that a change in the projected rent growth rate of 1.0 percentage
pointsresultedinachangeintheNOIgrowthrateof1.24percentagepoints(from6.71%to7.95%).As
will be discussed, a similar manipulation using the third quarter model resulted in a 1.25 percentage
pointsreduction.
DOCID4456413].
426

rates for publicly traded apartment REITS, including Archstone.1619 However, these
materialsdidnothavesimilardataforrentgrowth.1620TheExaminersfinancialadvisor
reviewed NOI growth rates for the purpose of analyzing the rent growth assumption
because: (1) rent growth contributes to NOI growth; (2) Lehman focused on NOI
growthwhenitwasdecidingwhethertocommittotheArchstoneacquisition;and(3)
the Examiners financial advisor determined that NOI is a relevant benchmark for
assessingthereasonablenessofLehmansrentgrowthassumption.1621
Lehmans DCF analysis projected NOI to increase at a higher rate than rent
growth due to the combined effect of other revenue and expense assumptions.
1619MemorandumfromMarkWalsh,Lehman,etal.,toBridgeLoanComm.&Inv.Comm.,Lehman,$23.4
billiondebtandequityfinancingcommitmentinconnectionwiththepotentialacquisitionofArchstone
Smith by Lehman Brothers and Tishman SpeyerProperties (May16, 2007),atpp. 21, 25[LBEXDOCID
1674960], attached to email from Webster Neighbor, Lehman, to Paul A. Hughson, Lehman (Aug. 22,
2008) [LBEXDOCID 1684700]. Neighbor referred to this attachment as the Final CC Memo, which
includedinformationregardingNOIgrowthrates.
1620EmailfromWebsterNeighbor,Lehman,toPaulA.Hughson,Lehman(Aug.22,2008)[LBEXDOCID
1684700].TheattachmentsincludedwhatwasreferredtobyNeighborintheemailastheFinalExec
Memo, Memorandum from Lehman to Mark Walsh, Lehman, et al., $23.4 billion debt and equity
financing commitment in connection with the potential acquisition of ArchstoneSmith Trust (May 18,
2007),atp.1[LBEXDOCID1722291],theExecUpdateMemo,MemorandumfromGREG,MarkWalsh,
etal.,Lehman,toCommitmentComm.,Lehman,re:[$18.3]billiondebtandequityfinancingcommitment
in connection with the potential acquisition of ArchstoneSmith Trust (May 22, 2007), at p. 1 [LBEX
DOCID 1721764], the Final CC Memo, Memorandum from Lehman, to Bridge Loan Comm. & Inv.
Comm., Lehman, $23.4 billion debt and equity financing commitment in connection with the potential
acquisitionofArchstoneSmithbyLehmanBrothersandTishmanSpeyerProperties(May16,2007),atp.
1 [LBEXDOCID 1674960], and the CC Update Memo, Memorandum from GREG: Mark Walsh,
Lehman, et al. to Exec. Comm., Lehman, re: $21.3 billion debt and equity financing commitment in
connection with the potentialacquisition of ArchstoneSmith by Lehman Brothers and Tishman Speyer
Properties(May7,2007),atp.1[LBEXDOCID1674758].
1621The Examiners financial advisor observed that Lehman applied a sensitivity analysis in the second
andthirdquartermodelstotherentgrowthrateassumptionapparentlyasaproxyforasensitivitytestof
theNOIgrowthrateassumption.Lehman,EasyLivingQ2ModelRisk(June15,2008),atCFDetailtab
[LBEXDOCID 4456413]; Lehman, Easy Living Q2 Model Risk (June 15, 2008), at CFDetail tab [LBEX
DOCID 4456413]; Lehman, Easy Living Corporate Q3 Model (Aug. 22, 2008), at CFDetail tab [LBEX
DOCID3119444].
427

LehmansfirstquarterDCFmodelprojectedNOIgrowthtobe7.63%peryearandthe
secondquartermodelprojectedsuchannualgrowthtobe7.95%.1622Lehmangenerally
appliedthesegrowthratestothesamesetofapartmentcomplexes,whichisreferredto
asasamestorecomparison.1623
TheacquisitionmemorandumprovidedtotheCommitmentCommitteesetforth
theactualsamestoreNOIgrowthbetween1994and2006forpubliclytradedapartment
building REITS, including Archstone, and projected samestore NOI growth for 2007
through 2009.1624 The averageannual samestore growth rate for these REITs between
1622Thefirstquarter2008DCFmodelprojectedNOIgrowthof8.52%forassetswithafiveyearholding
period and 7.63% for assets with a sevenyear holding period. The second quarter 2008 DCF model
projected NOI growth of 8.52% for assets with a fiveyear holding period and 7.95% for assets with a
sevenyearholdingperiod.TheExaminersfinancialadvisorobservedthatNOIgrowthwasprojectedto
behigherthanrentgrowthinpartbecauserentwasprojectedtogrowhigherthanexpenseswhichwere
projectedtogrowat3%peryearandinpartbecausetherewereotherdriversofrevenuegrowth.
[LBEXDOCID 1626080]; Lehman, Easy Living Q2 Model Risk (June 15, 2008) [LBEXDOCID 4456413].
Same store comparison means that properties acquired or sold during the studied time period are
excluded from the analysis such that the only properties considered are those held for the entire time
period. The Examiners financial advisor observed that the spreadsheets did not contain a samestore
calculation for the projected NOI mentioned above. However, the spreadsheets do show that the
aforementionedgrowthrateswereappliedtothelongtermholdcoreportfolioandwerenotaffectedby
thesaleoracquisitionofproperties.Whilethismeetsonedefinitionofasamestoreanalysis,sometimes
apartment complexes are excluded from the samestore analysis for other reasons (e.g., when there are
improvementsmadetotheproperty).TheExaminersfinancialadvisorconcludedthatthespreadsheets
did not contain the ability to incorporate this definition of same store for the projected cash flows.
However, the spreadsheets do contain a samestore analysis for the 2007 to 2008 time period in the
BudgetComparetab.Over81%(78outof96)ofthe7yearlongtermholdcoreportfolioassetswere
classifiedassamestoreinthisanalysis.TheExaminersfinancialadvisordeterminedthattheprojected
growth rates can be compared to benchmarks of samestore sales, subject to the previously discussed
limitations.
1624Memorandum from GREG: Mark Walsh, Lehman, et al., to Bridge Loan Comm. & Inv. Comm.,
Lehman, re: $23.4 billion debt and equity financing commitment in connection with the potential
acquisitionofArchstoneSmithbyLehmanBrothersandTishmanSpeyerProperties(May16,2007),atp.
21 [LBEXDOCID 1488740], attached to email from Ketaki Chakrabarti, Lehman, to Paul Higham,
428

1994 through 2009 was less than half the growth rate used in Lehmans first quarter
2008andsecondquarter2008DCFmodels.1625Inthismanner,LehmansbasecaseDCF
analysisusedNOIgrowthratesthatweremorethandoubletheaveragegrowthratefor
apartmentREITsoverthefifteenyearperiodfrom1994and2009.
A second quarter 2008 Lehman presentation states that Archstones same store
NOI increasedcumulativelyby 17.2% between2001and2007,1626andthatArchstones
growthduringthisperiodwashigherthananyofitspeers.1627This17.2%cumulative
growth rate over six years converts to a CAGR of 2.7% per year.1628 Accordingly,
Lehmans projected NOI CAGRs for Archstones longterm portfolio of 7.63% (first
quartermodel)and7.95%(secondquartermodel)werealmostthreetimeslargerthan
ArchstoneshistoricalsamestoreNOICAGRof2.7%.
b. SensitivityAnalysis
The Examiners financial advisor performed a sensitivity analysis using
Lehmanssecondandthirdquarter2008DCFmodels1629toshowhowareductioninthe
1625Id.
1627Id.
1628NOIincreasedfromabaseof100in2001to117.2by2007,whichmeansthatArchstonessamestore
NOI in 2007 was 1.172 times higher in 2007 than it was in 2001. The Examiners financial advisor
convertedthe17.2%cumulativegrowthratetoaCAGRthroughthefollowingcalculation:1.172(1/6)1=
2.68%
1629Lehman,EasyLivingQ2ModelRisk(June15,2008)[LBEXDOCID4456413](secondquartermodel);
Lehman,EasyLivingCorporateQ3(August22,2008)[LBEXDOCID311944](thirdquartermodel).
429

projectedrentgrowthrateassumptionaffectedtheprojectedNOIgrowthrate.1630The
tablebelowsetsforththeresultsofthisanalysis,anddemonstratesthatareductionin
theassumedrentgrowthhasaslightlylargerimpactonthecorrespondingNOIgrowth
rate. For example, as shown in the table below, reducing the second quarter models
rent growth rate by 100 basis points, from 5.62% to 4.62%, results in a 124basis point
reductionintheNOIgrowthrate,from7.95%to6.71%.
RentandNOIGrowthRateSensitivity
ChangeinRent Q2Model Q2ModelNOI Q3Model Q3ModelNOI

Growth1631 RentalGrowth GrowthRate RentalGrowth GrowthRate
RateCAGR CAGR RateCAGR CAGR
Rateusedin 5.62% 7.95% 4.90% 7.04%
Model
25bps 5.37% 7.64% 4.65% 6.73%
50bps 5.12% 7.33% 4.40% 6.42%
75bps 4.87% 7.02% 4.15% 6.10%
100bps 4.62% 6.71% 3.90% 5.79%
125bps 4.37% 6.40% 3.65% 5.47%
150bps 4.12% 6.08% 3.40% 5.15%
175bps 3.87% 5.76% 3.15% 4.83%
200bps 3.62% 5.45% 2.90% 4.50%
1630Lehman, Easy Living Q2 Model Risk (June 15, 2008) [LBEXDOCID 4456413]; Lehman, Easy Living
CorporateQ3Model(Aug.22,2008).Asensitivityanalysiscouldnotbeperformedonthefirstquarter
modelduetothestructureofthatmodel.Bycontrast,thesecondquarterandthirdquartermodelshada
functionalitythatenabledtheusertoenterindifferentsensitivityassumptionsforcertainvariables.The
Examinersfinancialadvisorenteredintherentgrowthassumptionsof0bpsthrough200bpsat25bps
intervalsandobservedtheoutputofthemodelforNOIgrowthratesbasedonthechangeinrentgrowth
assumptions.
1631The model included a function that permitted their user to lower the rent growth numbers. This
column represents the amount by which the Examiners financial advisor reduced the rent growth
assumptionforpurposesofunderstandingtherelationshipbetweentherentalgrowthrateandtheNOI
growthrate.
430

ThereasonablenessofLehmansrentgrowthassumptionisconsideredinlatersections
thataddressLehmansvaluationsasofspecificdates.
(ii) ExitCapitalizationRate
Thecapitalizationrateisequaltothediscountrateminustheexpectedlongterm
growthrateinexpectedfuturecashflows.1632Asnotedabove,theexpectedgrowthrate
infutureexpectedcashflowsandthediscountratearethetwoprimarycomponentsof
aDCFanalysis.Thecapitalizationratecombinesbothcomponentsintoonevariable.
The capitalization rate can be used to value an asset, which is calculated by
dividing next years expected cash flows by the capitalization rate.1633 Because the
capitalization rate is the denominator in this equation, the valuation is inversely
correlatedwiththecapitalizationrate.Thatis,holdingallelseconstant,anincreasein
the capitalization rate results in a decrease in the assets value and a decrease in the
capitalizationrateresultsinanincreaseintheassetsvalue.
Withintherealestateindustry,itisstandardtoseparatelycalculateandconsider
twotypesofcapitalizationrates:anenteringrateandanexitrate.1634Theentering(also
called goingin) capitalization rate is determined based on the expected future cash
flowsinthefirstyearafterthevaluationdate.Theexitcapitalizationrateisdetermined
1632ShannonP.Pratt&RogerJ.Grabowski,CostofCapital:ApplicationsandExamples25(3ded.2008).
1633Id.at596.
1634Id.at585.
431

basedontheexpectedfuturecashflowsinthefirstyearaftertheendoftheprojection
period,whichmayoccurmanyyearsafterthevaluationdate.
Lehmans base case DCF analysis assumed the exit capitalization rate for the
portfoliowouldbeapproximately70basispointshigherthanthegoingincapitalization
rate.1635 That is, Lehman projected the discount rate to increase and/or the longterm
growthrateinfuturecashflowstodecreasebyapproximately70basispointsoverthe
course of the projection period (which ended in 2014).1636 The Examiners financial
advisor, in analyzing Lehmans projected exit capitalization rates, assumed that such
rate would be 70 basis points higher than the corresponding goingin capitalization
rate.1637
1635WebsterNeighborexplainedtheassumptionLehmanusedregardingtheexitcapitalizationrateinan
emailtoJonathanCohenandAbebualKebedeonApril1,2008.Neighborwrotethatofthe$17.8bnof
stabilizedrealestate,weplanonholdingalmost80%($14.7bn)forthe7yrs.Weowntheseassetsata
4.08%cap(onourallocatedvalue),andplanonsellingthem7yearsfromnowatablended4.79%cap(in
other words, we underwrote as our base case 71 bps of cap widening over the 7 years. Email from
WebsterNeighbor,Lehman,toJonathanCohen,Lehman,etal.(Apr.1,2008)[LBEXDOCID1468705];see
also Lehman, Archstone Overview (Apr. 1, 2008) [LBEXDOCID 4320895]. The reference to allocated
valueinthequotereferstothepurchasepriceallocation,whichisdiscussedinAppendix12,Valuation
Archstone.
[LBEXDOCID1626080];Lehman,EasyLivingQ2ModelRisk(June15,2008)[LBEXDOCID4456413].
1637Tobenchmarkthereasonablenessofthisassumption,theExaminersfinancialadvisorrevieweddata
published by PwC in its Korpacz Real Estate Investors Survey. PricewaterhouseCoopers, Rough Road
Ahead for Investors: Korpacz Real Estate Investor Survey (First Quarter 2008), at p. 37 [LBEXBARFID
0011591];PricewaterhouseCoopers,InvestorsFaceUpsandDowns:KorpaczRealEstateInvestorSurvey
(SecondQuarter2008),atp.39[LBEXBARFID0011679].TheExaminersfinancialadvisorcomparedthe
differencesbetweentheenteringandexitcapratesasreportedbyPricewaterhouseCoopersintheirReal
Estate Investor Survey (Korpacz reports) over this time period. The Examiners financial advisor
observedthattheincreasebetweenthegoingincapitalizationratesandtheexitcapitalizationratesover
thistimeperiodweregenerallyconsistentwithLehmansassumption.
432

(iii) ExitPlatformValue
The exit platform value assumption refers to Archstones ability to generate
valuefromassetmanagementfees,futurepromotes1638anditsabilitytobuildapartment
buildings in the future for sale to third parties (which is referred to as its merchant
buildingplatform).
LehmansDCFanalysisvaluedtheexitplatformat$2.0billionasof2014.1639This
determinationwassupportedbythefollowinganalysisincludedinLehmansmodel.1640
ExitPlatformValuation
ValuationRange($inmillions)
Low Midpoint High
MerchantBuildingPlatform 1,571 1,767 1,963
AnnuitizedFeeStream 540 595 661
ValueofFuturePromotes 111 125 138
TotalPlatformValue 2,221 2,486 2,762
As the table shows, approximately 71% of the exit platform valuation was
attributable to the merchant building platform,1641 approximately 24% of the exit
1638Lehman,ProjectEasyLiving:TishmanSpeyerArchstoneSmithMultifamilyJV,LP(Mar.17,2008),
at Intro tab [LBEXDOCID 1626080]; Lehman, Easy Living Q2 Model Risk (June 15, 2008), at Intro tab
[LBEXDOCID 4456413]. Promote refers to the allocation of equity returns amongst different equity
investors in a joint venture. The value of future promotes was based on the assumption that (1)
Archstone would negotiate transactions with a promote feature and (2) these promote investments
wouldresultinArchstonereceivinghigherreturnsthanotherequityholders.
1639TheExaminersfinancialadvisorobservedthatthevalueasofearlierdateswouldbelowerduetothe
timevalueofmoneyandriskassociatedwiththefutureexpectedcashflows.Inotherwords,whereas
thevaluein2014wouldbe$2.0billion,thevaluein2008wouldbelessthan$1billion.
[LBEXDOCID1626080];Lehman,EasyLivingQ2ModelRisk(June15,2008),atIntrotab[LBEXDOCID
4456413].
1641The merchant platform value represented 70.7% of the total based on the low valuation range and
71.1% of the total based on the midpoint and high valuation ranges. The merchant building platform
433

platformvaluewasattributabletotheannuitizedfeestream,1642andtheremaining5%
wasattributabletofuturepromotes.1643
Lehmans second quarter DCF analysis included sensitivity analyses that
reducedtheexitplatformvaluefrom$2billionto$0,inincrementsof$500million.1644
valuation was based on the following assumptions: (1) Archstone would generate $283 million of net
incomefromitsmerchantbuildingplatformin2017;(2)thevaluationasof2017assumedthemerchant
buildingplatformcouldbesoldatavaluethatwaseighttotentimesthe$283millionofnetincomein
2017;and(3)thevaluationasof2017wasdiscountedtoreflectavaluationasof2014byapplyinga13%
annualdiscountrate.Lehman,ProjectEasyLiving:TishmanSpeyerArchstoneSmithMultifamilyJV,
LP (Mar. 17, 2008), at Intro tab [LBEXDOCID 1626080]; Lehman, Easy Living Q2 Model Risk (June 15,
2008),atIntrotab[LBEXDOCID4456413].Theeighttimestotentimesmultiplewasbasedonthelong
term historical average homebuilder multiple. The 13% discount rate was based on the merchant
buildingcostofequity.Themostimportantassumptioninthisanalysiswastheprojected$283millionof
net income in 2017. The Examiners financial advisor observed that this is the most important
assumptionbecausewithoutearnings,therewouldbenoneedtoapplyavaluationmultipleordiscount
a valuation as of 2017 to 2014. This net income figure was based on the following assumptions: (1)
Archstone would invest $1.4 billion in developing new apartment complexes in 2017; (2) Archstone
wouldgenerateNOIequalto6%ofthisinvestment;and(3)theapartmentcomplexeswouldbesoldata
4.5%capitalizationrate.Lehman,ProjectEasyLiving:TishmanSpeyerArchstoneSmithMultifamilyJV,
LP(Mar.17,2008)[LBEXDOCID1626080];Lehman,EasyLivingQ2ModelRisk(June15,2008)[LBEX
DOCID4456413].
1642TheExaminersfinancialadvisorobservedthatthevalueofannuitizedfeestreamsrepresented24.3%
of the total based on the low valuation range and 23.9% of the total based on the midpoint and high
valuation ranges. The annuitized fee stream valuation was based on two assumptions: (1) Archstone
wouldgenerate$31.8millionofannualnetincomederivedprimarilyfromfuturejointventuresandasset
management;and(2)thisincomestreamwouldincrease17to20.8timesasmuchasthecurrentamount.
Lehman, Project Easy Living: Tishman Speyer ArchstoneSmith Multifamily JV, LP (Mar. 17, 2008)
[LBEXDOCID 1626080]; Lehman, Easy Living Q2 Model Risk (June 15, 2008) [LBEXDOCID 4456413].
Approximately47%oftheannuitizednetincomewasprojectedtobefromfuturejointventuresandasset
management,assumingthatArchstonewouldearnassetmanagementfeesof0.35%offof$1.5billionof
assets. The 20.8 multiple was based on the average forward pricetoearnings multiple for Real Estate
Asset Management companies. The 17.0 multiple reflected an 18.3% discount to the 20.8 multiple.
Lehman,EasyLivingQ2ModelRisk(June15,2008),atIntrotab[LBEXDOCID4456413].
1643TheExaminersfinancialadvisorobservedthattheremaining5%oftheexitplatformvaluewasbased
onthevalueoffuturepromotes,whichwascalculatedbasedonthefollowingassumptions:(1)Archstone
wouldgenerate$114millionoffuturepromotesby2014;(2)the$114millionoffuturepromoteswouldbe
realizedratablyovera7yearperiod;(3)theappropriatetaxratewasthelongtermcapitalgainstaxrate
of15%;and(4)theappropriatevaluationmultiplewasbetween8.0and10.0,whichwaslowerthanthe
equityvaluationconventionof12.0to15.0asofthetimethisassumptionwasoriginallymade.Lehman,
ProjectEasyLiving:TishmanSpeyerArchstoneSmithMultifamilyJV,LP(Mar.17,2008)[LBEXDOCID
1626080];Lehman,EasyLivingQ2ModelRisk(June15,2008)[LBEXDOCID4456413].
434

The Examiners financial advisor observed that the sensitivity analyses were not
assumptions Lehman used in its valuation determination; rather the sensitivities
showedtheresultingdiscountrateassumingLehmansvaluationofArchstonesequity
remainedthesamewhileadjustmentsweremadetotherentgrowth,exitcapitalization
rateandexitplatformvalueassumptions.
A memo written by Tishman Speyer employees and sent to Archstones
managementanditsinvestorsduringthesecondquarterof2008discussedthetension
between managing Archstones liquidity needs and maintaining the value of the exit
platform.1645 This memo suggests that Archstones platform value may have declined
during2008duetochangesinmarketconditions.1646TheExaminersfinancialadvisor
determined that it is difficult to benchmark the reasonableness of Lehmans exit
1644Id.
ArchstoneUpdate(Mar.24,2008),atp.4[LBEXDOCID2932586]:Whileitishelpfultounderstandhow
much time we have if we cut back on our capex and development expenditures, there are several
negativeconsequencesofdoingso.First,ifwearenotmakinganynewinvestmentsbecauseofliquidity
issues it will have a negative impact on the platform value. It will also have a negative impact on the
overallequityreturnsofthedealandmakeithardertosyndicateequityatsomefuturedate.Finally,a
decisiontodeferallnewdevelopmentexpendituresin2008wouldleadtoanexodusoftheCompanys
top development talent, which would impact our ability to successfully complete projects already
underwayandwoulddiminishthevalueoftheCompanysplatform.Wecertainlyunderstandthattimes
have changed and most developers are scaling back their development plans in the short term. We
believethatweneedtostrikeacarefulbalancebetweennotdoinganyincrementaldevelopmentin2008
andproceedingwitheverythingcurrentlybudgeted.Ifwecanfocusoureffortsonthosedealswiththe
mostattractivereturns,weshouldbeabletomaintainsomeneartermliquiditywhilealsopreservingour
platformvalueandretainingourdevelopmenttalent.Wewillalsoalwaysputconstructionfinancingin
place prior to the start of any new groundup development in order to minimize the potential equity
commitment to each project. In these tough times, we will be most successful if we can find the right
balancebetweenmanagingforliquidityandmaximizingthelongtermreturnoninvestedcapital.
1646Id.
435

platform value assumption because there were no comparable sales of this type of
intangible asset, and no sales of Archstones bridge equity positions which would
reflect the platforms valuation as ascribed by contemporaneous market participants.
Accordingly, given the absence of evidence supporting a finding that Lehmans
assumption as to the value of Archstones exit platform was unreasonable, the
ExaminersfinancialadvisordidnotadjustLehmansexitplatformvalueinthequarter
byquarteranalysisdiscussedbelow.
(iv) DiscountRate
The discount rate assumption refers to the discount applied to convert future
cashflowstotheirpresentvalue.1647Thediscountrateincorporatesboththetimevalue
of money and the nondiversifiable risk associated with the asset.1648 Holding all else
constant,anincreaseinthediscountrateassumptionresultsinadecreaseinvalue,just
asadecreaseinthediscountrateassumptionresultsinanincreaseinvalue.1649
Lehmanusedadiscountrateassumptionofapproximately12%inMay2007,1650
13% to 14% in August 2007,1651 14.6% as of the first quarter of 2008,1652 and a 15%
1647Aswath Damodaran, Corporate Finance, Theory and Practice 750 (2nd ed. 2001); Eugene F. Brigham &
JoelF.Houston,FundamentalsofFinancialManagement395(8thed.1998).
1648Id.
1649Lehman,RealEstateProductControlUpdate(May27,2008),atp.115[LBHI_SEC07940_2258765].
1650Memorandum from Mark A. Walsh, Lehman, et al., to LBHI Bridge Loan Committee & Investment
Committee, re: Debt and Equity Financing Commitment Proposal for the Potential Acquisition of
ArchstoneSmith(May16,2007),atp.9[LBEXDOCID1674960].
1651Abebual A. Kebede, Lehman, Archstone Smith Valuation Update [Draft] (Aug. 23, 2007) [LBEX
DOCID 2689696]; Lehman, Project Easy Bridge Equity Discounting Sensitivity Spreadsheet (Mar. 17,
2008)[LBEXDOCID1626080].
436

discountrateduringthesecondandthirdquartersof2008.1653Lehmanusedthereturns
provided by coreplus funds, typically 12%15%, as the benchmark for its DCF model
discountrate.1654
The Examiners financial advisor did not locate materials that specifically
support Lehmans discount rate assumptions of between 13% and 15%.1655 Hughson
and Neighbor told the Examiner that the discount rates were based on judgment and
thattherewasnospecificsupportingdocumentation.1656AProductControlGroupMay
2008analysisindicatedthatanappropriatediscountratecouldbeintherangeof18%to
20%.1657
TheExaminersfinancialadvisorisnotawareofanycontemporaneousdatathat
suggests the discount rates used by Lehman were unreasonable, provided that this
1652Lehman, Archstone Bridge Equity Discounting Sensitivity (Apr. 1, 2008), at p. 1 [LBEXDOCID

4346983].
1653EmailfromWebsterNeighbor,Lehman,toPaulA.Hughson,Lehman,etal.(June14,2008)[LBEX
DOCID 1865693]; Lehman, Archstone Sensitivity Analysis (Aug. 22, 2008), at p. 1 [LBEXDOCID
2852318], attached to email from Webster Neighbor, Lehman, to Paul A. Hughson, Lehman (Sept. 12,
2008)[LBEXDOCID2903130].
1654Memorandum from Keith Cyrus, Lehman, et al., to Donald E. Petrow, Lehman, Archstone Update
(May16,2008),atp.3[LBHI_SEC07940_5521903].
1655The investigation seeking that information included detailed requests for information from Lehman
andareviewoftheFIDdrivesandLehmansSOXdrives.
1657Lehman,ArchstoneQ22008Update(June12,2008),atp.15[LBEXDOCID2929329].Anemailfrom
Jeff Wechsler to Abebual Kebede on May 27, 2008, included this analysis which showed a markdown
from the funded value of $945 million at a discount rate of 20.95%. Lehman, Archstone Risk Analysis
(May 27, 2008), at Base Case tab [LBEXDOCID 4447789], attached to email from Jeffrey Wechsler,
Lehman,toAbebualKebede,Lehman,etal.(May27,2008)[LBEXDOCID4327665].Earlierinthechain
ofemails,KebedeaskedWechslertopreparethisanalysisas15%and12%IRRsareprobablylessuseful
atthispoint.KebedealsoaskedforCAGRsensitivitiesat5.12%and4.62%butthisrequestapparently
wasnotfulfilled.
437

discount rate was applied to expected future cash flows. Expected future cash flows
refer to a probability weighted average of projected future cash flows.1658 Product
Control was less familiar with the underlying assumptions for the analysis,1659 but the
Examiners financial advisor observed that it appears that Product Control used the
higher discount rates of 18% to 20% in their sensitivity analysis as a substitute for
reducingprojectedfuturecashflowstoarriveatexpectedfuturecashflows.
(b) SumofthePartsMethod
LowittstatedonthesecondquarterearningscallthatLehmanusedaSumofthe
Parts analysis as a crosscheck to its DCF analysis. Lehman performed a Sum of the
Parts analysis based on its purchase price allocation.1660 The purchase price allocation
wasavaluationexercisethatallocated$22billion(representingthepurchasepricefor
purposes of this analysis) to Archstones assets. Lehman assigned $17.8 billion to
Archstones core portfolio, $1.4 billion to projects in development (referred to as
Development in the following table), $1 billion to the platform (comprised of
Archstonesabilitytogeneratevaluefromassetmanagementfees,futurepromotesand
1658ShannonP.Pratt&RogerJ.Grabowski,CostofCapital:ApplicationsandExamples17(3ded.2008).For
example, the Examiners financial advisor noted that if there were 2 projected scenarios: a 50% chance
thatcashflowwillbe$10anda50%chancethatcashflowwillbe$20inYear1,theexpectedcashflow
forYear1is$15,whichiscomputedasfollows:(50%x$10)+(50%x$20)=$15.Itisappropriatetoapply
the15%discountrateto$15ofprojectedcashflowinthisexample.Itwouldbeinappropriatetoapply
the15%discountrateto$20(whichwouldresultinanovervaluation)or$10(whichwouldresultinan
undervaluation)ofprojectedcashflowinthisexample.
1660FinalTranscriptofLehmanBrothersHoldingsInc.SecondQuarterEarningsCall(June16,2008),atp.
14 [LBHI_FIN 00007]. See Appendix 12, Valuation Archstone, for a summary of Lehmans purchase
priceallocationanalysis.
438

the merchant building platform), and $2 billion to other assets. The table below,
prepared by Tishman Speyer as part of a sensitivity analysis, includes the value
assignedtothevariousassetcategoriesinthepurchasepriceallocation(seetheleftmost
column).1661
Core
PortfolioCap
Rate 4.11% 4.25% 4.50% 4.75% 5.00% 5.25% 5.50% 5.75% 6.00%
CapRatew/o
Platform 3.89% 4.02% 4.24% 4.46% 4.68% 4.90% 5.11% 5.33% 5.54%

Core
Portfolio $17,789 $17,193 $16,238 $15,383 $14,614 $13,918 $13,285 $12,708 $12,178
AssetsHeld
forSale 596 596 596 596 596 596 596 596 596
Development 1,418 1,418 1,418 1,418 1,418 1,418 1,418 1,418 1,418
Germany 378 378 378 378 378 378 378 378 378
Ground
Leases 208 208 208 208 208 208 208 208 208
OtherAssets 374 374 374 374 374 374 374 374 374
Platform
Value 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000
Cash/WC 411 411 411 411 411 411 411 411 411
TotalValue $22,173 $21,577 $20,622 $19,767 $18,998 $18,302 $17,669 $17,092 $16,562

TotalDebt/
Preferred 17,073 17,073 17,073 17,073 17,073 17,073 17,073 17,073 17,073
Equity 5,100 4,504 3,549 2,694 1,925 1,229 596 19 (511)
Variance (596) (1,551) (2,406) (3,175) (3,871) (4,504) (5,081) (5,611)
1661ThetablewasobtainedfromanattachmenttoanemailthatwassentbySiebers(ofTishmanSpeyer)
tomanypeopleatArchstone,Lehman,BofA,BarclaysandTishmanSpeyeronJanuary31,2008.Tishman
Speyer, Spot Value Variance: Tishman Speyer Archstone Smith Multifamily Fund (Jan. 30, 2008)
[LBEXDOCID 1743458], attached to email from Kevin Siebers, Tishman Speyer, to R. Scot Sellers,
ArchstoneSmith, et al.(Jan.31, 2008)[LBEXDOCID 1861936]. The table was part of thematerials that
were circulated by Siebers in advance of a February 1, 2008 meeting. A similar version of this chart is
foundatLehman,SpotValueVariance,atp.11[LBHI_SEC07940_7548964].SeeAppendix12,Valuation
Archstone,formoredetailsregardingthepurchasepriceallocation.
439

While the table above summarizes the allocation of value to different asset
categories, the initial intent of the table was to show the effect of an increase in
capitalization rates on the core portfolio valuation. This can be seen in the columns
withdifferentcapitalizationrateslistedonthefirstline.Asshowninthetableabove,
an increase in the capitalization rate for the core portfolio from 4.10% to 5.75%
assumingsuchanincreasewasreasonablewouldeliminatevirtuallyallequityvalue.
The Examiners financial advisors review of the Sum of the Parts analysis
focusedonthedatainthistable,andmorespecificallyonthe$17.8billioncoreportfolio
valuation and $1 billion platform valuation. Subsequent Sections that address
Archstone valuations by date also address the Examiners review of the Sum of Parts
analysis and its implications for the reasonableness of Lehmans reported Archstone
valuationsforpurposesofthesolvencyanalysis.
(c) ComparableCompanyMethod
TheQ2BookincludedananalysisthatcomparedthevalueofArchstonetothe
valueofArchstonespubliclytradedcomparablecompaniesduringthesecondquarter
2008.1662Lehmandidnotperformasimilaranalysisforanyotherquarters.
Paul Hughson told the Examiner that the values of publicly traded companies
werenotrelevantforpurposesofvaluingArchstoneonceitbecameprivatelyheld.1663
1662EmailfromWebsterNeighbor,Lehman,toBrettBossung,Lehman,etal.[LBEXDOCID2820780];see
also Lehman, Archstone Q2 2008 Update (June 12, 2008), at p. 8 [LBEXDOCID 2929329], attached to e
mailfromWebsterNeighbor,Lehman,toBrettBossung,Lehman,etal.[LBEXDOCID2820780].
440

Jonathan Cohen generally agreed with Hughsons conclusion.1664 Lehman did use an
analysis of comparable companies in its valuation due diligence prior to the
CommitmentDate.1665HughsontoldtheExaminerthatthisanalysisdidnotmatteronce
the acquisition closed.1666 Jonathan Cohen told the Examiner that he never thought
about replicating a comparable company analysis because it would require a lot of
work.1667
Lehmans FAS 157 Fair Value Measurements Policy stated that a range of
factors, including the trading values on public exchanges for comparable securities,
should be considered for purposes of valuing Lehmans private equity positions.1668
Lehman,however,madeadeterminationthatsuchtradingvalueswerenotrelevantfor
purposes of valuing Archstone in a private market context. The Examiner recognizes
thatjudgmentisemployednotonlyinselectingtheinputsforavaluationanalysis,but
also in the selection of what analysis to perform. Although Lehmans stated policy
required consideration of the trading values of Archstones publicly owned peers, the
evidence does not support a finding that Lehmans decision not to undertake such an
analysistodeterminethefairvalueofitsArchstoneequitypositionswasunreasonable.
1663ExaminersInterviewofPaulHughson,Dec.21,2009,atp.2.
1665Lehman,ProjectEasyLiving:Discussion/ValuationMaterials(May21,2007),atp.8[LBEXDOCID
1695374].
1668Lehman, Lehman Brothers Holdings Inc. Accounting Policy Manual (Nov. 21, 2007), at p. 3 [LBEX
DOCID 1717234], attached to email from Marie Stewart, Lehman, to Dilan Abeyratne, Lehman, et al.
(Nov.21,2007)[LBEXDOCID1926752].
441

However, given Lehmans policy and that the markets view as to the value of
Archstonespeers(asexpressedthroughtheirstockprices)isausefulindicatorofvalue,
the Examiners financial advisor replicated the comparable company analysis that
LehmanundertookintheQ2Book,andconductedsuchanalysisforthefourthquarter
of2007,andforthefirst,secondandthirdquartersof2008.1669
The Q2 Books comparable company analysis involved three separate steps,
which the Examiners financial advisor replicated as discussed below. The Q2 Books
analysisfirstidentifiedthechangeintotalreturns(i.e.,stockpricesplusdividends)on
equity for the companies that Lehman determined were the primary comparables to
ArchstoneAvalonBay,EssexPropertiesandBREProperties.1670TheQ2Bookobserved
a17.8%declineintotalreturnsonequityforArchstonescomparablecompaniesduring
the period beginning on the Commitment Date and ending on June 10, 2008.1671 The
Examiners financial advisor replicated this analysis for each of the four quarters of
2007,andthefirstandthirdquartersof2008.Asshowninthechartbelow,theaverage
total returns on equity for the three primary comparable companies declined by over
20% during the period beginning on the Commitment Date and ending February 29,
2008.
1669The Examiners financial advisor also analyzed the cost of taking Archstone private, and then
comparedthatcosttothevalueofArchstonesequityatclosing.ThisanalysisissetforthinAppendix12,
ValuationArchstone.
1671Id.atp.13[LBEXDOCID2929329].
442

TotalReturnsonEquityforArchstonesPrimaryComparableCompanies
110%
% Change of Total Returns from May 29th, 2007
100%
90%
80%
70%
60%
50%
MeanofPrimaryComps

The second step in the Q2 Books analysis was to convert the change in total
returns on equity discussed above to a change in total returns on enterprise value.1672
Thisstepwasnecessarytonormalizethedifferentlevelsofdebtthateachcompanyhad
(i.e., to put the companies on an apples to apples basis).1673 The Q2 Books analysis
observed that the enterprise value of Archstones peers declined by 10.7% since the
CommitmentDate.TheExaminersfinancialadvisorreplicatedthisanalysisforeachof
the other quarters and, for example, observed a decline in total returns on enterprise
1673TheExaminersfinancialadvisorobservedthatLehmanconvertedthetotalreturnsonequitytototal
returnsonenterprisevaluebymakingthefollowingdeterminations:(1)therewasnodeclineinthevalue
of debt for these companies and (2) the capital structure for these companies was 60% debt and 40%
equity.
443

valueforArchstonesprimarycomparablecompaniesofapproximately13%duringthe
periodbeginningtheCommitmentDateandendingthelastdayofthefirstquarter.1674
The third step in Lehmans analysis computed the change in Archstones
enterprise value from the Commitment Date based on Lehmans valuation of its
Archstonepositions.1675Inotherwords,thiscalculationappliestheLehmansmarkon
its Archstone positions to Archstones enterprise value. The Q2 Book reported this
calculation illustrated that Archstones enterprise value had declined 5.7% during the
period beginning the Commitment Date and ending May 31, 2008.1676 The Examiners
financial advisor replicated this analysis for each other quarter, and using this
methodology,calculateda2%declineinArchstonesenterprisevalueduringtheperiod
beginningtheCommitmentDateandendingonthelastdayofthefirstquarter.1677
TheExaminersfinancialadviserconductedasensitivityanalysisforeachquarter
pursuant to which the change in enterprise value for Archstone based on Lehmans
valueofitsArchstonepositions(e.g.,5.7%throughthesecondquarter)wascomparedto
1674ThebaselinevalueasofMay29,2007,was$60equityand$40debt,whichisconsistentwithacapital
structure that was 60% equity and 40% debt. The value of the equity declined by 21.5% between the
Commitment Date and end of the first quarter (based on the total returns mentioned above), which
resulted in a revised equity value of approximately $47 ($60 multiplied by (100% 21.5%) = $47). The
value of the debt remained unchanged at $40. Therefore, the revised enterprise value was $87 ($47 of
equityplus$40ofdebt),whichwas13%lowerthanthe$100baselinevalueasofMay29,2007.
1676Id.Lehmanvaluationasoftheendofthesecondquarterresultedina24.9%declineinequityvalue
and0%declineindebtvalue,whichresultedin5.7%declineinenterprisevalue.
1677Lehmansvaluationasoftheendofthefirstquarterresultedina9.3%declineinequityvalueand0%
decline in debt value, which resulted in a 2.1% decline in enterprise value. The decline in enterprise
value (approximately 2%) is lower than the decline in funded value of Lehmans Archstone positions
(approximately 5%) because Lehmans Archstone positions were lower in Archstones capital structure
andthereforeitsvaluewasmoresensitivetochangesinArchstonesenterprisevalue.
444

the change in enterprise value for Archstones primary comparable companies (e.g.,
10.7%throughthesecondquarter).
In this manner, the sensitivity analysis illustrates what Archstones enterprise
valuewouldhavebeenasofeachdateifsuchvaluehaddeclinedinanamountequalto
theaveragedeclineexperiencedbyArchstonespubliclytradedpeers.Thetablebelow
compares that value (in row Enterprise Value Implied by Comparable Company
Analysis) to Archstones enterprise value as implied by Lehmans marks. The
difference between those two values, multiplied by Lehmans Archstone equity
ownership (expressed as a percentage), illustrates the difference between the value of
Lehmans Archstone positions determined according to this comparable company
analysisandLehmanscontemporaneousmarks.
(i) PotentialOvervaluationBasedonPrimaryComparable
Companies
Nov07 Feb08 May08 Aug08

EnterpriseValue
ImpliedbyLehmanMarks 21.8 21.7 20.9 20.6
ImpliedbyComparableCompanyAnalysis 19.3 19.3 20.4 20.4
Difference (2.5) (2.4) (0.5) (0.2)
Lehmansequityownership 47% 47% 47% 47%

ImpactonLehmanspositions($bn) (1.2) (1.1) (0.2) (0.1)
Given the Examiners conclusion regarding the reasonableness of Lehmans
decision to not employ the comparable company methodology, the following quarter
445

byquarteranalysisofLehmansArchstonevaluationsfocusesonthereasonablenessof
LehmansSumofthePartsandDCFanalyses.
(5) ExaminersAnalysisoftheReasonablenessofLehmans
ValuationofitsArchstonePositionsonaQuarterlyBasis
The discussion below addresses the Examiners analysis of the reasonableness,
for purposes of a solvency analysis, of Lehmans Archstone valuations quarterby
quarterbeginningwiththefourthquarterof2007.
(a) ReasonablenessasoftheFourthQuarterof2007
LehmandeterminedthatthevalueofitsArchstonepositionswas$5.1billionas
oftheendofthefourthquarterof2007.1678Thisvaluationreflecteda4.4%discountfrom
LehmansoriginalArchstoneinvestment.1679
TheArchstoneacquisitionclosedinOctober2007,thesecondmonthofthefourth
quarter. As of the Closing Date, Lehman reduced its Archstone marks by the $233
million in fees that it received in connection with the acquisition. Hughson told the
Examiner that recording fees into the positions resulted in a valuation that reflected
both Lehmans best judgment as to the value of the underlying assets at the time of
1678SeeCharttitled,LehmansValuationofArchstonePositions(U.S.$million,Oct07Aug08)inthe
precedingSectionofthisReport,withdatafromLehman,ArchstoneMonthlyExpensesasofJuly08(July
2008),atp.1[LBHIBARFID0013113]andLehman,TopGlobalRealEstateExposures(Aug.31,2008),at
p.18[LBHI_SEC07940_ICP_002615].
1679See Chart titled Archstone Marks by Month (Oct 07 Aug 08) in the preceding Section of this
Report, with data from Lehman, Archstone Monthly Expenses as of July 08 (July 2008), at p. 1 [LBHI
BARFID 0013113] and Lehman, Top Global Real Estate Exposures (Aug. 31, 2008), at p. 18
[LBHI_SEC07940_ICP_002615].ThediscountwascomputedbysubtractingthetotalmarkforNovember
from100(i.e.,100minus95.6equals4.4).
446

closing, including the state of debt markets, and Lehmans ability to syndicate the
bridge equity and the value of underlying assets.1680 Lehman did not take any other
writedowns other than for excess carry on their Archstone positions during that
quarter.1681
Hughson told the Examiner that he did not recall any details behind Lehmans
Archstone valuation analysis for the fourth quarter of 2007.1682 Hughson also did not
recallanypresentationsthatwerepreparedtoexplainthevaluationoranyeventsthat
wouldhaveledtoadramaticchangeinthevaluationofArchstonepositionsbetween
the Closing Date and the end of the fourth quarter.1683 Jonathan Cohen told the
Examiner that Product Control did little to review the reasonableness of Lehmans
Archstonevaluationduringthefourthquarter.1684TheExaminersfinancialadvisordid
not locate any analyses that were purported to have been performed for Archstone
valuationsasofthefourthquarterof2007.
WilliamSchlich,leadauditpartneratE&Y,toldtheExaminerthatE&Yfocused
on Lehmans Product Control process when it reviewed Lehmans valuations for
1681The total variance was $230 million, which was calculated based on the October funded value of
$5.398 billion, less the October reported valuation figure of $5.168 billion. See Lehman, Archstone
MonthlyExpensesasofJuly08(July2008),atp.1[LBHIBARFID0013113].Thefeesweretherefore$230
million.
1683Id.
447

reasonableness.1685 Schlich also told the Examiner that E&Y reviewed and understood
the Archstone transaction, but did not do any independent testing or modeling of the
Archstone valuation.1686 Schlich explained that since the acquisition closed in October
2007, E&Y determined that the best indication of the value of Lehmans Archstone
positions was the purchase price since it was based on the terms negotiated between
willingbuyersandawillingseller.1687
LehmansvaluationofArchstoneduringthefourthquarterof2007(andduring
thesubsequentquarters)involvedasignificantamountofjudgmentbecausetherewere
nomaterialsalesofArchstonedebtorequitypositionsduringthequarter(i.e.,SFAS157
Level 1 inputs), nor were there any meaningful benchmarks for Archstone equity
positionsinaprivatemarketcontext(i.e.,SFAS157Level2inputs).TheExaminernotes
theshortperiodbetweentheClosingDateandtheendofthefourthquarter,andthat
Archstone executed $1.5 billion of asset sales during the fourth quarter at a goingin
capitalization rate below 4%. These sale prices were close to Archstones budgeted
prices.TheExaminerfindsthatthereisinsufficientevidencetosupportafindingthat
1685ExaminersInterviewofErnst&Young,Nov.11,2009,atp.4.WilliamSchlichisE&Ysleadpartner
andJerryGrunerisE&YsseniormanagerontheMortgageCapitalteam.
1686Id.
1687Id. at p. 5. The Examiner, in analyzing the reasonableness of Lehmans Archstone marks for each
quarter, considered the scope and depth of Lehmans valuation efforts during each period. Given the
statementsmadebyHughsonandJonathanCohen,andtheabsenceofquarterendvaluationmaterials,
thereissufficientevidencetosupportafindingthatLehmandidnotundertakeasubstantivereviewof
Archstone marks other than in connection with the Closing Date marks. With respect to the Lehmans
fourth quarter valuation efforts, the Examiner has considered that the acquisition closed during the
month before the quarter ended, and Fannie Mae and Freddie Mac purchased over $8 billion of
Archstonefirstmortgagedebtinconnectionwiththeclosing.
448

LehmansvaluationofitsArchstonepositionswasunreasonableasofthefourthquarter
of2007.
(b) ReasonablenessasoftheFirstQuarterof2008
of the end of first quarter of 2008.1688 This valuation reflected a 4.9% discount from
LehmansoriginalinvestmentinArchstone.1689
Lehman did not record any valuationrelated writedowns during the first
quarter of 2008.1690 Lehman did record a relatively small reduction in Lehmans
valuationbetweenthefourthquarterof2007andthefirstquarterof2008(from95.6%of
fundedvalueto95.1%offundedvalue)primarilybasedonitsdecisiontomarkexcess
carry on the Archstone debt positions into the Archstone bridge equity position as
discussedabove.1691JonathanCohentoldtheExaminerthatHughsonmadethedecision
touseexcesscarrytoreducethebridgeequitymarkbecauseHughsondidnotwantto
showanyprofitsonArchstonepositions.1692
p.18[LBHI_SEC07940_ICP_002615].
1689SeeCharttitledArchstoneMarksbyMonth(Oct07Aug08)intheprecedingSectionofthisReport,
with data from Lehman, Archstone Monthly Expenses as of July 08 (July 2008), at p. 1 [LBHIBARFID
0013113] and Lehman, Top Global Real Estate Exposures (Aug. 31, 2008), at p. 18
from100(i.e.,10095.1=4.9).
1691Email from Paul Higham, Lehman, to Andy Lu, Lehman, et al. (Nov. 16, 2007) [LBEXDOCID
4320525].LehmanbeganrecordingexcesscarryintothebridgeequitymarkafterNovember14,2007.
449

(i) BarronsArticle
Barrons published an article on January 21, 2008 suggesting that Archstone
equity could be worthless.1693 Lehman prepared an analysis that rebutted Barrons
methodologyandconclusions.ThisSubsectionoftheReportaddressestheExaminers
analysisoftheBarronsarticleandLehmansrebuttal.
TheBarronsarticleconcludedthatArchstonesequitymayhavebeenworthless
basedonArchstoneshighlevelofdebtandthecapitalizationrateimpliedbythestock
prices of publicly traded apartment REITs.1694 With respect to the capitalization rate,
Lehman determined that the Archstone core portfolio (i.e., stabilized apartment
complexes)wasacquiredatagoinginrateofapproximately4%.1695TheBarronsarticle
observedthatthegoingincapitalizationrateimpliedbythestockpricesofArchstones
publicly traded peers by late January 2008 was over 7%.1696 This steep increase in the
goingin capitalization rate (i.e., between the Commitment Date and January 2008)
indicatedalargedecreaseinArchstonesenterprisevalueandthereforealargedecrease
in the value of Lehmans equity investment in Archstone. The Barron articles thesis
1693Andrew Bary, ApartmentHouse Blues, Barrons, Jan. 21, 2008, at p. 1, attached to email from Glenn
Schorr,UBS,toKeithA.Murray,UBS,etal.[LBEXUBS00886713],availableathttp://online.barrons.com/
article/SB120070919702802265.html#articleTabs_panel_article%3D1.
1694Id.TheExaminersfinancialadvisorcalculatedthatLehmansequityinvestmentinArchstonewould
bepracticallyworthlessifthevalueofArchstoneinitsentiretydeclinedbymorethan24%.
1695Lehman,ArchstoneUpdateQ22008(June12,2008),atp.2[LBEXDOCID2902980].
1696Andrew Bary, ApartmentHouse Blues, Barrons, Jan. 21, 2008, at p. 1, attached to email from Glenn
Schorr, UBS, to Keith A. Murray, UBS, et al. [LBEXUBS 00886713], available at http://online.barrons.
com/article/SB120070919702802265.html#articleTabs_panel_article%3D1.
450

was that the increase in capitalization rates was large enough to reduce the value of
equityinvestmentsinArchstonetozero.1697
As discussed above, Hughson told the Examiner that valuations based on the
stockpricesofcomparablepubliccompanieswerenotrelevantforpurposesofvaluing
Archstoneasaprivatecompany.1698HughsonalsosaidthatcomparisonsofArchstone
to AvalonBay were inapposite because AvalonBays assets were not as intrinsically
valuable as Archstones assets.1699 However, after the Barrons article was published,
Reilly, the Global Product Controller, asked Jonathan Cohen in an email to look at
the capitalization rate of AvalonBay when Lehman bought Archstone because
AvalonBaywasthebestcomp.1700
TheExaminersfinancialadvisorreviewedmaterialspreparedbyLehmanprior
to its decision to commit to fund the Archstone acquisition, and compared
1697Andrew Bary, ApartmentHouse Blues, Barrons, Jan. 21, 2008, at p. 1, available at http://
online.barrons.com/article/SB120070919702802265.html#articleTabs_panel_article%3D1; David Einhorn,
PresentationtoGrantsSpringInvestmentConference,PrivateProfitsandSocializedRisk(Apr.8,2008),
availableathttp://www.foolingsomepeople.com/main/mroom/Grants%20Conference%2004082008.pdf.
1699Examiners Interview ofPaul A. Hughson, Oct. 28,2009,at p.11. Hughson repeatedly emphasized
thatArchstonesassetswerethebestbuildings,inthebestmarkets,withthebestmanagement.Id.Asan
example,HughsonnotedthatAvalonBaysNewYorkMetropropertiesincludedalargedevelopmentin
NewRochelle(aNYCsuburb)directlyabuttingamajorfreeway(I95),whereasArchstonesproperties
includedalargedevelopmentonWestEndAvenueinNewYorkCity.Id.Hughsonexplainedthatwhile
a report might list AvalonBayand Archstone as both having properties in the New York metro area, a
reasonedjudgmentofthevalueofeachcompanyrequiredindividualscrutinyofeachcompanysspecific
assets.Id.
1700Email from Gerard Reilly, Lehman, to Jonathan Cohen, Lehman (Jan. 22, 2008) [LBEXDOCID
2778713].
451

capitalization rates for AvalonBay and Archstone.1701 Lehmans analysis determined
that Archstones stock historically traded at a lower Funds from Operations (FFO)
multiplethanitspeers.AcomparisonofFFOmultiplesservestocomparethevalueof
anasset(inthiscaseArchstonesstock)tothevalueofsimilarassetsthatwerepricedby
themarket.1702LehmansanalysisrevealsthatArchstonesstockwastradingevenwith
orslightlybelowitspeersbasedonFFOmultiplesasofMay2007.Therefore,Lehman
concluded that data demonstrated that market participants bought and sold
Archstones stock as if its growth prospects were slightly lower or inline with its
publiclytradedpeers.1703
Lehman prepared materials during this time period that also demonstrate
Archstone and AvalonBay had comparable goingin capitalization rates and were
valuedsimilarlyonaperapartmentunitbasis.1704Therefore,thereissufficientevidence
to support a finding that changes in AvalonBays capitalization rates between the
Commitment Date and February 29, 2008 should be considered for purposes of
assessingthereasonablenessofLehmansvaluationsofitsArchstonepositions.
1701Lehman,ProjectEasyLiving:Discussion/ValuationMaterials(May21,2007),atp.8[LBEXDOCID
1695374].
1702AswathDamodaran,InvestmentValuation:ToolsandTechniquesforDeterminingtheValueofAny
Asset453(2ded.2002).
1703Lehman,ProjectEasyLiving:Discussion/ValuationMaterials(May21,2007),atpp.4,8[LBEXDOCID
1695374].
1704Id.
452

WhilethereviewbytheExaminersfinancialadvisorofcomparablecompanies,
and AvalonBay specifically, generally supports the analysis set forth in the Barrons
article, Lehman determined that such analysis was neither accurate nor reasonable.1705
A rebuttaltothe analysis inthe Barrons article waspresentedtoLehmansExecutive
CommitteeonJanuary22,2008.1706Lehmansrebuttalargumentswere:
1. The 10 most recent sales in Archstones markets occurred at an average

goingin capitalization rate of 4.6%, which was significantly lower than the
goingincapitalizationratesof6%discussedintheBarronsarticle.1707
2. Archstone sold two of its own apartment complexes out of its Washington
DC portfolio that closed in January 2008 at a significantly lower goingin
capitalizationrate(4.1%)thantheimpliedgoingincapitalizationratesused
intheBarronsarticle(6%orhigher).1708
3. Underlying fundamentals (as evidenced by actual 5% rent growth in 2007

andprojectedrentgrowthof5%for2008)werestrong.1709
4. Stocks for apartment REITs were trading at a 30% discount to Net Asset
Value.
5. BarronsdidnotincludeanyvalueformanyofArchstonesassets,including
itsplatform.1710
TheExaminersfinancialadvisoranalyzedeachofLehmansrebuttalarguments.
1677086].
1706Lehman,ArchstoneASNTalkingPoints(Jan.22,2008),atp.1[LBEXDOCID1977228],attachedto
email from Gerard Reilly, Lehman, to Clement Bernard, Lehman, et al. (Jan. 22, 2008) [LBEXDOCID
1853344].
1707Id.
1708Id.
1709Id.
1710Id.
453

RebuttalArgument#1:The10mostrecentsalesinArchstonesmarketsoccurredatan
average goingin capitalization rate of 4.6%, which was significantly lower than the
capitalizationratesof6%andhigherdiscussedintheBarronsarticle.Lehmanproducedan
internal analysis to demonstrate that the top 10 transactions in Archstones markets
resulted in a 4.6% average goingin capitalization rate.1711 As this spreadsheet was
circulated among Lehman employees at the time they were developing rebuttal
analysestotheBarronsarticle,thereissufficientevidencetosupportafindingthatthis
analysisservedasLehmansunderlyinganalysisforRebuttalArgument#1.
Thespreadsheethadtwosetsofdata.Thefirstsetidentifiedthe10transactions
noted above, as well as the calculation of average goingin capitalization rates for 27
additional transactions for markets where Archstone did not own apartment
buildings.1712Alltransactionsinthisfirstsethadcapitalizationratesof5.2%orlower.1713
The first set was in the print range of the spreadsheet, meaning that it was the only
sectionthatwouldbeprinted(unlesstheusermanuallyadjustedtheprintrange).
1711Lehman, Project Easy Living: Recent Asset Sales (Jan. 22, 2008), at Sales Comps tab [LBEXDOCID
1482636],attachedtoemailfromJonathanCohen,Lehman,toGaryJ.Fox,Lehman(Jan.22,2008)[LBEX
DOCID1437414].Thisspreadsheetshowsthattheweightedaverageofthetop10transactionswas4.2%.
TheExaminersfinancialadvisorcomputedthemedianofthese10transactionsas4.6%.TheExaminers
financialadvisorobservedthatthisspreadsheetappearstobethesupportforthe4.6%thatwastoldto
theExecutiveCommittee.
1712Id.
1713Id.
454

Thesecondsetoftransactionswasoutsideoftheprintrangeofthespreadsheet.
Thissecondsetincluded250additionaltransactions.1714Eachofthesetransactionshada
goingincapitalizationrateof5.3%orhigher.1715Thesetransactionswerepresentedin
order from lowest to highest capitalization rate.1716 This second set included several
transactionsinornearArchstonesmarkets,includingfivetransactionsthathadgoing
in capitalization rates of 6% or higher. If these transactions accurately reflected the
capitalization rates for all of Archstones properties, this would result in virtually no
valueforArchstoneequity.1717
RebuttalArgument#2:ArchstonesoldtwoapartmentcomplexesoutofitsWashington
D.C.metroportfoliothatclosedinJanuary2008atasignificantlylowergoingincapitalization
rate (4.1%) than the implied goingin capitalization rates used in the Barrons article (6% or
higher).1718ThespreadsheetdescribedaboveincludeddataforthesaleoftwoArchstone
propertiesinArlington,Virginia(whichislocatedafewmilesoutsideofWashington,
D.C.),andtherearenoothertransactionslistedforArchstonesalesintheWashington,
1714Id.
1715Id.
1716Id.
1717Id. The spreadsheet lists five transactions that were located in the same cities as Archstones core
assets:(1)Creekside($177,823/unit&9.1%caprate)inSanJose,CA;(2)Woodbridge($208,784/unit,7.6%
caprate)inSunnyvale,CA;(3)HiddenWillows($199,107/unit,7.2%caprate)inSanJose,CA;(4)Solaire
($390,278/unit, 6.8% cap rate) in San Mateo, CA; and (5) Somerset on Garfield ($156,449/unit, 6.0% cap
rate)inMontebello,CA.
1718Lehman, Presentation entitled Archstone Q2 2008 Update (June 12, 2008), at p. 10 [LBEXDOCID
2929329]; Andrew Bary, ApartmentHouse Blues, Barrons, Jan. 21, 2008, at p. 1, available at
455

D.C. area.1719 The capitalization rates for these two transactions were 4.42% and
4.73%.1720 It is possible that the 4.1% goingin capitalization rate Lehman used in this
rebuttal argument was computed using a different method than that used in the
analysispresentedtoLehmansExecutiveCommittee.
Rebuttal Argument #3: Underlying fundamentals, as evidenced by actual 5% rent
growthin2007andprojectedrentgrowthof5%for2008,werestrong.ThisRebuttalfairly
describesArchstonesactualandprojectedrentgrowthfor2007and2008.
RebuttalArgument#4:PubliclytradedapartmentREITsweretradingbelowNetAsset
Value as quantified by contemporaneous analysts. The basic premise of this argument,
which was also articulated by Archstones CEO, was that the public markets were
inefficient and not indicative of value in the private market.1721 Lehman pointed to
Archstones ability to sell individual apartment buildings in the private market at
relatively lowgoingin capitalizationrates.Whilethisassertionhasmerit,it doesnot
directlyaddressthequestionofwhetherandtowhatextentthevalueofaprivatereal
estate company, Archstone, is equally susceptible to other factors that affect the stock
price of its publicly traded peers. Lehman was not able to rebut this argument by
1719Lehman, Project Easy Living: Recent Asset Sales (Jan. 22, 2008), at Sales Comps tab [LBEXDOCID
1482636],attachedtoemailfromJonathanCohen,Lehman,toGaryJ.Fox,Lehman(Jan.22,2008)[LBEX
DOCID1437414].ThetwopropertieswereCrystalSquareandtheBennington.Lehman,RecentAsset
Sales(Jan.22,2008),atSalesCompstab[LBEXDOCID1482639].
1720Lehman,RecentAssetSales(Jan.22,2008),atSalesCompstab[LBEXDOCID1482639].
[LBHI_SEC07940_111678].
456

pointing to sales of Archstone equity during this quarter because there were no such
sales.
Rebuttal Argument #5: Barrons did not include any value for many of Archstones
assets. As discussed above, Barrons concluded that there was zero equity value at a
capitalizationrateof 5.5%.ScottA.Levin,aLehmanbankerwhowasresponsiblefor
the Archstone positions, wrote in an email that there would not be much equity
value if the appropriate capitalization rate was 6%.1722 The Examiners financial
advisor observed that Levin referred to a higher capitalization rate at which point
Archstones equity lost substantially all of its value because Lehman and Tishman
SpeyerincludedassetsintheirvaluationthatwereexcludedbyBarron.
The Barrons article was based on a simple premise market participants were
buying and selling apartment REITs as if the value of their underlying assets had
deterioratedsubstantially.SomeofLehmansrebuttalargumentswerepersuasive(e.g.,
Archstone had been able to sell apartment complexes at relatively low capitalization
rates). Other responses, however, did not entirely rebut the argument that the
capitalizationrateimpliedbythestockpriceofpubliclytradedREITswererelevantin
determiningthevalueofArchstoneequity.
1677086].
457

(ii) DiscussionsAmongArchstone,TishmanandLenders
Tishman Speyer, in a memo dated January 30, 2008, stated that investors who
held debt and/or equity investments in Archstone faced many problems.1723 These
problemsincluded:
InvestorswereconcernedthatArchstonewasnotworthwhatLehman(and
others)hadpaidforit.1724
Archstone was hampered by its high level of debt, which left it with
limited funds to invest in its existing development pipeline and new
businessopportunities.1725
Effortstosyndicatethe$4.5billionofremainingArchstoneequityhadlost
momentum and there was no urgency for investors to invest in the deal
todaygiventheamountofequitylefttosyndicate.1726
It was difficult to syndicate the entitylevel debt because Archstone was

viewed as a risky credit and its ability to service its debt obligations was
dependentonassetsales.1727
Tishman Speyer observed that fixing many of these problems required
Archstones management to find ways to increase the value of the company and
improve the companys liquidity position.1728 They also observed that it would be
challengingtofixtheseproblemsinthenearterm.1729
1724Id.
1725Id.
1726Id.
1727Id.
1728Id.atp.2.
1729Id.
458

(iii) LehmansValuationDuringtheFirstQuarterof2008
The Bridge Equity business desk produced a sensitivity analysis on March 4,
2008, whichindicatedaFebruary2008mark for bridge equity of 90.21730Thebusiness
desk provided the complete Archstone DCF model to Product Control on March 17,
2008andthismodelhadsubstantiallythesamemarkforbridgeequityat89.9.1731
Shortlyaftertheendofthefirstquarter,JonathanCohengaveapresentationto
Andrew Morton, Lehmans Head of FID, that highlighted the critical need to
continuously review the collateral valuation of bridge equity positions and that
increases in capitalization rates were expected to reduce yields.1732 These presentation
materialslistedArchstoneasthetoppositionandalsonotedMajorPricingConcerns,
which included [p]rice flex on debt; increase in cap rates; liquidity.1733 Cohen also
observedafterthepublicationoftheBarronsarticlethattheonuswasonLehmanto
support its valuation of Archstone positions with current info. Aside from the
businessdeskssensitivityanalysis,theExaminersfinancialadvisordidnotlocateany
othersubstantiveanalysisbyLehmantosupportitsArchstonemarksasoftheendof
thefirstquarter.
1730Lehman,BridgeEquitySensitivityAnalysis(Mar.4,2008)[LBEXDOCID4345834],attachedtoemail
from Jeffrey Wechsler, Lehman, to Jonathan Cohen, Lehman [LBEXDOCID 4447709] (re: ASN Bridge
Equity Discounting Sensitivity). Hughson could not recall any details about any Archstone valuation
analysisdoneduringthefirstquarterof2008.ExaminersInterviewofPaulHughson,Dec.21,2009,atp.
3.
1731See Lehman, Project Easy Bridge Equity Discounting Sensitivity Spreadsheet (Mar. 17, 2008) [LBEX
DOCID1626080].
1732AbebualA.Kebede,Lehman,RealEstateInventoryValuation(Mar.10,2008)[LBEXDOCID1707877].
1733Id.
459

The Examinersfinancialadvisoranalyzedthereasonableness ofLehmans first
quarter2008valuationpursuanttotheSumofthePartsandDCFmethodologies.The
SumofthePartsanalysisispresentedfirstbecausethatanalysisisrelevanttotheDCF
calculation.
(iv) SumoftheParts
TishmanSpeyerperformedasensitivityanalysisshortlyaftertheBarronsarticle
was published.1734 This analysis illustrated how an increase in goingin capitalization
rateswouldreducethevalueofArchstonescoreportfolio,1735assumingallotherassets
(including theplatform)remainedattheir budgetedvalues.1736Thetablecirculatedas
partofTishmanSpeyerssensitivityanalysisisreproducedbelow:
1734TishmanSpeyer,SpotValueVariance:TishmanSpeyerArchstoneSmithMultifamilyFund(Jan.30,
2008)[LBEXDOCID1743458],attachedtoemailfromKevinSiebers,TishmanSpeyer,toR.ScotSellers,
Archstone, et al. (Jan. 31, 2008) [LBEXDOCID 1861936]. This document was part of the materials that
weresenttothebanksbyTishmanSpeyeronJanuary30,2008.
2008)[LBEXDOCID1743458],attachedtoemailfromKevinSiebers,TishmanSpeyer,toR.ScotSellers,
ArchstoneSmith,etal.(Jan.31,2008)[LBEXDOCID1861936].
1736Id.
460

TishmanSpeyersGoingInCapitalizationRateSensitivityAnalysis
Core
PortfolioCap
Rate 4.11% 4.25% 4.50% 4.75% 5.00% 5.25% 5.50% 5.75% 6.00%
CapRatew/o
Platform 3.89% 4.02% 4.24% 4.46% 4.68% 4.90% 5.11% 5.33% 5.54%

Core
Portfolio $17,789 $17,193 $16,238 $15,383 $14,614 $13,918 $13,285 $12,708 $12,178
AssetsHeld
forSale 596 596 596 596 596 596 596 596 596
Development 1,418 1,418 1,418 1,418 1,418 1,418 1,418 1,418 1,418
Germany 378 378 378 378 378 378 378 378 378
Ground
Leases 208 208 208 208 208 208 208 208 208
OtherAssets 374 374 374 374 374 374 374 374 374
Platform
Value 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000
Cash/WC 411 411 411 411 411 411 411 411 411
TotalValue $22,173 $21,577 $20,622 $19,767 $18,998 $18,302 $17,669 $17,092 $16,562

TotalDebt/
Preferred 17,073 17,073 17,073 17,073 17,073 17,073 17,073 17,073 17,073
Equity 5,100 4,504 3,549 2,694 1,925 1,229 596 19 (511)
Variance (596) (1,551) (2,406) (3,175) (3,871) (4,504) (5,081) (5,611)
TishmanSpeyer,inaFebruary14,2008email,wrotethatthetableabovecould
beusedtocalculatethecurrentvaluationofequityinvestmentsinArchstone:Wecan
all estimate what the potential value loss is vs. the appraisals (10%) and/or what cap
rateisappropriateforthecoreportfolio(4.254.50%?)asawaytotriangulatewhatthe
real value of the portfolio is today. Then I think we use a real platform value . . .
461

probably$1B,andwhatevergapexistsisyourplugorpotentialloss.Ofcoursethere
willbesomerangeofopinionshere.1737
The Examiners financial advisor used the data in this table to conduct a
sensitivity analysis. This sensitivity analysis adopts the Tishman Speyers tables
reduction in total equity and applies this reduction to Lehmans Archstone equity
position. The Examiners financial advisor then compared the reduction in Lehmans
equity value computed under this analysis to Lehmans cumulative writedowns
throughthefirstquarter of 2008.1738 Thisanalysisproduces avaluethatisrelative to
Lehmans valuation: a negative number indicates Lehmans valuation may have been
toolow;apositivenumberindicatesLehmansvaluationmayhavebeentoohigh.
The Examiners financial advisor deduced the capitalization rate Lehman
assumedinitsanalysis,asillustratedinthetablebelow.Thecoreportfoliocapratethat
results in an an incremental writedown closest to a value of 0 (i.e., supporting
Lehmans valuation) represents the goingin capitalization rate implicit in Lehmans
analysis. Accordingly, the sensitivity analysis below illustrates that Lehmans first
quarter2008valuationassumedagoingincapitalizationratejustbelow4.25%(because
theincrementalwritedownwas$17millionatthisrate).Thetablebelowalsoindicates
1737Email from Kevin Siebers, Tishman Speyer, to Keith Cyrus, Lehman, et al. (Feb. 14, 2008)
[TSREV00003451].
1738Thisanalysisincludedallreductionofvalueaswritedowns,includingthemarkingoffeesandexcess
carryintothepositions.
462

the extent to which Lehmans valuation of its Archstone positions would have been
overvaluedorundervaluedbasedontheassumedgoingincapitalizationrate.
GoingInCapitalizationRateSensitivityAnalysis(Q12008)
CorePortfolioCapRate 4.11% 4.25% 4.50% 4.75% 5.00% 5.25% 5.50% 5.75% 6.00%
ReductioninTotalEquityValue 0 596 1,551 2,406 3,175 3,871 4,504 5,081 5,611
ReductioninLehmansEquity(46.8%) 0 279 726 1,127 1,487 1,813 2,109 2,379 2,627
WriteDownsTakenbyLehmanasofQ12008 262 262 262 262 262 262 262 262 262
IncrementalWriteDowns (262) 17 464 865 1,225 1,551 1,847 2,117 2,365
OnJanuary22,2008,JonathanCohenobserved,onthebasisofdatacollectedby
others within Lehman, that AvalonBays goingin capitalization rate had increased by
over 30 basis points since the Archstone Commitment Date.1739 As shown in the table
above, applying this increase results in an Archstone capitalization rate approaching
4.50%, and a corresponding incremental writedown approaching $464 million. The
ExaminersfinancialadvisoralsoobservedthatasourcereferencedinCohensemail1740
notedthecapitalizationrateforAvalonBaywasbetween4.75%and5.0%,whichwould
result in an incremental writedown between $865 million and $1.225 billion if this
capitalizationratealsoappliedtoArchstone.
Lehman, in its rebuttal to the Barrons article, indicated that the 10 most recent
transactionsinArchstonesmarketswereexecutedatanimpliedaveragecapitalization
1739Aspreviouslynoted,ReillyconsideredAvalonBaytobethebestcomp.EmailfromKeithCyrus,
Lehman,toJonathanCohen,Lehman,etal.(Jan.22,2008)[LBEXDOCID2778713];ExaminersAnalysis
oftheReasonablenessofLehmansValuationofitsArchstonePositionsonaQuarterlyBasis.
1740Id.
463

rate of 4.6%.1741 As discussed above, Lehmans transaction analysis excluded relevant
transactions with higher capitalization rates, which indicated that the average
capitalizationratewashigherthan4.6%.Asthetableaboveillustrates,acapitalization
rate of 4.75% (the first rate higher than 4.6% in the table) supports an $865 million
incremental writedown and a 5.0% capitalization rate results in a $1.2 billion
incrementalwritedown.
(v) DCFMethod
TheanalysisbytheExaminersfinancialadvisoroftheDCFMethodfocusedon
Lehmansassumptionsasforrentgrowthandexitcapitalizationrates.
In the first quarter, Lehman used an Archstone exit capitalization rate of
approximately4.8%,whichwasbasedonanincreaseofapproximately70basispoints
over the goingin capitalization rate of 4.1%. As discussed above, the goingin
capitalization rates had increased since the Commitment Date. The Examiners
financialadvisorrerantheDCFanalysisusinghigherexitcapitalizationrates.
Lehmans rent growth assumption for assets held over the entire projection
period was 5.72% per year, and the resulting NOI growth rate was 7.63% per year.
Keith Cyrus identified that the longterm rent growth rate used in Lehmans DCF
Method for the first quarter of 2008 was almost 3 full percentage points higher than
thirdparty projected growth rates for other apartments within Archstones markets.
1741Lehman,ArchstoneASNTalkingPoints(Jan.22,2008),atp.1[LBEXDOCID1977228].
464

TheExaminersfinancialadvisordeterminedthatLehmansprojectedNOIgrowthrates
were significantly (i.e., hundreds of basis points) higher than Archstones historical
growthrate.Accordingly,andgiventheproblemsidentified byTishmanSpeyerin
theJanuarymemo,thereissufficientevidenceforafindingthatLehmansrentgrowth
rateassumptionwasunreasonablyhighasofthefirstquarterof2008.1742
As Lehmans first quarter 2008 valuation model could not support sensitivity
testing, the Examiners financial advisor used Lehmans second quarter model (which
could run sensitivity analyses) as a proxy for the first quarter 2008 valuation model.
The Examiners financial advisor created four scenarios for purposes of sensitivity
analysis, in which the two assumptions discussed above rental growth rate and exit
capitalizationratewerestressedtoobservetheeffectofthesameonthevaluationof
Lehmans Archstone positions. The Examiners financial advisor did not sensitize
Lehmans determination for platform value and discount rate, as such inputs were
within the range of reasonableness for purposes of this valuation analysis. The table
below sets forth the results of this sensitivity analysis, and incremental writedown
denotes the additional writedown on Lehmans Archstone marks indicated by each
scenario.
465

DCFMethodSensitivityAnalysis(Q12008)
NumbersinMillionsunlessstatedotherwise
Assumptions Case1 Case2 Case3 Case4
RentalGrowthRateDecrease 50bps 100bps 150bps 200bps
Inputs
ExitCapRateincrease 25bps 25bps 50bps 50bps

IRR 14.6% 14.6% 14.6% 14.6%
TotalFundedAmountoftheEquity $2,388 $2,388 $2,388 $2,388

LehmanReportedValuationfortheEquity $2,165 $2,165 $2,165 $2,165
WeightedAverageMarkoftheEquity 90.7 90.7 90.7 90.7
WriteDowntakenbyLehmanwithintheEquity $223 $223 $223 $223
Outputs
ImpliedValuation $2,128 $1,946 $1,605 $1,433

ImpliedMark 89.1 81.5 67.2 60.0
ImpliedIncrementalWriteDown $37 $219 $560 $732
ReasonablenessofLehmansArchstoneValuationas
oftheEndoftheFirstQuarterof2008
As previously discussed, there were no material sales of Archstone debt or
equity positions during the quarter, nor any meaningful benchmarks for Archstone
equitypositionsinaprivatemarketcontext.Therefore,ArchstoneequitywasanSFAS
157Level3assetwhosevaluationrequiredasignificantamountofjudgment.
For the reasons set forth above, the Examinerconcludes that there issufficient
evidence tosupport a finding for purposes of a solvency analysis thatLehmans
valuationforitsArchstonebridgeandpermanentequityinvestmentasoftheendofthe
first quarter of 2008 was unreasonable. Recognizing that the valuation of such an
illiquid investment requires the application of judgment to numerous factors and
criteria, the Examiner concludes that the evidence supports a finding that Lehmans
valuation of $2.165 billion for its Archstone bridge and permanent equity investment
466

was overvalued by $200 millionto$450 million. Nevertheless, the Examiner does not
findsufficientevidencetosupportacolorableclaimthatanyLehmanofficeractedwith
anintenttoproduceincorrectvalues,orconductedthevaluationprocessinareckless
manner.LehmansvaluationsofitsArchstonepositionswerenottheproductofactions
(or omissions) that would support a claim of a breach of fiduciary duty in this or
subsequentquarters.
The low end of the range implies a goingin capitalization rate on Archstones
core portfolio (assuming no decrease in value for Archstones other assets) between
4.25% and 4.50%, which is lower than the increase in goingin capitalization rates for
ArchstonesbestcompusingthesamedatasourceLehmanusedinitsduediligence
fortheArchstoneacquisition.Thelowendemploysarentgrowthassumptionthatis
100basispointslowerthanLehmansassumption.The100basispointdecreaseinthe
rentgrowthassumptionstillresultsinrentgrowthratesabovethirdpartyprojections
for Archstones markets and NOI growth rates that are significantly higher than
Archstoneshistoricalperformance.
The high end of the range implies a goingin capitalization rate on Archstones
core portfolio (assuming no decrease in value for Archstones other assets) of
approximately 4.50%, which is consistent with the increase in goingin capitalization
ratesforArchstonesbestcomp.Thehighendemploysanexitcapitalizationratethat
is less than 50 basis points higher and a rent growth assumption that is less than 150
467

basispointslowerthanLehmansassumptions.Thislessthan50basispointsincrease
in exit capitalization rates is somewhat higher than the increase in goingin
capitalization rate for Archstones best comp, while thislessthan150basispoints
decrease in the rent growth assumption still results in rent growth rates above third
party projections for Archstones markets and NOI growth rates that are significantly
higherthanArchstoneshistoricalperformance.
(c) ReasonablenessasoftheSecondQuarterof2008
of the end of the second quarter of 2008.1743 This valuation reflected a 12.0% discount
fromLehmansoriginalArchstoneinvestment.1744
ThedecreaseinLehmansArchstonevaluationfroma4.9%reductionoffunded
valueattheendofthefirstquarterof2008toa12.0%reductionoffundedvalueatthe
end of the next quarter was primarily due to $350 million of valuationrelated write
precedingSection,withdatafromLehman,ArchstoneMonthlyExpensesasofJuly08(July2008),atp.1
[LBHIBARFID 0013113] and Lehman, Top Global Real Estate Exposures (Aug. 31, 2008), at p. 18
[LBHI_SEC07940_ICP_002615].
from100(i.e.,10088.0=12.0).
468

downs that were taken during the quarter. These writedowns were taken in two
stages:$250millioninMarchand$100millioninMay.1745
(i) SecondQuarterEarningsCall
During its second quarter earnings call, Lehman disclosed that it valued its
Archstone equity positions at 75% and most Archstone debt positions at 99%.1746
Together, these resulted in a weighted average valuation of 88% of funded value for
LehmansArchstonepositions.1747
Lehman disclosed that it arrived at an Archstone enterprise value primarily
using a discounted cash flow analysis, which supports a midteens IRR.1748 Lehman
also disclosed that this analysis assumed that capitalization rates will be more than
100BPS [basis points] higher when the properties are sold than when the transaction
was entered into and [b]ased on this analysis, we are very comfortable with our
1745Lehman, Archstone Monthly Expenses as of July 08 (July 2008), at p. 1 [LBHIBARFID 0013113].

Lehmans decision to take the March writedown was triggered by buyers walking away from over $1
billionofpotentialArchstoneassetsalesshortlyafterBearStearnssnearcollapse.EmailfromJonathan
Cohen, Lehman, to Clement Bernard, Lehman, et al. (Mar. 20, 2008) [LBEXDOCID 1854627]. Cohen
informed Bernard that [b]efore month end also looking at archstone bridge equity. Approx $1bn of
propertysalesto2differentbuyersfellthruthisweekwiththehorriblemarketconditionsbeginningwith
thebearstearnsnews.Thedeskisrunningnumbersandstressingcaprates.Itcouldbeapprox200mm.
Wewouldbeholdingatapprox20%yieldtoinvestorsassumingnoassetmgmtfee,nopromoteandwe
get no preferred return from investor. I alerted gerry last night, but nothing is definitive at this point.
WillupdateyouwhenIgetmoreinfo.Abehasmoreinfoifyouneed.
14[LBHI_FIN00007].
1747Lehman,GREGUpdate,atp.3[LBEXDOCID1417258].HughsontoldtheExaminerthatBofAand
Barclays were upset with Lehmans public disclosure of it valuation. Examiners Interview of Paul A.
Hughson,Oct.28,2009,atp.12.HughsonalsosaidthatLehmansinvestmentwasmorevaluablethan
BofAsandBarclaysinvestment,duetothehigherfeesLehmanreceivedandLehmansownershipofa
generalpartnerinterest,whichBofAandBarclaysdidnotown.Id.
14[LBHI_FIN00007].
469

current Archstone mark.1749 The Examiners analysis of this Discounted Cash Flow
valuationisaddressedintheDCFMethodsubsectionbelow.
Lehman disclosed that it cross checked its DCF analysis with a number of
different methodologies, including sum of the parts, replacement costs and recent
comparabletransactionsbasedonbothcapratesandpriceperunit,themostimportant
including asset sales from the Archstone portfolio.1750 The Examiners financial
advisors analysis of sum of the parts and asset sales from Archstones portfolio are
addressedbelow.TheExaminerdidnotplacesignificantemphasisonthereplacement
costsmethodology,asitisdifficulttobenchmark,isnotavaluationanalysisperse,and
Lehman (and its partners) acquired Archstone at a material discount to replacement
costs.1751
Duringtheearningscall,LowittdisclosedthatArchstonesoldapproximately$2
billionofassetsaftertheacquisitionandwasundercontractorinactivenegotiationto
sellinexcessofanadditional$2billionofassets.1752Lowittalsostatedthattheaverage
goingincapitalizationrateforthe$4billionofactualandprojectedassetsaleswasin
1749Id.
1750Id.
1751Lehman, Archstone Q2 2008 Update (June 25, 2008), at p. 1 [LBEXDOCID 187370]. According to
Lehmans analysis, Archstones core portfolio was acquired for $328,000 per unit, which reflected a
material16%discounttoestimatedreplacementcostofapproximately$390,000perunit.
14[LBHI_FIN00007].
470

the mid4% range.1753 Lehmans Q2 Book, which was prepared in advance of the
earnings call, detailed these disclosures1754 and the table below was created using this
data. Consistent with Lehmans public disclosure, the average capitalization rate
according to Lehmans analysis was 4.46%.1755 This table illustrates that this 4.46%
average goingin capitalization rate was influenced by the relatively low goingin
capitalization rate of 3.62% for the $1.4 billion of asset sales that closed on the
acquisitions Closing Date (labeled October 5, 2007 Deals in the table below). The
analysisbytheExaminersfinancialadvisoralsoillustratesthattransactionsthatclosed,
were under contract, or were in negotiation in 2008 had an average goingin
capitalizationrateofapproximately5%.
ActualandBudgetedCapitalizationRatesfromArchstoneAssetSales1756
$inmillions CapRates
Budgeted
Value SaleValue 2008NOI Budget Sales Variance
October5,2007Deals 1,306 1,391 50 3.86% 3.62% 6.56%
October6,2007thruDecember31 331 335 16 4.79% 4.73% 1.10%
DevelopmentAssetssoldbetweenJanuary1andMay30 22 21 n/a n/a n/a 3.72%
January1throughMay30 164 155 8 5.12% 5.41% 5.42%
UnderContractasofMay30 398 386 19 4.74% 4.88% 2.95%
DealsinNegotiationasofMay30 1,546 1,415 71 4.58% 5.00% 8.44%
Development:UnderContractorDealsinNegotiation 131 113 n/a n/a n/a 13.52%
All(nondevelopment)Deals 3,745 3,683 164 4.39% 4.46%

AllDeals 3,897 3,817 2.06%
2007DealsCapRateandVariance 1,637 1,726 66 4.05% 3.84% 5.46%

2008DealsCapRate 2,108 1,957 98 4.65% 5.01%
2008DealsVariance 2,260 2,091 7.50%

1753Id.
1754Lehman,ArchstoneQ22008Update(June12,2008),atpp.1011[LBEXDOCID2929329].
1755Id.
1756Id.
471

During the earnings call, Lowitt stated that many of the assets that were
identifiedforsalebythecompanyasnoncoreornonstrategic,andincertaincasesdo
not represent the highest quality properties in their portfolio.1757 The sale of lower
quality properties would be expected to result in higher capitalization rates than
Archstoneshigherqualityproperties.
TheExaminersfinancialadvisoralsocomparedtheactualsalespricesofassets
toLehmansprojectionsofsaleprices(orallocated)valueforassets.Assetforthinthe
tableabove,thesalesvalueforassetssoldin2007wasover5%abovebudgetedvalue,
whileassetssold,undercontract,orinnegotiationin2008werevaluedbythirdparties
(as evidenced by their purchase offers) at more than 7% below budgeted value. A
LehmanJuly29,2008analysisofArchstonesassetsalesincludedthesamesalesvalues,
but different budgeted values.1758 In particular, the budgeted value for assets under
contract or deals in negotiation as of May 30 were higher in the July analysis, which
resultedinlargervariancesofsalesvaluesrelativetobudgetedvalue.Accordingtothe
July analysis, the assets that were under contract or in negotiation as of May 30 were
approximately12%belowbudgetedvalueasshowninthetablebelow.
14[LBHI_FIN00007].
1758Lehman,ArchstoneJuly2008Update(July29,2008),atpp.1011[LBHI_SEC_07940_ICP_008526].
472

UpdatedActualandBudgetedCapitalizationRatesfromArchstoneAssetSales1759
Budgeted
Value SaleValue 2008NOI Budget Sales Variance
October5,2007Deals 1,306 1,391 50 3.86% 3.62% 6.56%
October6,2007thruDecember31 331 335 16 4.79% 4.73% 1.10%
DevelopmentAssetssoldbetweenJanuary1andMay30 22 21 n/a n/a n/a 3.72%
January1throughMay30 164 155 8 5.12% 5.41% 5.42%
UnderContractasofMay30 441 386 19 4.27% 4.88% 12.43%
DealsinNegotiationasofMay30 1,606 1,415 71 4.41% 5.00% 11.88%
Development:UnderContractorDealsinNegotiation 131 113 n/a n/a n/a 13.52%
All(nondevelopment)Deals 3,849 3,683 164 4.27% 4.46%

AllDeals 4,001 3,817 4.59%
2007DealsCapRateandVariance 1,637 1,726 66 4.05% 3.84% 5.46%

2008DealsCapRate 2,212 1,957 98 4.43% 5.01%
2008DealsVariance 2,364 2,091 11.55%

The below budgeted sale prices support a determination that Archstones
enterprise value declined relative to the purchase price. The Examiners financial
advisor performed a sensitivity analysis to demonstrate the effect of this reduction in
enterprisevalue onthe potentialovervaluationasofthesecondquarter of2008. This
analysis is conceptually similar to the sensitivity analysis based on changes in
capitalization rates used in the Sum of the Parts method. This sensitivity analysis
startedwiththevaluesatclosing:$22.2billionforenterprisevalueand$5.1billionfor
equityvalue.1760Thesensitivityanalysisreducedthe$22.2billionenterprisevaluein2.5
percentagepointincrements.Thereductioninenterprisevaluewasappliedtoequity
1759Lehman,ValuationOverview(June12,2008),atpp.1011[LBEXDOCID2929326],attachedtoemail
fromWebsterNeighbor,Lehman,toColleenDay,Lehman,etal.(June12,2008)[LBEXDOCID2871718];
Lehman,ArchstoneJuly2008Update(July29,2008),atpp.1011[LBHI_SEC_07940_ICP_008526].
2008)[LBEXDOCID1743458],attachedtoemailfromKevinSiebers,TishmanSpeyer,toR.ScottSellers,
ArchstoneSmith,etal.(Jan.31,2008)[LBEXDOCID1861936].
473

duetotheequityspositioninthecapitalstructure(i.e.,equitytakesthefirstloss).The
nextstepwastocomparethedecreaseinequityvalueindicatedbythisanalysistothe
cumulativewritedownLehmantookasofthesecondquarterof2008.Forexample,as
shown in the table below, a 5% reduction in enterprise value would warrant a write
down of $500 million. In such a case, because Lehman had already cumulatively
reduced the value of its positions by approximately $600 million,1761 this analysis
indicates a $100 million writeup to Lehmans valuation would have been warranted.
By contrast, a 7.5% reduction in enterprise value would imply an $800 million write
down, which is greater than Lehmans approximately $600 million cumulative write
down and therefore would indicate that Lehmans valuation was overstated by $200
million.1762
1761The actual reduction in the valuation through the end of the second quarter was $628 million.
Lehman, GREG Update (May 30, 2008), at p. 3 [LBEXDOCID 1417258]. For presentation purposes, all
figuresinthisanalysisareroundedtothenearesthundredmilliondollars.
1762Theimpliedundervaluationwitha5%declineinenterprisevalueandimpliedovervaluationwitha
7.5% decline in enterprise value indicates Lehmans valuation assumed Archstones enterprise value
declined somewhere between 5% and 7.5%. Lehmans own analysis shows their valuation assumed a
5.72% decline in enterprise value. Lehman, Archstone Q2 2008 Update (June 12, 2008), at pp. 1011
[LBEXDOCID2929329].
474

EnterpriseValueSensitivityAnalysis(Q22008)
ReductioninEnterpriseValue
AtPurchase
($billions) 5.0% 7.5% 10.0% 12.5% 15.0% 17.5% 20.0% 22.5% 25.0% 27.5%
InitialEnterpriseValue 22.2 21.1 20.5 20.0 19.4 18.9 18.3 17.8 17.2 16.7 16.1
FaceValueofDebt 17.1 17.1 17.1 17.1 17.1 17.1 17.1 17.1 17.1 17.1 17.1
AmountofDebtCovered 17.1 17.1 17.1 17.1 17.1 17.1 17.1 17.1 17.1 16.7 16.1
EquityValue 5.1 4.0 3.4 2.9 2.3 1.8 1.2 0.7 0.1
LehmansEquityValue 2.4 1.9 1.6 1.3 1.1 0.8 0.6 0.3 0.0
ImpliedWriteDown 0.5 0.8 1.0 1.3 1.6 1.8 2.1 2.3 2.6 2.9
WriteDownsTakenthroughMay31 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6
IncrementalWriteDownRequired (0.1) 0.2 0.4 0.7 1.0 1.2 1.5 1.7 2.0 2.3
AmemowrittenbyCyrusandNeighboronMay16,2008statedthatArchstone
had sold $289 million of core assets to date for a 4.77% cap rate.1763 Cyrus and
Neighborexplainedthat [i]t should be notedthattheseassets,andmore broadlythe
assetsheldforsaleingeneral,arebiasedtowardlowerquality,lowergrowthassetsand
thustradeatawidercapratethantheaverageArchstoneasset.Also,theCompanyis
marketingduringunfavorablemarketconditionsandisperceivedasadistressedseller
(basedinpartonunfairmediacommentarybythelikesofBarrons),whichisputting
upward pressure on cap rates. We expect that once the initial marketing process has
concluded, Archstones shortterm liquidity issues are resolved, and credit and asset
sales markets improve throughout the year, cap rates will be lower on later sales.1764
Cyrus and Neighbor also mentioned in this memo that the third party research firm
1764Id.
475

Lehman referenced in the first quarter identified a 50 basis point increase in
AvalonBays capitalization rate since Lehmans May 22, 2007 analysis and an
approximately 90 basis point increase over the goingin capitalization rate Lehman
assignedtoArchstoneinitspurchasepriceallocation.1765AmemowrittenbyTishman
Speyertotheotherinvestorsduringthisquarternotedtheverydifficultenvironment,
stated that the plan was to only accept slightly lower prices if necessary and
committed to do everything we can to close deals at reasonable prices without
appearing desperate.1766 Tishman Speyer also noted that we are in the midst of
discussionswithseveralpotentialbuyersthatappeartobepromising.1767
(ii) SumoftheParts
TheSumofthePartsanalysisperformedbytheExaminersfinancialadvisorfor
thesecondquarterof2008issimilartotheanalysisperformedforthefirstquarter.This
analysis was updated to reflect the additional writedowns that Lehman took during
the second quarter. As a result of the writedowns taken during the second quarter,
andassumingtheplatformcontinuedtobevaluedat$1billion,Lehmansvaluationas
of the second quarter implied a goingin capitalization rate on the core portfolio that
wascloserto4.5%than4.25%,asshowninthetablebelow.
1765Id.;Lehman,Discussion/ValuationMaterials(May21,2007),atp.8[LBEXDOCID1695375].
ArchstoneUpdate(Mar.24,2008),atp.1[LBEXDOCID2932586].
1767Id.
476

IncrementalWriteDowns (637) (358) 89 489 849 1,175 1,471 1,741 1,989
Asdiscussedabove,theaveragegoingincapitalizationrateforArchstoneassets
thatweresold,undercontract,orinnegotiationduring2008wasapproximately5.00%.
Asillustratedinthetableabove,agoingincapitalizationrateof4.75%resultsina$489
million incremental writedown, and a 5.0% goingin capitalization rate results in an
$849millionincrementalwritedown.
A Lehman research report dated May 2008 published for publicly traded
apartmentREITs(whichwascirculatedtoJonathanCohen)notedanaveragegoingin
capitalization rate of 6.1% for the industry. AvalonBay had the lowest capitalization
rateat5.5%.1768Applyingthis5.5%goingincapitalizationtoArchstonewouldsupport
a$1.471billionwritedown.
(iii) DCFModel
Lehmans DCF calculation in the second quarter considered various
combinationsofdownwardadjustmentstothebasecaseanalysis.Lehmandiscloseda
1768DavidHarris,Lehman,etal.,REITsInvestorBriefingPackage(May14,2008),atp.45[LBEXDOCID
4329202],attachedtoemailfromDonaldE.Petrow,Lehman,toJonathanCohen,Lehman[LBEXDOCID
4432688].
477

specific scenario on its second quarter earnings call: an increase in exit capitalization
ratesofover100basispointsandnootheradjustmentstothebasecase.1769Thisisalsoa
scenario set forth in the Q2 Book.1770 However, the Q2 Book included other
combinationsofsensitivityscenariosthatresultedinasimilarvaluation.1771Inanemail
toHughson, Neighborsummarizedsomeof thesecombinations,whichincluded: a 75
basis point increase in the exit capitalization rate and 25 basis point decrease in rent
growth rate; a 50 basis point increase in the exit capitalization rate and 75 basis point
decreaseinrentgrowthrate;anda25basispointincreaseintheexitcapitalizationrate
and125basispointdecreaseinrentgrowth.1772
(iv) RentGrowth
Lehmans base case rent growth assumption for assets held over the entire
projectionperiodwas5.62%peryearandtheresultingNOIgrowthratewas7.95%per
year,whichissimilartoLehmansfirstquarterbasecaseanalysis.Therefore,thefirst
quarter analysis performed by the Examiners financial advisor is applicable to the
second quarter as well.1773 As was the case with the first quarter analysis, the
14[LBHI_FIN00007].
1771Id.atpp.1617.
1772EmailfromWebsterNeighbor,Lehman,toPaulA.Hughson,Lehman(June14,2008)[LBEXDOCID
1865693].
1773Cyrusrecognizedthatthelongtermrentgrowthrateswereapproximately3percentagepointshigher
thanprojectionsmadebythirdpartiesforapartmentsinsimilarmarketsandtheNOIgrowthrateswere
significantlyhigherthanArchstoneshistoricalperformance.EmailfromKeithCyrus,Lehman,toKevin
Siebers,TishmanSpeyer,etal.(Jan.4,2008)[TSREV00003176].
478

ExaminerconcludesthatthereissufficientevidencetosupportafindingthatLehmans
valuationforitsArchstonebridgeandpermanentequityinvestmentasoftheendofthe
second quarter of 2008 was unreasonable. The largest rent growth decrease in
NeighborsemailtoHughsonwas125basispoints.Asensitivityanalysispreparedby
ProductControlthatwaspresentedtoLehmansCFOconsideredadecreaseintherent
growthassumptionofupto200basispoints.1774
(v) ExitCapitalizationRate
Thebasecaseexitcapitalizationratewasapproximately4.9%,whichissimilarto
thebasecaseanalysisinthefirstquarterof2008.1775Therefore,theobservationsmade
bytheExaminersfinancialadvisorinitsanalysisofthefirstquarterareapplicableto
thesecondquarteraswell.SimilartotheExaminersfirstquarteranalysis,asignificant
increase in the exit capitalization assumption was warranted. Lehman recognized an
increasewaswarranted,asevidencedbyitsdecisiontodisclosethesensitivityanalysis
thatassignedthelargestpossibleincreaseinexitcapitalizationrates,ofover100basis
points.1776 A sensitivity analysis prepared by Product Control that was presented to
Lehmans CFO on May 27, 2008 considered a decrease in the exit capitalization
assumptionby50basispoints,whichwasthesamedecreaseLehmanusedinitsMarch
1774Lehman,RealEstateProductControlUpdate(May27,2008),atp.115[LBHI_SEC07940_2258765].
1775Id.
14[LBHI_FIN00007].Bystressingonlyoneassumption(exitcapitalizationrates),thisanalysisresulted
inthelargestpossiblereductiontoexitcapitalizationratesthatwouldresultinLehmansvaluation.The
inclusionofanothervariabletostresswouldreducetheabilitytoreducetheexitcapitalizationrateand
stillarriveatthesamevalue.
479

2008 valuation.1777 As discussed in the Sum of the Parts subsection above, goingin
capitalization rates were higher than the 4.1% used in the initial purchase price
allocation,andLehmansownvaluationimpliedagoingincapitalizationratethatwas
approaching4.5%.TheseindicationsarereflectedintheExaminerssensitivityanalysis
below.
(vi) QuantificationofChangesinAssumptions
TheExaminersfinancialadvisorusedLehmanssecondquartervaluationmodel
and created four scenarios for purposes of sensitivity analysis. The first scenario
analysis estimated an overvaluation of $183 million (see Case 1 in the table below).
Theassumptionsinthesubsequentscenarioswereprogressivelymorestringentandin
thefourthscenario,estimatedapotentialovervaluationof$657million.
1777Lehman, Real Estate Product Control Update (May 27, 2008), at p. 113 [LBHI_SEC07940_2258765].
TheMarchvaluation,whichresultedina$250millionwritedown,includeda50basispointincreasein
exit capitalization rates. Lehman, Global Real Estate Product Control, Real Estate Americas Potential
Writedowns(May2008),atp.80[LBHI_SEC07940_2258765].
480

DCFMethodSensitivityAnalyses(Q22008)
RentalGrowthRateDecrease 50bps 100bps 150bps 200bps
Inputs
ExitCapRateincrease 100bps 100bps 100bps 100bps

IRR 15.0% 15.0% 15.0% 15.0%

Outputs
ImpliedValuation $1,611 $1,449 $1,293 $1,137

ImpliedMark 67.5 60.7 54.2 47.6
(vii) ExaminersFindingsandConclusionsastothe
oftheEndoftheSecondQuarterof2008
As previously noted, because there were no meaningful amounts of sales of
Archstonedebtorequitypositionsduringthequarter,andnomeaningfulbenchmarks
for Archstone equity positions in a private market context, Archstone equity was a
SFAS157Level3asset.
The Examiner concludes that there issufficient evidence tosupport a finding
thatLehmansvaluationofArchstonebridgeequityasoftheendofthesecondquarter
of 2008 was unreasonable, for purposes of a solvency analysis. Recognizing that the
valuation of such an illiquid investment requires the application of judgment to
numerous factors and criteria, the Examiner concludes that the evidence supports a
finding that Lehmans valuation of $1.805 billion for its Archstone bridge and
481

permanent equity investment was overvalued by $200 millionto$500 million.1778
Nevertheless,theExaminerdoesnotfindsufficientevidencetosupporttheexistenceof
acolorableclaimforabreachoffiduciarydutyinconnectionwithLehmansvaluation
ofitsArchstonepositions.
The low end of the range implies a goingin capitalization rate on Archstones
core portfolio (assuming no decrease in value for Archstones other assets) between
4.50%and4.75%,whichislowerthantheaveragegoingincapitalizationrateofabout
5.0%fortheapproximately$2billionofactualsalesclosedin2008orundercontractor
innegotiationasofMay30,2008.Thelowendoftherangeisconsistentwitha7.5%
declineinenterprisevaluesincetheCommitmentDate,whichislowerthanthe11.6%
declinefortheapproximate$2billionofactualsalesclosedin2008orundercontractor
in negotiation as of May 30, 2008. Therefore, these assumptions give some credit to
Lehmansargumentthatthesesaleswerenotindicativeofthevaluefortheremainder
of the portfolio. The Examiners financial advisors analysis shows a $200 million
incremental writedown is generally consistent with a DCF analysis in which the exit
capitalizationrateincreased100basispointsandtherentgrowthassumptiondecreased
50basispoints.The100basispointincreaseinexitcapitalizationrateislowerthanthe
1778Conclusiononaprecisevaluationamountwouldreflectfalseprecisionasvaluingassetssuchasreal
estate properties and entities such as Archstone involves substantial judgment. Accordingly, Lehman
whenvaluingArchstonetookwritedownsinroundnumbers(250inMarch2008,100inMay,and125in
August). The Examiners estimations as to whether further writedowns or writeups were required is
doneinsimilarfashion.
482

assumptionLehmanpubliclydisclosedandisgenerallyconsistentwiththeincreasein
theaveragegoingincapitalizationratefortheapproximately$2billionofactualsales
closed in 2008 or under contract or in negotiation as of May 30, 2008, and the actual
capitalizationrateforAvalonBaynotedinLehmanscontemporaneousmemo.The50
basis point decrease in the rent growth assumption still results in rent growth rates
above thirdparty projections for Archstones markets and NOI growth rates that are
significantlyhigherthanArchstoneshistoricalperformance.
The high end of the range implies a goingin capitalization rate on Archstones
core portfolio (assuming no decrease in value for Archstones other assets) of
approximately 4.75%, which is lower than the average goingin capitalization rate of
approximately 5.0% for the approximately $2 billion of actual sales closed in 2008 or
under contract or in negotiation as of May 30, 2008. The high end of the range is
consistentwithanapproximate11%declineinenterprisevaluesincetheCommitment
Date,whichisgenerallyconsistentwiththe11.6%declinefortheapproximate$2billion
ofactualsalesclosedin2008orundercontractorinnegotiationasofMay30,2008.The
Examinersfinancialadvisorsanalysisshowsa$500millionincrementalwritedownis
generallyconsistentwithaDCFanalysisinwhichtheexitcapitalizationrateincreased
100 basis points and the rent growth assumption decreased 150 basis points. The 100
basis point increase in exit capitalization rate is lower than the assumption Lehman
publiclydisclosedandisgenerallyconsistentwiththeincreaseintheaveragegoingin
483

capitalizationratefortheapproximately$2billionofactualsalesclosedin2008orwere
undercontractorinnegotiationasofMay30,2008andtheactualcapitalizationratefor
AvalonBaynotedinLehmanscontemporaneousmemo.The150basispointdecrease
in the rent growth assumption still results in rent growth rates above third party
projectionsforArchstonesmarketsandNOIgrowthratesthataresignificantlyhigher
thanArchstoneshistoricalperformance.
(d) ReasonablenessasoftheThirdQuarterof2008
oftheendofthethirdquarterof2008.1779Thisvaluationreflecteda15.7%discountfrom
LehmansoriginalArchstoneinvestment.1780
The reduction in Lehmans valuation between the second and third quarters of
2008 (88.0% of funded value to 84.3% of funded value) was primarily due to $125
million of valuationrelated writedowns that were taken in August.1781 That write
down was based on a valuation model similar to that used for the second quarter
p.18[LBHI_SEC07940_ICP_002615].
[LBHI_SEC07940_ICP_002615]. The discount rate was computed by subtracting the total mark for
Novemberfrom100(i.e.,10084.3.=15.7).
1781The total $125 million writedown comprised a permanent equity writedown of $15 million and a
bridgeequitywritedownof$110million.
484

valuation, with changes in the rent growth and exit capitalization rate assumptions
resultinginalowervaluation.1782
The average variance between Archstones sales prices (including sales under
contract or in negotiation) and Lehmans budgeted values increased from
approximately12%inthesecondquartertoapproximately15%inthethirdquarter,as
showninthetablebelow.1783TheExaminersfinancialadvisorobtainedanExcelfile1784
thatheldtheunderlyingdatafordifferentbidsthatArchstoneappearedtohavebeen
entertaining. This table had the same headers (Assets Under Contract and Deals in
Negotiation) used in presentations to support the marks for Archstones May 2008
valuation.1785 Data in the presentation allowed the Examiners financial advisor to
deducethatitwascreatedbetweenJune27,2008andJune30,2008.1786
1782EmailfromWebsterNeighbor,Lehman,toPaulA.Hughson,Lehman(Sept.12,2008)[LBEXDOCID
2903130].
1783CompareLehman,ArchstoneAugust2008Update(Sept.19,2008),atp.7[LBEXDOCID2903110]with
Lehman,ArchstoneJuly2008Update(July29,2008),atp.10[LBHI_SEC_07940_ICP_008526].
1784Lehman,ArchstoneUpdate(July1,2008),atBidstab[LBEXDOCID4320349],attachedtoemailfrom
WebsterNeighbor,Lehman,toAbebualKebede,Lehman(July1,2008)[LBEXDOCID4377703].
1786PertheJulypresentation,therehadbeenassetssoldonJune30,2008;however,thisfileliststhelast
assetsaleasJune27,2008.Lehman,ArchstoneUpdate(July1,2008),atBidstab[LBEXDOCID4320349].
TheExaminersfinancialadvisornoticedthattherewasanextracategorytitledEvaluatingBidslisted
inthespreadsheet,whichimpliedthatbeforedealswereenteredintotheDealsinNegotiationheader,
theywerefirstprunedastobeworthyofnegotiations.TheExaminersfinancialadvisorobservedthat
the Evaluating Bids appeared to be severely off budget (19.5%) compared to the Deals in Negotiation
(14.5%)andAssetsunderContract(7.2%).TheExaminersfinancialadvisorwasnotabletofindthesame
spreadsheetforquarterenddates.
485

AssetsSaleAnalysisfromThirdQuarter20081787
BudgetedValue SaleValue 2008NOI Budget Sales Variance

AssetsSoldin2007 1,637 1,726 66 4.0% 3.8% 5.5%
AssetsSoldin2008 1,067 941 50 4.7% 5.3% 11.8%
AssetsSold 2,704 2,668 116 4.3% 4.4% 1.3%
AssetsUnderContract 442 404 18 4.2% 4.6% 8.6%
ASNWalnutCreekPort. 232 210 9 4.1% 4.5% 9.6%

CrystalCityPort. 809 680 32 4.0% 4.7% 15.9%
NewYorkCityPort. 1,569 1,275 59 3.8% 4.6% 18.7%
Others 167 152 8 4.5% 4.9% 8.9%
DealsinNegotiation 2,777 2,317 108 3.9% 4.7% 16.6%
2008DealsSold,Under 4,287 3,663 177 4.1% 4.8% 14.5%

ContractandInNegotiation
2008DealsUnderContract 3,220 2,722 127 3.9% 4.7% 15.5%
andInNegotiation
AllDeals 5,924 5,389 243 4.1% 4.5% 9.0%
As was done for the second quarter 2008, the Examiners financial advisor
performed a sensitivity analysis to demonstrate the effect of a reduction in enterprise
value on the required writedown as of the third quarter of 2008. The sensitivity
analysis for the third quarter was updated with new information, but otherwise
performed in the same manner as in the second quarter. As discussed above, the
averageassetsalein2008occurredat15%belowbudgetedvalue.A15%reductionin
enterprisevalueresultsinanimpliedwritedownof$1.6billion.Lehmanscumulative
writedowns through the third quarter were approximately $800 million. Therefore,
thisanalysissuggestsapotentialovervaluationof$800million.
1787Lehman,ArchstoneAugust2008Update(Sept.19,2008),atp.7[LBEXDOCID2903110].
486

(i) SumoftheParts
TheExaminersfinancialadvisorsSumofthePartsanalysisforthethirdquarter
of 2008 is similar to the analysis that was performed for the second quarter of 2008.
ThisanalysiswasupdatedbytheExaminersfinancialadvisortoreflecttheadditional
writedowns that Lehmantook duringthethirdquarter.See thetablebelow for this
analysis. Assuming the platform continued to be valued at $1 billion, Lehmans
valuation as of the third quarter implied a goingin capitalization rate on the core
portfoliothatwascloserto4.5%than4.75%,asshowninthetablebelow.
IncrementalWriteDowns (783) (504) (57) 344 704 1,030 1,326 1,596 1,844
Asdiscussedabove,theaveragegoingincapitalizationrateforArchstoneassets
that were sold, under contract, or in negotiation during 2008 was between 4.7% and
4.8%.Asshowninthechartabove,agoingincapitalizationrateof4.75%resultsina
$344millionincrementalwritedownanda5.0%goingincapitalizationrateresultsina
$704 million incremental writedown. The average sales capitalization rate declined
betweensecondandthirdquarterinpartbecauseadealonaNewYorkpropertywas
undernegotiationata4.6%capitalizationrate.HughsontoldtheExaminerthatthese
487

werethegoodassetsthatseparatedArchstonefromAvalonBay.1788Howeveritisalso
important to note that it was precisely this deal that increased the overall variance to
budget (i.e., it had a relatively low capitalization rate and a relatively high variance
betweensalespriceandLehmansbudgetedvalue).
ExaminersFinancialAdvisorsSensitivityAnalysis
ReductioninEnterpriseValue($inbillions)
AtPurchase 5.0% 7.5% 10.0% 12.5% 15.0% 17.5% 20.0%
InitialEnterpriseValue 22.2 21.1 20.5 20.0 19.4 18.9 18.3 17.8
FaceValueofDebt 17.1 17.1 17.1 17.1 17.1 17.1 17.1 17.1
EquityValue 5.1 4.0 3.4 2.9 2.3 1.8 1.2 0.7
LehmansEquity 2.4 1.9 1.6 1.3 1.1 0.8 0.6 0.3
ImpliedWriteDown (0.5) (0.8) (1.0) (1.3) (1.6) (1.8) (2.1)
WriteDownsTakenthroughAug31 (0.8) (0.8) (0.8) (0.8) (0.8) (0.8) (0.8)
IncrementalWriteDownRequired 0.3 0.0 (0.3) (0.5) (0.8) (1.0) (1.3)
(ii) DCFMethod
The Examiners financial advisors DCF Method analysis for the third quarter
2008 is similar to the analysis that was performed for the second quarter 2008. As
discussed above, the Examiners analysis of the DCF Method focused on two
assumptions: rent growth and exit capitalization rates. This Section addresses the
ExaminersfinancialadvisorsanalysisoftheassumptionsusedinLehmansvaluation
forthirdquarter2008.
488

TheDCFvaluationforthethirdquarterwasbasedonasimilarvaluationmodel
Lehmanusedforitssecondquartervaluation,thoughduringthethirdquartertherent
growthwasreducedto4.90%andtheexitcapitalizationratewasincreasedto5.57%.1789
The DCF valuation for the third quarter was lower than the DCF valuation for the
secondquarterduetothesechangesinassumptions.1790
(iii) RentGrowth
Duringthethirdquarter2008,LehmanrecognizedthatArchstonesgrowthrates
haddeclined,andLehmanadjusteditsprojectionsdownward.1791However,itappears
this was work was not completed by the end of the third quarter 2008.1792 To counter
this, Lehman ran the DCF model with a rental revenue CAGR of 4.90%, a more
conservativeassumptionthanpreviouslyused.1793
1789EmailfromWebsterNeighbor,Lehman,toPaulA.Hughson,Lehman(Sept.12,2008)[LBEXDOCID
2903130].
1790Lehman,EasyLivingCorporateQ3Model(Aug.22,2008)[LBEXDOCID3119444].
1791LehmanranthemodelataCAGRof4.9%,whichwasa74basispointsreductionfromthebasecase.
Email from Webster Neighbor, Lehman, to Paul Hughson, Lehman (Sept. 12, 2008) [LBEXDOCID
2903130].
1792Theprojectionswithinthethirdquartermodel,Lehman,EasyLivingCorporateQ3Model(Aug.22,
2008), at Full Rollup tab [LBEXDOCID 3119444], were the same ones as those in the second quarter
model,Lehman,EasyLivingQ2ModelRisk(June15,2008),atFullRolluptab[LBEXDOCID4456413].
Therewasdifferenceinthecashflowsthatwasdrivenbymoreassetshavingbeensoldbytheendofthe
thirdquarter.
1793Email from Webster Neighbor, Lehman, to Paul Hughson, Lehman, (Sept. 12, 2008) [LBEXDOCID
2903130].
489

(iv) ExitCapitalizationRate
Thebasecaseexitcapitalizationratewasapproximately5.57%,whichis75basis
pointshigherthanthebasecaseanalysisasofthesecondquarterof2008,1794butover25
basispointsbelowwhatLowittcitedastheover100basispointsincreaseonthesecond
quarterearningscall.1795
TheobservationsmadebytheExaminersfinancialadvisorinitsanalysisofthe
first and second quarter (i.e., that there is a correlation between goingin and exit
capitalizationrates,andgoingincapitalizationrateswereincreasing)applytothethird
quarter as well. The Examiners financial advisor increased the exit capitalization
assumptioninitsthirdquarteranalysislessthaninitsfirstandsecondquarteranalysis
since Lehman had recognized the need for an upward adjustment and increased the
basecaseexitcapitalizationrateby75basispoints.1796TheExaminersfinancialadvisor
made a further increase to this rate because Lehmans asset prices were increasing in
their variances from the budget and it became more readily apparent that goingin
capitalization rates were increasing.1797 As discussed in the asset sales section above,
thirdquartergoingincapitalizationrateswere6590basispointshigherthanthe4.1%
1794Lehman,ArchstoneSensitivityAnalysis082208(Sept.12,2008)[LBEXDOCID2852318],attached
toemailfromWebsterNeighbor,Lehman,toPaulA.Hughson,Lehman(Sept.12,2008)[LBEXDOCID
2903130].
14[LBHI_FIN00007].
1796Lehman,ArchstoneSensitivityAnalysis082208(Sept.12,2008)[LBEXDOCID2852318],attached
toemailfromWebsterNeighbor,Lehman,toPaulA.Hughson,Lehman(Sept.12,2008)[LBEXDOCID
2903130].
1797SeeSectionIII.A.2.f.4.bforadiscussionoftheSumofthePartsvaluationmethod.
490

usedintheinitialpurchasepriceallocation,andArchstonesownsalesimpliedagoing
in capitalization rate approaching 4.8%. The sensitivity analysis below accounts for
theseindicationsbyflexingtheexitcapitalizationrateassumptionfrom5.82%to6.07%.
(v) QuantificationofChangesinAssumptions
AnemailexchangebetweenWebsterNeighborandAlexKirkdetailsthemodel
Lehman used to value Archstone in the third quarter.1798 The base case in this model
assumed a flexed case of 5.57% for the exit capitalization rate and 4.90% for the rent
CAGR. The Examiners financial advisor created four different cases in the model
stressing each of these two assumptions. In the first case the Examiners financial
advisor assumed that the rental growth assumption was that of the base case that
Lehman used (4.90%) and that the exit capitalization rate was 1.0% higher than at
closing. Applying the same rental growth rate assumption Lehman used in the third
quarter,theExaminersfinancialadvisorsstressoftheexitcaprateraisedittotherate
Lowitt cited in the second quarter earnings call (albeit at a lower rental growth rate).
The second case maintained the same exit cap rate but further stressed the rental
growthrateby75basispoints,bringingtherentalrevenueCAGRto4.15%.Thethird
casealsomaintainedthesameexitcapratebutfurtherstressedtherentalgrowthrate
byanadditional75basispoints,bringingtherentalrevenueCAGRto3.90%.Inthelast
case,theExaminersfinancialadvisorranthemodelataCAGRof3.40%.
1798Lehman,EasyLivingCorporateQ3Model(Aug.22,2008),atFullRolluptab[LBEXDOCID3119444].
491

DCFMethodSensitivityAnalyses(Q32008)
RentalGrowthRateDecrease(from72bps) 0bps 75bps 100bps 125bps
Inputs
ExitCapRateincrease(from75bps) 25bps 25bps 25bps 50bps

IRR 15.0% 15.0% 15.0% 15.0%

Outputs
ImpliedValuation $1,507 $1,265 $1,187 $992

ImpliedMark 63.1 53.0 49.7 41.6
oftheEndoftheThirdQuarterof2008
Asnotedearlier,ArchstoneequitywasaSFAS157Level3assetwhosevaluation
is entitled to a significant amount of judgment. For the reasons set forth above, the
Examiners financial advisorconcluded that there issufficient evidence tosupport a
finding,forpurposesofasolvencyanalysis,thatLehmansvaluationforitsArchstone
bridgeequity investment as oftheend of the third quarter of 2008 was unreasonable.
Recognizingthatthevaluationofsuchanilliquidinvestmentrequirestheapplicationof
judgment to numerous factors and criteria, the Examiner concludes that the evidence
supports a finding that Lehmans valuation of $1.647 billion for its Archstone bridge
andpermanentequityinvestmentwasovervaluedby$140millionto$400million.
Thelowendoftherangeimpliesadeclineinenterprisevalueofbetween7.5%
and 10.0% since the acquisition. This decline is less than the decline in value of
492

Archstoneassetsundercontractorinnegotiationatthistime;thereforethelowendof
therangeassumesthereissomemerittoLehmansargumentthatassetsaleswerenot
indicative of the value for the remainder of the portfolio. The Examiners financial
advisors analysis shows a $140 million overvaluation based on a DCF analysis using
the following assumptions: a 25 basis points increase in exit capitalization rate and a
zero basis point decrease in rent growth (which results in rent growth that is
significantly higher than thirdparty projections for Archstones markets and a NOI
growthrateof7.0%,whichissignificantlyhigherthanArchstoneshistoricalaverage).
The Examiners financial advisor used Lehmans base case figure for the rent growth
but stressed the exit capitalization rate an extra 25 basis points from Lehmans base
case.Theresultingexitcapitalizationrateisthesameastheexitcapitalizationrateused
inthesecondquarteranalysis.
The high end of the range implies a decline in enterprise value since the
acquisitionof12.5%.A12.5%declineisstillbelowthedeclineinvalueforArchstone
assetsundercontractorinnegotiationatthistime.TheExaminersfinancialadvisors
analysis shows a $382 million overvaluation based on a DCF analysis making the
following assumptions: a 75 basis point decrease in rent growth and a 25 basis points
increase in exit capitalization rate. The Examiners financial advisor stressed the exit
capitalizationrate to 6.07%basedontheimpliedgoingincapitalization rate of 5.37%.
Thiscapitalizationrateisbelowthe5.5%thatwascitedastheappropriatecapitalization
493

rateforAvalonBayintheresearchreportpublishedbyLehmanonMay14,2008.1799The
rental growth CAGR assumed by a 75 basis point decline is 4.15% while the implied
NOI CAGRis 6.1%. The NOI CAGRissignificantly higherthanwhatArchstone was
abletoachievehistoricallywhiletherentCAGRisslightlyhigherthanArchstones10
yearhistoricalaverage.
WholeLoansPortfolio
This Section of the Report addresses Lehmans valuation of Residential Whole
Loans (RWLs) and Residential MortgageBacked Securities (RMBS) during the
secondandthirdquartersof2008.RWLs,thevaluationofwhichpresentsthegreater
challenge of the two, are addressed first and in greater detail. The comparatively
straightforward valuation of RMBS follows. While this Report notes several issues
withLehmanspricetestingofitsRWLportfolio,insufficientevidenceexiststosupport
acolorableclaimthatLehmansvaluationoftheseassetswasunreasonable.Likewise,
thereisinsufficientevidencetosupportacolorableclaimthatLehmansvaluationofits
RMBSportfoliowasunreasonable.
(1) ResidentialWholeLoansOverview
RWLsareresidential mortgagesfrom aroundtheworldthatcan be traded and
pooledasthefirststageinthesecuritizationprocess,thegoalofwhichisthecreationof
1799DavidHarris,Lehman,etal.,REITsInvestorBriefingPackage(May14,2008),atp.45[LBEXDOCID
4329202],attachedtoemailfromDonaldE.Petrow,Lehman,toJonathanCohen,Lehman[LBEXDOCID
4432688].
494

RMBS.1800 A sponsor of a RMBS transaction such as Lehman first acquires the
underlyingRWLs,whicharepooledtogetherinthesecuritizationprocess.Suchpools
are generally homogenous in some respects (e.g., in terms of quality of loans and
vintage)andaregeographicallydiversifiedinordertomitigatetheriskoflossduetoa
regional decline in home prices. Once the pool size reaches its target, the sponsor
preparesthelegaldocumentationtosellthepooltoaspecialpurposeentity(theSPE),
proposesadivisionoftheinterestandprincipalpaymentprioritiesintobondsthatare
tranched, obtains a rating from a rating agency for the applicable bonds, and then
sellsthebonds,alsoknownasRMBS,toinvestors.Thepurchasemoneythatinvestors
paytotheSPEenablestheSPEtopurchasetheRWLpoolfromtheissuer.
As a predicate to securitization, RWLs are created by loan originators that
approve mortgages and lend directly to homeowners. Government entities, such as
FannieMaeandFreddieMac,financialfirmssuchasLehmanandotherinvestorsbuy
thepooledmortgagesfromtheoriginators.Theseinvestorsmayholdwholeloanpools
as investments, sell them to other investors or create securities by carving up the
poolsandsellingthesecurities.Thislastoptionisthedomainofinvestmentbankssuch
1800SeePeterJ.Elmer,Conduits:TheirStructureandRisk,F.D.I.C.BankingRev.,Dec.1999,atpp.27,3233.
ThecreationofRMBSisdescribedingreaterdetailbelow.
495

as Lehman.Typically,investmentbankssecuritize orsell RWLs anddonotpurchase
RWLsforthepurposeofowningthemasinvestmentsforanextendedperiod.1801
As of May 31, 2008, Lehman reported that it owned RWLs with an aggregate
marketvalueofapproximately $8.3billion,asconsolidatedacrosssubsidiaries.1802For
valuation purposes, Lehman assigned RWLs to one of several categories that were
organized by geographic origin and the type of mortgage loan. The geographic
distribution of the RWL assets held by Lehman in May and August of 2008 was as
follows:
TotalValue(in$billions)1803
Origin/Class
May2008 Aug2008
U.S.Prime/AltA 2.1 1.2
U.S.Subprime/Second 1.1 0.6
Lien
OtherU.S. 1.0 0.9
Europe 3.6 3.1
AsiaPacific 0.5 0.5
Total 8.3 6.3

This Section of the Report examines whether Lehmans valuation ofits RWL
assets, as determinedbyLehmanin MayandAugustof2008, was reasonable.1804 The
1801Id. at pp. 3132 (stating that most loans held by conduits are newly originated and may be held for
severalmonthsawaitingsecuritization).
1802LBHI10Q(filedJuly10,2008),atp.69.
1803Id.atpp.6970;Lehman,Q3ResidentialTemplatew_Elq(v83).xls[LBEXBARFID0011867].August
dataatthislevelofdetailwasnotpubliclydisclosedpriortobankruptcy.
1804TheExaminerhasfocusedonthedatesMay31,2008andAugust31,2008becausethesedateswere
theendsofLehmanssecondandthirdquarterreportingperiods.WhileLehmandidnotactuallyfilea
496

ExaminersinvestigationhasrevealedthatLehmansproductcontrolprocessforRWLs
wasnotparticularlyrobustandthattherewassomeriskofmisstatementinthisasset
class.WhilecertainofthesourcesLehmanusedinpricetestingitsU.S.RWLportfolio
inMayandAugustof2008provedultimatelyunreliable,theassetvaluesarrivedatby
Lehmandidnotfalloutsidearangeofreasonableness.Accordingly,theExaminerdoes
notfindevidencetosupportafindingthatLehmansvaluationofitsU.S.RWLportfolio
inMayorAugustof2008wasunreasonable.Inlightofthisconclusion,andgiventhe
expensetotheDebtorsestatesandthetimethatwouldberequiredfortheExaminerto
conduct an investigation of the reasonableness of Lehmans valuation of its nonU.S.
RWLs,theExaminerdeterminedthatconductingsuchaninvestigationwouldnotbea
prudent use of the estates resources and therefore limited the investigation to the
reasonablenessofthevaluationofU.S.RWLs.
(2) LehmansU.S.ResidentialWholeLoansin2008
Lehman divided U.S. RWLs into 10 different categories based on the nature of
theunderlyingmortgageloan.1805Thetablebelowliststhese10categories,alongwith
theMay2008marketvalueofallofLehmansU.S.assetsinthatcategory.1806
quarterlyreportforthethirdquarterof2008,itdidcollectpricesfromitstradingdeskandperformprice
testingofitsU.S.RWLsforthisperiod.
1805SeeLehman,New053008WLTesting.xls,tabWLTestingSummary[LBEXBARFID0006698].The
categoriesofloanslabeledCapitalCrossingandSBFarenotincludedinthisanalysisbecausethey
are not residential loans. The amounts reported in LBHIs Quarterly Report for the second quarter of
2008varyslightlywiththeamountsinthetestingfilesreviewed.Explanationsforthisvarianceinclude
the possibility that the testing files included minimal amounts of nonUS assets or that Lehmans 10Q
numbersincludedsomehedgepositions.
497

CategoriesofU.S.RWLsHeldbyLehmanasofMay31,2008andAugust,31,20081807
MarketValue
CollateralType (in$billions)
May08 Aug08
FHA/VA 0.27 0.12
HighLTV 0.02 0.02
HomeExpress 0.00 0.00
NegAm 0.24 0.19
PrimeFixed 0.49 0.33
PrimeHybrid
1.36 0.66
ARMs
Reverse
0.62 0.65
Mortgages
Scratch&Dent 0.39 0.23
Subprime 0.16 0.11
Subprime2nds 0.89 0.50
Total 4.44 2.80
Lehman also divided each of the 10 categories listed above into performing
andnonperforminggroups,distinguishedbywhethertheloanswerestillproducing
timely interest and principal payments. Because loans in the reverse mortgages
categorycannotbenonperforming,1808Lehmanrecognized19uniquecategoriesofU.S.
RWLsforpricingpurposesinMayandAugustof2008.
1806LehmanhaddistinctProductControlgroupsforitsU.S.andEuropeandivisionsandtherewaslittle
communication and no standardization between U.S. and European entities. Examiners Interview of
BrianSciacca,Oct.19,2009,atp.4.
1807Lehman, New 053008 WL Testing.xls, tab WL Testing Summary [LBEXBARFID 0006698];
Lehman,PricingPackageAug08.xls(Aug.29,2008),tabWholeLoans[LBEXBARFID0006669].
1808Inareversemortgage,ahomeownerborrowsagainsttheequityintheirhome.Unlikeinatraditional
homeequityloan,norepaymentisrequireduntiltheborrowernolongerusesthehomeastheirprincipal
residence.Usuallymarketedtoseniors,theloanisrepaidwithinterestandfeeswhenthehomeissold
by the borrower or the borrowers estate. See U.S. Dept of Hous. and Urban Dev., Top Ten Things to
Know if Youre Interested in a Reverse Mortgage, Feb. 20, 2009, available at http://www.nls.gov/
offices/hsg/sfh/hecm/rmtopten.cfm(lastvisitedFeb.3,2010).
498

Despite the relationship between RWLs and RMBS, valuation of RWLs is more
difficult than the valuation of RMBS. In comparison to RMBS, the number of
identifiabletradesofRWLpoolsestablishingtypicalpriceandyieldrangesisrelatively
small.1809ThetotalvalueforwhichRMBSaresoldistypicallygreaterthanthevalueof
theRWLpoolonwhichtheyarebasedduetothevalueaddedduringthesecuritization
processandthebusinessmodeloftheinvestmentbank.1810Additionally,thevalueof
RWLpoolsislargelydependentontheanticipatedopportunitytosecuritizetheassets
in the nearterm and a robust secondary market for RMBS. Without a functioning
market, estimating the value of RWL pools awaiting securitization becomes more
difficult.Accordingly,thereislesscertaintyastothemarketpriceofRWLassetsheld
on Lehmans books during 2008 than for such assets during prior periods when the
RMBSmarketwasmorerobust.
In 2008, the pace of new securitizations slowed significantly.1811 Fewer loans
were being made to homeowners,1812 there was very little trading of RWLs between
1809Thisisadirectresultofthefactthatsecuritizationimprovesliquidity.SincethesecuritizationofRWL
pools into RMBS transactions enhances liquidity, it follows that the number of identifiable RWL trades
would be small in comparison to RMBS. See Peter J. Elmer, Conduits: Their Structure and Risk, F.D.I.C.
BankingRev.,Dec.1999,atpp.27,32.
1810When the securitization market is functioning, an investment bank will bid for a whole loan pool
based on the expected sale proceeds of the securities it will create, the expenses (such as ratingagency
andlegalfees and marketing costs)it will incur,and the desired fees (typically 12% of the transaction
size). Accordingly, the total RMBS value will exceed the RWL value in a functioning market. Lehman
BrothersHoldingsInc.,OverviewofSecuritization[LBEXBARFID0012513].
1811ExaminersInterviewofJosephSapia,Oct.26,2009,atp.2;SecuritiesIndustryandFinancialMarkets
Association, MortgageRelated Issuance, (1996 June 2009), available at http://www.sifma.org/

research/pdf/Mortgage_Related_Issuance.pdf(lastvisitedFeb.3,2010)(showingissuanceofnonagency
499

market participants1813 and several mortgage originators filed for bankruptcy.1814 One
resultofthesignificantdeclineofsecuritizationactivitywasthatitmadethepricingof
RWLassetsextremelydifficult.InMayof2008,Lehmanacknowledgedinternallythat
pricetransparencydoesnotexistforwholeloans.1815
Duringthesecondquarterof2008,thevalueofLehmansU.S.RWLportfoliofell
byapproximately$2.5billionfrom$6.6billionto$4.1billionduetoamixofwrite
downs and sales.1816 Ofthis decline of approximately $2.5 billion, approximately $750
millionwasduetowritedowns.1817Duringthistime,thecombinedgrosswritedown
ofbothRMBSandU.S.RWLswas$2.4billion.1818Duringthethirdquarterof2008,the
value of Lehmans U.S. RWL portfolio fell by approximately $1.4 billion from $4.1
mortgagebackedsecuritiesfellfromapproximately$774billionin2007to$41billionin2008);LuoJun,
CreditCrisisWillExtendInto2009,OppenheimerSays(Update1),Bloomberg.com,May20,2008,availableat
http://www.bloomberg.com/apps/news?pid=20601087&sid=aAMUjyxli6Lc(notingtheshutdowninthe
securitizationmarket).
1812MortgageBankersAssociation,MortgageOriginationEstimates,Oct.16,2009,http://www.mbaa.org/
files/Research/HistoricalWAS/HistoricalMortgageOriginationEstimates101609.xls(providingestimatesof
quarterlymortgageoriginations).
1813W. Joseph Caton, Will the Loan Trade Market Finally Open Up?, National Real Estate Investor, Jun. 1,
2008, http://nreionline.com/commentary/finance/real_estate_loan_trade_market_0601 (describing a

virtualstandoffintherealestateloaninvestmentandtradingmarketplace).
1814SeeWorthCivils&MarkGongloff,SubprimeShakeout,WallSt.J.Online,http://online.wsj.com/public/
resources/documents/infosubprimeloans0706sort.html (listing bankruptcy filings of mortgage

originatorsinlate2007).
1815Lehman,PricingPackageMay08.xls(May2008),atp.1[LBEXBARFID0006591].
1816Lehman,Q208HighLevelMortgageRollForward(v2).xls[LBEXBARFID0011863].
1817Id.
1818Lehman,Q32008FinancialReview(Sept.6,2008),atp.22[LBHI_SEC07940_744701].
500

billion to $2.7 billion due to a mix of writedowns and sales.1819 Of this decline of
approximately$1.4billion,approximately$840millionwasduetowritedowns.1820The
writedownsLehmantookontheseassetsthroughouttheyearreflectitsrecognitionof
thechangedmarketconditionsof2008andanacknowledgmentofthediminishedvalue
ofitsU.S.RWLandRMBSassets.
(3) LehmansValuationProcessforitsResidentialWholeLoans
TheassetvaluesLehmanreportedonitsbalancesheetforRWLswerethemarks
reported by its traders, which were subject to revision pursuant to the price testing
processdescribedbelow.1821EachLehmantradingdeskhaditsownmethodforpricing
assets and there was little consistency across desks as to methodology.1822 In order to
provideacheckonthetradersmarks,andtoprovidesomestandardization,Lehmans
ProductControlGroupperformedanindependentpriceverificationofU.S.RWLassets
onamonthlybasis,withspecialemphasisplacedonpriceverificationattheendofeach
fiscalquarter.1823WhilethetradingdesksmarkedindividualRWLassets,meaningthat
RWLswithinasinglecategorycouldbeassigneddifferentmarks,theProductControl
1819SeeLBHI10Q(filedJuly10,2008)atp.69;Lehman,PricingPackageAug08.xls(Aug.29,2008),tab
Whole Loans [LBEXBARFID 0006669]; Lehman, Q3 Residential Template w_Elq (v83).xls [LBEX
BARFID0011867].
1820Lehman,Q3ResidentialTemplatew_Elq(v83).xls[LBEXBARFID0011867].
1821ExaminersInterviewofUsmanBabar,October16,2009,atpp.35.
1822Id.
1823Lehman, Price Verification Policy Global Capital Markets 2008 [Draft], at pp. 4, 4954
[LBHI_SEC07940_2965994]. While the task of price verification was assigned to the Valuation Control
group, Lehman documents, as well as E&Y documents, refer to the Product Control group and
product controllers when describing this function. For ease of reference and consistency, the terms
ProductControlandproductcontrollersareusedthroughoutthisSection.
501

Groupspricetestingassignedasinglemarktoeachofthe19categoriesofU.S.RWLs
identified above.1824 As described below, the Product Control Group relied on several
differentmethodstovalueRWLassetsdependingonthecurrentmarketconditionsand
data available. When the variances between the Product Control Groups price
verificationandthedeskpriceforaparticularassetexceededcertaintolerances,1825the
ProductControl Groupwould seektoresolvethevariancethrough conversation with
the appropriate trading desk and would escalate material unresolved variances to
senior management.1826 The Product Control Group also prepared summaries of its
findings and procedures that were distributed to Lehmans senior management on a
monthlybasis.1827
Prior to 2008, Lehmans Product Control Group used a mock securitization
modeltovalueitsU.S.RWLassets.1828Themocksecuritizationapproachisbasedonthe
1824Lehman,New053008WLTesting.xls,tabWLTestingSummary[LBEXBARFID0006698].When
this report notes a single Lehman desk price for a category of RWLs, that number is the weighted
averageofthepricesassignedbythetradingdesk.TherangeofpricesreportedbyLehmanstradersare
oftenextremelylarge.ForPrimeHybridARMsinMayof2008,forexample,tradersreportedalowprice
of0.1andamaximumpriceof110.9.SixofthetencategoriesofperformingRWLsasdefinedbyLehman
showedrangesofessentially1to100.SeeAppendix16,ValuationResidentialWholeLoans,foramore
detaileddiscussionoftherangeofdeskpricesassignedtoeachcategoryofRWLs.
1825ThetolerancelevelforRWLswassetat3%,althoughinsomeunspecifiedinstanceshighervariances
wouldbedeemedacceptable.Lehman,PriceVerificationPolicyGlobalCapitalMarkets2008[Draft],at
p.53[LBHI_SEC07940_2965994].
1826Id.atp.54.
1827Id.atp.4.See,e.g.,Lehman,Valuation&ControlReportFixedIncomeDivision(Feb.2008),atpp.3
5[LBEXWGM002234].
1828Lehman, Price Verification Policy Global Capital Markets 2008 [Draft], at p. 49,
[LBHI_SEC07940_2966042].Theproductcontrollersalsoreliedtoalimitedextentonsalesdata,butthe
primary source for their price testing was mock securitization. See Lehman Brothers Holdings Inc.,
PrimeHybridArms.xls[LBEXBARFID0011869].
502

theory that the value of a pool of RWLs is closely related to the price that could be
realized by selling the RMBS created if the pool were to be securitized.1829 Using this
approach, a recently closed deal with similar underlying collateral meaning the
underlying loans had similar anticipated default rates, recovery rates and rates of
prepayment is selected as a point of reference. The sum total of the values of all
RMBSissuedinsuchadealisconsideredtoberepresentativeofthepriceoftheRWL
poolonwhichitisbased.Asindicatedpreviously,theRWLpoolwillhaveasomewhat
lower valuethan the totalofall the RMBS createdbythepool infunctioningmarkets
and this difference is estimated in order to determine the value of RWLs by mock
securitization.
The valuation of RWLs became more difficult in 2008 as securitization of
residentialmortgagesslowedsignificantly.1830PotentialbuyersofaRWLpoolwereno
longerabletorelyonneartermsecuritizationofthepool.Inaddition,theslowingpace
ofsecuritizationsmeantthattherewerefewerpotentialbuyersforRWLpoolsin2008,
because buyers whose goal was securitization rather than investment diminished in
number.Becauseofthischangeinmarketconditions,inMay2008Lehmanconcluded
that the mock securitization model was no longer a valid method for valuing its U.S.
1829E&Y Walkthrough Template, Residential Whole Loans, at p. 5 [EYLELBHIMCGAMX08072872]
(describingmocksecuritizationmethodology);ExaminersInterviewofUsmanBabar,October16,2009,
atp.4.
1830ExaminersInterviewofJosephSapia,Oct.26,2009,atp.2.
503

RWLassets.1831Instead,Lehmandecidedtorelysolelyonrecentsalesdataandprices
reportedbythirdpartysourcesasbenchmarksforpriceverification.1832
(a) LehmansMay2008PriceTesting
Lehmans Product Control Group price tested its entire U.S. RWL portfolio for
the second quarter of 2008.1833 In price testing assets using recent trade activity, it is
important that the recent transactions used as benchmarks involve the same general
typeofassetsastheLehmanassetsbeingvalued,andthatthetradesbecloseintimeto
therelevantreportingdate.Furthermore,agreaternumberofbenchmarksaleswould
allow a higher level of confidence in the estimated price of the assets being valued.
However,Lehmanhadverylittlerelevanttradedatatoprovidebenchmarkvaluesfor
its U.S. RWL assets in May and August 2008. Lehman Product Control records
demonstrate that Lehmans Product Control Group identified only seven trades upon
whichtorelyinpricetestingitsU.S.RWLassetsforitssecondquarterreporting.1834
The Examiner reviewed the May 2008 price testing records related to all 19
categories of Lehmans U.S. RWL portfolio, ten performing and 9 nonperforming.1835
For five of the 10 performing categories, Lehmans Product Control Group used only
1831E&YWalkthroughTemplate,ResidentialWholeLoans,atp.4[EYLELBHIMCGAMX08072872].
1832Id.;Lehman,ValuationReview2ndQuarter2008(July2008),atpp.810,[LBHI_SEC07940_750105].
1833Lehman,ValuationReview2ndquarter2008(July2008),atpp.810,[LBHI_SEC07940_750105].
1834Examiners Interview of Joseph Sapia, Oct. 26, 2009, at p. 2; Lehman, Whole Loan Closings (June 4,
2008), at pp. 12 [LBEXBARFID 0006588]; Lehman, New 053008 WL Testing.xls, at tab WL Testing
Summary[LBEXBARFID0006698].
1835Lehman,New053008WLTesting.xls,tabWLTestingSummary[LBEXBARFID0006698].
504

recenttradeactivityforpriceverification.1836Together,thesefivecategoriesaccountfor
$1.7 billion of Lehmans reported U.S. RWL asset value in May 2008. One of the
categories,FederalHousingAdministration(FHA)/VeteransAdministration(VA)
loans, was backed by an FHA guarantee, making its valuation relatively
straightforward.1837Another,theReverseMortgagecategory,waspricedusingarecent
saletotheGovernmentNationalMortgageAssociation(GinnieMae),astrongbasis
forthemarkgiven.1838
However,theother threecategories of performingloans valuedby reference to
recentsalesaremoreproblematic.ManyofthetradesLehmanusedasbenchmarksin
price testing its U.S. RWL portfolio in May 2008 failed to close and eventually were
cancelled,albeitafterLehmanrelieduponthetradesasbenchmarks.Inhindsight,itis
apparentthatthefailedtradesdidnotaccuratelyindicatethevalueoftheassetsatissue
becausenoassetsactuallytradedatthepricesreflectedbythetradedatareviewedby
Lehmans product controllers. Although it would be unreasonable for Lehmans
ProductControlGrouptorelyontradestheyknewwouldbecancelled,theExaminer
hasnotfoundevidencethattheProductControlGroupshouldhaveknown,atthetime
itperformedsecondquarter2008pricetesting,thatthetradesusedwouldeventuallybe
cancelled.ThetablebelowprovidesalistofthethenrecenttradesusedbyLehmanto
1836Id.
1837Id.
1838Id.
505

price test its RWL portfolio in May 2008 and the subsequent settlement status of the
trades.
BenchmarkTradesUsedByLehmanProductControlInMayof20081839
Category BenchmarkTrade Valueof Price Settlement/

Assets Cancellation
Traded
($million)
HighLTV FannieMae 56.0 94.7 Undetermined
PrimeFixed VerticalMortgage 87.5 86.0 Cancelledon7/1/08
Prime Hybrid ChevyChaseBank 37.0 96.0 Cancelledon8/5/08
ARMs
Reverse GinnieMae 33.0 100.8 Undetermined
Mortgages
Scratch RLT 11.0 65.0 Securitization closed
&Dent on5/31/08
Subprime ArchBay 105.0 65.0 Not Entered in Trade
System
Subprime GreatWestern 11.0 65.0 Cancelledon6/16/08
Seconds Bank
At the time they valued Lehmans U.S. RWL assets in May 2008, Lehmans
productcontrollersreliedonthelimitednumberoftradestheywereabletoidentifyas
thebestavailableinformation.AreviewofLehmanstradedatabasedemonstratesthat
oftradesonwhichLehmanpossessedinformationinMay2008,only5%ofDecember
2007tradesandnotradesinJanuaryorFebruary2008werecancelled.1840Higherrates
of cancellation existed for trades in March and April 2008 16% and 15%
1839Lehman,New053008WLTesting.xls,attabWLTestingSummary[LBEXBARFID0006698];APB
TradeDatabaseReport[LBEXBARAPB0049422].
1840APBTradeDatabaseReport[LBEXBARAPB0049422].
506

respectively.1841 While the March and April 2008 cancellation rates were high enough
thatLehmansproductcontrollersshouldhavebeenawarethattherewasapossibility
thatsometradesmaybecancelled,thecancellationrateswerenotsohighastorender
the controllers reliance on trade data unreasonable during the second quarter price
verificationprocess.
During interviews with the Examiner, Lehmans product controllers indicated
that no one in their group subsequently checked to confirm if the trades used as
valuationbenchmarksinMay2008actuallysettledandthatthegroupneverdiscussed
thesettlingorcancellingoftradesasapotentialissue.1842However,eventhoughgreater
diligenceininvestigatingthesetradeswouldhaverevealedsomeredflags,suchasthe
factthatatleastonetradewasneverenteredinLehmanstradedatabase,therewasno
wayfortheproductcontrollerstoknowconclusivelyinMayandearlyJune2008at
the time the price verification process occurred that certain trades would be
cancelled in the future. Accordingly, without more reliable information at their
disposal, it was reasonable for the product controllers to use the initial trade data in
performingpricetesting.Eachofthetradesrelieduponisdiscussedbelow.
1841Id.
1842ExaminersInterviewofBrianSciacca,Oct.19,2009,atp.3;ExaminersInterviewofJosephSapia,Oct.
26,2009,atp.3.
507

ThesubprimecategoryofRWLs,valuedat$87millionbythetradingdesk,was
pricetestedbasedonatradeof$105millionofassetstoArchBay(atapriceof65).1843
WhiletheproductcontrollersobtainedsomeinformationregardingtheArchBaytrade,
the Examiners investigation revealed that this trade never formally settled and
ultimatelydidnotoccur.1844HadLehmansproductcontrollerscheckedtoconfirmthat
thiswasapropertrade,theywouldnothavefoundanyentryinLehmansMTStrade
system, which would have been a red flag that this trade was irregular in some way.
However, there was no way for the product controllers to know conclusively, in May
2008,thatthistradewouldnotclose.
Similarly,theSubprimeSecondscategoryofRWLs,valuedat$656millionbythe
tradingdeskinMay2008,waspricetestedonthebasisofasingletradeof$11million
of assets to Great Western Bank (at a price of 65).1845 Unlike the Arch Bay trade, this
tradewasenteredintotheMTSsystem,butfailedtocloseandwascancelledonJune16,
2008, after the May 2008 price verification process ended.1846 There was no way for
Lehmans product controllers to have realized at the time they performed their price
testingthatthistradewouldbecancelledthefollowingmonth.Evenhadtheyfurther
investigatedthistradeinMay2008,productcontrollerswouldonlyhaveseenthatthe
1844This trade was never entered in Lehmans trade database; accordingly, it is unclear when the trade
was scheduled to settle and when it was cancelled. See APB Trade Database Report [LBEXBARAPB
0049422].
508

settlementdateforthistradewasTBD.1847Assuch,theirdecisiontorelyonthistrade
inpriceverificationofLehmansSubprimeSecondsRWLswasreasonableatthetime.
Finally,theScratch&Dentcategory,valuedat$158millionbythetradingdesk
in May 2008, was price tested on the basis of a thenrecent RMBS securitization.
Lehman created this securitization, entitled Residential Loan Trust (RLT) 20082, in
May 2008 and provided a mark of 49 that was used as the Product Control price for
these assets.1848 The underlying loans in the RLT securitization consisted of non
performing loans; the Baupost Group, a thirdparty hedge fund, provided
approximately60%ofthefundingfortheSPEtopurchasetheunderlyingloans,which
had already been securitized, and owned approximately 60% of the securitization.
WhentheSPEpurchasedtheunderlyingRWLs,arelevantpricepointwasestablished
thatcouldbeusedtotestRWLpoolswithsimilarcharacteristicstotheloansunderlying
theRLTsecuritization.However,thispricewasnotasrobustanindicatorofthevalue
oftheRWLsasasaletoawidergroupofinvestorswouldhavebeen.
The Product Control Groups price testing of the other five categories of
performing loans, together representing $2 billion of Lehmans $4.1 billion U.S. RWL
portfolio in May 2008, employed a price obtained from a Morgan Stanley research
1847Lehman,CopyofWholeLoanClosings06.04.08.xls[LBEXBARFID0006588].
1848Lehman,New053008WLTesting.xls,tabWLTestingSummary[LBEXBARFID0006698].While
therewaslittlesecuritizationactivityin2008,theRLTsecuritizationwasoneofthefew.
509

report.1849TwocategoriesofperformingloanswerevaluedbyreferencetothisMorgan
Stanleyreportalone,whileanotherthreecategoriesusedthereportinconjunctionwith
tradedata.1850InaninterviewwiththeExaminer,JosephSapia,aformerVicePresident
in Lehmans Securitized Products Valuation and Control group, stated that the trade
datawastheprimarysourceofthemarksgiventothesethreecategoriesofloansand
thatLehmanmerelyusedtheMorganStanleyreporttoconfirmthemarks.1851However,
this characterization of the methodology is inconsistent with the Product Control
Groups price testing spreadsheets. As described above, the prices reflected by the
tradedatarangedfrom86to96forthesethreecategories.1852However,ratherthanuse
theseprices,theproductcontrollersused89,thepriceidentifiedbytheMorganStanley
report,foreachofthesecategories.1853
TovalueitsHighLTV,HomeExpress,NegAm,PrimeFixedandPrimeHybrid
ARM RWLs, Lehmans Product Control Group used a mark of 89, which was the
1849SeeMorganStanleyResearch,SpecialReport:AWritedownWriteup(May13,2008),atp.4[EYLE
LBHIKEYPERS 2818439]. The pricing spreadsheet for these assets states that the price was [t]ested
usingMerrillLynchpriceforperformingprimeloansmarkedbackto93.Lehman,New053008WL
Testing.xls, tab WL Testing Summary [LBEXBARFID 0006698]. However, the Examiners
investigation has produced evidence, in the form of an email from Joseph Sapia, a Lehman Vice
PresidentintheSecuritizedProductsValuationandControlGroup,thatthesourcereferredtoisactually
a May 13, 2008 Morgan Stanley research report. See email from Joseph Sapia, Lehman, to Nicholas
McClay,Lehman(June14,2008)[EYLELBHIKEYPERS4651500].Itisunclearwhatthemarkedback
to93noterefersto.ThemarkusedbytheProductControlGroupwas89.Lehman,New053008WL
Testing.xls,tabWLTestingSummary[LBEXBARFID0006698].
1853Id.
510

averagepriceidentifiedbytheMorganStanleyresearchreportforAltAloans.1854These
categories together represented approximately $2 billion of Lehmans U.S. RWL
portfolio. While the Examiner has identified several significant issues with the use of
theMorganStanleyreportforMay2008pricetesting,itwasoneofthefewsourcesof
information available to Lehmans product controllers in May 2008 and the mark
identifiedthereinwasnotunreasonable,asdiscussedbelow.
The Examineridentified thefollowingissueswith theProduct Control Groups
use of the Morgan Stanley research report as part of the May 2008 price verification
process.First,andmostsignificantly,theMorganStanleyreportofferedanaverageof
thefirstquarter2008marksforAltARWLs.ItappearsthatLehmansimplytookthis
surveyoffirstquarterpricesandappliedittovalue$2billionofitsU.S.RWLportfolio
in the second quarter, without any confirmation that the first quarter mark remained
valid.Giventherapidlychangingmarketconditionsofthisperiod,athreemonthold
pricewouldbeoflimitedrelevanceindeterminingthepresentvalueofRWLassets.1855
Second,theMorganStanleyreportprovidesanaveragemarkforAltAloans,
a broader category than the specific loans Lehmans Product Control Group priced
using the report. The Morgan Stanley report is unclear as to which of the specific
1854Id.
1855It is possible that some first quarter numbers collected by Morgan Stanley would be for the period
endedMarch2008.WhileLehmanandmostinvestmentbanksendtheirfirstquarterinFebruary,some
banksendtheirfirstquarterinMarch.However,eventwomonthsisanundulylongperiodoftimeto
assumepricestability.
511

categories of loans, as defined by Lehman, its average price is based upon, making it
something of a blunt instrument to use for the pricing of more narrowly defined
categoriesofRWLs.Third,theMorganStanleymarkused,89,isactuallytheweighted
average of the marks given to U.S. and European AltA RWL assets. The Morgan
StanleymarkforU.S.assetswas86.Evenifthereportwasotherwisereliable,Lehmans
ProductControlGroupshouldhaveusedtheU.S.mark,86,nottheweightedaverage,
89,forpricingLehmansU.S.RWLassets.1856
DespitetheproblemswiththemannerinwhichtheProductControlGroupused
theMorganStanleyreport,thegrouphadveryfewoptionsforpricetestingU.S.RWL
assetsin2008.TheMorganStanleyreportprovidedasurveyofsalesprices,compiled
and reported by a credible source. Furthermore, given the wide uncertainty in the
valuation of this asset class in May of 2008, and the fact that the limited trade data
Lehman possessed revealed marks between 86 and 96, the mark Lehmans Product
ControlGroupused,89,wasnotunreasonable.
It should be noted, however, that two of the three trades the Product Control
Group used to conduct price testing in conjunction with the Morgan Stanley report
were cancelled and never closed. Lehmans Prime Hybrid ARMs category, valued at
$1.2 billion by the trading desk, was price tested using a combination of the Morgan
1856WhenaskedaboutLehmansuseofinternationaldata,JosephSapiahadnoexplanationforwhythe
weightedaveragewasusedandacknowledgedthatthiswassimplyamistake.ExaminersInterviewof
JosephSapia,Oct.26,2009,atpp.34.
512

Stanleyreportandasaleof$37millionofassetstoChevyChaseBankatapriceof96.1857
ThissaletoChevyChaseneversettledandwascancelledonAugust5,2008.1858
Similarly,LehmansPrimeFixedcategoryofRWLs,valuedat$456million,was
pricetestedusingboththeMorganStanleyreportandasaleof$87millionofassetsto
VerticalMortgageatapriceof86.1859ThetradetoVerticalMortgagealsoneversettled
and was cancelled on July 1, 2008.1860 As with the cancelled trades discussed above,
however,therewasnowayforLehmansproductcontrollerstoknowinMay2008that
thesetradeswouldbecancelled.Thus,theirdecisiontorelyonthesetradesfortesting
wasreasonableatthetime.
The pricing of the final category, High LTV loans, was based on a sale of $56
million of assets to Fannie Mae, at a price of 95, a trade that did actually settle.1861
Accordingly,thepricetestingofthiscategorywasbasedonamorereliablesource.
The nine categories of Lehmans nonperforming U.S. RWL assets, valued at
roughly$829million,werepriceverifiedinMay2008usingthesameRLTsecuritization
discussed earlier.1862 The loans underlying the RLT securitization are sufficiently
comparabletoLehmansnonperformingloanstousetheRLTsecuritizationpriceasa
1857Lehman,New053008WLTesting.xls,attabWLTestingSummary[LBEXBARFID0006698].
1862Id.
513

pricecheckforLehmansnonperformingU.S.RWLassets.Accordingly,theExaminer
findsthevaluationoftheseassetstohavebeenreasonable.
Overall,thevaluationsreachedbyLehmansProductControlGroupinMay2008
were fairly close to the marks applied by the desk. Taken together, there was a net
variance of $123 million between Lehmans desk prices for its U.S. RWL assets as of
May31,2008andthevaluescalculatedbytheProductControlGroup,about3%ofthe
totalvalueoftheU.S.RWLportfolioreportedbyLehmanatthistime.1863Inthecourse
of resolving variances there was a net reduction of $78 million in the desk prices of
LehmansU.S.RWLassets,demonstratingthattheProductControlGroupwasableto
influencethedeskinthevaluationofRWLsatthistime.1864
E&YconductedareviewofLehmansProductControlprocessesforpricetesting
ofU.S.RWLsinthesecondquarterof2008.1865Inthecourseofthisreview,E&Ynoted
Lehmans decision to switch to a price verification model based on recent sale prices
ratherthanmocksecuritizationandfoundthisdecisiontobeconsistentwiththelackof
1864Id.The$78millionreductionistheaggregateadjustmenttakenonallwholeloansinthetestingfile,
includingthenonresidentialwholeloancategoriesSBFandCapitalCrossingthatarenotincludedinthis
analysis.However,thedeskandProductControlpricesforthesetwocategoriesareveryclose,andfor
thelargerSBFcategorytheProductControlpriceisactuallyhigherthanthedeskprice.Therefore,the
Examinerconcludesthatthatthe$78millionreductionwasrelatedprimarilytoRWLsaddressedbythis
Report.
1865E&Y Walkthrough Template, Residential Whole Loans (Nov. 30, 2008), at p. 1 [EYSECLBHIMC
GAMX08072875].TheE&YdocumentisdatedNovember30,2008,butdiscussessecondquarter2008
pricetesting.
514

securitization activity in the second quarter of 2008.1866 However, the scope of E&Ys
reviewwaslimited.E&YdidnotconductanindependentvaluationofU.S.RWLassets
toverifythemarksreportedbyLehman.Rather,itsreviewwasqualitativeinnature,
focusingonwhetherLehmansProductControlprocedureswereadequateasdesigned,
whether Lehman followed its own procedures and whether there was a risk of
management override of controls.1867 Thus, E&Ys report approves of Lehmans
decisiontouseamethodologybasedoncomparisontorecentsalesdatatovalueitsU.S.
RWLassets;itdoesnotaddressthespecificvaluationsreachedbyLehman.
(b) LehmansAugust2008PriceTesting
The Examiners investigation has revealed similar problems with Lehmans
August 2008 price verification process for U.S. RWLs, but also finds that there is not
sufficient evidence to support a finding that the U.S. RWL values determined for
Augustof2008wereunreasonable.Asnotedabove,Lehmanwrotedownthevalueof
itsU.S.RWLportfoliobyapproximately$750millionduringthesecondquarterof2008
and by $840 million during the third quarter of 2008.1868 The Examiner reviewed the
August 2008 price testing records related to all U.S. RWL performing and non
performingcategories.AsinMay,recentsaleswereusedtovaluemanyofLehmans
1866Id.atp.4.
1867Id.atp.16.
1868Lehman,Q2 08 High Level Mortgage Roll Forward(v2) [LBEXBARFID 0011863]; Lehman, Q3

ResidentialTemplatew_Elq(v83).xls[LBEXBARFID0011867].
515

U.S.RWLpositionsinAugustof2008.1869AlsoasinMay,thedatatheProductControl
Group relied upon for third quarter price verification was somewhat thin for the
purposeoftestingtheentiretyofLehmansU.S.RWLportfolio.
For its August 2008 U.S. RWL price verification process, Lehman Product
Control used the average of four Prime Whole Loan sales to test five categories of
performingU.S.RWLsHighLTV,HomeExpress,NegAm,PrimeFixedandPrime
HybridARMs.1870However,threeoutofthefourbenchmarktradeswerelatercancelled
and never closed, and one of the trades was never entered into Lehmans trading
system.1871
Lehmans product controllers reliance in August 2008 on trades that were
ultimately cancelled is more problematic in third quarter price testing than in second
quarter testing. By August of 2008, the product controllers would have been able to
discover that most of the trades they relied upon in performing their second quarter
price testing were cancelled. Furthermore, most of the trades used for third quarter
pricetestingwerecancelledbeforetheendofthatquarter.Ofthefourtradesaveraged
1869Lehman,PricingPackageAug08.xls(Aug.2008)[LBEXBARFID0006669].
1870SeeLehman,PricingPackageAug08.xls(Aug.2008)[LBEXBARFID0006669];Lehman,WholeLoan
Sales Q3.xls [LBEXBARFID 0006667]. The four trades averaged were RWPO 20081, Bayview Fund
Acquisitions20083,Fortress20081andPennymac20081.
1871TheFortress20081tradedoesnotappearinLehmanstransactiondatabases.TheRWPO20081and
Pennymac20081tradesappearascancelled.SeeAPBTradeDatabaseReport[LBEXBARAPB0049422].
516

to provide a mark for the five categories of U.S. RWLs, three were cancelled between
August27,2008andAugust29,2008.1872
Use of canceled trades in performing price testing conducted after the
cancellation dates would have been unreasonable. However, despite this
methodologicalproblem,themarkappliedtothesefivecategories,66.31,isultimately
reasonablegiventhefactthattheonetradethatdidactuallyclosehadapriceof66.0.1873
TheExaminerobservedthatLehmansproductcontrollersemployedadifferent
methodologyinpricetestingthreeotherperformingU.S.RWLcategoriesintheirthird
quarter2008priceverificationprocess.ThetestpricesfortheScratch&Dent,Subprime
andSubprimeSecondsassetcategorieswerenotcalculatedinthesamewayasthosefor
theotherperformingloancategories.LehmanhaddataonthreesalesofScratch&Dent
RWL pools during or proximate in time to the third quarter of 2008.1874 However,
instead of taking the average of these prices, as was done with other categories of
performingloansduringtheAugust2008priceverificationprocess,LehmansProduct
Control Group used 50.25, the highest mark among the three sales, to value these
categoriesofRWLs.1875Inaddition,thesingletradeusedbytheProductControlGroup
to provide the mark for these RWLs was not the largest trade; another trade existed,
1872Id.
1873This was the Bayview Fund Acquisitions 20083. Lehman, Pricing Package Aug 08.xls (Aug. 2008)
[LBEXBARFID0006669];Lehman,WholeLoanSalesQ3.xls[LBEXBARFID0006667].
1874Lehman,WholeLoanSalesQ3.xls[LBEXBARFID0006667].
1875ThismarkwasbasedonthesaleofaFasthold20081wholeloanpool.Lehman,PricingPackageAug
08.xls(Aug.2008),tabWholeLoans[LBEXBARFID0006669].
517

involving three times the value of RWLs, at a mark of 30.55, 40% less than the mark
usedbytheproductcontrollers.1876TheweightedaveragemarkofthethreeScratch&
DentRWLsaleswas37.4.However,thesethreecategoriesofperformingloans,andan
additional nine categories of nonperforming loans,1877 together representing a $1.2
billionvalueasdeterminedbythetradingdesk,werepricetestedusingthe50.25mark.
Had the Product Control Group used the average of the three marks, as it did
with other asset categories, the third quarter value of these assets would have been
approximately$890million($1.2billion*37.4/50.25),orapproximately$310millionless
than the value calculated by the product controllers in August of 2008. When asked
aboutthisinconsistency,JosephSapiacouldnotrecallwhythehighestpricewasused
insteadoftheaverage.1878Hespeculatedthatitmayhavehadsomethingtodowiththe
underlyingcollateral,butcouldnotbecertain.1879
The decision by the Product Control Group not to use an average of the prices
available is also problematic because the single trade relied upon was cancelled on
August8,2008,wellbeforetheendofthethirdquarter.1880Whilethemethodologyused
topricethesecategoriesofRWLsraisesseriousissues,bothbecauseofthefailuretouse
the average price reflected by the trade data and because the single trade used was
1876ThiswasatradeofArchbay20082.Lehman,WholeLoanSalesQ3.xls[LBEXBARFID0006667].
1877Inadditiontotheissuesdiscussedabove,theuseofthissaleofapoolofperformingloanstovalue
nonperformingloansisalsomethodologicallyquestionable.
1879Id.
518

cancelled well before quarter end, the U.S. RWL values arrived at do not themselves
appearunreasonable.Thereasonablenessofthisvaluationisdiscussedinthefollowing
Section.
Despite the issues identified above, the Examiner concludes that the U.S. RWL
values determined by Lehman in August 2008 were not unreasonable. The marks
calculatedbytheProductControlGrouppresentedavariancewiththepricesnotedby
the trading desk of only approximately $28 million, or 1.0% of the total value of
Lehmans U.S. RWL portfolio at the time.1881 As noted, Lehman took approximately
$750millioninwritedownsonitsU.S.RWLportfolioduringthesecondquarterof2008
and an $840 million writedown during the third quarter of 2008,1882 demonstrating a
responsivenesstochangingmarketconditions.AsinMay,theproductcontrollershad
verylittleinformationtorelyuponinpricetestingU.S.RWLassetsandhadnooption
but to use information that would have been unreliable, due to its nature and limited
scope,inidealmarketconditions.Moreover,inAugust2008,themarketforRWLswas
anythingbutidealandLehmansproductcontrollerswereforcedtomakedowiththe
information available. The marks they determined for price testing were not
unreasonableunderthecircumstances.
1881Lehman,PricingPackageAug08.xls(Aug.2008),tabWholeLoans[LBEXBARFID0006669].
1882Lehman,Q2 08 High Level Mortgage Roll Forward(v2) [LBEXBARFID 0011863]; Lehman, Q3

ResidentialTemplatew_Elq(v83).xls[LBEXBARFID0011867].
519

(4) ExaminersIndependentValuationofLehmansResidential
WholeLoansPortfolio
BecauseofthelimitedsalesdataavailabletoLehmantopriceitsU.S.RWLassets
in the second and third quarters of 2008, this asset class was at some risk of
misstatement.Inordertofurtherassessthereasonablenessofthevaluesdeterminedby
Lehman, the Examiner requested that an independent estimate of the value of these
assetsbeperformed.Thisvaluation doesnot representtheExaminersopinionof the
truevalueoftheseassetsinMayorAugust2008,butissimplyanalternatemethodto
estimatepricesoftheseassets,providingcontextinwhichtoassessthereasonableness
ofLehmansvaluations.Foreachoffourmajorloantypes,PrimeHybridARM,Prime
Fixed, Subprime and AltA, two representative securitized deals among Lehmans
recent securitizations were chosen. The deals chosen are representative of Lehmans
U.S.RWLassetsinMay2008asawhole.
Therepresentativedealsidentifiedwere:
LoanType RepresentativeDeals
PrimeHybrid
SARM200802,SARM200709
ARMs
PrimeFixed LMT200603,LMT200604
Subprime SASCO2007BC4,SASCO2007BNC1
LehmanXSTrust0710H,LehmanXSTrust2007
AltA
17H
The Examiner chose these bonds by either looking at the Securitization Shelf
NameusedbyLehmansProductControlGroupforeachcategoryofWholeLoansfor
520

purposes of mock securitization,1883 or by finding a recent vintage deal originated by
Lehmanwithsimilarunderlyingcollateral,ifavailable.
ThepriceofallthenotesintheselecteddealswasthenestimatedusingIntex,a
data source provider capable of performing calculations based on userdefined
inputs.1884Forinputs,themodelreliedonestimatesastodefaultrate,lossseverityand
prepayment rate of the underlying assets, as well as the discount yield demanded by
investors. These inputs were based only on information that would have been
availabletoLehmansproductcontrollersinMayandAugust2008.Thevalueofallof
LehmansU.S.RWLassetsasofMayandAugust2008wasthenestimatedbyusingthe
weightedaverageoftheestimatednoteprices,withweightstakenastheproportionof
thedifferentnotesinthecapitalstructureofthesecuritization.
However, the assumptions required by the analysis were made more uncertain
bythedistressedmarketconditionsof2008.Whileitcouldbeassumedthatthedefault
rate, loss severity and prepayment rate of the underlying loans would be the same
whetherinanunsecuritizedRWLorinanRMBStransaction,1885theyielddemandedby
investors for RWLs would be higher for several reasons. There are fewer potential
buyers of whole loan pools than for RMBS since the latter has credit ratings, CUSIP
identifiers andpubliclyavailabledatafromsourcessuchasIntex.Thisavailabledata
1883E&YWalkthroughTemplate,ResidentialWholeLoans,atp.6[EYLELBHIMCGAMX08072872].
1884SeeAppendix16,ValuationResidentialWholeLoans.
1885Theseinputs,whichareusedinpricingbothRMBSandRWLs,arecharacteristicsoftheunderlying
mortgageloansand,bydefinition,areunaffectedbytheirpresenceinasecuritization.
521

provides investors significantly more information than is typically available for RWL
pools. Primarily for these reasons, RWLs are less liquid than RMBS and an investor
wouldnormallydemandahigheryieldforRWLsthanforthecorrespondingRMBS.1886
However,reliableexpectedmarketyieldsforRWLswerenotavailableasofmidtolate
2008.Therefore,theExaminerusedRMBSyieldstotestRWLassets.TheRMBSyields
used were the same ones used to test Lehmans RMBS securities, as discussed in the
following Section. It is worth noting that because the Examiners model uses RMBS
yields, the resulting values effectively establish an upper limit of value based on the
notion that an investor would normally require a higher yield for RWLs than for
correspondingRMBSsecurities.
Using this approach, the Examiner estimated values for the U.S. RWL assets
testedthatwereclosetoLehmansvalues.HavingreviewedallofLehmansU.S.RWL
assets, comprising $4.4 billion of Lehmans reported $8.3 billion in worldwide RWL
assets as of May 31, 2008, the Examiners estimated prices result in a valuation $375
millionbelowthatofLehman.1887
In contrast, the Examiners analysis suggests that the third quarter value of
LehmansU.S.RWLassetsasdeterminedbythetradingdesk,$2.8billionof$6.3billion
worldwide,mayhavebeenunderstated.ApplyingthesameanalysistoLehmansthird
1886SeeYakovAmihudetal., LiquidityandAssetPrices, 1 Found.andTrendsinFin.269,269364(2005)
(providingadetailedstudyontherelationshipbetweenliquidityandassetprices).
1887SeeAppendix16,ValuationResidentialWholeLoans.
522

quarter U.S. RWL assets, and using August 31, 2008 RMBS yields demanded, the
Examiner estimates an understatement of the value of Lehmans U.S. RWL assets of
$276million.1888
BecausetheanalysisoperatesbyestimatingtheaveragepriceofallRMBSbonds
inasecuritizationtodeterminethevalueoftheRWLsunderlyingthesecuritization,the
accuracy of the Examiners valuation can be gauged by looking to sales prices of
securitiesfromtheverysecuritizationsitusedforpricetestingRWLs.Therewerefew
trades of RMBS in 2008, but the Examiner identified a few trades of RMBS from the
representative securitizations he used to provide estimated prices for Lehmans U.S.
RWLportfolio.Thetradedataidentifieddoesnotprovidepricesforeverytrancheof
any one securitization, as would be required to directly estimate the prices of the
underlying RWLs. However, the data can be used to check the accuracy of the
Examinersestimatedpricesforindividualtranchesthatwerecalculatedasaninterim
step in providing a model price for RWLs. The table below provides sales prices for
those tranches for which sales were identified, along with the Examiners model
price.1889
1888Id.
1889ABPTradeDatabase[LBEXBARAPB0049422].
523

Examiners Transaction Buy/

Deal Tranche Date ThirdParty
ModelPrice Price Sell
SARM A1 87.4 100 Sell 5/30/08 FHLBSeattle
20082
(Prime)
A2 87.8 88.9 Sell 5/30/08 Mutualof
Omahaand
UnitedofOmaha
Ins.
SARM 2A1 87.3 60.25 Buy 6/24/08 SmithBreeden
20079 Assoc.
(Prime)
60 Sell 6/25/08 SmithBreeden
Assoc.
SASCO A3 82.3 93.25 Buy 4/9/08 MorganStanley
2007BC4 &Co.
(Subprime) 93.75 Sell 4/9/08 MerrillLynch
93.625 Sell 4/9/08 MerrillLynch
94 Sell 5/28/08 R3Capital
Management
M1 31.8 29 Sell 6/30/08 HarbertFund
Advisors
M2 24.6 14.5 Sell 6/30/08 HarbertFund
Advisors
As the table shows, the trades indicate prices both higher and lower than the
Examinersmodelprices.Forexample,onJune30,2008,therewasasaleoftheM1and
M2classesoftheSASCO2007BC4subprimesecuritizationtoHarbertFundAdvisorsat
prices of 29 and 14.5, respectively. The prices calculated by the Examiner for these
tranches were 31.8 and 24.6, respectively, suggesting that the Examiners prices may
havebeenoverstated.InthePrimeHybridARMscategory,thereweretrades,bothbuy
andsell,ofthe2A1classoftheSARM20079securitizationbetweenLehmanandSmith
524

BreedenAssociatesonJune24and25,2008.Thesetradeswereexpectedatpricesof60
and 60.25. The Examiners mark for this tranche was 87.3, again suggesting that the
Examinerscalculationsmayhavebeenoverstated.
Other trades suggest that the Examiners model prices may have been
understated. For example, some of the A1 class of the SARM 20082 prime
securitization was sold at a price of 100 on May 30, 2008, which compares to the
Examiners price of 87.4. Similarly, some of the A3 tranche of the SASCO 2007BC4
subprime securitization was sold on May 30, 2008, at a price of 94 to R3 Capital
Management,whichexceedstheExaminersmodelpriceof82.3.
Insummary,whilethetraderesultsgenerallysupporttheExaminersestimated
marks, the results also support the notion that estimating prices for these assets was
difficult,andtherewaslikelyawiderangeofreasonablenessaroundthevalueofthese
assets in May and August 2008. Importantly, the fact that the Examiners model
provides a total value of Lehmans U.S. RWL portfolio less than that reported by
Lehman in May 2008 but greater than that determined by Lehman in August 2008
indicatesthatLehmansvaluationswerenotuniformlyaggressive.
ReasonablenessofLehmansValuationofItsResidential
WholeLoansPortfolio
Asnoted,LehmanstoppedusingitsownmocksecuritizationmodelinMay2008
because of the declining rate of mortgage securitizations occurring at approximately
525

thistime.1890Forthereasonsdescribedabove,thisdecisionandtheswitchtoamethod
based on comparison to recent sales prices were reasonable. The sales data that
Lehman used to price test its U.S. RWL assets in May and August 2008 was thin;
however, Lehmans Product Control Group had few options available for price
verificationatthistime.Eventhoughseveralofthetradesusedforpriceverificationin
May2008werelatercancelled,Lehmansproductcontrollershadnowaytoknowthis
atthetimetheyundertookthepriceverificationprocess.WhiletheAugust2008price
testingprocesspresentsmoreseriousissues,theultimatevaluationsdeterminedforthe
third quarter of 2008 by both the Product Control Group and the trading desk were
within the range of reasonableness, and, when compared to the Examiners model
pricesdescribedabove,appearunderstated.
The Examiner has identified evident errors and questionable judgments by the
ProductControlGroupinconnectionwithitspricetestingprocessforU.S.RWLsinthe
secondandthirdquartersof2008.However,evaluatedinthelightoftheinformation
availableinMayandAugust2008,theExaminerconcludesthattherearenotsufficient
factstosupportafindingthatLehmansvaluationsofitsU.S.RWLassetsasreportedin
its financial statement for the period ending May 31, 2008, and as determined by its
tradingdeskandProductControlGroupasofAugust31,2008,wereunreasonable.
1890SeeLehman,ValuationReview2ndquarter2008(July2008),atpp.810[LBHI_SEC07940_750105].
526

h) ExaminersAnalysisoftheValuationofLehmansRMBSPortfolio
In reporting the value of its residential mortgagerelated assets, Lehman
distinguished between RWLs and the RMBS formed by securitization.1891 While the
valuationofRWLsduring2008wasdifficultinlightoftheissuesdescribedabove,the
valuation of RMBS was more straightforward. Throughout 2008, there was a greater
degreeofpricetransparencyforLehmansRMBSassetsthanexistedforitsRWLassets.
Consistent with this observation, the Examiner has not identified problems with
LehmanspricetestingofRMBSduringthisperiodlikethosewhichexistedforRWLs.
HavinginvestigatedthevaluationofLehmansRMBSportfolioduringthesecondand
third quarters of 2008, the Examiner concludes that there is insufficient evidence to
supportafindingthatthevaluationoftheseassetswasunreasonable.
As described above, RMBS are a form of bond backed by loans to residential
property owners. To create RMBS, the sponsor of an RMBS transaction, often an
investmentbanksuchasLehman,willsetupaSPE,identifyagroupofRWLsandsell
the RWLs owned by the bank to the SPE. The SPE, in turn, receives its funds for the
purchase of the RWLs from the investors purchases of the RMBS. These RWLs
producethecashflowtopayinterestandprincipalundertheRMBSissuedbytheSPE.
RMBS are generally formed as tranches with claims on the interest and principal
payments of varying seniority; thus, investors holding securities from senior tranches
1891LBHI10Q(filedJuly10,2008),atpp.6970.
527

arerepaidbeforethoseholdingthejuniortranches.Inthismanner,theseniortranches
are designed to be the least risky while junior tranches carry the most risk. To
compensate for the higher level of risk borne by the junior tranches, these securities
offerhighercouponpaymentsand/orlowerprices.
Asnoted,thepaceofsecuritizationofRWLsintoRMBSslowedsignificantly in
2008.1892 However, throughout 2008, Lehman still held many RMBS previously
securitizedbyitselfandotherinvestmentbanks.Lehmanheld$18.2billioninRMBSon
February29,2008,$12.4billionofwhichconsistedofU.S.RMBS.1893OnMay31,2008,
LehmansRMBSportfoliohaddeclinedto$14.4billion,$8.5billionofwhichconsisted
ofU.S.RMBS.1894ByAugust31,2008,thevalueofLehmansRMBSportfoliohadfurther
declinedtoapproximately$8.3billion,$4.1billionofwhichconsistedofU.S.RMBS.1895
These values represent Lehmans entire portfolio of nonCDO securities related to
1892ExaminersInterviewofJosephSapia,Oct.26,2009,atp.2;SecuritiesIndustryandFinancialMarkets
Association, MortgageRelated Issuance (1996 June 2009), available at http://www.sifma.org/research/

pdf/Mortgage_Related_Issuance.pdf (last visited Feb. 3, 2010) (showing issuance of nonagency
mortgagebackedsecuritiesfellfromapproximately$774billionin2007to$41billionin2008);LuoJun,
CreditCrisisWillExtendInto2009,OppenheimerSays(Update1),Bloomberg.com,May20,2008,availableat
http://www.bloomberg.com/apps/news?pid=20601087&sid=aAMUjyxli6Lc (last visited Feb. 3, 2010)
(notingtheshutdowninthesecuritizationmarket).
1893LBHI 10Q (filed July 10, 2008) at pp. 6970. As with other asset classes, information regarding the
valuation and price testing of European and Asian RMBS assets is not available. Accordingly, the
Examiner draws no conclusions regarding the reasonableness of the marks applied to these assets by
Lehmanin2008.
1894Id.
1895Lehman,Q3ResidentialTemplatew_Elq(v83).xls,tabQ3TradeData[LBEXBARFID0011867].
528

residential mortgage loans, as reported in its quarterly Form 10Q statements and
reflectedinitsthirdquarterProductControlpricetestingspreadsheets.1896
Thus, during the second quarter of 2008, the value of Lehmans U.S. RMBS
portfoliofellbyapproximately$3.9billionduetoamixofwritedownsandsales.Of
this decline, approximately $1.0 billion was due to writedowns.1897 Similarly, during
the third quarter of 2008, the value of Lehmans U.S. RMBS portfolio fell by
approximately$4.4billion,ofwhich$2.3billionwasduetowritedowns.1898Thewrite
downs Lehman took on these assets throughout the year reflect its recognition of the
changedmarketconditionsof2008andanacknowledgmentofthediminishingvalueof
itsU.S.RMBSassets.
As with RWLs, the asset values Lehman reported on its balance sheet for its
RMBSportfoliowerethosereportedbyitstradingdesks.1899Thesemarksweresubject
torevisionpursuanttothepricetestingprocessdescribedbelow.1900UnlikewithRWLs,
the pricing of which was done manually, the pricing of RMBS was an automated
1896Lehman did not file a quarterly report for the third quarter of 2008 before filing for bankruptcy.
Accordingly,information regarding this period is obtained from data compiled by the Product Control
groupforpricetestingpurposes.
1897Lehman,Q208HighLevelMortgageRollForward(v2).xls.pdf[LBEXBARFID0011863].
1898Lehman,Q3ResidentialTemplatew_Elq(v83).xls,tabQ3TradeData[LBEXBARFID0011867].
1899ExaminersInterviewofUsmanBabar,Oct.16,2009,atpp.34.
1900Lehman, Price Verification Policy Global Capital Markets 2008 [Draft], at p. 4

[LBHI_SEC07940_2965994].
529

process, meaning that the prices provided by the trading desks were standardized
acrossdesks.1901
Aswithanyasset,thepreferredstrategyforperformingvaluationofRMBSisto
look to recent trade prices to determine the market value. If recent trade data is not
available, models are used to price RMBS; most models function in a similar manner.
ThoughdifferentRMBSbondsvaryconsiderablyinlevelofriskandremainingaverage
life, the common structure of RMBS allows for a relatively standardized valuation
process.ThekeyfeatureofRMBSforvaluationpurposesisthetranchestructureand
the associated cash flow waterfall. Once this information, which is available from
vendors,isobtained,theonlyremainingstepisforthepricetestertoapplyassumptions
regardingtheunderlyingRWLcollateral.Theseassumptionsinclude:(i)theexpected
defaultrate,(ii)lossseverityexpectations,and(iii)expectedratesofprepayment.These
inputs, along with information about the tranche structure of the RMBS, provide
estimatesofthecashflowproducedbytheRMBS.Afterthesecashflowsarecalculated,
the party performing valuation need only take into account the yield demanded by
investorsinthemarkettodeterminethepriceatwhichtheRMBScouldbesold.
AnalystsreachdifferentconclusionsregardingthevalueofagivenRMBSbond
only if they apply different assumptions regarding these variables. Accordingly, the
majorissueinpricetestingRMBSistheselectionofproperassumptionstouseasinputs
530

in the price testing process. In price testing RMBS, Lehmans Product Control Group
confirmedthereasonablenessoftheassumptionsappliedbythetradingdesks.1902
The primary model used by Lehman to value RMBS in 2008 was the Intex
waterfall engine, the same model used for the mock securitization model described
above.Intexisasoftwaretool,publiclyavailableforasubscriptionfee,whichcanbe
used to analyze structured finance transactions. This tool incorporates underlying
collateralinformationandinformationregardingthetranchestructureofmanypublicly
traded RMBS, and projects the cash expected to flow to different tranches under
differentassumptionsappliedtotheRWLcollateral.Inperformingmocksecuritization
valuationofRWLassets,thevalueofallRMBSinasecuritizationisestimatedandthen,
by estimating the costs associated with securitization and profits expected by the
originator, the relationship of this value to the value of the underlying RWL can be
determined.BecausethevaluationofRMBSdoesnotrequirethisadditionalstep,and
becauseitdoesnotassumeafunctioningsecuritizationmarket,thisassetclasspresents
alesscomplicatedvaluationexercisethandoRWLs.
PricetestingforRMBScanalsobeperformedthroughcomparisontorecenttrade
data and thirdparty prices. Unlike RWLs, where each pool of loans is inevitably
uniqueevenwithinbroadcategories(e.g.,Prime,AltAandSubprime),bondsfromthe
sametrancheofthesameRMBSsecuritizationareidentical.Therefore,whenavailable,
1902Id.
531

the prices at which these bonds trade on the secondary market provide a readily
observableindicatorofthevalueofRMBS.Additionally,comparedtoRWLs,thereare
moreidentifiabletradesofRMBSprovidingpricinginformation.1903Accordingly,since
thesecondarymarketforRMBSismorerobustthanthemarketforRWLs,thepricingof
RMBSismorestraightforward,andagreaterdegreeofpricetransparencyexists,than
for RWLs. The stated policy of Lehmans Product Control Group was to price test
approximately60%ofLehmansPrimeandnonPrimeRMBSusingrecenttradeprices
orusingIntex.1904Theother40%ofRMBS,forwhichtherewasnotradeorIntexdata
available,weretobepricetestedbymeansofthirdpartyprices.1905
As with other asset classes, Lehman identified certain tolerances within which
variances between the desk prices and Product Control prices would be deemed
acceptable for RMBS.The acceptabletoleranceswere defined byatolerancematrix
thattookintoaccountwhetherthecollateralbackingtheRMBSwereagency,primeor
nonprime loans, and which of several tranche categories the bonds fell into.1906 The
1903Thisisadirectresultofthefactthatsecuritizationimprovesliquidity.SincethesecuritizationofRWL
pools into RMBS transactions enhances liquidity, it follows that the number of identifiable RWL trades
would be small in comparison to RMBS. See Peter J. Elmer, Conduits: Their Structure and Risk, F.D.I.C.
BankingRev.,Dec.1999,atpp.27,32.
1904Lehman, Price Verification Policy Global Capital Markets 2008 [Draft], at pp. 62, 64
[LBHI_SEC07940_2965994].
1905Id.
1906Id.atp.61.
532

categories of bonds included: Interest Only, Principal Only, Inverse, ZeroCoupon,
Subordinate,MezzanineandSupplemental.1907
ThepaceoftradingRMBSonthesecondarymarketalsoslowedconsiderablyin
2008.1908 This meant that it was difficult for Lehmans trading desks and Product
Control Group to gather the information necessary to price RMBS by means of recent
tradedata.Additionally,whiletherewerestillthirdpartysourcesprovidingpricesfor
RMBS,thesesourceswerenotasreadilyavailableorasreliableastheywouldbeina
normally functioning market. Lehmans Product Control Group did use thirdparty
sources in performing its price testing of RMBS in 2008, but it also relied heavily on
IntextomodelRMBScashflowstodeterminethevalueofthebonds.1909Additionally,
the Product Control Group simply noted the valuations of many RMBS bonds
mainlyfromtheIOandsubordinatetranchesasok,becausethetradingdeskshad
markedthemdownsosignificantlythattheirmarketvaluewasimmaterial.1910Among
RMBS bonds backed by subprime RWL collateral, the trading desks marked the
1907Id.
1909Lehman, 53008 PRICING.xls [LBEXBARFID 0002548]; Lehman, 082908 PRICING.xls [LBEX

BARFID0004120].
BARFID0004120].
533

majority down to prices less than 10% of their notional value, and in many cases to
pricesofjustafewcentsonthedollar.1911
OfLehmans80largestRMBSpositionsbyexposureamountonMay31,2008,54
were also held by Lehman on August 31, 2008.1912 Lehmans Product Control Group
price tested these positions using a variety of methods as summarized in the table
below.1913
May2008 Aug2008
May2008 Aug2008
ProductControlGroup positions positions
positions positions
TestingMethod tested tested
tested(#) tested(#)
($million) ($million)
Intex 41 44 768.5 650.5
Thirdpartyquote 8 4 71.6 21.8
Tradedata 2 0 154.4 0
Intex/Thirdpartyquotemix 1 0 49.5 0
Immaterial 1 2 0.2 1.0
Other 1 4 149.8 290.1
Total 54 54 1,194.0 963.4
Asthistableshows,theprimarymethodusedbytheProductControlGroupfor
price testing in May and August 2008 was the Intex model. Thirdparty quotes and
tradedatawerealsousedbuttoamuchlesserextent.

BARFID0004120].
1912ThisinformationwasobtainedfromLehmansGFSandGQuestsystems.
BARFID0004120]. The market valuesof the positions were obtained from the GFS system. The Other
methodsincludedusingaveragepricesfromothersecurities,wasusingamethodcalled1xmultiple,
andtwomarksinAugustwereassignedavalueof0withanotetofollowupwiththetradedesk.
534

In order to further assess the reasonableness of the values determined by
Lehman,theExaminerperformedavaluationofasampleofLehmansRMBSpositions.
This valuation does not represent the Examiners opinion of the value of these assets
duringMayandAugust2008,butratherisintendedonlytoprovidecontextinwhichto
evaluate the reasonableness of Lehmans valuations of its RMBS portfolio. The
Examiner valued each of the 54 positions noted above, those of the 80 largest RMBS
positionsthatLehmanheldonbothMay31,2008andAugust31,2008,usingtheIntex
model. As previously noted, in determining inputs for the Intex model the reported
historical rates of prepayment, default and loss severity serve as a starting point. In
ordertocalculatethepresentvalueofRMBS,ausermustmakeassumptionsregarding
futureprepaymentrates,defaultratesandlossseverity.FortheExaminersvaluation,
these assumptions were determined by considering the observed performance of
residentialmortgagesinMayandAugust2008asreportedbyindustryresearchatthe
time.1914Usingtheactualratesandlossseverityasabasis,theExaminerestimatedwhat
rates and loss severity market participants would have expected going forward from
May and August 2008. The Examiner also estimated the yield that investors would
haverequiredforRMBSbonds.
The followingtables present theinputsappliedbytheExaminerinvaluing the
54LehmanRMBSpositionsidentified.
1914SeeJ.P.Morgan,SOSSummaryofSubprime,AltA,PrimeJumbo(May22,2009),atpp.13.
535

TheExaminersAssumptionsforValuationasofMay2008
Product Prepayment Default LossSeverity Resulting Yield

Type Rate Rate (1st/2ndLien) Losses
Prime 15% 5% 50%/100% Highsingle 10%
digits
AltA 10% 10% 50%/100% Highteens 15%
Low20s
Subprime 5% 15% 50%/100% Mid30s 20%
TheExaminersAssumptionsforValuationasofAugust2008
Product Prepayment Default LossSeverity Resulting Yield

Type Rate Rate (1st/2ndLien) Losses
Prime 15% 5% 50%/100% Highsingle 10%
digits
AltA 10% 10% 50%/100% Highteens 15%
Low20s
Subprime 4% 17% 50%/100% MidHigh30s 20%
Applying these assumptions to the 54 Lehman RMBS positions identified, and
usingIntextoperformavaluation,theExaminercalculatedatotalvalueforthesebonds
close to that determined by Lehman. The table below provides a comparison of the
valuationsfortheseassetsinMayandAugust2008.
LehmanTotal ExaminersEstimated
MarketValue($ TotalMarketValue($
billion) billion)
May2008 1.19 1.14
Aug2008 0.97 1.04
In aggregate, the Examiners estimated valuation was 4.1% lower than that of
LehmaninMay2008and7.1%higherthanthatofLehmaninAugust2008.However,
the range of results with respect to any particular RMBS was, in some cases,
536

significantly wider. For individual RMBS bonds, the Examiners estimated values in
May2008rangedfrom58%lessthanLehmansvalueatthelowextremeto129%more
atthehighextreme.InAugust2008,theExaminersvaluesrangedfrom80%lessatthe
lowextremeto70%moreatthehighextreme.However,thesedifferencesinvaluation
arenotinconsistentwithreasonabledifferencesinestimatesofprepaymentrate,default
rate, loss severity and yield. Furthermore, the fact that the Examiners valuations fall
both above and below those of Lehman suggests that Lehmans valuations were not
uniformly aggressive or uniformly conservative. Despite these wide ranges, because
the Examiners estimates were not consistently above or below the Lehman marks, in
aggregatethedifferencesinvaluationwerenotsignificant.
As described, RMBS do not present the same valuation challenges that arise in
attempting to value RWLs. Even without bondspecific trade data or thirdparty
pricinginformation,theIntexmodelprovidedareasonablemethodforestimatingthe
value of these assets in the unprecedented market conditions of 2008. Of course, the
model remains sensitive to the assumptions used as inputs, but industry reports
provide some guidance regarding conventional wisdom in the industry as to these
inputs throughout 2008. Although these assumptions may not have accurately
predicted ultimate residential mortgage loan performance, it would be reasonable for
one to have relied on themfor valuation purposesatthetime. Furthermore,Lehman
acknowledged the falling value of these assets throughout 2008, as reflected by the
537

writedown of $1.0 billion it took on its RMBS portfolio in the second quarter of 2008
and the $2.3 billion writedown it took in the third quarter of 2008. In light of the
foregoing, the Examiner has not found evidence sufficient to support a finding that
LehmansvaluationofitsRMBSportfolioin2008wasunreasonable.
i) ExaminersAnalysisoftheValuationofLehmansCDOs
Collateralized debt obligations (CDOs) are a form of assetbacked security
(ABS) backed by a portfolio of fixedincome securities such as RMBS, commercial
mortgagebacked securities (CMBS) or corporate bonds and loans.1915 CDOs backed
by RMBS are typically referred to as ABS CDOs, while CDOs backed by CMBS are
typically referred to as CRE CDOs. To create CDOs, an originator, often an
investmentbanksuchasLehman,willsetupaspecialpurposeentity(SPE),identifya
groupofdebtobligationssharingcertaincharacteristics,suchasdebtrating,andeither
transfer to the SPE conforming debt obligations owned by the bank or use investors
funds to purchase such obligations. Those debt obligations produce the cash flow to
payinterestandprincipalundertheCDOsissuedbytheSPE.CDOsaredividedinto
tranches and interest and principal payments are made in order of seniority; thus,
1915Broadlydefined,thetermCDOincludesCollateralizedLoanObligations(CLO)andCollateralized
BondObligations(CBO),whicharealsoconsideredinthisSection,butarenottreatedasdistinctasset
classes.Asageneralmatter,CLOsandCBOshavethesamebasicstructureasCDOs,thedifferencebeing
thatCLOsarebackedbycorporateloansandCBOsbycorporatebonds.ForthepurposesofthisSection,
the term CDO includes CLOs and CBOs unless otherwise noted. For financial reporting purposes,
LehmangroupedCDOswithotherassetbackedsecuritiesinacategoryittermedOtherAssetBacked.
Forvaluationpurposes,LehmantestedeachABSposition(includingCDOpositions)separately,butthe
overallmethodsweresimilaracrossABSclasses.
538

investors holding securities from senior tranches are repaid before those holding the
junior tranches. In this manner, the senior tranches are designed to be the least risky
andjuniortranchesaredesignedtocarrythemostrisk.Tocompensateforthehigher
levelofriskbornebythejuniortranches,thesesecuritiesofferhighercouponpayments
and/orlowerprices.
TheassetsunderlyingtheCDOsissuedbyLehmanwereprimarilyRMBS,CMBS
andotherassetbackedsecurities.1916Lehmanoriginated$16.2billionofCDOsinfiscal
year2006,$25.0billioninfiscalyear2007,and$17.0billioninfiscalyear2008.1917This
2008declineisgenerallyconsistentwith,butnotasdrasticas,thedeclineintheglobal
CDOmarket,asthefollowingchartindicates.1918
1916LehmanBrothersHoldingsInc.,053008PRICING.xls[LBEXBARFID0002548].
1917ThedataforthischartwascompiledbytheExaminersfinancialadviserfromcommerciallyavailable
sources.
1918Securities Industry and Financial Markets Association, Global CDO Market Issuance Data (fourth
quarter 2008), available at http://www.sifma.org/research/pdf/CDO_Data2008Q4.pdf (last visited Feb. 3,

2010).
539

Global CDO Issuances by Quarter 1Q04 - 4Q08

(US$million)
200,000
180,000
160,000
140,000
120,000
100,000
80,000
60,000
40,000
20,000
-
1Q04
2Q04
3Q04
4Q04
1Q05
2Q05
3Q05
4Q05
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08

NotwithstandingthebillionsofdollarsworthofCDOsthatLehmanoriginated,
from 2006 to 2007 Lehman accounted for only 3% of the total value of new CDO
issuances.1919LehmanidentifieditskeyoperatingtenetregardingCDOsasdistribute
notretain,meaningthatitwouldmovenotwarehouserisk,andminimizeitsown
CDOholdings.1920LehmanreportedholdingCDOswithavalueofapproximately$1.2
billion as of May 31, 2008, and $0.9 billion as of August 31, 2008.1921 Because the
positionsheld inLehmans CDO portfolio wereprimarily ABS/CRECDOs, backedby
1919Lehman,LehmanBrothersABSCDOExposure(Nov.1,2007),atpp.56[LBEXBARFID0011553].
1920Id.atp.5.
1921These figures represent the CDO positions identified by Lehmans Product Control group for price
verification purposes. See Lehman, 053008 PRICING.xls [LBEXBARFID 0002548]; Lehman, 082908
PRICING.xls[LBEXBARFID0004120].SomeLehmansecuritizations,suchasPine,SpruceandVerano,
would qualify as CDOs or CLOs, but are represented for balance sheet and valuation purposes by the
underlyingcollateral(mostlynoninvestmentgradebankloans)ratherthanbyCDO/CLOtranches.See
Lehman,LoansPxTesting_053108final.xls[LBEXBARVAL0061231].TheExaminerlocatedsupporting
documentation for the U.S. CDO balances noted, but estimates that another $400 million in NonU.S.
CDO assets are on Lehmans balance sheet based on a review of CUSIPs, though no supporting
documentshavebeenlocatedtosupportthisestimate.
540

RMBS and CMBS, they were subject to the disruptions in the credit markets and
deterioratingvalueofmortgagesandmortgagelinked securities thatoccurredin 2007
and2008.1922Asthemarketdeteriorated,Lehmanwasunabletosellsubordinatepieces
ofsecuritizations,andmanyofLehmansCDOpositionsweresuchpieces.1923However,
muchofLehmansCDOportfoliowasmadeupofseniortranchesofsecuritizationsthat
itcreatedin2007and2008andwasunabletosell.1924
Betweenthefirstandsecondquartersof2008,Lehmanwrotedownthevalueof
itsABS/CRE CDO portfolio by$168millionon agrossbasis($97millionnet),leaving
$834milliononthebalancesheetexcludinghedges. 1925Betweenthesecondandthird
quarters, Lehman further wrote down the value of its ABS/CRE CDO portfolio by
another $178 million gross ($99 million net) leaving $489 million on the balance sheet
1922Theterm position is used to refer to a pool of like securities from the same tranche of a
securitization.Additionally,thetermissometimesusedtorefertothemarketvalueofthepool.
1923Diane Hinton, S&P, Liquidity Management In Times Of Stress:How TheMajor U.S. BrokerDealers
Fare, Nov. 2007, S&P RatingsDirect, at pp. 23 [LBHI_SEC07940_439424] (Recent disruptions in the
subprime market and its contagion effects into the leveraged finance, assetbacked commercial paper
(ABCP), and CDO spaces have substantially curtailed market liquidity.); Timothy Geithner, FRBNY
President,TranscriptofRemarkstoTheEconomicClub,ReducingSystemicRiskInADynamicFinancial
System (June 9, 2008), http://www.newyorkfed.org/newsevents/speeches/2008/tfg080609.html (The
fundingandbalancesheetpressuresonbankswereintensifiedbytherapidbreakdownofsecuritization
andstructuredfinancemarkets.Bankslostthecapacitytomoveriskierassetsofftheirbalancesheets,at
the same time they had to fund, or to prepare to fund, a range of contingent commitments over an
uncertaintimehorizon.).
1924Over onethird of the total value of Lehmans May 2008 CDO portfolio was comprised of Ceago, a
2007 securitization that Lehman was unable to sell. See Lehman, 053008 PRICING.xls, tab ABS
Secondary,[LBEXBARFID0002548].
1925Lehman, Write downs, Key Exposures & Level 3 Assets 2Q 2008 (July 15, 2008), at p. 1
[LBHI_SEC07940_167791].NotethatthisnumberincludesbothU.S.andEuropeanassets.
541

excluding hedges.1926 These writedowns are generally consistent with what was
occurring in the market as ABS/CRE CDOs were experiencing increasing numbers of
events of default.1927 For example, of the $431 billion of ABS/CRE CDOs originated in
20062007, more than half had experienced events of default by November 2008, with
increasingnumbersofdefaultsovertime.1928
TheExaminersanalysisofthereasonablenessofLehmansvaluationofitsCDO
positions begins by describing Lehmans process for valuing CDO assets, with
particular attention to the price verification procedure of Lehmans Product Control
Group, and the E&Y review of that process. Next, Lehmans largest CDO position,
Ceago,isaddressed.WhilethesuperseniorCeagotranchewasappropriatelyvalued,
themostjunioroftheCeagosubordinatetranches,togetherarelativelysmallportionof
thewhole,werenotaccuratelyvalued.Inordertoprovidefurthercontextinwhichto
assess the reasonableness of Lehmans CDO valuations, a sample of Lehmans CDO
portfolio is valued by means of an alternate method, with particular attention paid to
the most junior Ceago subordinate tranches. While the Examiners investigation has
1926Lehman, Write downs, Key Exposures & Level 3 Assets Q3 FINAL (Sept. 11, 2008), at p. 6
[LBHI_SEC07940_828711].NotethatthisnumberincludesbothU.S.andEuropeanassets.
1927An event of default typically occurs in an ABS CDO due to ratings downgrades of the underlying
collateral.Whenaneventofdefaultoccurs,aCDOmayeitheraccelerateallcashpaymentstotheAAA
controllinginvestor,liquidatetheCDO,orremainindefaultwithcashflowsperthewaterfallpriority.In
all cases, the impact is a large reduction in cash flow and value for tranches beneath the most senior
tranche of the CDO. Additionally, the most senior tranche may not recover its par amount if the
collateralvalueshavefallensignificantly.
1928J.P.Morgan,USFixedIncomeMarkets2009Outlook,CollateralizedDebtObligations(Nov.28,2008),
atp.1.
542

produced evidence that Lehmans price verification process for CDOs was not
particularly robust, given the lack of information available and the condition of the
CDO market during second and third quarters of fiscal year 2008, the Examiner does
not find evidence to support a finding that Lehmans valuations of CDOs as of these
dateswereunreasonable.
(1) LehmansPriceTestingProcessforCDOs
TheassetvaluesLehmanreportedonitsbalancesheetforCDOswerethemarks
reported by its traders.1929 Each trader used his or her own method for pricing assets
and there was no uniformity across trading desks as to methodology.1930 In order to
provide a check on the marks reported by the traders for each position (commonly
referredtoasdeskmarks),LehmansValuationControlgroup,apartoftheProduct
Control Group, performed an independent price verification of CDO assets.1931 The
Product Control Group performed price verification procedures on a monthly basis,
and particular attention was paid to testing the marks at quarterend.1932 In doing so,
theProductControlGroupreliedonseveraldifferentmethodsforpricetestingCDOs.
The preferred method was to use executed trade activity to provide a basis for
1929ExaminersInterviewofUsmanBabar,Oct.16,2009,atpp.34.
1930ExaminersInterviewofBrianSciacca,Oct.19,2009,atpp.25.
1931Lehman, Valuation Review 2nd Quarter 2008, at p. 3 (July 2008) [LBHI_SEC07940_750107] (listing
ProductControlCoreFunctions).
1932Id.
543

valuation.1933Typically,pricesfromtradesthatoccurredfourtosixweekspriortothe
month end were considered reasonable to use for this purpose. However, if markets
weresovolatilethatthesetradeswouldbeconsideredstalebymonthend,tradescloser
to the valuation date were used to provide a more accurate basis for valuation.1934 If
there was no recent trade activity with which prices could be verified, the Product
Control Group looked to external prices obtained from thirdparty providers such as
Bloomberg,MarkitGroupLimited(Markit)andothersources.1935
Illiquid products for which recent trade activity or thirdparty prices are not
availableareclassifiedasLevel3assetspursuanttoSFAS157.1936Fortheseassets,the
ProductControlGroupperformedanindependentvaluationofthepositionsmarkby
usingamodel.ThegroupsPolicy&Proceduresdocumentidentifiestheprimarytool
used for this modeling as the Intex cash flow engine, a program widely used for
modeling CDO cash flows.1937 However, the Examiners interviews with product
controllersindicatedthatthosecontrollersresponsibleforpricetestingCDOsregarded
IntexasunreliableanddidnottypicallyuseittopriceCDOs.1938Instead,somepositions
were price tested by using interestonly models or by estimating the value of the
1933Lehman,CDOPriceVerificationPolicy&Procedure(Jan.242008),atp.3[LBHI_SEC07940_4228808].
1934Id.
1935Id.atpp.24.Additionally,whereLehmanhedgedapositionandthemarksonthetwopositionswere
thesame,theproductcontrollersconsideredthepricetobevalId.
1936SeeSFASNo.157,FairValueMeasurements,atSFAS1576.
1937Lehman,CDOPriceVerificationPolicy&Procedure(Jan.24,2008),atp.4[LBHI_SEC07940_4228808].
1938ExaminersInterviewofBrianSciacca,Oct.19,2009,atp.4.
544

underlying assets held by the SPE that issued the CDOs.1939 Product controllers used
various inputs, such as spreads based on collateral type, that were published by
JPMorgan, along with prepayment, default and recovery assumptions obtained from
other providers, to calculate the mark for each asset tested.1940 Additionally, the
LehmanLive CDO calculator, which received an Intex feed and a pricing feed to
determine the net asset value of a given tranche, was used in some cases. Finally,
interestonly analysis or pricing from ABX indices were used as last options to value
CDOs.1941
After Product Control determined its estimated mark for a CDO position, it
wouldcompareitsmarktothatofthedesk.Whereavarianceexceededtheapplicable
threshold, Product Control would discuss the variance with the appropriate trader.1942
Theproductcontrollerandthetraderwoulddiscusshoweachderivedtheirrespective
marksandwouldattempttoresolvethevariancebyagreeingoneitherthedeskmark
ortheProductControlmark.Inattemptingtoresolvethevariance,thepartieswould
considermarketconditions,thequalityofthevendorsfromwhompricinginformation
1939See Lehman, Ceago & Ballyrock Subs 53008.xls, at tab IO Analysis, [LBEXBARFID 0010998].
BecauseoftherelativelysmallsizeofLehmansCDOportfolio,theExaminerdidnotinvestigateeachof
themodelsused,butfocusedonthoseusedforthelargestpositionsheldbyLehman.
1940Lehman,CDOPriceVerificationPolicy&Procedure(Jan.2008),atp.4[LBHI_SEC07940_4228809].
1941Id.
1942TheapplicablevariancethresholdforCDOswas$400,000forSFAS157Level1and2securities,and
$300,000forSFAS157Level3securities.Id.
545

wasreceived,traderstrackrecordsandthesizeofthepositionandthevariance.1943If
theproductcontrollerandthetradercouldnotresolvethevariance,theissuewouldbe
escalated by Product Control to senior finance management, who would discuss the
variance with their counterparts on the trading desk.1944 Brian Sciacca, a former Vice
President and Head of the Credit Valuation group, stated in an interview that some
tradersweremoreopentodiscussingvarianceswithproductcontrollersthanothers.1945
Sciaccarecalledoneinstanceinwhichanissueregardingunresolvedvariancesforbank
loanmarkswasescalatedtoseniormanagement.Hedescribedtheoutcomeasarude
awakening for the trader and an education on the necessity of writedowns.1946
However, Sciacca also stated that no one trader stood out in his memory as being
particularlyrecalcitrantinconversationswithproductcontrollersaboutvariances.
At the conclusion of each monthly price verification process, assets for which
there were variances were either remarkedby the desk or the Product Control Group
determined that the desk price was reasonable. The Product Control Group then
preparedmonthlypriceverificationvariancereportssettingforththelargestvariances
by asset class andnotingwhetherthedesk remarkedtheasset. Ifa materialvariance
1943Lehman,CDOPriceVerificationPolicy&Procedure(Jan.24,2008),atp.4[LBHI_SEC07940_4228809];
ExaminersInterviewofBrianSciacca,Oct.19,2009,atp.4.
1944Lehman,CDOPriceVerificationPolicy&Procedure(Jan.24,2008),atp.4[LBHI_SEC07940_4228809];
Brian Sciacca also described escalating variances to Clement Bernard, former CFO, Fixed Income
Division.ExaminersInterviewofBrianSciacca,Oct.19,2009,atp.4.
1946Id.
546

didnotresultinawritedownoftheasset,thereportincludedanexplanationastowhy
the desk price was acceptable. These reports were distributed to Product Control
managementandthetradingdesk.1947
WhilethefunctionoftheProductControlGroupwastoserveasacheckonthe
desk marks set by Lehmans traders, the CDO product controllers were hampered in
two respects. First, the Product Control Group did not appear to have sufficient
resources to price test Lehmans CDO positions comprehensively. Second, while the
CDO product controllers were able to effectively verify the prices of many positions
usingtradedataandthirdpartyprices,theydidnothavethesamelevelofquantitative
sophisticationasmanyofthedeskpersonnelwhodevelopedmodelstopriceCDOs.
Regarding its limited resources, in its May 2008 Valuation and Control Report,
the Product Control Group noted that CDOs were an asset class at high risk of
misstatement because of a large review backlog of 250 trades and inefficient data
preparation.1948Theseissueswouldhavelimitedtheabilityoftheproductcontrollersto
userecenttradedataforpriceverification.However,itisunclearwhethertheseissues
hadmuchimpactbyMay2008,atwhichtimetherewasverylittletradeactivityupon
which to rely. This report also states that the Product Control Group deemed super
seniortranchesofCDOsandCLOstobeatamediumriskofmisstatementbecausethey
1947Id.
1948Lehman,
Valuation & Control Report Fixed Income Division (May 2008), at p. 27
[LBHI_SEC07940_2962709].
547

werenotfullytestedandresidualstobeatamediumriskofmisstatementduetopoor
coverage.1949TheseproblemswerenotresolvedbyAugust2008,asthesameissuesare
indicated in the August Valuation & Control report.1950 In May 2008, the Product
ControlGroupnoted that itwas abletopricetest78%ofLehmans CDOpositions.1951
However,itappearsthattheactualpercentageofpositionstestedmayhavebeenmuch
lower.
A review of the Product Control spreadsheets used for May 2008 price testing
revealsthatapproximatelyhalfofLehmansCDOpositionswerepricetestedusingone
ofthepreferredmethodsdescribedintheProductControlGroupsPolicy&Procedures
document. A pricing spreadsheet for CDOs shows that the group used prices from
thirdparty providers toverifythepricesofapproximately10%ofCDOpositionsand
usedamodelpriceforapproximately37%.1952However,approximatelyaquarterof
LehmansCDOpositionswerenotaffirmativelypricedbytheProductControlGroup,
but simply noted as OK because the desk had already written down the position
significantly.1953 For these positions, the Product Control Group noted that the desk
1949Id.atp.28.
1950Lehman, Valuation & Control Report Fixed Income Division (Aug. 2008), at pp. 2829, [LBEX
BARFID0000257].
1951Lehman, 053008 PRICING.xls, tab ABS Secondary Control Tab [LBEXBARFID 0002548]. Note
thatthisisthenumberofdistinctpositions,unweightedbypositionsize.
1952Id. at tab ABS Secondary. The spreadsheet also shows certain positions for which product
controllershadathirdpartypricebutelectednottouseitinfavorofahighermodelpriceornotedonly
thatthedeskhadalreadymarkeddownthepositionsignificantly.
1953Id.Onthisspreadsheet,thesepositionsarenotassignedanymodelpriceorthirdpartyprice,butare
simplynotedasbeing:OK,distressedmarketbondhasbeenwrittendown.
548

price fell below a certain threshold and thus concluded that it required no further
review. Withonlytwoexceptions,thedeskmarksgiventothesepositionswereless
than10%ofpar,andinmanycaseswereessentiallyzero.1954Thetotalvalueofthe35
positionsmarkedinthisfashionwasapproximately$9million.1955Accordingly,itwas
reasonablefortheProductControlGrouptohaveconcludedthatthesepositionswere
so small as to be immaterial and thus not worth expending limited resources to price
test. The Product Control Group considered these positions reviewed and they are
includedincalculatingthat78%ofCDOpositionswerereviewedinMay2008.Ifthey
arecountedasnotreviewed,thenapproximatelyhalfofLehmansCDOportfoliowas
unreviewedinMay2008.
The effectiveness of the Product Control Group was also limited because it did
not havethe technicalsophisticationtodevelopcomplexmodelsfor pricingCDOs, as
didcertainofthedeskpersonnel(commonlyreferredtoasquants)theywerecharged
withmonitoring.1956Sciacca,aformerVicePresidentandHeadoftheCreditValuation
group, described their respective roles by explaining that the desk developed models
forpricingCDOs,whichwerecheckedandapprovedbytheModelValidationgroup.1957
TheProductControlGroupdidnothavetheirownmodels,anddidnothavetheability
to develop or evaluate the type of models being used by Lehmans desk traders.
1954Lehman,053008PRICING.xls,tabABSSecondary[LBEXBARFID0002548].
1955Id.
1957Id.
549

Instead,theCDOProductControlGrouplimiteditselftocheckingtheinputsusedby
the desk to determine whether they were reasonable and using the other price
verification methods described above. Sciacca explained his deference to the models
developedbythedesksbysimplystating:[W]erenotquants.1958
The Examiner also reviewed work papers from E&Ys 2007 annual audit and
2008 quarterly reviews. In its 2007 annual review, E&Y examined Lehmans Product
ControlmodelingprocessforCDOsaswellasmodelinputs.1959E&Ynotedthatthere
wasmuchilliquidityintheCDOmarketduringthelatterhalfof2007andstatedthat
neither Lehman nor it were able to obtain market prices for CDOs from vendors.1960
E&Y observed that Lehmans Product Control Group relied on two methods for price
testing CDOs: comparison to recent trade activity and Intex modeling.1961 Reviewing
CDO positions comprising between 75% and 80% of Lehmans total CDO population,
E&Y concluded that the control was operating as designed and that the value of
LehmansCDOportfoliowasfairlystatedasofNovember30,2007.1962Inpreparingits
second quarter 2008 Summary Review Memorandum, E&Y observed and interviewed
1958Id.
1959StephanieL.Weed,etal.,E&Y,MemorandumtoFiles:CDOValuationApproach(Jan.21,2008),atp.1
[EYSECLBHIABS000063].
1960Id.atp.7.
1961Id.TheobservationthattheProductControlgroupusedIntexisconsistentwithLehmansCDOPrice
TestingPolicyandProceduredocument,butiscontradictedbystatementsmadeinaninterviewwitha
CDOproductcontroller.ExaminersInterviewofBrianSciacca,Oct.19,2009,atp.4;seeLehman,CDO
PriceVerificationPolicy&Procedure(Jan.24,2008),atp.4[LBHI_SEC07940_4228809].
1962Lehman, CDO Price Verification Policy & Procedure (Jan. 24, 2008), at pp. 78
[LBHI_SEC07940_4228809]
550

Lehman product controllers, focusing on the reasonableness of the product control
process and not the specific valuations produced.1963 The stated purpose of the
quarterlyreviewwastoprovide[E&Y]withabasisforcommunicatingwhether[they
were] aware of any material modifications that should be made to the Companys
interim financial information for it to conform with generally accepted accounting
principles.1964AfterobservingLehmansProductControlprocessforCDOsandnoting
the writedowns Lehman had taken on its CDO portfolio, which included the super
senior tranche of the Ceago securitization, described below, E&Y did not identify any
necessary material modifications.1965 While this did not constitute approval of the
particular valuations reported, it did reflect the reasonableness of Lehmans Product
Controlprocessasawhole.1966
(2) PriceTestingResultsfortheSecondandThirdQuarters2008
The following table summarizes the results of the Product Control Process for
CDOs,CLOsandCBOsforthesecondquarterof2008.
1963E&Ys quarterly reviews were of a more limited scope than a full audit and consisted of applying
analytical review procedures and making inquiries of persons responsible for financial and accounting
matters.E&Y,LehmanBrothersHoldingsInc.SummaryReviewMemorandum,ConsolidatedFinancial
Statements,QuarterendedMay31,2008(Aug.8,2008),atp.2[EY_SEC_LBHIWP2Q08000119].
1964Id.
1965Id.atpp.78,17.
1966Id.
551

U.S.PositionsasofMay31,20081967
MarketValue Numberof Numberof Variance %Variance

($000) Positions Positions betweenPC
Tested
1968 andDesk($000)
CDOs 679,362 93 73 (21,867) 3.22%
CLOs 447,610 23 18 (32) 0.01%
CBOs 53,764 11 5 (4) 0.01%
Total 1,180,735 127 96 (21,903) 1.86%
Asthetableshows,thedeskvaluationoftheCDOstestedwasapproximately3%
higher than the Product Control valuation for the positions tested, and there was
virtuallynovarianceinthepricingofCLOsandCBOs.1969
The following table summarizes the results of the Product Control Process for
CDOs,CLOsandCBOsforthethirdquarterof2008.
U.S.PositionsasofAugust31,20081970

Number Variance
MarketValue Numberof of betweenPCand
%Variance
(US$000) Positions Positions Desk
Tested ($000)
CDOs 510,837 67 64 (40,284) 7.89%
CLOs 329,932 16 4 (796) 0.24%
CBOs 50,103 9 5 (993) 1.98%
Total 890,872 92 73 (42,073) 4.72%
The variances between Lehmans desk and Product Control prices increased
fromMay2008toAugust2008.ThevarianceinABS/CRECDOswasnearly8%andthe
1967Lehman,053008PRICING.xls[LBEXBARFID00025480004119].
1968The reported number of positions tested includes those positions which the Product Control group
did not affirmatively test, but deemed acceptable because they had been heavily writtendown by the
desk.
1969Lehman,053008PRICING.xls[LBEXBARFID00025480004119].
1970Lehman,082908PRICING.xls,attabABSSecondary[LBEXBARFID0004120].
552

variance for CDOs, CLOs and CBOs was approximately 4.7%. However, the Product
Control spreadsheets showing third quarter 2008 price testing are missing some data
foundinthesecondquarterspreadsheets.1971Accordingly,althoughAugust2008marks
are calculated for many Lehman positions, it is unclear whether the Product Control
GroupcompleteditsthirdquarterpricetestingprocessbeforeLBHIfileditschapter11
petition.
(a) LehmansPriceTestingofitsCeagoCDOs
CeagosecuritieswerebyfarthelargestCDOpositionheldbyLehmanasofMay
andAugust2008.Ofthe$1.2billionmarketvalueofCDOsLehmanreporteditheldin
May2008,severaltranchesofCeagosecuritiesaccountedforover$520million.1972This
is due to the fact that Lehman was unable to sell, and still held, many of the senior
positionsofthis2007securitization.Thetablebelowshowshowmuchofeachtranche
oftheCeagosecuritizationLehmanstillheldandwhatitconsideredthemarketvalue
ofeachtrancheasofMay31,2008.
1971Id.
553

RetainedCeagoPositionsasofMay31,2008
Balanceasof NotionalValue Percentage MarketValue

May31,2008 ofLehman Retained ofLehman
Tranche ($000)1973 Position by Position
($000)1974 Lehman ($000)1975
Ceago20071A 837,385 837,385 100% 480,241
A1
Ceago20071A 104,854 76,167 73% 25,897
A2
Ceago20071A 20,773 20,773 100% 5,816
B
Ceago20071A 11,376 11,376 100% 3,185
C
Ceago20071A 2,473 2,473 100% 742
D
Ceago20071A 5,782 5,782 100% 5,320
S
Ceago20071A *** *** *** ***
Preferred1976
Total 982,643 953,957 97% 521,201
Lehman sold virtually none of the Ceago securities and, as of May 30, 2008,
retainedapproximately97%ofthesecuritization.Alone,thesecuritiesheldbyLehman
from the supersenior tranche of Ceago were valued at approximately $480 million,
1973The balance of each tranche is the value at offering minus principal payments made since offering.
ThisinformationisobtainedfromIntex.
1974Lehman,053008PRICING.xls,tabABSSecondary[LBEXBARFID0002548].Thetermnotional
referstothefacevalueofthesecurities.
1975Id.
1976The price testing spreadsheet shows inconsistent values for this position. While it shows that the
notional value of the position is only $4,000, it shows a mark of 515.00 and a market value of
approximately$2million.Id.Notonlyisthemarkinexplicablyhigh,but,evenacceptingthatmark,the
marketvalueisincorrectlycalculated.Thepositionissmallenoughthattheseissuesdonotmaterially
affecttheanalysis.
554

over onethird ofthetotal valueofLehmansMay 2008 CDO portfolio.1977Thesize of
thispositionmeritedcloserreviewofLehmansvaluation.
TheproductcontrollerspricetestedthesuperseniortrancheofCeagosecurities
bytakingthemarketvalueoftheunderlyingcollateralandsubtractingthevalueofthe
othertranchesinthedeal.1978TheSandPreferredtranchesofCeago,togethervalued
at$10million,werepricetestedusingIntex,1979andthesubordinatetranches,valuedat
$35 million, were price tested using the interestonly method described below. In its
SecondQuarter2008SummaryReviewMemorandum,E&Yreviewedthisprocessand
noted that Lehmans Product Control Group price verified each of the underlying
collateralinthesuperseniortrancheoftheCeagoCDOthroughthirdpartyquotes.1980
E&Yfoundthatthisprocesswasmethodologicallysoundandobservedthatitresulted
innosignificantvariancesbetweenthedeskandProductControlprices.1981
However,E&YdidnotreviewLehmanspricetestingofthesubordinateCeago
tranches,reasoningthattheywereimmaterialtoLehmansproductcontrolprocessasa
whole for purposes of a quarterly, nonaudit review.1982 Lehmans Product Control
Group price tested the subordinate tranches of Ceago as if the tranches were interest
1977Id.
1978Lehman,Ceago53008.xls,attabSSValue,PortfolioandESM[LBEXBARFID0011033].
1979Lehman,Ceago&BallyrockSubs53008.xls,attabsCeago071S,andPriceYieldPREF[LBEX
BARFID0010998].
1980See E&Y, Lehman Brothers Holdings Inc. Summary Review Memorandum Consolidated Financial
StatementsQuarterendedMay31,2008(Aug.8,2008),atpp.78[EYSECLBHIWP2Q08000125].
1981Id.
1982ExaminersInterviewofJenniferJackson,Nov.3,2009.
555

only(IO)bonds,meaningthatalthoughtheholderofthetranchewaslegallyentitled
to repayment of principal, Lehman determined that the likelihood of such repayment
wassoremotethatthesecuritiesshouldbeviewedaspayinginterestonlyforacertain
period.1983 Using this analysis, the Product Control Group discounted coupon cash
flows obtained from reports prepared by the Ceago trustee at the swap rate
correspondingtotheprojectedtenorofthebonds.1984However,suchamethodwould
be sensitive to the discount rate and tenor assumptions used and it appears that the
ProductControlGroupwasoverlyoptimisticinbothrespects.
The discount rates used by Lehmans Product Controllers were significantly
understated. As stated, swap rates were used for the discount rate on the Ceago
subordinate tranches. However, the resulting rates (approximately 3% to 4%) were
significantly lower than the approximately 9% discount rate used to value the more
seniorStranche.Itisinappropriatetouseadiscountrateonasubordinatetranchethat
is lower than the rate used on a senior tranche.1985 Doing so would suggest that the
subordinatetrancheislessriskythantheseniortranche.Further,itisunderstoodinthe
financial industry that applying the prevailing swap rate as the discount yield is
1983Lehman, Ceago & Ballyrock Subs 53008.xls, at tab IO Analysis [LBEXBARFID 0010998];
ExaminersInterviewofUsmanBabar,Oct.16,2009,atp.4.
1984BasedontheofferingmemorandumforthepreferredsharesintheCeagosecuritization,thetrustee
wasLaSalleBankNationalAssociation.PreferredSharesOfferingMemorandum:CeagoABSCDO2007
1,Ltd.,(Aug.16,2007)[LBEXLL1006113].
1985See JPMorgan, US Fixed Income Markets 2009 Outlook, Collateralized Debt Obligations (Nov. 28,
2008),atp.1(providingCDOspreadsshowingthisrelationship).
556

reasonable when the projected cash flows have minimal uncertainty. For the reasons
described above, the cash flows from the subordinate Ceago tranches, and even the
senior S tranche, were subject to great uncertainty in May 2008. Thus, there are
significantdoubtsastothediscountratesusedtovaluethesubordinateCeagotranches
andastotheultimatereasonablenessoftheProductControlGroupsmarks.
Inadditiontothisoverlyoptimisticdiscountrate,theperiodsduringwhichthe
securitieswereexpectedtopayinterest,knownasthetenorassumptions,usedforthe
IOmodelwerealsooverstated.TheProductControlGroupassumedafouryeartenor
for the C and D Ceago tranches, a sixyear tenor for the B tranche, and an eightyear
tenorfortheA2tranche.1986Thesetenorsassumethattheunderlyingsecuritieswillpay
interest for longer periods of time than would be estimated by a waterfall cash flow
model.1987 As a contemporaneous Intex calculation would have demonstrated, the
ProductControlGroupsassumptionsareunreasonablyoptimisticgiventhesecurities
comprising these tranches. 85% of the collateral debt securities underlying the Ceago
CDOswereresidentialmortgagebackedsecurities.1988AsstatedintheCeagoOffering
Memorandum, many of these were comprised of subprime mortgage loans posing a
heightened risk of default.1989 As of May 2008, the delinquency rate of U.S. subprime
mortgagesoriginatedin2006wasashighas37%,andthatofloansoriginatedin2007
1986Lehman,Ceago&BallyrockSubs53008.xls,attabIOAnalysis[LBEXBARFID0010998].
1987SeeAppendix14,ValuationCDO.
1988CeagoABSCDO20071OfferingMemorandum(Aug.16,2007),atp.32.
1989Id.atpp.3539.
557

wasalmost26%.1990ByAugust2008,banksaroundtheworldhadwrittenoffmorethan
$500billionofvalueinsecuritiestiedtosubprimerelatedassets.1991Itwasunlikelyin
May 2008 that RMBS, comprised in large part of subprime and AltA loans, would
continue to provide cash flows for as long as Lehmans Product Control Group
assumedintheIOpriceverificationmodelfortheCeagosubordinatetranches.Hadthe
Product Control Group used an Intex model for the Ceago subordinate tranches they
would have discovered that the estimated cash flows following from their tenor
assumptions, and thus the valuations of the Ceago subordinate tranches, were
overstated.1992
It is unclear why the Product Control Group chose the tenor assumptions and
discountrateassumptionsthatitdidorwhyitfailedtouseanIntexmodeltopricetest
thesubordinateCeagotranchesasinstructedbyitsownPolicy&Proceduresdocument.
Usman Babar,aformerVice President and product controllerin Securitized Products,
toldtheExaminerthathecouldnotexplainwhytheProductControlGroup used the
tenorassumptionsthatitdidfortheCeagosubordinatetranchesorwhyitfailedtodoa
waterfall cash flow analysis.1993 He noted only that the subordinate tranches were a
relatively small part of the entire Ceago deal, approximately $100 million notional
1990Walen Slew, Subprime, AltA Mortgage Delinquencies Rising: S&P, Reuters, May 22, 2008,
http://www.reuters.com/article/gc03/idUSN2249493920080522.
1991YalmanOnaran,BanksSubprimeLossesTop$500BilliononWritedowns,Bloomberg.com,Aug.12,2008,
http://www.bloomberg.com/apps/news?pid=20601087&sid=a8sW0n1Cs1tY&refer=home#.
1993ExaminersInterviewofUsmanBabar,Oct16,2009,atp.4.
558

value, as compared to the $800 million supersenior tranche.1994 As stated above,
Sciacca,aVicePresidentinCreditValuationgroupresponsibleforpricetestingCDOs,
stated that he deemed Intex generally unreliable in modeling CDO cash flows,1995 but
thisdoesnotexplaintheparticulartenoranddiscountrateassumptionsusedfortheIO
model.
ByusingtheIOmodelwiththetenorassumptionsanddiscountratesitadopted,
theProductControlGroupvaluedthesubordinatetranchesoftheCeagosecuritization
at prices very close to the desk marks, thus avoiding large variances. But, because of
the use of unreasonably optimistic tenor and discount rate assumptions, there is a
findingthattheMay2008valuescalculatedbytheProductControlGroupforthemost
juniorofthesubordinateCeagotrancheswasoverstated.
The potential extent of this overvaluation is demonstrated by an alternate
valuation method employed by the Examiner to test the reasonableness of Lehmans
reportedCDOassetvalues.ThisalternatevaluationdoesnotrepresenttheExaminers
opinionofwhattheactualvalueoftheseassetswasatthetime,butisratherintendedto
provide context in which to judge the reasonableness of Lehmans valuations. As is
describedbelow,thisalternate valuation methodprovides apriceforthe Btranche of
Ceago securities that is approximately onehalf of the price reported by Lehman.
Furthermore, the prices estimated for the C and D tranches of Ceago securities are
1994Id.
559

approximatelyonethirtiethofthepricereportedbyLehman.Thetablebelowprovides
the May 31, 2008 desk prices, Product Control prices, and prices estimated by an
alternative method applied by the Examiners financial advisor,1996 for each tranche of
theCeagosecuritization.
May31,2008ValuationsofTranchesofCeagoSecuritization

NotionalValue Examiners
ofthePosition Desk PC Model
Position CUSIP ($000)1997 Price1998 Price1999 Price2000
CEAGO20071AA1 14984XAA6 837,385 57.35 52.65 65.13
CEAGO20071AA2 14984XAC2 76,167 34.00 30.83 26.33
CEAGO20071AB 14984XAD0 20,773 28.00 29.39 16.63
CEAGO20071AC 14984XAE8 11,376 28.00 29.68 0.91
CEAGO20071AD 14984XAF5 2,473 30.00 35.78 1.10
CEAGO20071AS 14984XAB4 5,782 92.00 88 84.17

As noted, the table shows large variances between the Lehman prices and the
Examiners Model price for the B, C, and D Ceago tranches. While the variances
betweenthepricesestimatedfortheothertranchesarenotinsubstantial,thevariances
seen for these three tranches are large enough to challenge the reasonableness of
Lehmans valuations. The valuations for these three tranches also appear less
reasonableinlightofthemethodologicalproblemsdescribedabove.

1996This alternative method is described in detail in the following Section and is applied to Ceago and
severalotherLehmansecuritizations.
1998Id.
1999Id.
560

As is described above, the lack of relevant information in May 2008 made the
process of determining the appropriate valuations of Lehmans CDO assets very
difficult. Accordingly, the Examiner acknowledges a wide range of reasonable
valuations for any given class of CDOs. As the table above shows, the alternate
valuation performed by the Examiner provides a price that is materially higher than
bothLehmansdeskandProductControlpricesforthelargesuperseniorA1trancheof
Ceago securities. The Examiner used the same model, with different inputs, to value
eachtrancheoftheCeagosecuritization.Thefactthatthismodelproducedpricesthat
were forsome trancheslower,butforthesuperseniortranche higher,thantheprices
reportedbyLehmanreflectsthewiderangeofreasonablevaluationsforCDOsinMay
2008. Only those valuations presenting variances that are too large to explain by
differingreasonablemethodologiesandassumptions,suchasthe301differenceinthe
CeagoCandDtranches,falloutsideofthiszoneofreasonableness.
DespitetheissueidentifiedwiththemostjuniorCeagosubordinatetranches,2001
theproblemswithLehmanspriceverification processes occurredonly intesting very
smallportionsofLehmansCDOportfolio.Itshouldbenotedthatthemostjuniorof
theCeagosubordinatetranches,tranchesB,C,andD,accountedforonlyabout3.6%of
thenotionalvalueofthesecuritizationandabout1.9%ofthemarketvalue,asreported
2001OneotherinstancewasidentifiedinwhichitappearsthatanIOmethodwithsimilarlyunrealistically
optimistictenorassumptionswasusedtopricethemuchsmallerBallyrockABSCDO20071subordinate
tranches.SeeLehman,Ceago&BallyrockSubs53008.xls,attabIOAnalysis[LBEXBARFID0010998].
561

byLehman.2002ThemuchlargersuperseniorA1tranche,accountingforalmost88%of
the notional value of the securitization and about 92% of the market value,2003 had a
reasonable value.2004 Thus, the Product Control Group used a recognized and reliable
methodforpricingthemuchlargersuperseniortrancheofthissecuritization.Whileit
used a reasonable methodology in pricing the subordinate tranches, the assumptions
used as inputs were unreasonable. However, given the relatively small size of these
subordinate positions, the decisions made in price testing these assets would not
supportafindingthatthevaluationofLehmansentireCDOportfolioinMay2008was
unreasonable.
(3) ExaminersReviewofLehmansLargestU.S.ABS/CRECDO
Positions
To provide a second check on the reasonableness of Lehmans valuation of its
U.S.ABS/CRECDOassets,asampleofLehmansABS/CRECDOpositionswerechosen
for review using the Intex cash flow engine.2005 This review does not represent the
Examiners opinion of the actual 2008 value of these CDOs, but rather is intended to
provide context in which to assess the reasonableness of Lehmans valuations. Those
2003Id.
2004See E&Y, Lehman Brothers Holdings Inc. Summary Review Memorandum Consolidated Financial
StatementsQuarterendedMay31,2008(Aug.8,2008),atp.8[EYSECLBHIWP2Q08000125].
2005TheExaminerdidnotindependentlyreviewLehmansvaluationofCLOs.AninterviewwithUsman
BabarconfirmedthatLehmansproductcontrollersusedIntextovalueCLOsandhadconfidenceinthe
market yields used. While Babar noted that Lehman did not check the Intex model against deal
documents,whichwouldtypicallybebestpractice,thevaluationofCLOsbythismethodislesslikelyto
resultinmisstatement.ExaminersInterviewofUsmanBabar,Oct.16,2009,atp.3.
562

positions chosen for valuation were the largest Lehman positions held in May and
Augustof2008forwhichIntexwasabletocomputecashflows.TheABS/CRECDOs
chosenwereCEAGO20071A,thevaluationofwhichisbrieflydescribedabove,CBRE
20071A, ACCDO 5A, and NEWCA 20057A. Two of these securities, CEAGO and
ACCDO are primarily backed by residential mortgagebacked securities. CBRE and
NEWCA are primarily backed by commercial mortgagebacked securities. Taken
together,thesefourCDOpositionsrepresent80%ofthetotalvalueoftheU.S.ABS/CRE
CDOpositionsidentifiedontheLehmanbalancesheetasofMay31,2008.2006
OnlyinformationavailabletoLehmansproductcontrollersinMayandAugust
2008wasusedincalculatingestimatedpricesfortheseCDOs.Theprincipalsourcesof
information used were the contractual terms of the securities, along with market
interest rate data and credit index data from JPMorgan, Intex Solutions, Markit, and
Bloomberg.Thepricesofthesecuritieswereestimatedusingawaterfallapproach.The
future cash flows of each CDO were estimated through time according to the terms
outlinedintheprospectus,includingperiodicexaminationofovercollateralizationand
interest coveragetests. The Examiner estimated the liquidation price and defaultrate
foreachsecurityunderlyingtheCDObylookingatratingagencyreportsforstructured
products or using representative indices. Prepayment assumptions were calibrated
using the historical information available over the last five months for each of the
2006Id.
563

underlying securities where available. Recovery assumptions for the underlying
securities were calibrated from data in the trustee reports, as provided through Intex.
The future cash flows of the assets were applied according to the waterfall and
incorporating these default and prepayment assumptions. The coupon and principal
payments ofeachtranchewere discountedat therate ofreturnrequired by investors,
based on the characteristics of the security as calculated from the indices described
aboveinordertodeterminethepriceofthesecurity.
The results of this independent valuation were mixed, as would be expected
given the extremely illiquid CDO market in May 2008. The following table shows
Lehmansdesk price,theprice calculatedby itsProductControlGroup,and the price
estimated by the Examiners model for tranches of each of the four securitizations
selectedasofMay31,2008.
564

CDOPositions,DeskPrice,PCPrice,andExaminersModelPriceasofMay31,2008
Notional
Value Examiners
ofthe Model
Position Desk PC Price2010
Position CUSIP ($000)2007 Price2008 Price2009
CEAGO20071AA1 14984XAA6 837,385 57.35 52.65
65.13
CEAGO20071AA2 14984XAC2 76,167 34.00 30.83
26.33
CEAGO20071AB 14984XAD0 20,773 28.00 29.39
16.63
CEAGO20071AC 14984XAE8 11,376 28.00 29.68
0.91
CEAGO20071AD 14984XAF5 2,473 30.00 35.78
1.10
CEAGO20071AS 14984XAB4 5,782 92.00 8884.17

CBRE20071AD 1248MLAL7 10,000 80.00 NCF
50.43
CBRE20071AE 1248MLAN3 7,000 80.00 NCF
50.70

ACCDO5AB 00388EAB7 8,250 69.24 NCF
40.31

NEWCA20057A3 651065AE4 5,000 79.23 NCF
50.72

By differing amounts, the model price calculated by the Examiner was lower
thanthedeskandProductControlpricesreportedbyLehmaninalmosteveryinstance.
Asdiscussedabove,thevaluationofthemostjunioroftheCeagosubordinatetranches
providessignificantlylowervaluationsthanthosereportedbyLehman.However,the
oneexceptiontothisrulewasthesuperseniorCeagoA1tranche,whichwasthelargest
position of those tested by a factor of 10. For the Ceago A1 tranche, the Examiners
estimate provided a price higher than that reported by Lehman. Applying the prices

2008Id.
2009Id.
565

calculatedtothenotionalvaluesofthepositions,theExaminersestimateofthevalueof
theseCDOpositionsis$44millionhigherthanthevaluereportedbyLehman.
ForAugust2008,thesamegroupofCDOsaccountedforapproximately81%of
thetotalvalueoftheU.S.ABSCDOsreportedonLehmansbalancesheet.
CDOPositions,DeskPrice,PCPriceandExaminersModelPriceasof
August31,2008

NotionalValue Examiners
ofthePosition Desk PC Model
Position CUSIP (US$000)2011 Price2012 Price2013 Price2014
CEAGO20071AA1 14984XAA6 834,033 43.50 37.09 59.94
CEAGO20071AA2 14984XAC2 76,167 30.00 30.21 21.04
CEAGO20071AB 14984XAD0 20,773 25.00 23.02 12.34
CEAGO20071AC 14984XAE8 11,376 10.00 9.34 0.96
CEAGO20071AD 14984XAF5 2,473 10.00 11.26 1.16
CEAGO20071AS 14984XAB4 5,560 92.00 85.00 80.11

CBRE20071AD 1248MLAL7 10,000 50.00 20.76 42.48
CBRE20071AE 1248MLAN3 7,000 50.00 20.76 42.69

ACCDO5AB 00388EAB7 8,250 69.24 31.23 31.61

NEWCA20057A3 651065AE4 5,000 79.23 34.21 39.02

While there are some large differences between the desk and Product Control
pricesinAugust2008,thesedifferencesappearlargelywithLehmanssmallerpositions.
Furthermore,asinMay,themodelpricescalculatedbytheExaminerarelowerthanthe
2012Id.
2013Id.
566

desk and Product Control prices reported by Lehman in almost every instance.
However, the higher price calculated by the Examiner for the Ceago A1 tranche once
again brings the Examiners total valuation of these CDO positions above that of
Lehmanby$119million.
Ultimately, this exercise in valuation confirms only that pricing ABS/CRE CDO
assets in the 2008 market was extremely difficult and results were sensitive to small
deviationsininputassumptionsandmethodology.However,thefactthatthismodel
providesatotalvaluationthatiscloseto,andslightlyhigherthan,thetotalvaluations
reported by Lehman in both May and August 2008, supports the reasonableness of
Lehmansvaluationsbydemonstratingtherangeofpossiblevaluations.
ReasonablenessofLehmansValuationofitsCDOs
The lack of regular transactions in 2007 and 2008 reduced the quality and
availability of the basic market information necessary to reliably value many types of
securities, including CDOs. This lackofpricetransparencymeantthat theexercise of
judgment was a large part of the process of providing a valuation of Lehmans CDO
portfolio in 2008. The inherent difficulty of pricing Lehmans CDO portfolio in the
unprecedented market conditions of 2008 makes it difficult to support a finding that
Lehmans valuation of its CDO portfolio was unreasonable. Lehmans own Product
Control process, which was reviewed by E&Y, provided May 2008 valuations that
varied from the desk prices by only 3%. Furthermore, a review of Lehmans largest
567

CDOpositionsusinganIntexmodelprovidedpricesclosetothosereportedbyLehman
andactuallysuggeststhatthevalueofLehmansCDOportfoliomayhavebeenslightly
understated. As noted, the Examiner identified problems with several aspects of
Lehmans price control process for certain CDOs and it does not appear that the
Product Control Group was a robust check on desk prices. However, the valuations
reportedbyLehmanwerereasonableinthecontextof2008marketconditionsandthe
informationavailable.Asnotedabove,theExaminerhasidentifiedproblemswiththe
valuationofcertainportionsofLehmansCDOportfolioduring2008;however,thesize
ofthepositionsatissuerenderstheseproblemsimmaterial.Accordingly,theExaminer
does not find evidence to support a finding that Lehmans CDO valuations were
unreasonable.
Positions
(1) OverviewofLehmansDerivativesPositions
Derivativesareabroadcategoryoffinancialinstrumentswhosevalueisderived
from some other asset or index.2015 The derivative itself is a contract between two or
more parties and is sometimes referred to as a financial contract.2016 Its value is
determined by fluctuations in the underlying asset, typically stocks, bonds,
2015JohnC.Hull,Options,Futures,andOtherDerivatives1(6thed.2006);seealsoInternationalSwapsand
Derivatives Association, Product Descriptions and Frequently Asked Questions,

http://www.isda.org/educat/faqs.html#1(lastvisitedJan.13,2010).
2016See,e.g.,U.S.DeptoftheTreasury,CrossBorderDerivativesReportingSystemBecomesOperational
(Apr.27,2007),availableathttp://www.treas.gov/tic/dqanda.html.
568

commodities,currencies,interestratesormarketindices.Commontypesofderivatives
include futures contracts, in which an agreement is made to buy or sell a particular
commodity or financial instrument at a predetermined price in the future; forward
contracts, transactions in which delivery of the commodity is delayed until after the
contractismadeandthepricedetermined;options,inwhichapartypurchasestheright
to buy or sell a commodity or financial instrument at a predetermined price at some
point in the future; and swaps, the exchange of one security or rate for another.2017
Derivativescanbeusedtohedgerisk,orforspeculativepurposes.
Lehmanenteredintoderivativetransactionsonbehalfofitsclientsanditselfto
takeadvantageofspeculativeopportunities,andtomanageitsexposuretomarketand
credit risks resulting from its trading activities.2018 As of May and August of 2008,
Lehman held over 900,000 derivatives positions worldwide.2019 The net value of
Lehmansderivativespositionswasapproximately$21billionasofMay31,2008.2020At
that time, the net value of these positions made up a relatively small percentage of
Lehmans total assets, approximately 3.3%. Approximately 90% of Lehmans
derivatives assets were classified as Level 2 assets under SFAS 157.2021 The following
2017John C. Hull, Options, Futures, and Other Derivatives 18 (6th ed. 2006); U.S. Commodity Futures
TradingCommn,Glossary,http://www.cftc.gov/educationcenter/glossary/index.htm(lastvisitedJan.13,
2010).
2018LBHI10Q(filedJuly10,2008)atpp.9192.
2019FRBNY,ExternalTradeCount[FRBNYtoExam014654].
2020LBHI10Q(filedJuly10,2008)atp.26.
2021Id.atp.29.
569

table shows the value and type of Lehmans various derivatives positions from
November 30, 2006 to May 31, 2008. Derivative contracts with positive values were
booked as assets, while those with negative values were booked as liabilities. As per
the Financial Accounting Standards Board, derivative assets are defined as probable
futureeconomicbenefitsobtainedorcontrolledbyaparticularentityasaresultofpast
transactions or events.2022 Derivative liabilities are defined as probable future
sacrificesofeconomicbenefitsarisingfrompresentobligationsofaparticularentityto
transfer assets or provide services to other entities in the future as a result of past
transactionsorevents.2023
2022Fin. Accounting Standards Bd., Statement of Financial Accounting Concepts No. 6, Elements of
FinancialStatements6(December1985).
2023Id.
570

FairValueofDerivativesandOtherContractualAgreements
AssetsandLiabilities2024
Note:Allvaluesarein$million
November November May31,

30,2006 30,2007 2008
Assets Liabilities Assets Liabilities Assets Liabilities
Overthe
Counter
Interestrate,
currencyand
creditdefault
swapsand $
options $8,634 $5,691 $22,028 $10,915 25,648 $9,733
Foreign
exchange
forward
contractsand $
options $1,792 $2,145 $2,479 $2,888 2,383 $2,270
Otherfixed
income
securities
contracts
(includingTBAs $
andforwards) $4,308 $2,604 $8,450 $6,024 10,341 $5,692
Equitycontracts
(including
equityswaps,
warrantsand $
options) $4,739 $4,744 $8,357 $9,279 6,022 $6,391
Exchangetraded
Equitycontracts
(including
equityswaps,
warrantsand $
options) $3,223 $2,833 $3,281 $2,515 2,597 $1,799
$
Total $22,696 $18,017 $44,595 $31,621 46,991 $25,885
2024Lehman,AnnualReportfor2006asofNovember30,2006(Form10K)(filedonFeb.13,2007),atp.91
(LBHI200610K);LBHI200710Katp.106;LBHI10Q(filedJuly10,2008)atp.26.
571

The following table shows the net value of Lehmans derivatives positions
betweenNovember2006andMay2008.
FairValueofDerivativesandOtherContractualAgreementsNet2025
Note:Allvaluesarein$million
November30,2006 November30,2007 May31,2008

OvertheCounter
Interestrate,currencyandcreditdefault
swapsandoptions $2,943 $11,113 $15,915
Foreignexchangeforwardcontractsand
options $(353) $(409) $113
Otherfixedincomesecuritiescontracts
(includingTBAsandforwards) $1,704 $2,426 $4,649
Equitycontracts(includingequityswaps,
warrantsandoptions) $(5) $(922) $(369)
Exchangetraded
Equitycontracts(includingequityswaps,
warrantsandoptions) $390 $766 $798
Total $4,679 $12,974 $21,106
While Lehman did not file public financial statements for the third quarter of
2008beforeitsbankruptcyfiling,documentsfromitsProductControlGroupshowthat,
as of August 31, 2008, it determined its derivative assets to be $46.3 billion and its
derivativeliabilitiestobe$24.2billion,foranetvalueof$22.2billion.2026Thisrepresents
analmost100%increaseoverthenetvaluestatedninemonthsearlier.
The largest holder of Lehmans derivatives positions was Lehman Brothers
SpecialFinancing(LBSF),anLBHIAffiliate.2027Accordingtoapresentationprepared
bytheNewYorkFederalReserveBankinMayof2008,thethreemostcommontypesof
2025LBHI200610Katp.91;LBHI200710K,atp.106;LBHI10Q(filedJuly10,2008)atp.26.
2026Lehman,RECAugust08asof17SeptemberExtRep.xls[LBEXLL1104812].
2027FRBNY,ExternalTradeCount[FRBNYtoExam014654].
572

transactions to which Lehman was a party were credit default swaps, interest rate
swaps, and foreign exchange derivatives.2028 Of the top 25 counterparties in terms of
numberoftransactions,allarecommercialbanksandfinancialbrokerdealerswiththe
exceptionofAmericanInsuranceGroup,which,with5,400trades,isnineteenthonthis
list.2029ThesameNewYorkFederalReserveBankreportshowsthatLehmanstopthree
counterparties as of May 2008 were Deutsche Bank, JPMorgan, and UBS, with
approximately59,000,53,000and45,000trades,respectively.2030
Thevaluationmethodappliedtoderivativesdiffersdependingontheassetson
which the derivative contract is based. Because derivatives are a large and
heterogeneousassetclass,thereexistsnosinglemethodtopriceallderivatives.Rather,
depending on the underlying assets, traders develop and apply different valuation
methods. Accordingly, the Examiner draws no conclusions regarding the pricing
methodologyusedforanysubsetofLehmansmorethan900,000derivativespositions.
Rather, the Examiners analysis has focused on Lehmans ultimate valuations for the
derivativespositionsreportedontherespectiveLBHIAffiliatesbalancesheets.
TheExaminerhasfoundinsufficientevidencetosupportafindingthatLehmans
valuationofitsderivativesportfolioin2008wasunreasonable.Thisconclusionisbased
on two factors. First, the nature of derivative transactions with sophisticated
2028Id.
2029FRBNY,Derivatives:Top25CounterpartiesbyDealCount[FRBNYtoExam014653].
2030Id.
573

counterparties,who,throughcreditsupportannexes,willagreewithordisputemarks
intheirownselfinterest,limitsthepossibilityofmisstatement.Second,areviewofthe
internal price verification performed by Lehmans Product Control Group provides a
furtherlevelofassurancethatthederivativevaluesreportedbyLehmanin2008were
reasonable.
(2) LehmansUseofCreditSupportAnnexestoMitigate
DerivativesRisk
To reduce counterparty credit exposure in its derivative transactions, Lehman,
likemostotherfinancialinstitutions,executedbindingcreditsupportannexes(CSAs)
with its financial institution counterparties. CSAs establish the rules and procedures
under which a party that is out of the money on a derivatives transaction provides
collateraltoitscounterpartybasedonitsmarktomarketliabilityunderthetransaction.
Inthismanner,CSAsoperatetomitigatetheriskthatapartywouldholdanunsecured
claimagainstitscounterpartyinrespectofthisliabilityintheeventofearlytermination
of the derivative transaction, such as due to the counterpartys filing for bankruptcy
protection.2031
ApartytoaCSAisgenerallypermittedtorequest,onadaily,weekly,orother
defined basis, depending on the terms of the CSA, that its counterparty post
2031See
International Swaps and Derivatives Association, 2002 Master Agreement, 5(a)(vii) (listing
bankruptcyasaneventofdefault).
574

collateral.2032Typically,CSAsprovideforathresholdamountofriskexposure,below
which a counterparty need not post collateral.2033 Accordingly, if Lehman determined
thataderivativescontracthadapresentvalueof$20million,andtheCSAprovidedfor
a$5millionthresholdamount,Lehmanwouldaskthatitscounterpartypost$15million
in collateral. CSAs also typically contain a dispute resolution clause, providing a
mechanism for parties to resolve disputes about the marktomarket value of a
derivativescontract.2034
CSAs are thus constructed to require the parties to come to agreement, or
otherwiseresolvetheirdifferences,regardingthepriceofaderivativescontractatany
given point in time.2035 Even though any two parties may have many derivatives
transactionsbetweenthem,asingleCSAmaycoverallofthesetransactions.Lehman
executed CSAs with the majority of the counterparties with which it entered into
derivatives transactions. Among the top 25 counterparties by number of derivatives
transactions, Lehman executed 24 CSAs.2036 Of the top 25 counterparties by exposure,
2032SeeIntlSwapsandDerivativesAssn,GuidelinesforCollateralPractitioners(1996),atp.24,available
athttp://www.isda.org/press/pdf/colguide.pdf.
2033Lehman,CSACollateralAgreementScreen[LBEXLL3150609].
2034Id.
2035Thegreatmajorityoftrades(suchascreditdefaultswapsonthemajorityofreferenceentities,interest
rate swaps, and foreign exchange swaps) have well accepted valuation techniques as defined in the
FASBsAccounting Standards Codification 8201055 and 81510. However, differences ofopinionsare
possible given the role that judgment necessarily plays in valuing financial assets that do not have a
readilyobservablemarketprice.
2036FRBNY, Derivatives: Top 25 Counterparties by Deal Count [FRBNY to Exam 014653]; CSAs pulled
fromEntityMaster,aBarclayssystem.
575

Lehmanexecuted15CSAs.2037Typicalindustrypracticewasthatonlyinvestmentgrade
sovereignandnonfinancialcorporateentitiesmightnotbeboundbytheseagreements,
andtransactionswithsuchentitieswerelikelytobelimitedtovanilla,i.e.,standard
andnotexotic,products.
Derivativecounterpartiesseektoavoidpledgingcollateralwhenpossibleforthe
reason that doing so diminishes liquidity and imposes an opportunity cost. In other
words,ifapartydidnotpledgeanassetascollateralunderaCSA,itcouldotherwise
finance or sell such asset at its discretion. Hence, a sophisticated party would not
accept its counterpartys claim of a derivatives value without performing its own
analysis. Just as Lehman would not agree to send $15 million to a counterparty, for
example, upon that partys request for collateral without verifying the derivatives
marks itself, neither would Lehmans sophisticated counterparties accept Lehmans
marksabsenttheirownscrutiny.
As part of the investigation, the Examiner reviewed the values that one of
Lehmanscounterparties,Citigroup,determinedforapproximately700ofitsderivative
trades with Lehman as of April 18, 2008.2038 While these marks cover only a small
portionofthederivativespositionsheldbyLehman,theyprovideanexampleofhow
sophisticatedcounterpartiesprovideacheckontheothersmarksforderivatives.
2037Id.
2038Citigroup,untitledspreadsheet[CITILBHIEXAM00030489].
576

ThederivativecontractsbetweenLehmanandCitigroupincludedcreditdefault
swapsoncorporateentities,creditdefaultswapsonABSandderivativesbasedonthe
CDX,LCDXandCMBXindices.2039TheCitigroupmarksindicateanaggregatevalueof
thepositionsofapproximately$426millioninfavorofLehman.2040Lehmansmarksfor
the same positions suggest an aggregate value of approximately $460 million in its
favor,about8%higherthantheCitigroupvaluationasofApril18,2008.2041Whilethis
varianceisnotinsignificant,itisnotunreasonablefortwomarketparticipantstohave
aggregate prices that vary by this much, particularly in light of the adverse market
conditionsofApril2008.ThecomparisonofmarksrevealedinthisCitigroupdocument
demonstrates how sophisticated counterparties tracked one anothers valuations of
derivativescontracts,aprocessnecessitatedbyCSAs.
In this manner, CSAs operated in the normal course of business to effectively
limitthelatitudeLehmanhadinmarkingitsderivativespositionsand,relativetoother
2039CDXfamilyofindicesisthestandardNorthAmericanandEmergingMarketstradablecreditdefault
swapfamilyofindicesworldwide.TheseindicesareadministeredbyMarkit.Theindicesprovidecredit
default swaps on a basket of reference entities. The main indices are: Markit CDX North American
InvestmentGrade(125names),MarkitCDXNorthAmericanInvestmentGradeHighVolatility(30names
fromCDXIG),MarkitCDXNorthAmericanHighYield(100names),MarkitCDXNorthAmericanHigh
Yield High Beta (30 names), North American Emerging Markets (15 names), and North American
Emerging Markets Diversified (40 names). LCDX (loanonly credit default swap) consists of 100
referenceentities,referencing1stlienloanslistedontheMarkitSyndicatedSecuredList.Theseindices
are administered by Markit. CMBX index is a synthetic tradable index referencing a basket of 25
commercial mortgagebacked securities. Markit owns and administers the CMBX, which is a liquid,
tradable tool allowing investors to take positions on commercial mortgagebacked securities via CDS
contracts.
2040Citigroup,untitledspreadsheet[CITILBHIEXAM00030489].
2041Id.
577

asset classes, provided an additional level of protection against a material
misstatement.2042
(3) LehmansPriceTestingofitsDerivativesPositions
Aswithotherassetclasses,themarksLehmanreportedforitsderivativesassets
weredeterminedbyitstradingdesks,andthesemarksweresubjecttopricetestingby
Lehmans Product Control Group.2043 Because of the large number of derivatives
positionsheldbyLehmanandthedifferentmethodsusedbythetradingdeskstomark
these positions, the Examiners analysis has focused on Lehmans Product Control
Groupanditspriceverificationprocessforderivatives.2044
The Examiners review of Lehmans product control process for derivatives
revealedthatLehmanspricetestingoftheseassetswasmorerobustthanthatforother
asset classes. There were four groups at Lehman primarily responsible for valuation,
2042TheExaminerhasidentifiedaspreadsheetinwhichLehmantrackeddisputeswithitscounterparties
over the marktomarket value of derivatives. This spreadsheet also shows which disputes have been
resolved, although it does not specify the outcome of each dispute. See Lehman,
DERIVATIVES_MTM_DISPUTE_LOG.xls[LBEXLL3638800];seealsoeMailfromTylerPeters,Lehman,
toRossShapiro,Lehman,etal.(Jun.25,2008)[LBEXLL3638822].
2043E&Y,WalkthroughGlobalTradingStrategiesWalkthrough[EYSECLBHIEEDGAMX07007515];
Lehman, Price Verification Policy Global Capital Markets 2008 [Draft], at pp. 4, 4954
[LBHI_SEC07940_2965994].
2044The Examiner also notes that E&Y performed yearly audits and quarterly reviews of Lehmans
Product Control process. After performing quarterly walkthroughs in 2008, E&Y concluded that
appropriate controls had been effectively designed and placed in operation for the price verification of
Lehmans derivatives. See, e.g., E&Y, Walkthrough Template, Derivative Margin / Collateral
Management [EYSECLBHIEEDGAMX08014919]; E&Y, Walkthrough Template, High Grade and
High Yield Credit Default Swap Process [EYSECLBHIFIDGAMX08060341]; E&Y, CRE Derivative
PriceVerificationProcess[EYSECLBHIMCGAMX08085788].
578

price testing and model approval regarding derivatives.2045 The Capital Markets
Financegroupwas responsiblefordaily revenue analysisandreporting,validationof
inventory valuations and interfacing with internal and external auditors and
regulators.2046TheProductControlGroupperformedpriceverificationproceduresfor
derivatives on a monthly basis.2047 The Complex Derivatives Review Committee
reviewed complex transactions to ensure that they were modeled, valued and booked
appropriately.2048 Finally, the Model Control Committee reviewed and approved the
modelsusedtomarkderivativespositions.2049
As noted above, the valuation of derivatives follows no set methodology, but
varies according to the nature of the derivative contract at issue.2050 Price verification
proceduresusedbytheProductControlGroupincludedtheuseofindependentmarket
quotes from vendors, benchmarking against similar assets, recent trading activity and
collateral marks.2051 Inthe case of illiquid positions, the Product Control Group could
use internallydeveloped analyticalproceduresorexternalpricingservices.Variances
above certain thresholds were considered for adjustment and variances were resolved
2045SeeLehman,PriceVerificationPresentation(Aug.10,2006),atpp.4,8,12&15[LBEXWGM747129].
2046Id.atp.4.
2047Id.atpp.89.
2048Id.atpp.1214.
2049Id.atpp.1516.
2050Lehman, Price Verification Policy Global Capital Markets 2008 [Draft], at pp. 1317
[LBHI_SEC07940_2965994] (noting different price verification methodologies for different kinds of
derivatives).
2051Id.
579

throughconversationsbetweentheProductControlGroupandtheappropriatetrading
desk.2052
The Examiner obtained detailed information regarding Lehmans Product
Controlprocessforitsportfolioofcreditdefaultswaps(CDS)writtenonassetbacked
securities (ABS) and collateralized debt obligations (CDOs). As of May 31, 2008,
the total market value of these positions, as reported by Lehman, was approximately
$5.4 billion, or 25% of the aggregate market value of Lehmans entire derivatives
portfolio.2053
To perform price verification of these assets, Lehmans Product Control Group
obtainedthirdpartymarksforindividualCUSIPs2054fromdataprovidersFitchRatings
(Fitch) and Markit. Where the Product Control Group had only one Fitch or Markit
priceforaparticularsecurity,itadoptedthatpriceasitsmark.WherebothFitchand
Markitpriceswereavailable,theaverageofthetwowasused.2055
Whiletherewassomevarianceattheindividualsecuritylevelbetweenthedesk
marks and the Product Control valuations, there does not appear to be a bias toward
2052Theestablishedvariancethresholdsalsodiffereddependingonthetypeofderivativeinquestion.See
Lehman, Price Verification Policy Global Capital Markets 2008 [Draft], at pp. 1317
[LBHI_SEC07940_2965994] (noting different price verification methodologies for different kinds of
derivatives).
2053See Lehman, 53008 CDS on CDO.xls [LBEXBARFID 0015341]; Lehman, 53008 CDS on ABS.xls
2054CUSIP refers to the 9character alphanumeric security identifier established by the Committee on
UniformSecurityIdentificationProcedures.
2055See Lehman, 53008 CDS on CDO.xls [LBEXBARFID 0015341]; Lehman, 53008 CDS on ABS.xls
580

either under or overstatement. As a result, the aggregate difference in valuation
between the desk and Product Control valuations was not significant relative to the
valueofthepositions.ThetablesbelowprovidethetradingdeskandProductControl
valuationsforeachofCDSonABSandCDSonCDOasofMay31,2008,andAugust31,
2008.2056 Because multiple Lehman entities may have held positions in a single
derivatives transaction, the number of positions held as of May 31, 2008, was much
greaterthanthenumberofuniquetransactionCUSIPs.
ValuationsofCreditDefaultSwapsasofMay31,20082057
# # Notional DeskValue ProductControl/ Variance

Positions CUSIPs ($billion) ($billion) ThirdParty ($billion)
Value
CDS 12998 1474 6.25 4.26 4.34 0.08
on
ABS
CDS 1910 349 3.38 1.18 1.20 (0.02)
on
CDO
2056LBSFwaslikelytheprimaryLBHIAffiliateholdingthesepositions,seeFRBNY,ExternalTradeCount
[FRBNYtoExam014654],althoughinformationconfirmingthisfactwasnotavailable.
205753008 CDS on CDO.xls [LBEXBARFID 0015341]; 53008 CDS on ABS.xls [LBEXBARFID
0013231].
581

ValuationsofCreditDefaultSwapsasofAugust31,20082058
# # Notional Desk ProductControl/ Variance

Positions CUSIPs ($billion) Value ThirdPartyValue ($billion)
($billion) ($billion)
CDS 12938 1584 4.90 3.60 3.68 0.08
on
ABS
CDS 572 347 3.40 1.02 1.03 (0.01)
on
CDO
Asthetablesabovedemonstrate,thevariancebetweenLehmansDeskvaluation
ofCDS,whichwasthevaluationreportedbyLehmaninitspublicfinancialstatements,
andtheProductControlvaluationwasimmaterialrelativetothesizeofLehmansCDS
portfolioinbothMayandAugustof2008.BecausetheProductControlGroupbasedits
valuationsonthirdpartypricingsources,itsestimatedmarksrepresentmarketopinion
andnotsimplytheviewofLehmansproductcontrollers.2059
Forthereasonsdescribedabove,includingtheroleplayedbyCSAs,thereview
providedbytheProductControlGroupandthelackofmaterialvarianceswiththird
2058Lehman, 12.32.6 082908 CDS on CDO[1].xls [LBEXLL 3642034]; Lehman, 12.32.5 082908 CDS on
ABS[1].xls[LBEXLL3638826].
2059LehmansProductControlgroupproducedmonthlyValuation&ControlReports.See,e.g.,Lehman,
Valuation&ControlReportFixedIncomeDivision(July2008)[LBEXWGM790236];LehmanBrothers
Holdings Inc., Valuation & Control Report Fixed Income Division (June 2008) [LBEXWGM 763320].
Amongotherthings,thesereportsnotethechallengesproductcontrollersfacedinperformingtheirprice
verificationduties.SuchissuesincludedthefactthattheCDSpricetestingdatabasewasinefficientand
sometimescreatedfalsevariancesandthefactthatsomeclassesofderivativeswerenotpricetestedatall.
Lehman, Valuation & Control Report Fixed Income Division (May 2008), at p. 27
[LBHI_SEC07940_2962709].AstheseissuesrelatedonlytotheProductControlreviewprocess,andnot
to the trading desks valuation of derivatives, they did not directly suggest that any marks were
misstated. As described with respect to the valuation of residential whole loans, the Examiner has
determined that weaknesses in the price verification process did not impact the reasonableness of the
marksdeterminedbyLehman.
582

partypricingsources,theExaminerhasfoundinsufficientevidencetosupportafinding
thatLehmansvaluationofitsderivativesportfolioin2008wasunreasonable.
k) ExaminersAnalysisoftheValuationofLehmansCorporateDebt
Positions
(1) OverviewofLehmansCorporateDebtPositions
Lehman actively invested in the debt of both public and private companies
aroundtheworld.In2008,Lehmanscorporatedebtportfolioincludedbothhighgrade
andhighyieldbondsandloans.2060AsofMay31andAugust31,2008,thenumberof
corporate debtpositionslistedinLehmansGlobalFinanceSystem(GFS),Lehmans
tracking system for financial inventory, was 10,629 and 10,374 respectively.2061 As of
May 31, 2008, Lehman reported that it held approximately $50.0 billion in corporate
debtassets,89%ofwhichLehmandeterminedwereLevel2assets.2062AsofAugust31,
2008, Lehman determined that the value of its corporate debt portfolio was
approximately$41.7billion,allofwhichitdeterminedwereLevel2assets.2063
The valuation of corporate debt positions for which external quotes or recent
trade information do not exist involves an analysis of the financial condition and
2060Lehman, REC May08 13June08 FINAL.xls [LBEXLL 1104843]; Lehman, REC August 08 as of 17
SeptemberExtRep.xls[LBEXLL1104812].
2061Lehman, REC May08 13June08 FINAL.xls [LBEXLL 1104843]; Lehman, REC August 08 as of 17
September Ext Rep.xls [LBEXLL 1104812]. These thousands of positions approximate the number of
uniquecorporatedebtpositionsheldbyLehman,thoughtheactualnumberofuniquepositionsdiffered
because (1) GFS reports the same investment held by two different legal entities as two different
positions, and (2) adjustments to positions made by system users appear in GFS as a unique position
wheninfacttheseentriesareadjustmentstoanexistingposition.
2063Lehman,RECAugust08asof17SeptemberExtRep.xls[LBEXLL1104812].Lehmandidnotfilea
quarterlyreportforthethirdquarterof2008beforeitsbankruptcyfiling.
583

prospectsofthecompanythatissuedthedebt.2064Inordertodeterminewhetherthere
is a finding that Lehmans valuation of its entire portfolio of corporate debt positions
was unreasonable, the Examiner would have needed to collect and analyze such
contemporaneous information with respect to each of Lehmans corporate debt
positions. The Examiner also considered what impact the valuation of these assets
wouldhaveonthesolvencyanalysisforLBHIAffiliates.AccordingtoLehmansGFS
database,LCPIwastheonlyLBHIAffiliateholdingsignificantcorporatedebtassetsin
Mayand August 2008.2065 BecausetheExaminerhasdeterminedthatLCPI waseither
borderline solvent or insolvent during the relevant period, the valuation of corporate
debtassetsdoesnotmateriallyenhancethesolvencyanalysisofanyLBHIAffiliate.In
light of this fact, and the time and expense of such an exercise, the Examiner
determinedthatextensiveinvestigationofLehmansvaluationofcorporatedebtassets
wouldbeanimprudentuseofEstateresources.
However,theExaminerdidreviewasampleofLehmanslargestU.S.corporate
debt positions and has identified a number of issues with respect to the price
2064Theinformationrequiredincludesfinancialandoperationalmetricssuchasthedebtissuersbalance
sheetleverageratios,profitabilityratios,andreturnoninvestment.SeeShannonP.Prattetal.,Valuinga
Business52225(4thed.2000).
2065TheExaminerreviewedthelargest15corporatedebtpositionsheldbyLehmaninMayandAugustof
2008. Of these, LBSF held an immaterialamount of assetsand LCPI was the only other LBHI Affiliate
holdingcorporatedebtassets.SeeLehman,GFSReconciliationFilesRECFeb08.03.08FINAL.xls[LBEX
LL1104828];Lehman,RECMay0813June80FINAL.xls[LBEXLL1104843];Lehman,RECAugust08
as of 17September Ext Rep.xls [LBEXLL 1104812]. While the positionlevel data in Lehmans GFS
system was understood to contain some inaccuracies, it was relied on as a management reporting tool
andistheonlycomprehensivesourceshowingownershipofindividualpositions.ExaminersInterview
ofKristieWong,Dec.2,2009,atp.4.
584

verification process performed by the Product Control Group for these positions. In
aggregate, the issues and errors found by the Examiner are not biased toward either
underorovervaluationanddonot,bythemselves,suggestthatthereexistsafinding
thatthevalueofanycorporatedebtpositionwasunreasonable.Shouldsufficienttime
andresourcesbeavailabletheseissuesmaybeinvestigatedfurther.
(2) LehmansPriceTestingofitsCorporateDebtPositions
The marks Lehman reported in its public financial statements for its corporate
debtassetswerethosedeterminedbyitstradingdesks,and,aswithotherassetclasses,
thesemarksweresubjecttopricetestingbyLehmansProductControlGroup.2066The
Product Control Groupused anumber ofmethodologiestoperformprice verification
of corporate debt positions, ranging from use of external quotes and trade prices to
modeling techniques. The method used for price verification was determined
according to the SFAS Fair Value level of the position, as well as its liquidity and the
availabilityofinformation.2067
The methods preferred by Lehmans product controllers for price testing
corporate debt positions were the use ofexternal quotes and recent trade prices.2068 If
2066Lehman, Price Verification Policy Global Capital Markets 2008 [Draft] [LBHI_SEC07940_2965994];
Lehman, HG, HY, & EMG Cash Price Testing Policy & Procedure (Jan. 2008), at p. 2 [LBEXBARVAL
0000001].
2067Id.
2068See Lehman, HG, HY, & EMG Cash Price Testing Policy & Procedure (Jan. 2008), at p. 3 [LBEX
BARVAL 0000001]; Lehman, Valuation Review 2nd Quarter 2008 (July 2008), at p. 15
[LBHI_SEC07940_1184255]. In using external quotes, the product controllers would test desk prices
basedonbidpricesfortheassetreportedbytheLoanSyndicationsandTradingAssociation(LTSA)or
585

externalquotesdidnotexistandtherewasnorelevanttradingactivityforaparticular
position,LehmansProductControlGroupusedmodelstodetermineatestpricefora
particular position.2069 In addition, product controllers also occasionally used
Markit Partners. See Lehman, Valuation Review 2nd Quarter 2008 (July 2008), at p. 15
[LBHI_SEC07940_1184255]. A more generalized price verification policy document also mentions EJV
(EJV Partners L.P.), Interactive Data Corporation (IDC), Asset Backed Securities Group (ABSG), IDSI
(InteractiveDatassecuritiespricingservice),andBloombergaspricingsources.SeeLehman,HG,HY,&
EMG Cash Price Testing Policy & Procedure (Jan. 2008), at p. 3 [LBEXBARVAL 0000001]. Prices that
weremorethanamontholdandpricesthatwereotherwisedeemedincorrectweredisregarded.Id.
2069ThemodelsusedwereknownastheCreditDefaultSwap(CDS)andCreditRating(CR)Matrices.
Therearethreeprimarydriversorinputsinvaluingadebtsecurity:(1)thepaymentstobereceivedon
the debt (i.e. the income Lehman would receive from holding the security), (2) the timing of the
payments, including how long until maturity, and (3) the appropriate yield to apply to the future
paymentstoestimatethepresentvalue.SeeShannonP.Prattetal.,ValuingaBusiness521(4thed.2000).
Thefirstinput,alsocalledthecouponrate,wasdeterminedbylookingatthedebtinstrumentitself.The
coupon rate is the stated interest rate paid by the borrower. The second input, the timing of the
payments, was assumed by Lehman to be semiannual, and, until 2008, was assumed to last until
expected maturity. See Lehman, Loans PxTesting_033108.xls [LBEXBARVAL 00540400061041].
Through April 2008, the stated maturity was used as a proxy for expected maturity, with some
adjustmentforsituationspecificinformation.SeeLehman,Loans_PxTesting022908.xls[LBEXBARVAL
0000005].InMay2008,theProductControlgroupchangeditspracticesothattheexpectedmaturitywas
assumed to be 60 percent of stated maturity. See Lehman, Loans PxTesting_053108final.xls [LBEX
BARVAL 0061231]. The third and final value driver in valuation of a debt security is the yield, or
discountrate,usedtodeterminethepresentvalueofthepaymentsreceived.Thisisanassumptionthat
requires some analysis in order to estimate properly, and a CDS Matrix is a tool that can be used to
estimate this rate. See Lehman, Valuation Review 2nd Quarter 2008 (July 2008), at p. 15
[LBHI_SEC07940_1184255].WhenusingaCDSMatrixmethodologythediscountrateisestimatedusing
matrices of yields based on CDS prices reported for the same issuer or a comparable issuer. Lehman,
Loans PxTesting_053108final.xls [LBEXBARVAL 0061231]. These yields or spreads are marketbased
indications of what investors would expect to receive on similar debt, and therefore are appropriate
discount rates to use to value the specific debt instrument. If appropriate CDS yields are not available,
perhaps because there is no CDS market for the companys debt or a comparable companys debt, an
alternative approach known as a Credit Rating (CR) Matrix may be used to determine an estimated
yield. Lehman, Valuation Review 2nd Quarter 2008 (July 2008), at p. 15 [LBHI_SEC07940_1184255].
The difference between the CDS Matrix and CR Matrix approaches is in the estimation of the discount
rate.IntheCRMatrixmethodology,thediscountrateisdeterminedbasedonspreadsfordebtissuedby
a benchmark company with a similar business model and capital structure as the subject issuing
company. For this process, Product Controllers developed a credit rating matrix using rating/yield
informationfromLoanConnector,aninternalLehmansystem,andgenericspreadsbasedonloancredit
ratingsasprovidedbyReutersLoanPricingCorporation.
586

alternative procedures, which included determining test prices for certain
instrumentsbasedontypicalrelationshipsbetweenthetypesofloans.2070
On a monthly basis, Lehman would populate a Microsoft Excel file, which it
calledthepricetestingworkbook,withallofitsU.S.bankloans,andperformoneof
the testing methodologies identified above. In May 2008, the price testing workbook
contained positions accounting for $32.7 billion, or 65% of Lehmans corporate debt
portfolio.2071InAugust2008,thepricetestingworkbookcontainedpositionsaccounting
for $29.0 billion, or 70% of the corporate debt portfolio.2072 Following is a table of the
methodsusedtotestLehmansU.S.positions.
2070Forexample,ifthepriceofaTermLoanwasassumedtobeFairMarketValue,aDelayedDrawTerm
Loanwaspricedat0.5pointsabovetheTermLoan.SeeErnst&Young,ContingentAcquisitionFacility
Audit Approach [EYSECLBHIFIDGAMx07 025076]. For example, in the May price testing file, the
testingmarkfortheFirstDataSr.CashPayBridgepositionwasdeterminedbasedonthetestpricefor
theTermLoan(basedonathirdpartysale)less4.75basispoints.SeeLoansPxTesting_053108final.xls,
Tab PV,lines 533549 [LBEXBARVAL0061231]. Similarly, Term Loans were priced at 2points above
Revolving Facilities; Senior Subordinate Notes were priced at 4 points above Senior PIK Bridge Loans;
andSenior Bridges werepricedat 1 point aboveSubordinate Bridges. Id. The reasonableness of these
rangesdependsontheparticularcircumstancesofthepositioninquestion.
2071Lehman,LoansPxTesting_05310final.xls[LBEXBARVAL0061231].
2072Lehman, Loans PxTesting_083108 v3.xls [LBEXBARVAL 0048917]. Testing files for nonU.S.
positionswerenotavailableandtheExaminerexpressesnoviewofthereasonablenessofthevaluation
methodologyorultimatemarksreportedforLehmansnonU.S.corporatedebtpositions.
587

MethodsUsedtoPriceTestLehmansCorporateDebtPortfolio
inMayandAugust20082073
Percentageofassets
tested(byvalueof
Method
positions)
May08 Aug08
ExternalQuote 13.8% 16.3%
TradingActivity 9.6% 2.3%
CDSmatrix 64.2% 60.3%
CRmatrix 11.9% 15.5%
AlternativeProcess 0.4% 5.6%
Total 100.0% 100.0%
As the table above indicates, in May and August of 2008, Lehmans product
controllers were unable to use external quotes or trading activity to perform price
testing for most corporate debt positions and relied on the modeling techniques
describedabove.
After the product controllers determined their test marks for a position,
varianceswerecalculated.Variancesaredefinedasthedifferencebetweenthetrading
desks mark and the mark calculated by the product controller. The thresholds for
variances requiring further action were higher for high grade and high yield
instruments as compared to debt positions held by the Emerging Markets Group.
Variances in excess of $500,000 for high grade and high yield Level 2 and Level 3
positionswereconsideredsignificantandwereinvestigatedfurther.2074Variancesin
2073Lehman,LoansPxTesting_053108_final.xls[LBEXBARVAL0061231].
2074Lehman,HG, HY, & EMG Cash Price Testing Policy & Procedure (January 2008), at p. 3 [LBEX
BARVAL0000001].Varianceswereresolvedusingthesameproceduresdescribedaboveforotherasset
classes.
588

excessof$300,000forLevel1highgradeandhighyieldassetsweretreatedsimilarly.2075
Variances for emerging markets securities were considered significant above $400,000
forLevel2and3assetsand$300,000forLevel1assets.2076
ValuationofLehmansCorporateDebtPositions
WhiletheExaminerdeterminedthatitwasnotaprudentuseofEstateresources
toperformanextensiveinvestigationofthevaluationofLehmansentireU.S.corporate
debtportfolio,theExaminerdidreviewLehmanspricetestingofitslargestcorporate
debt positions. The review of Lehmans Product Control price testing materials was
revealing in two respects. First, the price testing materials were not well organized,
creating opportunities for errors on the part of the product controllers. Second, the
workrequiredtopopulatethepricetestingworkbookswasmanualandlaborintensive,
andcertainrelevantassumptionsdidnotappeartohaveanytestingprocessatall.The
Examiner,inthecourseofreviewingLehmanspricetestingprocessforitslargestU.S.
corporate debt positions, identified three weaknesses in the Product Control Groups
price testing of corporate debt: reliance on trades that did not occur, quality control
errors,andnotestingofinternallydeterminedcreditratingsfordebtinstruments.
2075Id.
2076Id.
589

(a) RelianceonNonTrades
As described above, one source of information for price verification is recent
tradeactivityshowingthepricethatathirdpartypaidtoacquirethedebtinstrumentin
an armslength transaction. Transactions such as these are a useful source of
informationbecause they reflect thevalue as determinedbetween awilling purchaser
and a willing seller. In the price testing workbooks, the product controllers had a
columnthatrecordedthecounterpartytoeachtransactionthatwasusedasasourcefor
pricetesting.2077InMay2008,therewere57instanceswherethelistedcounterpartywas
INVENTORY ADJUSTMENT TMS.2078 However, this denoted an internal transfer,
such as a transfer of a position between Lehman entities, and not a true thirdparty
transaction.2079 Debt investments marked in May 2008 by internal trades included
American Airlines, Aramark Corp., Community Health Systems, DAE Aviation
Holdings, Daimler Chrysler, Dana Corp, Dollar General, First Data, HCA Inc.,
SupervaluInc.,TribuneCompanyandTXUEnergy.2080
An error of this nature would not have been captured by the review process,
which was designed to identify situations where the price testing generated
variances.2081Thepricetestingworkbook,whichwastypicallycompletedbyaProduct
2077Lehman,LoansPxTesting_053108final.xls,TabPVColumnBL[LBEXBARVAL0061231].
2078Id.
2079Lehman,CATS.XLXS[LBEXBAR0001102].
2080Lehman,LoansPxTesting_053108final.xls,TabPV,ColumnBL[LBEXBARVAL0061231].
590

Control Group staff member, was not reviewed by senior managers, and was never
checked for errors.2082 If the marks for the internal transfers were close to the marks
obtained from thirdparty transactions, this error would be unlikely to be significant.
However,evenifthemarkswereidentical,thiserrorwouldmakeitappearthatthere
was a greater number of trades upon which to base price testing of corporate debt
assets,lendingagreatersenseofconfidencetothemarksthanwouldbewarranted.
(b) QualityControlErrorsMismatchedCompanies
Foroneofthepositionsexamined,Lehmansproductcontrollersusedthewrong
assettoverifythetradingdesksmark.CLPHoldingsisaprivateequityfirm.InMay
2008, Lehman owned a $250 million position in a term loan to this firm, which was
reduced to a $100 million position by August 2008.2083 The price of this asset was
verifiedinFebruaryandMay2008usingCDSMatrixpricingbasedontheCLPticker.2084
However, CLP is the ticker for Colonial Realty, a publicly traded entity entirely
unrelatedtoCLPHoldings.Thepriceestimatedforthesecurityusingadiscountrate
based on Colonial Realtys debt profile was 100.00 in May 2008, slightly above the
Lehmanmark.2085TheerrorpersistedthroughJuly2008.2086Thiserrorwouldnothave
2082Id.
2083Lehman, Loans PxTesting_053108 final.xls, Tab PV Cells AA270 and AA271 [LBEXBARVAL
0061231]; Lehman, Loans PxTesting_083108 v3.xls, Tab PV, Cell AB261 and AB262 [LBEXBARVAL
0048917].
2084Lehman,LoansPxTesting_053108final.xls,TabCDSMatrix,CellE200[LBEXBARVAL0061231].
2085Lehman,LoansPxTesting_053108final.xls,TabPV,Lines270and271[LBEXBARVAL0061231].
The product control group incorrectly relied on the CLP ticker in February 2008 as well. See Lehman,
LoansPxTesting_022908.xlsTabPV[LBEXBARVAL0000005].
591

generated further scrutiny because the pricing did not generate a significant variance.
By August 2008, product controllers were able to obtain external quotes for the
security.2087
(c) NoTestingofInternalCreditRating
For closelyheld debt instruments that were not rated by a ratings agency,
Lehmangeneratedaninternalcreditrating.2088Thecreditratingisanecessaryelement
inassessingthevalueofasecurity,andisparticularlyimportantwhenusingtheCDS
MatrixorCRMatrixmethodologysincethesemethodologiesrelyonthecreditratingof
the security to determine a benchmark discount rate. In general, a higher rating will
translateintoalowerspreadandyield,whichareusedtodiscountthefutureprincipal
andinterestpayments.Therefore,higherratingswillleadtoahigherprice.Theprice
testing workbooks included a credit rating for each debt security being price tested,
though external and internally generated ratings were indistinguishable.2089 An
interview with a product controller revealed that the Product Control Group did not
haveanyestablishedprocedurestotesttheseinternalratings.2090
The Examiner did not test each credit rating assumption. However, the
Examiner did identify one instance that called into question the credit rating
2086Lehman,LoansPxTesting_073108v1.xls[LBEXBARVAL0037526].
2087Lehman,LoansPxTesting_083108v3.xls,TabPVCellBJ262[LBEXBARVAL0048917].
2088See Lehman, Internal Ratings: Scorecard Framework and User Guide (May 1, 2007), at p. 1 [LBEX
BARFID0019865].
2089Lehman,LoansPxTesting_053108final.xls,TabCDXMTRXMapping[LBEXBARVAL0061231].
592

assumptionsusedbyproductcontrollers.OZManagement,LLC(OZManagement)
isasubsidiaryofOchZiffCapitalManagementGroup,LLC,andLehmanheldaterm
loan to OZ Management with a principal amount of $250 million, maturing in 2013.
The Product Control Group price tested this security using a credit rating of AA.2091
However,accordingtoaCommitmentCommitteememodatedlessthanoneyearprior,
theOZManagementinvestmentwasgivenanimpliedBBBratingasofJune2007.2092
Underthetermsoftheloanagreement,OZManagementwasobligedtouseits
best efforts to obtain a rating for the loan in early 2008.2093 In addition, Lehman
indicatedthatthetermsofthisinvestmentwerebelowmarket.2094Itdoesnotappear,
however, that a rating was ever obtained for this loan. The Examiner was unable to
locateany evidence thatOZ Management was rated by any rating agency duringthis
timeframe.Inthisparticularinstance,ifthecorrectratingwereBBBinsteadofAA,the
resultwouldhavebeenanoverstatementofvalueoftheinvestment.
Asnoted,theExaminerisnotabletoquantifythepotentialimpactoftheseissues
withoutperforminganindependentvaluationofeachofthemorethan10,000corporate
debtpositionsheldbyLehman.Becauseofthetimeandexpenserequiredbysuchan
exercise, the Examiner did not deem this to be a prudent use of Estate resources.
2091Lehman,LoansPxTesting_053108final.xls,TabCDSMTRX,Line656[LBEXBARVAL0061231].
2092Lehman,RequesttoparticipateasaJointBookrunnerinOchZiffsIPO(June1,2007),atp.10[LBEX
AM112872].
2093SeeemailfromGregL.Smith,Lehman,toStevenBerkenfeld,Lehman(Oct.25,2007)[LBEXDOCID
821562].
2094Id.
593

However, the Examiner notes that the issues identified relate exclusively to the price
verification process performed by the Product Control Group and do not directly
suggestthatthevaluationofLehmanscorporatedebtpositions,asdeterminedbythe
tradingdesks,wasunreasonable.Forthereasonsstatedabove,theExaminerdrawsno
conclusion as to the reasonableness of Lehmans valuation of any particular corporate
debtpositionorthevaluationofitscorporatedebtportfolioasawhole.
EquitiesPositions
(1) OverviewofLehmansCorporateEquitiesPositions
Lehman actively invested in the equity of both public and private companies
around the world. Corporate equities, as defined by Lehman, include common and
preferred securities in both public and private companies, as well as equity options,
investments in general partnerships and limited partner positions in private equity or
hedge funds.2095 This Section of the Report addresses Lehmans valuation of common
and preferred securities in public and private companies, and the term corporate
equitiesasusedhereinrefersonlytothesetypesofinvestments.2096AsofMay31,2008,
the number of worldwide corporate equity positions listed in GFS, Lehmans tracking
2095SeeLehman,RECMay0813June08FINAL.xls[LBEXLL1104843].
2096OptionsareaddressedwithintheDerivativesSectionofthisReport,assetsrelatedtocommercialreal
estate are addressed in the CRE and Commercial Book sections, and limited partnership funds are not
addressed because they are marked based on Net Asset Value (NAV) statements provided by the
respective fund, and effectively unreviewable since none of the underlying assets are disclosed. See
Lehman,PrivateInvestmentValuation,atp.1[EYSECLBHIPEGAMx07000995].Lehmansmarking
of fund investments is consistent with how other market participants would have marked fund
investmentsassumingthattheyweresubjecttothesameaccountingrulesaswasLehman.
594

systemforfinancialinventory,was33,174.2097OnAugust31,2008,thetotalnumberof
positionswas39,205.2098AsofMay31,2008,Lehmanreportedthatitheld$47.5billion
in corporate equity assets, approximately 56% of which were Level 1 assets.2099 As of
August31,2008,Lehmandeterminedthatthevalueofitscorporateequityportfoliowas
$43.2billion,approximately60%ofwhichwereLevel1assets.2100
As is discussed below, the valuation of equity positions in publiclyheld
companies is more straightforward than the marking and valuation of equities in
privatelyheld companies. In reviewing Lehmans publicly traded corporate equities,
the Examiner has found that Lehmans marks for these positions closely tracked
publiclyquoted prices. The Examiner has found insufficient evidence to support a
finding that Lehmans marks for these assets were unreasonable. With respect to
Lehmans equity positions in privatelyheld companies, evaluating the reasonableness
of Lehmans valuations of these assets would require an investigation of the financial
circumstances and prospects of each privatelyheld company. Furthermore, the
Examinerhasconsideredwhatimpactthevaluationoftheseassetswouldhaveonthe
2097Id.; Examiners Interview of Kristie Wong, Dec. 2, 2009, at p. 4 (describing function of GFS system).
These thousands of positions approximate the number of unique corporate equity positions held by
Lehman.However,theactualnumberofuniquepositionshelddifferedbecause(1)GFSreportsthesame
investmentheldbytwodifferentlegalentitiesastwodifferentpositions,(2)multipleoptionpositionsare
groupedtogetherintoonepositionforGFSpurposes,and(3)systemusersenterAdjustmentsdirectly
into the system that appear as a position but are more accurately described as adjustments to existing
positions.Lehman.,RECMay0813June08FINAL.xls[LBEXLL1104843]
2098Lehman,RECAugust08asof17SeptemberExtRep.xls[LBEXLL1104812].
2100Lehman, REC August 08 as of 17September Ext Rep.xls [LBEXLL 1104812]. Lehman did not file a
Form10Qstatementforthethirdquarterof2008beforeitsbankruptcyfiling.
595

solvencyanalysisforLBHIAffiliates.AccordingtoLehmansGFSdatabase,LCPIwas
the only LBHI Affiliate to hold significant corporate equity assets.2101 Because the
Examiner has determined that LCPI was either borderline solvent or insolvent during
therelevantperiod,ananalysisofLehmansvaluationofcorporateequityassetswould
notmateriallyenhancethesolvencyanalysisofanyLBHIAffiliate.Forthisreason,and
because of the time and expense required by such an exercise, the Examiner did not
deemanextensiveinvestigationoftheseassetstobeaprudentuseofEstateresources.
However, the Examiner has investigated a number of individual equity positions in
publiclyheld companies and other nonpublicly traded equities and identified issues
thatmayberelevanttothevaluationoftheseassetsgenerally.
(2) LehmansValuationProcessforitsCorporateEquities
Positions
As with other classes of assets, the marks reported by Lehman in its public
financial statements for corporate equities were the values determined by its trading
desks, and these values were subject to price testing performed by Lehmans Product
Control Group.2102 Within the Equity Division, the global Equity Valuation Group
(EVG)wasresponsiblefortestingequityinvestmentsinpubliccompaniesandsome
2101TheExaminerreviewedthelargest15corporateequitypositionsheldbyLehmaninMayandAugust
2008. No LBHI Affiliate held any of these in May 2008, and only LCPI held any in August 2008. See
Lehman, REC Feb08.03.08 FINAL.xls [LBEXLL 1104828]; Lehman, REC May08 13June08 FINAL.xls
[LBEXLL1104843];Lehman,RECAugust08asof17SeptemberExtRep.xls[LBEXLL1104812].While
the positionlevel data in Lehmans GFS system was understood to contain some inaccuracies, it was
reliedonasamanagementreportingtoolandistheonlycomprehensivesourceshowingownershipof
individualpositions.ExaminersInterviewofKristieWong,Dec.2,2009,atp.4.
2102Lehman,PriceVerificationPolicyGlobalCapitalMarkets2008[Draft][LBHI_SEC07940_2965994].
596

private companies.2103 Equity positions in most privatelyheld companies were price
testedbythePrivateEquityValuationCommittee.2104Eachgroupisdiscussedbelow.
TheEVGgatheredinformationonlistedequitypositionsheldbyLehmanfrom
the GQuest system, while information on overthecounter equities positions was
gathered from its GEDS system.2105 The preferred method for price testing publicly
traded equities was to look to the market price of these assets.2106 In order to avoid
circular reliance on its own prices, the Product Control Group considered Bloomberg
quotesderivedfromLehmansowntradersmarkstobeunreliable.2107Similarly,ifthe
product controllers only had a quote from a single broker, and could not corroborate
that quote with information from another source, they would deem that quote to be
unreliable.2108
For price testing of positions for which they did not have either visible market
pricesorinformationfromthirdpartysources,Lehmansproductcontrollersreliedon
methods they termed input pricing.2109 In performing input pricing, the Product
Control Group used models to determine the appropriate marks for corporate equity
2103Id.atp.103.
2104EVG would test equity investments in certain positions in private companies that were held
exclusivelyinEquitiesGroupwithintheCapitalMarketsbusinessline.Thisseparationoftestingwasa
functionofwhichinternalbusinesslineheldtheequityposition.
[LBHI_SEC07940_2965994].
2106Id.
2107Id.atp.105.
2108Id.
2109Id.atp.104.
597

positions and relied on interpolation and extrapolation from observable indicators.2110
In addition, product controllers sometimes performed statistical analyses, relying on
regressionanalysisandvolatilityestimation.2111
After the EVG determined a benchmark, the price testing variance between
EVGs and the traders mark was calculated. Product controllers and traders would
attempt to resolve variances through conversation and unresolved variances were
escalatedtoseniormanagementaswithotherassetclasses.2112Asummaryoftheprice
testing results was subsequently submitted for inclusion in the Valuation and Control
Reportspresentedtoseniormanagement.2113
As noted above, the price testing of most private equity positions was a more
difficult process than the testing of positions in publiclyheld corporations. Lehmans
private equity holdings were not price tested as were other asset classes, but rather
valueswereestablishedbasedonacommitteereview.Acommittee,informallytitled
thePrivateEquityValuationCommittee(PEVC),wouldmeetquarterlytodiscussthe
valuation of private equity assets.2114 Each private equity investment typically had a
2110Id.atp.105.
2111Id.
2112Id.atp.107;Lehman,EquitiesFinanceOrgChart[BCIEX(S)00109843].
[LBHI_SEC07940_2965994].
2114ExaminersInterviewofJamesEmmert,October9,2009,atpp.34;Lehman,PrivateEquityValuation
Committee,May2008,FinalVersion(June3,2008)[LBHI_SEC07940_889460].
598

traderthatwouldbeconsideredtheownerofthatinvestment.2115Afteranalysisofa
privatelyheldcorporation,eachtraderwoulddeterminewhatmarkheorshethought
appropriate for Lehmans position in that corporation. In doing so, the trader would
developasetofdocumentstosupportthemark.Thesedocumentsincludedfinancial
statementsandotherdocumentsdescribingthefinancialandoperationalcircumstances
of the company in question. In the course of its quarterly review, these supporting
documents would be presented to the PEVC for its consideration. The PEVC would
review the supporting documents, the subject corporations most recent financial
metrics, and any significant events or transactions that would impact the value of
Lehmans investment.2116 Based on all the facts available, the PEVC would settle on a
markfortheinvestment.Followingeachquarterlymeeting,thePEVCwouldassemble
apresentationsummarizingitsfindings.2117
ValuationofLehmansCorporateEquitiesPositions
The Examiner reviewed a number of Lehmans May and August 2008 publicly
tradedLevel1corporateequitypositionsandconfirmedthatthemarkusedbyLehman
matched the publicly traded price. This was to be expected given the price
2115ExaminersInterviewofJamesEmmert,October9,2009,atpp.34.
2116Id.
2117See,
e.g., Lehman, Private Equity Valuation Committee, May 2008 (June 3, 2008), at p. 2
[LBHI_SEC07940_889460].
599

transparencyforthisassetclass. TheseLevel1assetsmadeupapproximately56% of
LehmanstotalcorporateequitypositionsinMay2008,and60%inAugust2008.2118
BecausevisiblemarketpricesarenotavailableforLevel2and3corporateequity
assets, which are generally equity positions in privatelyheld corporations, a similar
approach is not possible for these assets. Rather, the valuation of Level 2 and 3
corporate equity positions typically requires a host of supporting information and a
number of assumptions on the part of the party performing the valuation. Typical
documents and information that would be required to determine the value of these
equity positions included historical financial statements, projections for the business,
business plans, capital structure tables, customer lists, discussions with executive
officers or others addressing operations and sales, competitor analyses, articles of
incorporation,marketingplansandothersimilarinformation.2119
InorderfortheExaminertoevaluatethereasonablenessofLehmansvaluation
ofitsLevel2and3corporateequitypositions,allofthissupportingdocumentationand
information would have to be reviewed and analyzed for each privatelyheld
corporation in which Lehman held an equity position. Additionally, interviews with
individuals who attended PEVC meetings revealed that this type of background
informationwassometimesnotdisclosedinhardcopy,butwasreportedorallybythe
2118LBHI 10Q (filed July 10, 2008) at p. 29; Lehman, REC August 08 as of 17September Ext Rep.xls
[LBEXLL1104812].
2119ShannonP.Prattetal.,.ValuingaBusiness:TheAnalysisandAppraisalofCloselyHeldCompanies
77(5THED.2007).
600

traderresponsiblefortheposition.2120Asnoted,theExaminerdeterminedthatthetime
andexpenserequiredtoassembleandthenanalyzethisinformationwasnotaprudent
use of the Estate resources. Accordingly, the Examiner has not evaluated the
reasonablenessofeachofLehmansvaluationsofitsequitypositionsinprivatelyheld
corporations.
However, the Examiner did review a limited selection of Lehmans corporate
equitypositionsinordertounderstandthetypeofissuesthatmayariseinthevaluation
oftheseassets.Thepositionsreviewedwerethe15largestLevel2and15largestLevel
3positionsonMay31,2008,andAugust31,2008.2121Theissuesidentifiedinthecourse
of reviewing these positions do not, by themselves,suggest that there exists a finding
that the value of any particular corporate equity position held by Lehman was
unreasonable. However, they do indicate that further review of Lehmans corporate
equity positions may be warranted if supporting documents and sufficient time and
resourcesareavailable.
(a) ImpairedDebtwithNoEquityMarkDown
The capital structure of any given company is comprised of various types of
equity and/or debt. It is axiomatic that, within a capital structure, debt is senior to
equity.Accordingly,ifthereisimpairmentofthevalueofdebtataparticularcompany
2120ExaminersInterviewofJamesEmmert,October9,2009,atpp.34.
2121SeeLehman,RECMay0813June08FINAL.xls[LBEXLL1104843]andLehman,RECAugust08asof
17SeptemberExtRep.xls[LBEXLL1104812].
601

due to increased riskiness, it would strongly suggest that the value of the companys
equitymustalsobereducedduetothesamerisk.
TheExamineridentifiedanexamplewhereLehmanhadmarkeddownthedebt
but not the equity of the same company. This company was Bawag PSK (Bawag).
Bawag is a privately held company that provides financial services, principally in
Austria.2122InanAugust29,2008email,therewasdiscussionaboutthepossibilityofa
10% writedown of Bawags equity.2123 However, by September 1, 2008, it was
determinedinternallythatBawagsequitynolongerneededtobewrittendown,even
though the debt component, represented by a position held by the Investment
ManagementDivision(IMD),hadalreadybeenwrittendown.2124Itishighlyirregular
for an equity position toremainunchangedwhenadebtsecuritysitting higher in the
capitalstructureiswrittendownsincebothsecuritieswouldlikelybeimpactedbythe
sameriskfactorsthatcauseadecreaseinthevalueofthedebtinstrument.Inthesame
September 1, 2008 email, it is mentioned that the writedown on equity is still being
discussedduetotheimpactonIMD,suggestingthatthewritedownonequitymay
2122DataavailablefromCapitalIQ.
2123Email from Gilles Aublin, Lehman, to James Emmert, Lehman, et al. (Aug. 29, 2008)
[LBHI_SEC07940_2492814].
2124Email from Tony Ellis, Lehman, to Gilles Aublin, Lehman, et al. (Sept. 1, 2008)
[LBHI_SEC07940_2499269].
602

nothave beenevaluatedbasedonfundamentals, butratherhowitwould affect other
businesseswithinLehman.2125
(b) StaticMarks
The Examiner identified several instances in which the valuations of some of
Lehmans corporate equity positions remained unchanged for up to 15 months.2126
Givendaytodayfluctuationsinthemarket,economicvariables,andthecircumstances
ofanyparticularcompanyanditsbusinessoperations,itishighlyimprobablethatthe
value of a company, and therefore the value of Lehmans equity position in it, would
remainconstantoveranextendedperiodoftime.
One example of Lehman keeping its mark on an investment unchanged for an
extendedperiodoftimeisLehmansBawaginvestment,mentionedabove.InMayand
August of 2008 Lehman valued its equity position in Bawag at approximately $170
million with a mark of 100 cents on the dollar, implying that $170 million was the
amount of its initial investment.2127 Based on the fact that the initial investment in
BawagwasinMay2007,thisimpliesthatLehmanmarkeditspositioninBawagat100
2125Id.
2126Examples include First Data Corporation, BATS Holding, Greenbrier Minerals, and Floatel
International. See Lehman, REC Feb08.03.08 FINAL.xls [LBEXLL 1104828]; Lehman, REC May08 13
June08FINAL.xls[LBEXLL1104843];Lehman,RECAugust08asof17SeptemberExtRep.xls[LBEXLL
1104812]; Lehman, GFS Export [LBEXLL 1174708]; Lehman, GFS Export [LBEXLL 2236006]; Lehman
GFSExport[3280239].
2127Lehman,RECMay0813June08FINAL.xls[LBEXLL1104843]andLehman,RECAugust08asof17
SeptemberExtRep.xls[LBEXLL1104812].
603

centsonthedollarfora15monthperiodbeforebankruptcy.2128ComparingLehmans
valuations of corporate equity positions in February, May and August of 2008, the
Examineridentified343examples,totaling$455millionininvestments,wherethemark
for a corporate equity position did not change over this 6 month time period.2129 For
lackofdetailedinformationregardingthecompaniesinquestion,theExaminerdraws
noconclusionaboutthereasonablenessofthevaluationofanyparticularoneofthese
positions. However, Lehmans static marks for these positions may warrant further
investigation.
Inadditiontotheseissues,theExamineridentifiedother,lesssignificant,issues
withLehmansvaluationofcorporateequityassets.Theseincludetheperformanceof
corporate equity positions as compared to an index of similar companies,2130 and the
applicationofadiscountforlackofmarketability.2131
2128BAWAG Revised Terms and Underwriting Amount, High Yield Commitment Committee,
Memorandum (Feb. 7, 2007) [LBEXDOCID 511627]; Austrian BAWAGs $4.3 bln sale to Cerberus closed,
Reuters,May15,2007
21292129 Lehman Brothers Holdings Inc., REC Feb08.03.08 FINAL.xls [LBEXLL 1104828 1104842];
Lehman Brothers Holdings Inc., REC May08 13June08 FINAL.xls [LBEXLL 1104843 1104857];
Lehman Brothers Holdings Inc., REC August 08 as of 17September Ext Rep.xls [LBEXLL 1104812
1104827].
2130The Examiner identified several cases in which Lehmans valuation of a private equity position
implied that the company in question significantly diverged from, and usually outperformed, a
comparable set of publiclytraded corporations. These include investments in Wilton Re Holdings
(Wilton),FirstDataCorporation,ECLFinance,BATSTrading,Castex,andGreenbrierMinerals.Inone
such case, that of Wilton, a provider of risk and capital management solutions for the life insurance
industry, outperformed an index of comparable companies equities by 12.6% as of May 31, 2008, and
19.4% as of August 31, 2008, according to Lehmans estimates. During the first three quarters of 2008,
LehmansmarksforWiltonincreasedslightlywhileacomparableindexshowedasignificantdecreasein
value.Id.ItwouldbeinappropriatetoblindlyconcludethatLehmanshouldhaveadjusteditsvaluation
ofitspositioninWiltontomatchtheperformanceofasetofcomparablecompanies.Theperformanceof
604

As noted, none of the issues identified provide evidence that the value of any
particularLehmancorporateequitypositionismisstated.Athoroughinvestigationof
the subject companys financial and operational circumstances would be necessary to
reach such a conclusion. In fact, without reviewing every one of Lehmans corporate
equity positions, it is impossible to know what portion of Lehmans corporate equity
comparablecompaniesisbutoneindicatorofthevalueofaprivateequityposition,tobeconsideredin
the context of the financial information and particular circumstances of the company in question.
However, comparable companies provide insight into the valuation trends to which a company in a
particular industry may be subject. Instances in which Lehmans valuation of a particular private
corporate equity position seem inconsistent with the performance of comparable companies suggest
furtherreviewmaybewarranted.
For Wilton, the comparable companies were: AFLAC; The Hartford; Allstate; Everest Re; and
Reinsurance Group of America. For First Data Corporation, the comparable companies were: Alliance
Data Systems; Global Payments, Inc.; Fidelity National; and Fiserv, Inc. For ECL Finance, the
performance was compared to Edelweiss Capital, the publicly traded parent company. For BATS
Trading, the comparable companies were: Interactive Brokers; MarketAxess Holdings; Intercontinental
Exchange;andBGCPartners.ForCastex,theperformancewascomparedtotheU.S.OilFundETF,as
well as major oil companies. For Greenbrier, the comparable companies were: James River Coal Co.;
AllianceHoldingsGP,LP;InternationalCoalGroup,Inc.;PatriotCoalCorporation;andArchCoal,Inc.
Lehman,GFSExport[LBEXLL1174708];Lehman,GFSExport[LBEXLL2236006];LehmanGFSExport
[3280239].
2131OfthepositionsreviewedbytheExaminer,anumberhadarestrictiononthesaleoftheunderlying
security,sometimesreferredtoasalockupprovision.Alockupprovisionisarestrictionthatlimitsthe
ability to sell a particular security, even if the security is publiclytraded, for a certain period of time.
Lehmansaccountingfortheserestrictions,whileconsistentwithGAAP,resultedinreportedvaluesthat
mayhavedeviatedfromfairmarketvalueforpurposesofsolvencyanalysis.
When Lehman held a publiclytraded security that had a restriction, the policy was to apply a
discounttothepubliclytradedpriceforvaluationpurposes,basedontheperiodofrestriction.Lehman,
Global Consolidated Policy on Valuation Adjustments: Global Capital Markets (Sept. 2008) [LBEX
BARFID 0011765]. This discount, called a discount for lack of marketability (DLOM), is typically
drivenbythedurationoftherestrictionandthevolatilityoftheunderlyingsecurity.TheDLOM,which
wasbookedasaliability,wouldthenbeamortized,ataconstantorstraightlinepace,overthelifeof
the restriction. Id. Such a process would approximate fair market value at any point along the
amortizingtimelineunlesssomethingsignificantchanges,suchasthevolatilityoftheunderlyingstock.
However,thevolatilityoftheunderlyingstockisalwayschangingandthischangeinvolatilityshould
affect the magnitude of the DLOM, and therefore the fair market value of the position held. Because
Lehmans method did not take into account potential changes in volatility of the underlying stock, the
valuesreportedonLehmansGAAPbalancesheetmaynothavereflectedfairmarketvalue.Whilethis
suggests a deviation from fair market value for solvency purposes, the potential misstatement is not
likelytobesignificantunlessvolatilitysignificantlychangesovertime.
605

portfolio may have been subject to these issues, or others like them. However, these
limitations applied to a minority of Lehmans corporate equity positions. Most of
Lehmans corporate equity portfolio was made up of SFAS Level 1 assets,2132 which
benefited from relative price transparency. The Examiner has not found sufficient
evidencetosupportafindingthatthevaluationofLehmansLevel1corporateequity
portfolio was unreasonable. For the reasons described above, and noting that the
valuation of these assets does not materially enhance the solvency analysis for any
LBHI Affiliate, the Examiner draws no conclusions regarding the reasonableness of
LehmansvaluationofitsLevel2and3equitypositionsinprivatelyheldcompanies.
2132LBHI 10Q (filed July 10, 2008) at p. 29; Lehman, REC August 08 as of 17September Ext Rep.xls
[LBEXLL1104812].
606

x
:
:
etal., :
Debtors. :
x
REPORTOF

TABLEOFCONTENTS
(1) ExaminersConclusions .......................................................................609
(2) IntroductiontoLehmansSurvivalStrategies ..................................612
Stearns............................................................................................................622
(1) RejectionofCapitalInvestmentInquiries .........................................623
(a) KIAOffer........................................................................................ 624
(b) KDBMakesItsInitialApproach................................................. 625
(c) ICDsInitialApproach ................................................................. 626
(2) DivergentViews....................................................................................627
(a) CompetitorsRaiseCapital........................................................... 627
(b) InternalWarningsRegardingCapital........................................ 629
(1) LehmansAttempttoIncreaseLiquidity...........................................633
(2) LehmansAttempttoReduceitsBalanceSheet ...............................634
(3) LehmanSellsStocktoPrivateandPublicInvestors ........................638
(4) SpinCo ....................................................................................................640
(a) EvolutionofSpinCo ..................................................................... 642
(b) ExecutionIssues ............................................................................ 644
(i) EquityHole .......................................................................... 645
(ii) OutsideFinancingforSpinCo ........................................... 649
(iii) SECIssues............................................................................. 653
a. AuditingandAccountingIssues ............................... 653
b. TaxFreeStatus ............................................................. 658
(iv) ValuationofAssets ............................................................. 659
(c) BarclaysSpinCo ....................................................................... 661
(5) PotentialStrategicPartners..................................................................662
(a) BuffettandBerkshireHathaway ................................................ 664
(i) March2008 ........................................................................... 664
(ii) LastDitchEffortwithBuffett............................................ 667
(b) KDB................................................................................................. 668
607

(i) DiscussionsBegin................................................................ 668

(ii) DiscussionsResume:SecondRoundofTalks
betweenKDBandLehman ................................................ 673
(iii) ThirdRoundofTalksbetweenKDBandLehman ......... 677
(iv) KDBsSeptember9,2008Announcement ....................... 681
(c) MetLife ........................................................................................... 687
(d) ICD .................................................................................................. 691
(e) BankofAmerica............................................................................ 694
(i) InitialDiscussionsintheSummerof2008....................... 694
(ii) TalksResumeinSeptember............................................... 696
(f) Barclays .......................................................................................... 703
(6) GovernmentCommunications............................................................711
(a) TreasuryDinner ............................................................................ 712
(b) ShortSales ...................................................................................... 713
(c) PossibilityofFederalAssistance ................................................ 716
(7) LehmansBankruptcyPlanning .........................................................718
608

3. LehmansSurvivalStrategiesandEfforts
a) IntroductiontoLehmansSurvivalStrategiesandEfforts
(1) ExaminersConclusions
With the near collapse of Bear Stearns on March 16, 2008, a widely held belief
was that Lehman would be the next investment bank to fail.2133 SEC Chairman
Christopher Cox thought so; FRBNY President Timothy F. Geithner thought so;
TreasurySecretaryHenryM.Paulson,Jr.,thoughtso;FederalReserveChairmanBenS.
Bernanke thought so.2134 More important, Lehman knew that its survival was in
question. WhenLehmanannouncedits secondquarter2008 losses, SecretaryPaulson
spokewithRichardS.Fuld,Jr.AccordingtoPaulson,Fuldtoldhimthatfurtherlosses
mightbereportedinthethirdquarter.2135Fuld,though,toldtheExaminerthathedid
not recall previewing Lehmans third quarter results with anyone from Treasury, and
noted that Lehman was performing well in the first half of June (Lehman pre
announceditssecondquarterresultsonJune9,2008).2136Inanyevent,Paulsonwarned
2133See,e.g.,RileyMcDermid&AlistairBarr,WallStreetWatchesLehmanWalkonThinIce,MarketWatch,
Mar.17,2008,availableathttp://www.marketwatch.com/story/wallstreetwatchesLehmanwalkonthin
ice;DavidBogoslaw,IsLehmanLiquidEnough?,BusinessWeek,Mar.18,2008,availableat
http://www.businessweek.com/investor/content/mar2008/pi20080317_703353.htm?chan=top+news_top+n
ews_index_top+story.
2134Email from Donald L. Kohn, Federal Reserve, to Ben S. Bernanke, Federal Reserve (June 13, 2008)
[FRBtoLEHExaminer000781](informingBernankethatinstitutionalinvestorsbelievedthatitwasnota
questionofwhetherLehmanwouldfail,butwhenthefailurewouldoccur);ExaminersInterviewofBen
S.Bernanke,Dec.22,2009,atpp.45;ExaminersInterviewofTimothyF.Geithner,Nov.24,2009,atp.2;
Examiners Interview of Henry M. Paulson, Jr., June 25, 2009, at pp. 89; Examiners Interview of
ChristopherCox,Jan.8,2010,atp.8.
2135ExaminersInterviewofHenryM.Paulson,Jr.,June25,2009,atp.14.
609

Fuld that Lehman needed to have a buyer or other survival plan in place before
announcingfurtherlossesinquarterthreeoritssurvivalwouldbeindoubt.2137
With that backdrop, the Examiner determined that it was necessary to explore
whatLehmandidanddidnotdo,toassesswhetheranyofficerordirectorbreacheda
fiduciary duty by not diligently pursuing potential survival strategies. The Order
appointingtheExaminerdirectedaninvestigationintocolorableclaimsforbreachof
fiduciary duties . . . arising in connection with the financial condition of the Lehman
enterprise prior to the commencement of the LBHI chapter 11 case on September 15,
2008.2138 Accordingly, the Examiner reviewed the actions of Lehmans management
and Board, including their efforts to help Lehman survive, for potential breaches of
fiduciary duties. In particular, the Examiner investigated the efforts of Lehmans
management and Board to raise capital through public offerings; to strengthen its
financial position through transactions with one or more strategic partners and
investors;andtorestructurethefirmbyspinningoffcommercialrealestateassetsinto
an entity Lehman internally referred to as SpinCo. With respect to those areas, the
ExamineranalyzedwhetherLehmansofficersanddirectorsfulfilledorbreachedtheir
fiduciarydutiesofcareorloyalty,includingthedutiesofcandor,monitoring,andgood
faithduringtheperiodfollowingthenearcollapseofBearStearns.
atp.3,DocketNo.2569,InreLehmanBrothersHoldingsInc.,No.0813555(Bankr.S.D.N.Y.Jan.16,2009).
610

TheExaminerconcludes:
1. There is no substantial evidencethat Lehmans officers breached their duty

ofcareinconnectionwiththesubstanceoftheireffortstoraisecapital,attract
strategic investors or spin off Lehmans commercial real estate assets,
particularly in light of the protection provided by the business judgment
rule.
2. (a) Lehmans senior management appears not to have been aware of some
facts that turned out to be significant. Similarly, Lehmans Board was not
aware of facts that turned out to be significant. Even so, there is no
substantialevidencethatLehmansofficersbreachedtheirdutyofcandoror
otherwise breached their duty of loyalty to the Board in connection with
efforts to raise capital, attract strategic investors or spin off Lehmans
commercialrealestateassets,exceptassetforthelsewhere.2139

of candor or otherwise breached their duty of loyalty to Lehmans
shareholders in connection with efforts to raise capital, attract strategic
investors or spin off Lehmans commercial real estate assets, except as set
forthelsewhere.2140

of good faith in connection with efforts to raise capital, attract strategic
investors,orspinoffLehmanscommercialrealestateassets.
5. There is no substantial evidence that Lehmans directors breached any

applicable fiduciary duty in connection with Lehmans efforts to raise
capital, attract strategic investors, or spin off Lehmans commercial real
estateassets.
6. ThereisevidencethatKDBmayhavebreachedaconfidentialityagreement
withLehman,butaclaimbasedonthatbreachdoesnotappeartobeworth
pursuing because it would be difficult to establish that the breach caused
Lehmantocollapseorotherwisetoincursubstantialdamages.
2139SeeSectionIII.A.4ofthisReport,whichdiscussesLehmansuseofRepo105ingreaterdetail.
2140Id.
611

(2) IntroductiontoLehmansSurvivalStrategies
Bytheendof2007,eventsinthemarket,suchasthecollapseoftwoBearStearns
hedge funds in July, combined with Lehmans own challenges in funding all of its
commitments, led some Lehman executives to recognize that Lehman had to move
away from the growth strategy it had been pursuing since 2006.2141 In January 2008,
Lehman was reducing its positions in some areas but did not see a need to raise
additional equity capital.2142 To the contrary, at that point, LBHI was continuing its
longstandingpracticeofrepurchasingitsownsharestopreventdilutionthatotherwise
would result from the issuance of new shares as part of Lehmans compensation
process.2143 On February7, 2008, LBHI shifted course and issued a prospectus for an
offeringofpreferredsharesinwhichLehmanraised$1.59billion.2144
On March 16, 2008, JPMorgan announced that it was acquiring Bear Stearns,
saving Bear Stearns from bankruptcy.2145 After Bear Stearns near collapse, many
2141See, e.g., Lehman, Global Real Estate Update (Nov. 6, 2007) [LBEXDOCID 514265]; Examiners
InterviewofRichardS.Fuld,Jr.,Dec.9,2009,atpp.1011.AccordExaminersInterviewofRogerNagioff,
Sept.30,2009,atp.10;seealsoSectionIII.A.1,bofthisReport,whichdiscusseseventsin2007ingreater
detail.
2142See, e.g., email from David Goldfarb, Lehman, to Richard S. Fuld, Jr., Lehman (Jan. 9, 2008)
[LBHI_SEC07940_670045]; email from Erin M. Callan, Lehman, to Larry Wieseneck, Lehman (Feb. 1,
2008) [LBHI_SEC07940_069737]; email from Erin M. Callan, Lehman, to Philip Lynch, Lehman, et al.
(Mar. 15, 2008) [LBHI_SEC07940_075250]. Accord Examiners Interview of Richard S. Fuld, Jr., Dec. 9,
2009,atp.11.
2143Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Jan. 29, 2008), at pp. 23
[LBHI_SEC07940_027446].
2144LehmanBrothersHoldingsInc.,ProspectusSupplementasofFeb.5,2008(Form424B2)(filedonFeb.
7,2008)(LBHI424B2Feb.7,2008).
2145J.P.MorganChase&Co.,CurrentReportasofMar.16,2008(Form8K),atEx.99.1(filedonMar.18,
2008)(JPMorgan8K(Mar18,2008)).
612

financial experts speculated that Lehman was the next most vulnerable investment
bank.2146 However, Lehmans executives were themselves successful investment
bankers,skilledinidentifying,analyzing,pursuingandconsummatingstrategicdeals,
and never before had failed to get the deal done when necessary.2147 The financial
markets reactions to the near collapse of Bear Stearns, including speculation that
Lehmanmightbethenextinvestmentbanktofail,ledLehmantorefocusitseffortson
improvingcapitalandliquidity.2148Atthesametime,Lehmanmanagementcontrasted
itselfwithBearStearnsininternaldiscussionsbynotinghowLehmansliquiditypool
and funding requirements, among other things, differed in important respects from
BearStearns.2149
After the near collapse of Bear Stearns, Lehman moved to raise additional
capital.2150 Lehman initiated work on an equity offering and restarted efforts to locate
candidateswillingtomakeastrategicinvestmentinLehman.2151InlateMarch,Lehman
2146See,e.g.,RileyMcDermid&AlistairBarr,WallStreetWatchesLehmanWalkonThinIce,Mar.17,2008,
available at http://www.marketwatch.com/story/wallstreetwatchesLehmanwalkonthinice; David

Bogoslaw,IsLehmanLiquidEnough?,Mar.18,2008,availableat
http://www.businessweek.com/investor/content/mar2008/pi20080317_703353.htm?chan=top+news_top+n
ews_index_top+story.
2147ExaminersInterviewofHughE.McGee,III,Aug.12,2009,atp.28.
2148See, infra, Section III.A.3.c of this Report, which discusses Lehmans efforts after Bear Stearns near
collapseingreaterdetail.
2149Lehman, Lehman Brothers Board of Directors, Liquidity & Market Update (Mar. 25, 2008), at p. 2
[LBHI_SEC07940_027782].
2150Seeinfra,SectionIII.A.3.cofthisReport,whichdiscussesLehmanseffortstoraisecapitalafterBear
Stearnsnearcollapseingreaterdetail.
2151See id., infra Section III.A.3.c of this Report, which discusses Lehmans efforts to find a strategic
partneringreaterdetail.
613

undertook discussions with Warren E. Buffett, CEO of Berkshire Hathaway.2152
However, those discussions did not result in any investment by Buffett, Berkshire
Hathaway, or any of its affiliates.2153 Instead, at the beginning of April 2008, Lehman
completed a $4.0 billion convertible preferred stock offering.2154 Other offerings to
bolsterLehmanscapitalfollowedinMayandJune.2155
InlateMay2008,LehmanbegantalkswithaKoreanbankconsortiumregarding
an investment.2156 By early June, the consortium and Lehman circulated a draft term
sheet.2157 However, Lehman did not complete a deal with the consortium;2158 instead,
Lehmanraisedcapitalfromothersources.2159
2152ExaminersInterviewofRichardS.Fuld,Jr.,Sept.30,2009,atp.8;ExaminersInterviewofWarrenE.
Buffett,Sept.22,2009,atpp.23.
2153ExaminersInterviewofWarrenE.Buffett,Sept.22,2009,atp.4;ExaminersInterviewofRichardS.
Fuld,Jr.,Sept.30,2009,atp.11.
2154Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Mar. 31, 2008), at p. 1
[LBEXAM003597];LehmanBrothersHoldingsInc.,CurrentReportasofApr.1,2008(Form8K)(filed
onApr.4,2008)(LBHI8K(Apr.4,2008)).
2155See Lehman, Presentation to Lehman Brothers Board of Directors, Estimated April 2008 Financial
Information(May7,2008),atp.8[LBHI_SEC07940_028014].
2156SeeMemorandumfromKunhoCho,Lehman,toHughE.McGee,III,Lehman,etal.,re:Opportunity
Briefing and Key Issues for Investment by Korea Inc. Consortium in Lehman Brothers (May 29, 2008)
[LBEXDOCID1374131],attachedtoemailfromKunhoCho,Lehman,toDavidGoldfarb,Lehman(May
29,2008)[LBEXDOCID1466211].
2157Hana Investment Bank, Elements of Strategic Relationship [Draft] (June 4, 2008) [LBEXDOCID
1401999],attachedtoemailfromChanLee,HanaInvestmentBank,toLarryWieseneck,Lehman,etal.
(June4,2008)[LBEXDOCID1527489].
2158See infra Section III.A.3.c of this Report, which discusses Lehmans June discussions with KDB in
greaterdetail.
2159SeeLehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(June6,2008),atpp.13
[LBEXAM003709];LehmanBrothersHoldingsInc.,CurrentReportasofJune9,2008(Form8K)(filed
onJune12,2008)(LBHI8K(June12,2008)).
614

OnJune9,2008,Lehmanissuedprospectusesfortwoofferingsthattotaled$6.0
billion,2160onthesamedaythatLehmanpreannounceda$2.8billionlossforthesecond
quarter of 2008.2161 Lehmans offering was completed on June12, 2008.2162 That same
day,Lehman announced that HerbertBartH.McDade,III,was replacingJosephM.
GregoryasPresident,andIanT.LowittwasreplacingErinM.CallanasCFO.2163Fuld
told the Board that he intended the management change to be a dramatic
demonstration to Wall Street that Lehman was taking action to make changes.2164 On
June 13, 2008, Federal Reserve Vice Chairman DonaldL. Kohn expressed to Bernanke
theopinionheldbysomeinstitutionalinvestors,whichKohnappearedtoshare,thatit
wasnotamatterofwhetherLehmanwouldfail,butwhen.2165However,Bernanketold
theExaminerthathewasneveroftheviewthat[Lehmans]failurewasinevitable.2166
2160LehmanBrothersHoldingsInc.,ProspectusSupplementasofJune9,2008regardingCommonStock
(Form424B2)(filedonJune9,2008);LehmanBrothersHoldingsInc.,ProspectusSupplementasofJune9,
2008regardingPreferredStock(Form424B2)(filedonJune9,2008).
2161LehmanBrothersHoldingsInc.,CurrentReportasofJune16,2008(Form8K)(filedonJune16,2008)
(LBHI8K(June16,2008));seealsoDavidEllis,LehmanPosts$2.8BillionLoss,CNNMoney.com,June9,
2008;availableat
http://money.cnn.com/2008/06/09/news/companies/lehman_results/index.htm?postversion=2008060909.
2162LBHI8K(June12,2008).
2163LehmanBrothersHoldingsInc.,CurrentReportasofJune12,2008(Form8K)(filedonJune17,2008)
(LBHI8K(June17,2008)).
2164Examiners Interview of Jerry A. Grundhofer, Sept. 16, 2009, at p. 9. See Appendix 18 III to this
Report,whichdiscussestheeventsofJune12,2008ingreaterdetail.
2165Email from Donald L. Kohn, Federal Reserve, to Ben S. Bernanke, Federal Reserve (June 13, 2008)
[FRBtoLEHExaminer000781].
2166ExaminersInterviewofBenS.Bernanke,Dec.22,2009,atp.7.
615

By midJune 2008, the Korean consortium had dropped out and only Korea
Development Bank (KDB)2167 remained principally involved as a potential investor.
At the same time, the possible contours of the investment by KDB expanded.2168
Lehman also explored potential transactions with other possible partners. By the
summer of 2008, Lehman was considering a restructuring of its business to return to
whatFuldcalledcoreLehman.2169Underthatplan,Lehmanwouldrestructureitself
by spinning off its commercial real estate assets into an entity provisionally called
SpinCo,2170 and by selling all or part of Lehmans Investment Management Division
(IMD), including the profitable Neuberger Berman (NB) asset management
group.2171 Some outside observers were skeptical of the SpinCo plan or of Lehmans
ability to execute it quickly enough to improve Lehmans situation.2172 Nonetheless,
Lehman worked with the SEC and rating agencies to move Lehmans restructuring
plansforward.2173LehmanalsoconsultedwithLazardFrres&Co.toexploreavailable
options.2174
2167KDBiswhollyownedbytheRepublicofSouthKorea.
2168See infra Section III.A.3.c of this Report, which discusses Lehmans June negotiations with KDB in
greaterdetail.
2169ExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atp.5.
2170SeeinfraSectionIII.A.3.cofthisReport,whichdiscussesSpinCoingreaterdetail.
2171ExaminersInterviewofHughE.McGee,III,Aug.12,2009,atpp.2324.
2172SeeinfraSectionIII.A.3.cofthisReport,whichdiscussesSpinCoingreaterdetail.
2173SeeemailfromPaoloR.Tonucci,Lehman,toDavidGoldfarb,Lehman(Aug.11,2008)[LBEXDOCID
1533879].AccordExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atpp.68.
2174ExaminersInterviewofGaryParr,Sept.14,2009,atp.6.
616

InJuly2008,rumorscirculatedgloballythatLehmanwasdone&dustedwith
noforthcomingBernankebailout.2175LehmansBoardmetnumeroustimesinJulyto
monitoranddiscussLehmanseffortstosecureinvestmentsandreacttodevelopments
in the markets.2176 Paulson told the Examiner that he advised Fuld in July that there
would be no federal assistance for Lehman.2177 While Fuld agrees that Paulson never
promised federal assistance, Fuld said that Paulson never expressly ruled out the
possibility.2178 Other senior members of the Government, Wall Street executives and
expertsdoubtedthattheGovernmentreallywouldrefusetomakemoneyavailablefor
Lehman if necessary. As late as September 10, 2008, the FRBNY circulated a
presentation that discussed potential federal monetary assistance to Lehman.2179 On
September 11, 2008, Geithners discussions with the Financial Services Authority (the
2175Email from Steven Berkenfeld, Lehman, to Beth Rudofker, Lehman, et al. (July 11, 2008) [LBEX
DOCID316032].
2176LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(July13,2008)[LBEXAM
003834];LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(July14,2008)[LBEX
AM 003837]; Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (July 15, 2008)
[LBEXAM003840];LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(July16,
2008)[LBEXAM003848];LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(July
17,2008)[LBEXAM003850];LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors
(July 18, 2008) [LBEXAM 003852]; Lehman Brothers Holdings Inc., Minutes of Meeting of Board of
Directors (July 22, 2008) [LBEXAM 003866]; Lehman Brothers Holdings Inc., Minutes of Meeting of
BoardofDirectors(July31,2008)[LBEXAM003875].
2177ExaminersInterviewofHenryM.Paulson,Jr.,June25,2009,atpp.1415.
2178ExaminersInterviewofRichardS.Fuld,Jr.,Apr.28,2009,atp.11.
2179See FRBNY, Liquidation Consortium Presentation (Sept. 10, 2008) [FRBNY to Exam. 003517]
(documentwasneitherseennorapprovedbyGeithner),attachedtoemailfromMichaelNelson,FRBNY,
to Christine Cumming, FRBNY, et al. (Sept. 10, 2008) [FRBNY to Exam. 003516]. Accord Examiners
Interview of William Brodows, Aug. 20, 2009, at p. 6; Examiners Interview of Jan H. Voigts, Aug. 25,
2009.
617

FSA) left open the possibility that there would be Government assistance.2180 On
September 12, 2008, Paulson advised the FSA that the FRBNY might be prepared to
provideBarclayswithregulatoryassistanceifnecessary.2181CoxtoldtheExaminerthat
LehmansapparentbeliefthattheGovernmentwouldprovidehelpwasarealfactof
lifeandsaidthatmostattendeesoftheFRBNYmeetingsonSeptember12through14,
2008,probablyassumedthat[PaulsonsstatementthattherewouldbenoGovernment
help]wasanegotiation.2182ChairmanBernanketoldtheExaminerthatheremainedin
Washington,D.C.,duringLehmansfinalweekendinpartbecauseapossibilityexisted
thatBernankemightneedtoconveneameetingoftheFederalReserveBoardtoexercise
the Federal Reserves emergency lending powers under Section 13(3) of the Federal
ReserveAct.2183
Similarly, executives and experts on Wall Street doubted Paulsons statement.
GregoryL.Curl,BankofAmericas(BofA)executiveresponsibleforglobalstrategic
planning, told the Examiner that during the weekends negotiations, the Government
gaveconflictingsignalsregardingtheavailabilityofsomeformoffederalassistance.2184
LehmandirectorDr.HenryKaufmanbelievedthat,asatacticalmatter,Lehmanshould
2180FSA,StatementoftheFSA(Jan.20,2010),10.
2181Id.23.
2182ExaminersInterviewofChristopherCox,Jan.8,2010,atp.15.
2184ExaminersInterviewofGregoryL.Curl,Sept.17,2009,atpp.1112.
618

have opened for business on Monday, September 15, 2008, to impress upon the
regulatoryauthoritiesthatabankruptcywouldposeanenormoussystemicrisk.2185
Throughout the summer of 2008, Lehman undertook exploratory discussions
withpossiblestrategicpartners.2186ByAugustandSeptember,Lehmanhadconsidered
andrejectedaproposalfromKDB.2187Lehmanalsorejectedtermsheetsfromtwoother
potentialinvestors,MetLife2188andtheInvestmentCorp.ofDubai(ICD).2189Although
Lehman rejected a KDB proposal, Lehman indicated its willingness to continue
discussions with KDB.2190 Lehmans management apprised the Board of the status of
talkswithpotentialpartners,althoughitdidnotprovidethetermsorconditionsofany
proposals.2191
2185ExaminersInterviewofDr.HenryKaufman,Sept.2,2009,atp.19.
2186See Section III.A.3.c of this Report, which discusses Lehmans efforts to find a strategic partner in
greaterdetail.
2187Letter from Jasjit Bhattal, Lehman, to Euoo Sung Min, Korea Development Bank, re: Lehmans
intention to continue pursuing alternative paths (Sept. 1, 2008) [PWP 00001727]; email from Jasjit
Bhattal,Lehman,toBradWhitman,Lehman,etal.(Sept.1,2008)[LBHI_SEC07940_651987].
2188LetterfromStevenA.Kandarian,MetLife,toRichardS.Fuld,Jr.,Lehman,re:movingforwardwitha
potential transaction (Aug. 6, 2008) [LBHI_SEC07940_741210]; Examiners Interview of Steven A.

Kandarian,Sept.17,2009,atp.5.
2189Email from Stefano Marsaglia, Rothschild Ltd., to Jeffrey L. Weiss, Lehman, et al. (Sept. 3, 2008)
[LBHI_SEC07940_653425].
2190Letter from Jasjit Bhattal, Lehman, to Euoo Sung Min, Korea Development Bank, re: Lehmans
intention to continue pursuing alternative paths (Sept. 1, 2008) [PWP 00001727]; email from Jasjit
Bhattal, Lehman, to Brad Whitman, Lehman, et al. (Sept. 1, 2008) [LBHI_SEC07940_651987]; Examiners
InterviewofJasjitBhattal,Oct.12,2009,atp.16.
2191See,e.g.,LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(July31,2008),at
pp. 12 [LBEXAM 003875]; Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors
(Aug.6,2008),atp.1[LBEXAM003877];LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardof
Directors(Aug.13,2008),atp.3[LBEXAM003879];LehmanBrothersHoldingsInc.,MinutesofMeeting
ofBoardofDirectors(Aug.25,2008),atp.2[LBEXAM003897];LehmanBrothersHoldingsInc.,Minutes
ofMeetingofBoardofDirectors(Sept.9,2008),atpp.23[LBEXAM003910];LehmanBrothersHoldings
Inc., Minutes of Meeting of Board of Directors (Sept. 11, 2008), at pp. 12 [LBEXAM 003918]; Lehman
619

Events accelerated during the week of September 8, 2008. On Sunday,
September7, the Government announced that it had placed Fannie Mae and Freddie
Macintoconservatorship,providing$200billioninfederalmoney.2192OnSeptember9,
aKoreangovernmentofficialannouncedthatKDBstalkswithLehmanhadended.2193
KDB publicly confirmed that information the following day.2194 On the morning of
Wednesday, September 10, Lehman preannounced its third quarter earnings and
restructuringplans,includingthefuturespinoffofitscommercialrealestateassets.2195
By the late afternoon of September10, Moodys and other rating agencies had placed
Lehmanonnegativewatchforadowngrade.2196
BrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Sept.12,2008),atpp.12[LBEXAM
003920];LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Sept.13,2008),atpp.
14[LBEXAM003927].
2192UnitedStatesTreasury,PressRelease:StatementbySecretaryHenryM.Paulson,Jr.onTreasuryand
Federal Housing Finance Agency Action to Protect Financial Markets and Taxpayers (Sept. 7, 2008),
available at http://www.ustreas.gov/press/releases/hp1129.htm(last visited Jan. 31, 2010); Mark Jickling,
Congressional Research Service, CRE Report for Congress: Fannie Mae and Freddie Mac in
Conservatorship(Sept.7,2008),availableat:http://fpc.state.gov/documents/organization/110097.pdf.
2193Email from Catherine Jones, Lehman, to Hugh E. McGee, III, Lehman, et al. (Sept. 9, 2008) [LBEX
DOCID131058](forwardingJinYoungYook,KoreaFSC:KDB,LehmanInvestmentTalksHaveEnded,Dow
JonesIntlNews,Sept.9,2008);emailfromTimSullivan,Lehman,toMarkG.Shafir,Lehman,etal.(Sept.
9,2008)[LBEXDOCID131059](forwardingSteveGoldstein,KoreanregulatorsaysKDBtalkswithLehman
ended,MarketWatch,Sept.9,2008);emailfromHughE.McGee,III,Lehman,toJasjitBhattal,Lehman,et
al. (Sept. 9, 2008) [LBEXDOCID 224552] (forwarding Evan Ramstad & JinYoung Yook, Talks Between
KDB,LehmanOnPossibleInvestmentEnd,WallSt.J.Online,Sept.9,2009).
2194Email from Shelby Lauckhardt, Lehman, to Richard S. Fuld, Jr., Lehman (Sept. 10, 2008)
[LBHI_SEC07940_213466]; Leo Lewis, Korea Blames Differences for Ending Lehman Talks, Times Online,
Sept.10,2008;SusanneCraig,etal.,KoreanRemarksHitLehman,WallSt.J.,Sept.9,2008.
2195Final Transcript of Lehman Brothers Holdings Inc. Third Quarter 2008 Preliminary Earnings Call
(Sept.10,2008)[LBHI_SEC07940_612771].
2196Email from Stephen Lax, Lehman, to Rajiv Muthyala, Lehman, et al. (Sept. 9, 2008)
[LBHI_SEC07940_557829] (forwarding Fitch Press Release, Fitch Places Lehman Brothers on Rating Watch
Negative(Sept.9,2008));S&PPlacesLehmanonNegativeRatingsWatch,AssociatedPress(Sept.9,2008);e
mail from Paolo R. Tonucci, Lehman, to Carlo Pellerani, Lehman (Sept. 10, 2008)
620

OnSeptember11,2008,JPMorgandemandedanadditional$5billionincollateral
fromLehman.2197Thatsameday,LehmansmanagementtoldtheBoardthatliquidity
is forecasted to decrease to $30 billion today as a result of providing collateral, from
thepreviousdaysannouncedliquidityof$42billion.2198OnFriday,September12,2008,
Citibank obtained an amendment to its Clearing Agreement, which strengthened
Citibanks lien over LBIs property at Citibank.2199 By the evening of September12,
Lehmansonlyhopetosurvivewasfederalassistanceoramerger.Overtheweekendit
becameclearthatthoseoptionswouldnotbeavailable.2200Lehmanalsolearnedthatit
would not be able to fund opening in Europe that Monday.2201 Finally, on Sunday,
September 14, 2008, the SEC, with the support of the FRBNY and Treasury, all but
directedLehmantodeclarebankruptcy.2202
Some published reports assert that Lehmans hasty bankruptcy filing cost the
estate billions, and that bankruptcy planning should have begun earlier than
[LBHI_SEC07940_558653] (forwarding Moodys Press Release, Moodys Places Lehmans A2 Rating On

ReviewWithDirectionUncertain(Sept.9,2008)).
2197Email from Paolo R. Tonucci, Lehman, to Daniel Fleming, Lehman, et al. (Sept. 12, 2008) [LBEX
DOCID073346]([JPM]want[s]$5bntomorrowfirstthing).
[LBEXAM 003918]; Final Transcript of Lehman Brothers Holdings Inc. Third Quarter 2008 Preliminary
EarningsCall(Sept.10,2008)[LBHI_SEC07940_612771].
2199Citibank,DirectCustodialServicesAgreementDeed(Sept.12,2008)[CITILBHIEXAM00005903];e
mailfromPatriciaGomes,HSBC,toAgnesLau,HSBC,etal.(Sept.12,2008)[HBUS00001760].
2200See infra Section III.A.3.c of this Report, which discusses Lehmans negotiations with BofA and
Barclaysingreaterdetail.SeealsoAppendix15,SectionIVX.
[LBEXAM003932].
621

September.2203 However, Lehman consciously avoided bankruptcy planning because
potential strategic partners remained interested and because Lehmans officers and
directorsbelievedthatbankruptcyplanningwouldbecomeaselffulfillingprophecy.2204
Stearns
In early 2008, prior to the near collapse of Bear Stearns, Lehman received
overturesfromseveralentitiesthatwereinterestedininvestinginLehman.2205Lehman
chose not to pursue those overtures for several reasons. First, Lehmans focus at the
time was on selling assets rather than raising capital.2206 Either route would result in
improvednetleverage,animportantgoalforLehman.However,Lehmanpreferredto
sell assets because that would remove Lehmans troubled assets, including its
commercialrealestateandleveragedloans,fromitsbalancesheet.2207Second,Lehman
was concerned that raising capital would signal to the market that Lehman was in a
weak position, a perception that Lehman considered harmful.2208 Fuld told the
2203See,e.g.,JeffreyMcCracken,LehmansChaoticBankruptcyFilingDestroyedBillionsinValue,WallSt.J.,
Dec.29,2008.AccordExaminersInterviewofBryanP.Marsal,Dec.14,2009,atp.2.
2204Examiners Interview ofJohn D. Macomber, Sept.25,2009,at p.5; Examiners Interview of Jerry A.
Grundhofer,Sept.16,2009,atp.15;ExaminersInterviewofDr.HenryKaufman,Sept.2,2009,atp.20.
2205See, e.g., email from Saleh Faraj, Lehman, to Richard S. Fuld, Jr., Lehman, et al. (Jan. 9, 2008)
[LBHI_SEC07940_670045];emailfromJeremyM.Isaacs,Lehman,toRichardS.Fuld,Jr.,Lehman,etal.
(Jan. 11, 2008) [LBHI_SEC07940_066820]; email from Joonkee Hong, Lehman, to Larry Wieseneck,
Lehman(Jan.31,2008)[LBHI_SEC07940_069737];emailfromPhilipLynch,Lehman,toJeremyM.Isaacs,
Lehman,etal.(Mar.15,2008)[LBHI_SEC07940_075250].AccordExaminersInterviewofJeremyM.Isaacs,
Oct.1,2009,atpp.813.
2207Id.
2208Id.atp.26.
622

ExaminerthatneitherhenorthemajorityofLehmansExecutiveCommitteewasaware
of any concerns about Lehmans CSE capital adequacy figures.2209 Because 2007 had
been a record year for Lehman in some respects, Lehmans Board and senior
management did not see a need to raise additional equity capital in January 2008.2210
Third, Lehman did not think that the proposals it received included a sufficient
premium to Lehmans thencurrent stock price to make any of the transactions
attractive.2211
(1) RejectionofCapitalInvestmentInquiries
Atthebeginningof2008,Lehmandeclinedtopursueinvestmentoverturesfrom
theKuwaitInvestmentAuthority(KIA),KDBandICD.2212Atthesametime,Lehman
continued to repurchase its own shares to avoid dilution that otherwise would result
whenLehmanissuednewsharesaspartofitscompensationscheme.2213
2209ExaminersInterviewofRichardS.Fuld,Jr.,Dec.9,2009,atp.18.SeeSectionIII.A.1ofthisReport,
whichdiscussesthecapitaladequacyfiguresinmoredetail.
2210Id. Although Eric Felder was the U.S. Head of Credit Products and not yet a member of Lehmans
senior management in January 2008, he made a presentation at the January 29, 2008 Board meeting
suggesting that Lehman should frontload issuances for the year. See Lehman Brothers Holdings Inc.,
Minutes of Meeting of Board of Directors (Jan. 29, 2008), at p.9 [LBHI_SEC07940_027446]; Eric Felder,
Lehman,2008FinancialSupply/DemandDynamics(Jan.29,2008),atpp.1620[LBHI_SEC07940_027353].
2212OnSeptember4,2007,LehmandeclinedaninvestmentoverturefromCITIC.Atthetime,however,
CITICsinterestwaspurelyfinancial,whileFuldsoughtastrategicpartner.EmailfromRichardS.Fuld,
Jr.,Lehman,toDavidGoldfarb,Lehman(Sept.2,2007)[LBEXDOCID997624];ExaminersInterviewof
RichardS.Fuld,Jr.,Nov.19,2009,atp.18.
2213Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Jan. 29, 2008), at p. 2
[LBHI_SEC07940_027446].
623

(a) KIAOffer
On January 9, 2008, KIA approached Lehman about acquiring shares at a
discount to the market price.2214 On January11, 2008, Jeremy M. Isaacs, CEO of LBIE,
respondedtoKIAthatLehmanwouldbeareluctantseller[]at$65pershare,a12%
premium over the $58 closing price on January 11, 2008.2215 Lehman expressed
enthusiasmaboutdevelopingabroaderpartnershipwithKIAbutshowednointerestin
sellingshareswithoutreceivingapremium.2216NeithertheminutesoftheJanuary29,
2008BoardmeetingnorthehandwrittennotestakenbyJeffreyA.Welikson,Lehmans
corporate secretary, reflect that management advised the Board of KIAs proposal.2217
However, phone logs suggest that Fuld advised directors individually about KIAs
proposal.2218
2214Email from Saleh Faraj, Lehman, to Richard S. Fuld, Jr., Lehman, et al. (Jan. 9, 2008)
[LBHI_SEC07940_670045];emailfromJeremyM.Isaacs,Lehman,toRichardS.Fuld,Jr.,Lehman,etal.
(Jan.11,2008)[LBHI_SEC07940_066820];ExaminersInterviewofJeremyM.Isaacs,Oct.1,2009,atp.8.
2215Email from Jeremy M. Isaacs, Lehman, to Richard S. Fuld, Jr., Lehman, et al. (Jan. 11, 2008)
[LBHI_SEC07940_066820]. Isaacs told the Examiner that he thought Lehman should have negotiated
withKIAregardingitsinterestinbuyingLehmanstock,butFuldwasnotinterestedwithoutKIApaying
apremium.ExaminersInterviewofJeremyM.Isaacs,Oct.1,2009,atpp.89.
2216Email from Jeremy M. Isaacs, Lehman, to Richard S. Fuld, Jr., Lehman, et al. (Jan. 11, 2008)
[LBHI_SEC07940_066820].
2217Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Jan. 29, 2008)
[LBHI_SEC07940_027446].
2218RichardS.Fuld,Jr.,Lehman,CallLogs(Jan.1115,2008)[LBEXWGM674339].
624

(b) KDBMakesItsInitialApproach
In January 2008, Korea Investment Corporation, a sovereign wealth fund,
invested $2 billion in preferred Merrill Lynch stock.2219 In early 2008, KDB began
considering various potential investment opportunities in U.S. investment banks, and
Lehman was one of those banks.2220 On January 31, 2008, KDB expressed interest in
investing in Lehman.2221 KDBs desired outcome in February was a $2 to $3 billion
private equity investment for a minority share of Lehman.2222 While Lehman was
pleasedtohaveKDBbuyitsstockintheopenmarket,asofFebruary2008,Lehmanwas
notlookingtoraisecapitalordiluteitsshareholdersthroughaprivateplacementata
discountedprice.2223 There isnorecord that managementadvised theBoard of KDBs
overture during an official meeting, although phone logs suggest that Fuld may have
advised three members of Lehmans Board of Directors, JohnD. Macomber, Marsha
MartyJohnsonEvansandSirChristopherGent,ofKDBsinterest.2224
2219KimYeonhee,S.KoreaKICChanges$2blnintoMerrillCommonStock,Reuters,July29,2008availableat
http://www.reuters.com/article/is/isUSSE06726320080729.
2220ExaminersInterviewofKDB,Oct.26,2009,atp.6.
2221Email from Joonkee Hong, Lehman, to Larry Wieseneck, Lehman (Jan. 31, 2008)
[LBHI_SEC07940_069737].
2222Id.
2223Email from Erin M. Callan, Lehman to Larry Wieseneck, Lehman (Feb. 1, 2008)
[LBHI_SEC07940_069737].
2224RichardS.Fuld,Jr.,Lehman,CallLogs(Feb.15,2008),pp.13[LBEXWGM674352].
625

(c) ICDsInitialApproach
On March 15, 2008, ICD, a sovereign wealth fund, approached Lehman about
buyingequity,butLehmandeclinedtopursuethatpossibility.2225Lehmanhadaprior
banking relationship with ICD, having worked on the potential financing and
derivativeoverlayonasubstantialpositionICDconsideredacquiring.2226Basedonthat
relationship,ICDbelievedthatLehmansbusinessmixandmanagementweresound.2227
ICD expressed an interest in making a capital investment, preferably in equity.2228
Lehman told ICD that Lehmans capital and liquidity positions were very strong and
that Lehman was not interested in raising equity capital at that time.2229 ICD
responded that if and when Lehman considered raising capital, ICD should be
Lehmans first call in the Middle East.2230 The March 25, 2008 Board minutes and
Weliksons handwritten notes do not reflect that management advised the Board of
ICDsinterest.2231
2225See email from Philip Lynch, Lehman, to Jeremy M. Isaacs, Lehman, et al. (Mar. 15, 2008)
[LBHI_SEC07940_075250].
2226Id.
2227Id.
2228Id.
2229Id.
2230Id.
2231LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Mar.25,2008)[LBEXAM
003586];JeffreyA.Welikson,Lehman,BoardMeetingNotes(Mar.25,2008)[WGM_LBEX_00781].
626

(2) DivergentViews
AlthoughLehmanoptednottoraiseadditionalequityonthetermsavailablein
early2008,otherfinancialinstitutionsdidraisecapital.SomeLehmanexecutivesalso
expressedthebeliefthatLehmanshouldraiseadditionalequity.2232
(a) CompetitorsRaiseCapital
Afterannouncinglossesduring2007,2233duringlate2007andthefirstquarterof
2008, Merrill Lynch issued $6.2 billion dollars in common stock.2234 Merrill sold the
shares at $48; Merrills stock was trading at $54.63 at that time.2235 In addition, in
January 2008, Merrill issued $6.6 billion of convertible preferred shares to KIA, the
KoreanConsortium,andMizuhowithadividendyieldof9%.2236
Similarly,duringlate2007andthefirstquarterof2008,afterannouncinglosses
during 2007,2237 Citibank issued $30 billion of preferred stock, trust preferred, and
forwardpurchasecontracts.Thatcapitalraiseincluded$7.5billionofequityunitsthat
2232See,e.g.,EricFelder,Lehman,2008FinancialSupply/DemandDynamics,PresentationtotheBoardof
Directors(Jan.29,2008),atpp.1620[LBHI_SEC07940_027353].
2233MerrillLynch&Co.,Inc.,CurrentReportasofOct.24,2007(Form8K)(filedonOct.24,2007),atp.1
of Ex. 99.1 (Merrill 8K (Oct. 24, 2007)); Merrill Lynch & Co., Inc., Current Report as of Jan. 17, 2008
(Form8K)(filedonJan.17,2008),atp.1ofEx.99.1(Merrill8K(Jan.17,2008)).
2234Merrill Lynch & Co., Inc., AnnualReport for2007 as of Dec.28,2007 (Form10K) (filed on Feb.25,
2008),atp.23(Merrill200710K).
2235KristinaCooke,U.S.StocksMarketClimbsasMerrillDealLiftsFinancials,Reuters,Dec.24,2007.
2236Merrill200710Katpp.5356.
2237CitigroupInc.,CurrentReportasofJan.15,2008(Form8K)(filedonJan.15,2008),atEx.99.1(Citi8
K(Jan.15,2008)).
627

theAbuDhabiInvestmentAuthoritypurchasedinaprivateplacementonDecember3,
2007.2238
In December2007, after posting its firstever quarterly loss,2239 Morgan Stanley
raised $5 billion through an investment by the China Investment Corporation.2240
Morgan Stanley sold equity units that included futures contracts to buy common
shares.2241
Followingadeclineinincomein2007,2242onJanuary24,2008,Bank of America
sold $6 billion in depositary shares, each representing a 1/25th interest in a share of
fixedtofloating preferred stock.2243 That same month, Bank of America also sold $6.9
billionofconvertiblepreferredsecurities.2244
On March 5, 2008, after announcing a CHF2245 4.4 billion loss (roughly $3.9
billion)2246 on January 30, 2008,2247 UBS issued CHF 13 billion (roughly $11.7 billion) in
2238CitigroupInc.,AnnualReportfor2007asofDec.31,2007(Form10K)(filedonFeb.22,2008),atpp.
7577(Citi200710K).
2239MorganStanley&Co.,CurrentReportasofDec.19,2007(Form8K)(filedonDec.19,2007),atEx.
99.1(Morgan8K(Dec.19,2007)).
2240Tomoeh Murakami Tse & David Cho, First Quarterly Loss Posted In Morgan Stanleys 72 Years,
WashingtonPost,Dec.20,2007.
2241MorganStanley&Co.,AnnualReportfor2007asofNov.30,2007(Form10K)(filedonJan.29,2008),
atpp.17879(Morgan200710K).
2242BankofAmericaCorp.,CurrentReportasofOct.18,2007(Form8K)(filedOct.18,2007),atEx.99.1
(BofA8K(Oct.18,2007));BankofAmericaCorp.,CurrentReportasofJan.22,2008(Form8K)(filed
onJan.22,2008),atEx.99.1(BofA8K(Jan.22,2008)).
2243BankofAmericaCorp.,AnnualReportfor2007asofDec.31,2007(2007Form10K)(filedonFeb.28,
2008),atp.125(BofA200710K).
2244Id.
2245CHFistheabbreviationforSwissfrancs.
2246The converted U.S. dollar amounts are approximations based on the exchange rates in effect at the
time.
628

convertible stock to the government of Singapore Investment Corporation and an
undisclosedinvestorfromtheMiddleEast.2248
(b) InternalWarningsRegardingCapital
In February 2008, Eric Felder, then Lehmans U.S. head of Global Credit
Products, voiced concern to Lehman management about Lehmans real estate
exposures,continuingathemehebeganinMarch2007. 2249HewarnedthatLehmans
situationwouldworsen,particularlyintermsofmarketaccess.2250InearlyMarch2008,
2247UBSAG,ReportofForeignIssuerasofJan.30,2008(Form6K)(filedonJan.30,2008),atp.1(UBS6
K(Jan.30,2008)).
2248UBSAG,ReportofForeignIssuerasofFeb.27,2008(Form6K)(filedonFeb.28,2008),atp.1(UBS
6K(Feb.28,2008)).
2249Email from Eric Felder, Lehman, to Andrew J. Morton, Lehman (Feb. 20, 2008) [LBEXDOCID
1229335]; email from Eric Felder, Lehman, to Andrew J. Morton, Lehman, et al. (Feb. 21, 2008)
[LBHI_SEC07940_071680].BeginningasearlyasMarch4,2007,Felderbegantoexpressbearishviewson
themarketsfuture.EmailfromEricFelder,Lehman,toBrianMaggio,Lehman(Mar.4,2007)[LBEX
DOCID 1268976] (I think its the end of financials as a safe haven). On July 17, 2007, two of Bear
Stearns hedge funds collapsed. See, e.g., Ben White, et al., Subprime Losses Ravage Bear Funds, Financial
Times, July 17, 2007. On August 5, 2007, Felder warned about the impact of the collapse of the Bear
Stearnshedgefunds,predictingthat[i]fbearspreadswidensignificantlyIwouldalsoexpectwewillsee
pressureonlehmanspreadsandconsiderablesellingofcashpaper.EmailfromEricFelder,Lehman,to
AlexKirk,Lehman(Aug.5,2007)[LBEXDOCID184521].Felderwasnotalwaysconsistentinhisbearish
views during 2007. On February 28, 2007, Felder wrote: I dont think subprime will take the whole
marketdownandifIhadmoreflexibilityIwouldbewaybiggerthanweare.Iviewthisasaoncein5
yearopportunityandImnotgoingtomissit.EmailfromEricFelder,Lehman,toJonathanHoffman,
Lehman(Feb.27,2007)[LBEXDOCID4075098].OnMay25,2007,Felderwrote:Weneedeveryoneto
beshootingbeyondhigh.Gelbandisgonebecausehedidnt.Iknowrogerwillmakeustryfor2bat
somepoint.Iactuallythinkwearesupposedtogetridofbudgets.Theydonothingbutconstrain.Also
haveplentyofroomtotaketheriskup.Wewontgetanyresourcesifwedontthinkreallybig.Email
from Eric Felder, Lehman, to Thomas Corcoran, Lehman (May 25, 2007) [LBEXDOCID 4244988]. See
SectionIII.A.1ofthisReport,whichdiscusseseventsin2007ingreaterdetail.
2250Email from Eric Felder, Lehman, to Andrew J. Morton, Lehman (Feb. 20, 2008) [LBEXDOCID
1229335](Iremainconcernedasalehmanshareholderaboutourresiandcmbsexposure....[H]aving
18boftangibleequityand90binresi(includingalta)andcmbs(includingbridgeequity)scaresme);e
mail from Eric Felder, Lehman, to Andrew J. Morton, Lehman, et al. (Feb. 21, 2008)
[LBHI_SEC07940_071680] (We are again underperforming the market significantly on the backs of
629

Felder repeatedly warned Lowitt, Callan and Paolo R. Tonucci, Lehmans Global
Treasurer,aboutthedifficultyofaccessingthemarketstoraisecapital,coupledwithan
anticipated increase in loans to fund.2251 Felder urged that Lehman aggressively sell
assets, specifically its contingent commitments, in order to bring down its balance
sheet.2252 On March 12, 2008, Felder expressed concerns to Callan focusing on dealer
liquidityandshrinkingleverage.2253FelderforwardedanemailfromaLehmantrader
that warned that dealers were demanding increased haircuts and refusing to take
assignments of any Bear or Lehman trades even if the trades were inthemoney.2254
OnMarch17,2008,thedayafterJPMorganmadeitsBearStearnsoffer,Felderwarned
Lowitt, Callan and McDade that collapsing equity values eventually would compel
Lehmantosellassets, andthat the distressed pricesavailablewouldcreatea needfor
additionalcapital,forcingfurthersales.2255
rumorsofwritedowns....[Duetowideningspreads,]itwil[l]becomeverydifficultforustoaccessthe
marketinanysignificantsizeonaregularbasis(asbscisgoingthrough)).
2251See email from Eric Felder, Lehman, to Ian T. Lowitt, Lehman, et al. (Feb. 29, 2008)
[LBHI_SEC07940_053967];emailfromEricFelder,Lehman,toPaoloR.Tonucci,Lehman(Mar.4,2008)
[LBHI_SEC07940_439441]; email from Eric Felder, Lehman, to Erin M. Callan, Lehman (Mar. 12, 2008)
[LBHI_SEC07940_074441].
2252See email from Eric Felder, Lehman, to Paolo R. Tonucci, Lehman (Mar. 4, 2008)
[LBHI_SEC07940_439441]. Accord Examiners Interview of Eric Felder, May 21, 2009, at pp. 78;
ExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,atpp.2728.
2253Email from Eric Felder, Lehman, to Erin M. Callan, Lehman (Mar. 12, 2008)
[LBHI_SEC07940_074441].
2254Id.
2255See email from Eric Felder, Lehman, to Ian T. Lowitt, Lehman (Mar. 17, 2008)
[LBHI_SEC07940_075534](forwardedtoErinM.Callan);emailfromEricFelder,Lehman,toHerbertH.
McDade,III,Lehman(Mar.17,2008)[LBHI_SEC07940_623492].
630

c) ActionsandEffortsFollowingtheNearCollapseofBearStearns
FollowingthenearcollapseofBearStearns,WallStreetperceivedLehmantobe
the next most vulnerable bank.2256 Bernanke, Geithner, Cox and Paulson all told the
Examinerthattheysharedthatview.2257
Bernanke told the Examiner that the Federal Reserve, SEC and markets in
general viewed Lehman as the next most vulnerable investment bank because of
Lehmansfundingmodel.2258BernankedidnotbelievethatFuldappreciatedLehmans
vulnerability, and believes that Fuld should have worked more aggressively to find
waystostrengthenLehman.2259BernanketoldtheExaminerthathebelievedthatFuld
wasalwaysmoreoptimisticaboutLehmansconditionthanthemarketswere.2260
Geithner told the Examiner that his concerns about Lehman began in August
2007 and grew steadily into 2008.2261 Geithner told the Examiner that, following Bear
Stearns near collapse, he considered Lehman to be the most exposed investment
bank.2262GeithnertoldtheExaminerthatheconsideredLehmansproposalstoconvert
2256See, e.g., Riley McDermid & Alistair Barr, Wall Street watches Lehman walk on thin ice, MarketWatch,
Mar. 17, 2008, available at http://www.marketwatch.com/story/wallstreetwatcheslehmanwalkonthin

ice; David Bogoslaw, Is Lehman Liquid Enough?, Business Week, Mar. 18, 2008, available at
http://www.businessweek.com/investor/content/mar2008/pi20080317_703353.htm.
2257ExaminersInterviewofBenS.Bernanke,Dec.22,2009,atpp.45;ExaminersInterviewofTimothyF.
Geithner, Nov. 24, 2009, at p. 2; Examiners Interview of Henry M. Paulson, Jr., June 25, 2009, at p. 9;
ExaminersInterviewofChristopherCox,Jan.8,2010,atp.8.
2259Id.atpp.3,56.
2260Id.atp.6.
2261ExaminersInterviewofTimothyF.Geithner,Nov.24,2009,atp.2.
2262Id.
631

to a bank holding company gimmicky.2263 On the other hand, both Goldman Sachs
andMorganStanleyconvertedthemselvesintobankholdingcompaniesonSeptember
21,2008.2264
Similarly, Paulson told the Examiner that he began to have concerns about
Lehman in 2007 when he learned about the Archstone deal.2265 Paulson told the
ExaminerthathepressedLehmanlesshardpriortothenearcollapseofBearStearns
due to Lehmans record 2007 results, but that after Bear Stearns near collapse, he
focused on Lehman as the most vulnerable investment bank.2266 Paulson believes that
Fuld heard what he wanted to hear and was more optimistic than he should have
been.2267 Paulson also told the Examiner that Fuld had quixotic . . . ideas about
boostingmarketconfidence,citingtheremovalofCallan,whichPaulsonthoughtcould
beviewedasmorealarmingthancalming.2268
In the weeks following Bear Stearns near collapse, Lehman took steps: (1) to
increaseitsliquidity;(2)tocontinueeffortsbegunin2007toreduceitsbalancesheet;(3)
to raise equity from public and private investors; (4) to implement SpinCo; and (5) to
findastrategicpartner.ThisSectiondiscussesthoseeffortsinturn.
2263Id.atp.6.
2264FederalReserveSystem,OrdersApprovingFormationofBankHoldingCompanies(Sept.21,2008),
availableathttp://www.federalreserve.gov/newsevents/press/orders/orders20080922a1.pdfand
http://www.federalreserve.gov/newsevents/press/orders/orders20080922a2.pdf. See Appendix 13 II to
thisReport,whichdiscussesLehmansbankholdingcompanyproposalingreaterdetail.
2266Id.atpp.1011.
2267Id.atpp.6,11.
2268Id.atp.14.
632

(1) LehmansAttempttoIncreaseLiquidity
On March 25, 2008, Lehmans Board met for a regularly noticed meeting. The
Board focused in significant part on Lehmans position following the near collapse of
BearStearns.InmaterialsprovidedtotheBoard,Lehmansmanagementassertedthat
it had the strongest liquidity position of the brokers and that Lehmans funding
frameworkwassignificantlydifferentthanBearStearns.2269Thematerialsnotethat
Bear Stearns liquidity pool relied on shortterm debt, a large free credit balance and
repofinancing.2270ThematerialsimplythatLehmansfundingframeworkdidnotsuffer
fromthesamedefects.2271CallaninformedtheBoardthatLehmandidnotrelyonfree
creditbalances,assetbackedcommercialpaperorsecuredfundingforwholeloans.2272
CallanalsoreportedthatLehmanoperatedatnearrecordlevelsofliquidity.2273Lehman
director Marsha Marty J. Evans told the Examiner that the tone of the meeting was
not about preventing a Lehman collapse similar to Bear Stearns but rather about
navigatingthetroubledwatersandmovingforward.2274
2269Lehman, Presentation to the Board of Directors, Liquidity & Market Update (Mar. 25, 2008), at p. 2
[LBHI_SEC07940_027782].
2270Id.
2271Id.
[LBEXAM003586].
2273Id.
2274ExaminersInterviewofMarshaJ.Evans,May22,2009,atp.15.
633

In late March and early April 2008, Lehman reported nearrecord levels of
liquidity to rating agencies.2275 At the same time, though, Lehman told the rating
agencies that it was focused on building its liquidity fortress.2276 However, Fuld
assertedthat,evenaslateasSeptember15,2008,hewasunawareofanyproblemswith
Lehmans liquidity pool.2277 Similarly, none of the directors who were asked recalled
being apprised of any problem with Lehmans liquidity pool at the March 25, 2008
meetingoratanyothertimepriortoSeptember.2278
(2) LehmansAttempttoReduceitsBalanceSheet
In the second half of 2007, individuals at Lehman began to discuss the need to
reduceLehmansbalancesheetinordertoreduceriskandimproveLehmansreported
leverage ratio.2279 Fuld told the Examiner that by January 2008 he had directed that
2275See, e.g., Lehman, Fitch Ratings Q1 2008 Update (Mar. 27, 2008), at p. 4 [LBEXDOCID 1409767]
(Despitemarketconditions,wehavebeenabletooperateclosetorecordlevelsthroughouttheperiod.
Closed Q1 2008 with $34B of liquidity, representing $7B excess over our cash capital requirements.
MaintainedstrengthoverBSCcollapse:$31B(3/14),$30B(3/17),$33B(3/20).Thereforenoneedaccessto
financingforoveroneyear.).LehmanalsoadvisedtheBoardofnearrecordlevelsofliquidityonMarch
25,2008.LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Mar.25,2008),atp.3
[LBEXAM003586].
2276See,e.g.,Lehman,MoodysInvestorsServiceQ22008Update(May29,2008),atp.12[LBEXDOCID
1021230]. See Section III.A.5.i of this Report and Appendix 20 to this Report, which discusses the
problemswithLehmansliquiditypoolingreaterdetail.
2278ExaminersInterviewofDr.HenryKaufman,Sept.2,2009,atp.12;ExaminersInterviewofThomas
H.Cruikshank,Oct.8,2009,atp.9;ExaminersInterviewofSirChristopherGent,Oct.21,2009,atp.23;
ExaminersInterviewofJerryA.Grundhofer,Sept.16,2009,atpp.67;ExaminersInterviewofRolandA.
Hernandez,Oct.2,2009,atpp.16,20;ExaminersInterviewofJohnD.Macomber,Sept.25,2009,atp.20.
2279See Lehman, Global Real Estate Update (Nov. 6, 2007) [LBEXDOCID 514265] (GREG proposing an
estimated $15 billion reduction in its global balance sheet). Accord Examiners Interview of Richard S.
Fuld,Jr.,Dec.9,2009,atpp.1011;ExaminersInterviewofRogerNagioff,Sept.30,2009,atp.10;seealso
SectionIII.A.1ofthisReport,whichdiscusseseventsduring2006and2007ingreaterdetail.
634

LehmanreduceitsbalancesheetinareasinwhichLehmanwasvulnerable.2280InMarch
2008, Fuld appointed McDade to be balance sheet czar2281 and instructed him to sell
off assets and take other actions necessary to reduce the size of Lehmans balance
sheet.2282ThechartbelowshowshowaspectsofLehmansfinancialconditionchanged
betweenDecember31,2006,andMay31,2008.
2280ExaminersInterviewofRichardS.Fuld,Jr.,Dec.9,2009,atp.11.FuldinitiallytoldtheExaminerthat
hedirectedthereductionofallpositionsbutmatchedbook.ExaminersInterviewofRichardS.Fuld,Jr.,
Sept.25,2009,atp.26.FuldthentoldtheExaminerthathedirectedthereductionoflessliquidassets.
ExaminersInterviewofRichardS.Fuld,Jr.,Nov.19,2009,atpp.89.
2281ExaminersInterviewofAndrewJ.Morton,Sept.21,2009,atp.11.
2282 See Section III.A.1 of this Report, which discusses Lehmans efforts to reduce the balance sheet in
greaterdetail.
635

Q4 Q1072284 Q2072285 Q3072286 Q4072287 Q1082288 Q2082289

062283
NetAssets 268.936 300.797 337.667 357.102 372.959 396.673 327.774
($Billions)
Total 19.191 20.005 21.129 21.733 22.490 24.832 26.276
Shareholder
Equity
($Billions)
WhileLehmansnetassetsgrewbetweentheendofthefourthquarterof2007andthe
closeofthefirstquarterof2008,Lehmanreduceditsholdingsinsomeassetclasses.2290
Duringthefirstquarterof2008,Lehmanreduceditsmortgagerelatedinventoryby$2.7
billion, its high yield instruments by $2.9 billion and acquisition facilities by $6.1
billion.2291
Although Fuld told the Examiner that he directed a reduction in the balance
sheetinJanuary2008,Lehmandidnotmeaningfullyreduceitsbalancesheetinitsmost
2283LehmanBrothersHoldingsInc.,AnnualReportfor2006asofNov.30,2006(Form10K)(filedFeb.13,
2007),atpp.2829(Lehman200610K).
2284LehmanBrothersHoldingsInc.,QuarterlyReportasofFeb.28,2007(Form10Q)(filedApr.9,2007),
atpp.59,61(Lehman10Q(Apr.9,2007)).
2285LehmanBrothersHoldingsInc.,QuarterlyReportasofMay31,2007(Form10Q)(filedJuly10,2007),
atp.65(Lehman10Q(July10,2007)).
2286LehmanBrothersHoldingsInc.,QuarterlyReportasofAug.31,2007(Form10Q)(filedOct.10,2007),
atp.68(Lehman10Q(Oct.10,2007)).
2287LehmanBrothersHoldingsInc.,AnnualReportfor2007asofNov.30,2007(Form10K)(filedJan.29,
2008),atpp.2930(Lehman200710K).
2288LehmanBrothersHoldingsInc.,QuarterlyReportasofFeb.28,2008(Form10Q)(filedApr.9,2008),
atp.72(Lehman10Q(Apr.9,2008)).
2289LehmanBrothersHoldingsInc.,QuarterlyReportasofMay31,2008(Form10Q)(filedJuly10,2008),
atpp.85,88(Lehman10Q(July10,2008)).
2290 See Lehman, Balance Sheet and Key Disclosures, 2008 3Q Targets [Draft] (June 19, 2008), at p. 3
[LBHI_SEC07940_6952937].
2291Id.
636

vulnerable area commercial real estate until the second quarter of 2008.2292 As
disclosed in its periodic filings, Lehmans reduction of its commercial mortgage
related assets, other assetbackedrelated positions and real estaterelated investments
generally2293isshowninthechartbelow.
Q4072294 Q1082295 Q2082296

CommercialRealEstate 38.938 36.110 29.390
AtRisk($Billions)
The reduction during the first quarter of 2008 included a large proportion of
writedownswritedownsrepresented$1.4billionofthe$2.8billiongrossreductionin
commercial real estate.2297 Asset dispositions accelerated during the second quarter of
2292See, e.g., email from Gary Mandelblatt, Lehman, to Alex Kirk, Lehman, et al. (Jan. 15, 2008) [LBEX
DOCID1600235](notingthatthebusinesscontinuestoincreaseitsbalancesheetusagebutisnotselling
or syndicating at the same pace putting pressure on funding needs); email from Mark A. Walsh,
Lehman, to Andrew J. Morton, Lehman (Feb. 26, 2008) [LBHI_SEC07940_115814] (stating that a zero
origination model had been imposed to get the balance sheet down quickly); email from Kenneth
Cohen,Lehman,toCarmineVisone,Lehman,etal.(Mar.27,2008)[LBEXDOCID1374413](Wearevery
muchinneedofbalancesheet.Wemustmovethingsoffbytheendofthequarter.Ineedyoualltogo
back to clients and offer them discounts to move things off. Wehave alot ofwood to chop in a short
period of time but we cant afford to fail. If this means leaving p&l on the table so be it. If you have
questions get back to me but we HAVE TO DO THIS!!); Lehman, Balance Sheet and Disclosure
Scorecard for Trade Date April 21, 2008 (Apr. 22, 2008), at p. 2 [LBEXDOCID 3187588] (showing
continuedgrowthofGREGbalancesheet);emailfromErinM.Callan,Lehman,toHerbertH.McDade,
III,Lehman,etal.(Apr.3,2008)[LBEXDOCID1538729](expressingdismayinthegrowthofthebalance
sheet); email from Erin M. Callan, Lehman, to Joseph M. Gregory, Lehman, et al. (May 13, 2008)
[LBHI_SEC07940_034732].
2293Lehman200710Katp.104.
2294Id.
2295Lehman10Q(Apr.9,2008)atp.20.
2296Lehman10Q(July10,2008)atp.69.
2297Seeid.atp.67.
637

2008,whenwritedownsrepresentedonly$900millionofthe$6.7billiongrossreduction
incommercialrealestateassets.2298
Lehmansetitsbalancesheettargetsandnetleverageratiotargets,inpartatleast,
to improve the firms stature with the rating agencies. Senior Lehman management
made a concerted effort to manage and reduce the firms balance sheet with an eye
towardstheratingagenciesviewsofLehman.2299Fuldexplainedthatalthoughraising
equityalsocouldreducethenetleverageratio,Lehmanhadtoimproveitsnetleverage
by ridding itself of inventory because there was a perception issue with raising
equity, and because raising equity would not eliminate Lehmans problem assets.2300
FuldtoldtheExaminerthatifLehmanhadraisedequity,itwouldhavebroughtdown
thenetleveragenumberbutwouldnotreallyhavefixedanything.2301
(3) LehmanSellsStocktoPrivateandPublicInvestors
On March 28, 2008, Lehman approached Buffett about a potential $3.5 billion
private investment in convertible preferred stock with a conversion price of $54 per
share.2302 Lehman and Buffett did not agree on terms for an investment, and Lehman
proceededinsteadwithapublic offering. OnMarch 31, 2008, Lehmansmanagement
2298Id.
2300Id.
2301Id.
2302
See infra Section III.A.3.c of this Report, which discusses Lehmans conversations with Buffett in
greaterdetail.
638

presented a $4 billion offering of convertible preferred shares to the Board.2303
ManagementspresentationtotheBoardstatesthattheofferingconstitutedpartofthe
firmsplantodeleverage,andthatthefirmalsointendedtoreduceassetsaspartofthe
plan.2304 The Board passed a resolution authorizing the offering.2305 On April4, 2008,
LBHI raised $4 billion by issuing convertible preferred stock.2306 Paulson told the
ExaminerthatFuldwasresistantinitially.AccordingtoPaulson,Fuldpreferredtofind
a strategic investor, rather than pursue other methods of raising capital.2307 Although
LBHI did raise capital in April 2008, Paulson said that he recommended issuing
commonratherthanpreferredstock.2308
OnApril30,2008,LBHIissued$1billion(500million)in10yearseniornotes.2309
OnMay2,2008,LBHIissued$2billionin30yearsubordinatednotesand$2.5billionin
10yearseniornotes.2310
On June 6, 2008, Lehmans management presented a stock offering totaling $6
billiontotheBoard.2311TheBoardpassedaresolutionauthorizingtheoffering.2312On
[LBEXAM003597].
2304Id.
2305Id.atpp.23.
2306LBHI8K(Apr.4,2008).
2308Id.
2309See Lehman, Presentation to Lehman Brothers Board of Directors, Estimated April 2008 Financial
Information(May7,2008),atp.8[LBHI_SEC07940_028014].
2310Id.
2311Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (June 6, 2008), at p. 3
[LBEXAM003709].
639

June12,2008,LBHIsold2millionsharesofconvertiblepreferredstockfor$2billion.2313
That same day, LBHI sold 143 million shares of common stock for $4 billion ($28 per
share),completingthe$6billionoffering.2314
TheGovernmentspokefavorablyofLehmansJune2008actionstoraisecapital.
TreasuryUndersecretaryRobertSteelpubliclystatedthatLehmanwasaddressingthe
issuesthroughitsJune2008capitalraise.2315PaulsontoldtheExaminerthathedidnot
knowofanychiefexecutiveswholosttheirjobsforraisingtoomuchequitycapital.2316
(4) SpinCo
TheSpinCoideawasavariationonagoodbank/badbankstructure.2317Among
Lehmans strategic options, SpinCo had a longer time horizon than other options,
becausesubstantialadvanceworkwouldbeneeded.ByearlyAugust2008,2318Lehman
anticipated completing the spinoff in the first quarter of 2009.2319 Lehman intended
SpinCo to accomplish four interrelated purposes. The first and primary purpose of
2312Id.
2313LBHI8K(June12,2008).
2314Id.
2315Seeemail from Thomas A. Russo, Lehman, to Richard S. Fuld, Jr., Lehman (June 13, 2008)
[LBHI_SEC07940_212723].
2317ExaminersInterviewofGaryParr,Sept.14,2009,atp.10.
2318See Lehman, Commercial Real Estate Spinoff Summary (Aug. 6, 2008), at p. 8
[LBHI_SEC07940_013317](PreliminarySummaryTimelineshowsSpinCodistributiondateduringthe
weekof1/2/2009);accordLehman,ProjectGreenRevisedProjectedCapitalAnalysis(Aug.14,2008),atp.
1[LBEXDOCID236909](CREassetsof$31.7Bspunoffattheendof1Q09.),attachedtoemailfrom
BradWhitman,Lehman,toKunhoCho,Lehman,etal.(Aug.14,2008)[LBEXDOCID407341].
(Sept.10,2008),atp.5[LBHI_SEC07940_612771].
640

SpinCowastorelieveLehmansbalancesheetofitsoutsizedcommercialrealestate
exposure that had become a source of increasing market concern and pressure.2320
Second, by moving those assets to a separate entity, Lehman hoped to avoid the
necessityofhavingtocontinuemarkingdownthoseassetsasthemarketcontinuedto
deteriorate.ThatprocesshadexposedLehmantocriticisminthepressandbyanalysts
inwhatHughSkipE.McGee,III,theheadofLehmansInvestmentBankingDivision,
referredtoasthearewemarkedcorrectlygame.2321
Third, by spinning off those assets, Lehman would avoid a fire sale for the
vultures2322thatwouldhavelockedinitspaperlosses.2323Instead,SpinCowouldallow
LehmantomanagethoseassetsonavaluemaximizingbasisforthebenefitofLehmans
shareholders, either by selling the SpinCo assets or holding them to maturity.2324
2320See Lehman, Lehman Commercial Mortgage Exposure is Outsized Relative to Peers

[LBHI_SEC07940_339455],attachedtoemailfromKevinThatcher,Lehman,toIanT.Lowitt,Lehman,et
al.(June10,2008)[LBHI_SEC07940_339451];Lehman,TheGameplan(Sept.2008),atp.4[LBEXDOCID
2727665] (In recent months, shareholders, creditors, and counterparties have expressed increasing
concern about the size and concentration of our positions and their impact on our overall
creditworthiness, and they have put increasing pressure on the firm to reduce our exposure.). Accord
ExaminersInterviewofThomasA.Russo,May11,2009,atp.9.
2321Email from Hugh E. McGee, III, Lehman, to Steven R. Hash, Lehman, et al. (June 11, 2008)
[LBHI_SEC07940_398653]; Examiners Interview of Mark A. Walsh, Oct. 21, 2009, at p. 14; Examiners
InterviewofHughE.McGee,III,Aug.12,2009,atpp.2021.
2323See email from Larry Wieseneck, Lehman, to Brad Whitman, Lehman (July 5, 2008)
[LBHI_SEC07940_401266]([CREspinoff]doesnotrequirenegotiationswithsomeonewhowillfeelthey
haveleverageagainstusanddemandalowerprice.).AccordExaminersInterviewofRichardS.Fuld,
Jr., May 6, 2009, at p. 6; Examiners Interview of David OReilly, Oct. 26, 2009, at p. 3; Examiners
InterviewofLisaBeeson,Oct.23,2009,atpp.89.
2324ExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atpp.56(SpinCowouldtakecareofthe
valuationproblemforsomeoftheassets);ExaminersInterviewofHughE.McGee,III,Aug.12,2009,at
p. 23 (spinning off the commercial real estate assets to the shareholders, who owned them already
641

Fourth, once Lehman had purged its balance sheet of toxic commercial real estate
assets, it hoped that the postspin clean or core Lehman (a.k.a. CleanCo) could
achievereturnsonequityinthelowteens,twelvetimesnetleverage,andmaintainanA
rating.2325
However,SpinCofacedsubstantialstructuralandexecutionissuesthatledsome
observerstoquestionitsfeasibility.PaulsontoldtheExaminerthatheexpressedgreat
skepticism about SpinCo to Fuld and advised him to abandon the plan.2326 James L.
JamieDimon,JPMorgansCEO,toldtheExaminerthathedidnotbelievethatSpinCo
wouldwork,thinkingthattheproposalwastooleveraged,toocomplex,andinvolved
toomuchrealestate.2327WhentheconceptwasdescribedtoBuffett,hedismissedit.2328
Ultimately,LehmanwasnotabletocarryouttheSpinCoplanpriortoitsbankruptcy.
(a) EvolutionofSpinCo
LehmanexecutivesfirstconsideredshiftingLehmanstroubledrealestateassets
toanoffbalancesheetentityinMarch2008.2329OnMarch12,2008,CallanaskedMark
anyway,wouldrelievethemarktomarketpressureonLehmanwhilelettingtheassetsmatureoutofthe
glareofthemarket);ExaminersInterviewsofStevenBerkenfeld,Oct.5and7,2009,atp.17.
2325See,e.g.,Lehman,TransactionSummary[Draft](Sept.5,2008)[LBEXDOCID237627](investorterm
sheetdescribingoptiontoinvestinCleancoshares);Lehman,SpinCoConceptandRationaleInvestor
PresentationOutline(Aug.12,2008),atp.3[LBEXDOCID2929104](PostSpinCo,theremainingClean
Lehmanwillbewellpositionedforsuccess),attachedtoemailfromTimothyLyons,Lehman,toIanT.
Lowitt, Lehman, et al. (Aug. 12,2008)[LBEXDOCID 3116194]. Accord Examiners Interview of GaryS.
Barancik,Sept.25,2009,atp.4.
2326ExaminersInterviewofHenryM.Paulson,Jr.,June25,2009,atpp.3,24.
2327ExaminersInterviewofJamieL.Dimon,Sept.29,2009,atp.5.
2328ExaminersInterviewofWarrenE.Buffett,Sept.22,2009,atp.4.
2329See email from Erin M. Callan, Lehman, to Mark A. Walsh, Lehman (Mar. 12, 2008)
[LBHI_SEC07940_116854];emailfromStevenR.Hash,Lehman,toDanielKerstein,Lehman,etal.(Apr.
642

A.Walsh,theHeadofGlobalRealEstate,whathethoughtofputtingsomeofLehmans
commercial mortgage assets into a new real estate investment trust and spinning it
(i.e., transferring ownership of the new entity) to Lehmans shareholders.2330 Walsh
respondedwithconcernsabouthowthenewentitywouldtradeanditsimpactonhow
Lehmanwouldtrade.2331Lehmandidnotpursuetheideaatthattime.
OnJune11,2008,McGeeproposedhisownversionofthecommercialrealestate
spinoff concept to a group of Lehmans investment bankers.2332 The initial response
wasthatotherLehmanexecutivesalreadyhadrejectedtheideabecauseitrequiredtoo
muchequitybeneathit.2333Nonetheless,theSpinCoideagainedtractioninJune2008
andbecameacentralcomponentofLehmanspostBearStearnssurvivalstrategy.
Led by McGee,2334 the SpinCo plan (codenamed by Lehman Project Green
Acres)wasakeycomponentoftheFirmsselfhelpstrategy.Itwassupposedtobea
way to address Lehmans problems without a strategic partner, before collapsing
11,2008)[LBHI_SEC07940_089122];emailfromErinM.Callan,Lehman,toStevenR.Hash,Lehman,et
al. (Apr. 17, 2008) [LBHI_SEC07940_274912]; email from David Baron, Lehman, to David Goldfarb,
Lehman,etal.(Apr.23,2008)[LBEXDOCID1558959,1400312](attachingslidesreManagingtoaBad
AssetSolution).
2330Email from Erin M. Callan, Lehman, to Mark A. Walsh, Lehman (Mar. 12, 2008)
[LBHI_SEC07940_116854].
2331Email from Mark A. Walsh, Lehman, to Erin M. Callan, Lehman (Mar. 12, 2008)
[LBHI_SEC07940_116854].
2332 See email from Hugh E. McGee, III, Lehman, to Larry Wieseneck, Lehman, et al. (June 11, 2008)
[LBHI_SEC07940_398653].
2333Email from Larry Wieseneck, Lehman, to Hugh E. McGee, III, Lehman, et al. (June 11, 2008)
[LBHI_SEC07940_398653]([Daniel]Kersteinproposedthis3monthsago.ComboofGoldfarbandparts
of RE rejected it. I think Hash knows why it was challenging. I believe because it required too much
equitybeneathit.).
2334Lehman,GreenAcresWorkingGroup(July23,2008)[LBHI_SEC07940_125904](showingMcGeeas
head).
643

commercial real estate values [took] down the mother ship.2335 As Fuld told David
Goldfarb, Lehmans Chief Strategy Officer, in a July 19, 2008 email: The key to our
success is the viability of the spinco.2336 At the July 22, 2008 Board meeting, McGee
presented SpinCo as a strategic alternative, and Gary Parr, Deputy Chairman of
Lazard, Lehmansstrategicadvisor,toldtheBoardthatSpinCo wasa great idea that
shouldbeaggressivelypursued.2337Appendix13tothisReportprovidesgreaterdetail
onSpinCo.
(b) ExecutionIssues
From the outset, Lehman recognized that the SpinCo plan faced significant
obstacles.2338First,providingthenewentitywithsubstantialcashcapitalthreatenedto
leaveanequityholeinLehmansowncapitalstructure.Second,Lehmanneededtofind
investorswhowouldbewilling,inatroubledmarket,tofinanceanentitycomprisedof
Lehmans commercial real estate assets. Third, Lehman needed to clear critical
accountingissueswiththeSEC.Fourth,preparingfinancialmodelsforSpinCowould
2335See email from Hugh E. McGee, III, Lehman, to Mark A. Walsh, Lehman (June 13, 2008)
[LBHI_SEC07940_123660]. Accord Examiners Interview of Hugh E. McGee, III, Aug. 12, 2009, at p. 23;
Examiners Interview of Herbert H. McDade, III, Sept. 16, 2009, at p. 3; Examiners Interview of Lisa
Beeson,Oct.23,2009,atp.9.
2336Email from Richard S. Fuld, Jr., Lehman, to David Goldfarb, Lehman (July 19, 2008)
[LBHI_SEC07940_213011].
2337Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (July 22, 2008), at p. 6
[LBEXAM003866].SeeAppendix13IV,V,whichdiscussesLazardsproposedalternativeandSpinCo
ingreaterdetail.
[LBHI_SEC07940_116854];Lehman,ManagingtoaBadAssetSolution[Draft][LBEXDOCID1400312]
(keychallengestoBadAssetsolutionincludedfinancingNewCoassetsandreplenishingcapitallost
inassetdispositions),attachedtoemailfromDavidBaron,Lehman,toDavidGoldfarb,Lehman,etal.
(Apr.23,2008)[LBEXDOCID1558959].
644

require Lehman to value thousands of rapidly devaluing commercial real estate
positions.
(i) EquityHole
To establish SpinCo as a viable independent entity and to avoid consolidation
with Lehman, Lehman would have to capitalize SpinCo with substantial equity,
amounting to at least 20 to 25 percent of SpinCos net asset value.2339 Providing that
equity from Lehmans own cash capital would leave a corresponding hole in
Lehmanscapitalstructure,whichalreadywasdepletedbywritedownsandlosses.2340
Indeed, when McGee floated the good bank/bad bank concept in early June 2008,
Larry Wieseneck, Lehmans Global Head of Risk Solutions, responded that Goldfarb
andLehmansGlobalRealEstateGrouphadrejectedtheideabecauseitrequiredtoo
muchequitybeneathit.2341
2339See email from Daniel Kashdin, Lehman, to Daniel Kerstein, Lehman, et al. (July 11, 2008)
[LBHI_SEC07940_401374] (To preclude consolidation, there will need to be a substantial amount of
equityinthedeal);emailfromDavidGoldfarb,Lehman,toRichardS.Fuld,Jr.,Lehman(July21,2008)
[LBEXDOCID 1224222] (There is a minimum of capital needed to deconsolidate which is approx $6
billion and obviously we would like to raise much more to reduce our ongoing financing of Spinco).
AccordExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atp.7;ExaminersInterviewofHughE.
McGee,III,Aug.12,2009,atp.23.
2340See,e.g.,emailfromGerardReilly,Lehman,toMartinKelly,Lehman(July19,2008)[LBEXDOCID
2117905](Ihaveheardasmuchas14bofequityneededon35bofassets.Doesnotleaveremainingcow
much.); email from Eric Felder, Lehman, to Paolo R. Tonucci, Lehman (Aug. 10, 2008)
[LBHI_SEC07940_538151](Wearetoosmallpostspincoinmyopinion).
2341Email from Larry Wieseneck, Lehman, to Hugh E. McGee, III, Lehman (June 11, 2008)
[LBHI_SEC07940_398653]; see also email from Daniel Kerstein, Lehman, to Larry Wieseneck, Lehman
(July22,2008)[LBHI_SEC07940_404505](Havebeenthinkingthisthroughandcomingtoconclusionwe
wontdospinbecausetoomuchequityandfinancingwontworkforthespinco);emailfromTimothy
Lyons, Lehman, to Alex Kirk, Lehman (July 22, 2008) [LBHI_SEC07940_174554] (Given your views on
thelikelihoodofspinco,IthinkweneedtomoveharddownthepathofPlanB);emailfromEricFelder,
645

For McGee and Goldfarb, the questions were how big the hole would be and
whetherLehmanwouldhavetofillitpreorpostspin.2342Tofillthatholeandbolster
its own position,2343 Lehman would need to raise capital.2344 By midsummer 2008,
Lehmans ability to raise capital by issuing shares was severely constrained by its
previouscapitalraisesaswellasaconstrictingmarket.2345Thenextoptionwastosell
assets, so Lehman looked to its crown jewel, IMD, and especially, NB, which was
IMDsprivateassetmanagementarm.2346DuringJuly2008,Lehmanconsideredselling
Lehman,toPaoloR.Tonucci,Lehman(Aug.10,2008)[LBEXDOCID1297372](Wearetoosmallpost
spincoinmyopinion.).
2342See, e.g., email from David Goldfarb, Lehman, to Richard S. Fuld, Jr., Lehman (July 20, 2008)
[LBHI_SEC07940_213013] (The construct of Spinco does work. The challenge is getting the outside
capital . . . . There is a minimum of capital needed to deconsolidate which is approx $6 billion and
obviously we would like to raise much more to reduce our ongoing financing of Spinco);email from
BradWhitman,Lehman,toHughE.McGee,III,Lehman(Aug.5,2008)[LBEXDOCID4067934](Model
suggestingthatmaintaining12xleveragewouldrequireabout$7BincapitalincleanRemainderCO.Ian
[Lowitt]thinksthatweshouldbetargetinghigherleverageratio(becausehavegottenridofhigherrisk
weighted assets). Which is to say, hes thinking capital [to fill equity hole] of some number north of
$5B.); email from Hugh E. McGee, III, Lehman, to Brad Whitman, Lehman (Aug. 10, 2008)
[LBHI_SEC07940_538201](Wehavealreadyraisedalotofcapital.Canweusesomeofwhatwealready
raised to bridge us here. Then we raise capital at time of diversion of equity to spinco). Accord
ExaminersInterviewofHughE.McGee,III,Aug.12,2009,atp.23.
2343SeeLehman,SECtalkingpoints[Draft](Aug.11,2008),atp.2[EYLELBHIKEYPERS0907480](The
distributedequity[forSpinCo]willnotbereplacedonadollarfordollarbasisasLehmanwillnolonger
besupportingthecommercialrealestateportfolio).
2344ExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atpp.911;ExaminersInterviewofHughE.
McGee,III,Aug.12,2009,atp.23;ExaminersInterviewofGaryParr,Sept.14,2009,atpp.1011.
2345See, e.g., email from Paolo R. Tonucci, Lehman, to Christian Wait, Lehman (July 17, 2008)
[LBHI_SEC07940_529261](forwardingMoodysInvestorsService,PressRelease(July17,2008)(Lehman
has very limited capacity for additional preferred securities in its capital structure, and the difficult
market environment for Lehman in raising common equity capital . . . limits its ability to respond to
furtherunexpectedlosses)).
2346Examiners Interviews of Steven Berkenfeld, Oct. 5 and 7, 2009, at p. 18; Examiners Interview of
RichardS.Fuld,Jr.,May6,2009,atpp.911;ExaminersInterviewofHughE.McGee,III,Aug.12,2009,
atpp.2324;ExaminersInterviewofGaryParr,Sept.14,2009,atpp.910.Lehmanseniormanagement
had contemplated the possibility of selling off all or part of IMD since 2007. See Memorandum from
HughE.McGee,III,Lehman,toRichardS.Fuld,Jr.,Lehman,etal.,re:analysisofpossiblesaleorcarve
646

IMDaspartofitsProjectGreensurvivalstrategies.2347ByearlyAugust2008,McGee
and other Lehman executives had come to regard an IMD sale as one of the primary
options for addressing the equity hole.2348 Lehman was concerned that selling IMD
would have a negative impact on Lehmans credit ratings, but by the end of August
2008,LehmansmanagementandtheBoardhadacceptedtheneedtosellatleastpartof
IMDtofilltheequityholethatSpinCowouldcreate.2349
In early September 2008, a Lehman presentation circulated among senior
management,CapitalHoleAnalysis,estimatesthatspinningoff$31.6billioninassets
out of IMD (May 29, 2007) [LBEXDOCID 711211]; David Erickson, Project Hercules (May 18, 2007)
[LBEXDOCID727278].
2347SeeLehman,DiscussionMaterialsfortheExecutiveCommittee(July21,2008),atp.3[LBEXDOCID
612664] (estimates that, at $6 billion total valuation of IMD, sale of 100% will generate aftertax cash
proceedsof$1.7billion,plus$3billiongaintoLehmanequityviareducedgoodwill),attachedtoemail
from Timothy Sullivan, Lehman, to Jasjit Bhattal, Lehman, et al. (July 21, 2008) [LBEXDOCID 741718];
Lazard, Discussion MaterialsProject Green [Draft] (Aug. 7, 2008) [LBHI_SEC0794_647930] (comparing
effects on Lehman of commercial real estate spinoff with or without a sale of 51% or 100% of IMD);
LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(July31,2008),atp.2[LBEX
AM 00387576] (Fuld reported to the Board about the threepart transaction that had been previously
reviewedwiththeBoardofDirectorsinvolvingaspinoutofthecommercialrealestatebusiness,thesale
of the Investment Management Division, and the raising of capital). Accord Examiners Interview of
RichardS.Fuld,Jr.,May6,2009,atp.9.
2348See, e.g., Lehman, Discussion Materials for the Executive Committee (July 21, 2008), at p. 3 [LBEX
DOCID612664],attachedtoemailfromTimothySullivan,Lehman,toJasjitBhattal,Lehman,etal.(July
21,2008)[LBEXDOCID741718];emailfromAngelaJudd,Lehman,toHughE.McGee,III,Lehman,et
al. (Aug. 8, 2008) [LBHI_SEC07940_647930] (forwarding Project Green presentation prepared by
Lazard,comparingeffectsonLehmanofcommercialrealestatespinoffwithorwithoutasaleof51%or
100%ofIMD);LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(July31,2008),
atp.2[LBEXAM003875].AccordExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atp.9.
2349ExaminersInterviewofDr.HenryKaufman,Sept.2,2009,atpp.1617;ExaminersInterviewofJerry
A.Grundhofer,Sept.16,2009,atp.13;ExaminersInterviewsofStevenBerkenfeld,Oct.5and7,2009,at
p. 18. But see email from Hugh E. McGee, III, Lehman, to Richard S. Fuld, Jr., Lehman (Aug. 25,2008)
[LBHI_SEC07940_213294](forwardingtalkingpointsthatincludetheneed[t]ofilltheequityholefrom
SpinCo, will need to raise $34B of equity. May raise this via partial sale of IMD but that is not the
preferredroute.RunningaprocessforallofIMD;initialindicationsforthewholethingrangefrom$8
11B.TotalmarketcapofGreentodayis~$9.5Bmakesnosense).
647

wouldrequireLehmantotransfer$7.9billionequitytoSpinCoforSpinCotoachievea
75% loantovalue ratio.2350 To provide that $7.9 billion, Lehman hoped to raise $2.5
billionthroughasaleof51%ofIMDandtoraiseanother$3billionbyissuingequity,
butthatstillwouldleave$2billionormoretoberaisedfromathirdpartyinvestor.2351
WhenLehmanpreannounceditsearningsonSeptember10,2008,Lehmanhad
not yet finalized its approach to filling the equity hole. During the earnings call,
Lehman announced its planto separateavast majorityofourcommercialrealestate
assetsfromourcorebusinessbyspinningoffthoseassetstoourshareholdersandtoan
independent, publicly traded entity which will be adequately capitalized, and stated
thatLehmanwasinthefinalstagesofraisingcapitalwithsaleofamajoritystakein
IMD.2352 Analysts asked whether Lehman needed additional capital in order to
capitalizeSpinCo,andwhetherthesaleofIMDwasexpectedtoresultinonly$3billion,
towhichLowittresponded:Wedontfeelthatweneedtoraisethatextraamountto
coverthe$7billionbecauseyouwillhavelessleverageableequityincoreLehmanthan
inwhereyouareattheendofthisquarter.2353
2350Lehman,CapitalHoleAnalysis(Sept.8,2008),atp.1[LBHI_SEC07940_409438].
2351Id.ButseeLehman,SECtalkingpoints[Draft](Aug.11,2008),atp.2[EYLELBHIKEYPERS0907480]
(Thedistributedequity[forSpinCo]willnotbereplacedonadollarfordollarbasisasLehmanwillno
longerbesupportingthecommercialrealestateportfolio).
(Sept.10,2008),atp.3[LBHI_SEC07940_612771].
2353Id.at19.
648

Afterthecall,analystsreactedskepticallytoLehmansexplanationsandzeroed
inontheequityhole.2354BarclaysCapitalanalystRobertFergusonwrote:
ThekeyproblemistheamountofequitythatitwilltakeforthenewREI
spinoff.Theyreallyseemedtododgethequestiononthecall....[H]ow
wouldtheyexpecttotransfertheCREportfolioatitscurrentmarktothe
SpinCoifthemarketbidsforthataresignificantlylower?Wouldntthey
havetoholdsomeprovisioninanonMTMbook?2355
VincentCurotto,ananalystforSanfordBernstein,wrote:
While Lehmans management yesterday said that it does not expect to

havetoraisecapitalinordertoreachitsdestinationofbeinganewLEH
(sale of NEU, spinoff of CRE/CMBS, etc), we are skeptical. Our work in
our Monday piece implies that LEH would have to raise $7.5 billion in
order to capitalize this spin off adequately and maintain a 20x leverage
ratio.2356
AnalystsestimatedthatLehmanwouldhavetoraiseatleast$6to$9billiontocapitalize
thespinoffandrestoreLehmansleverageratio.2357
(ii) OutsideFinancingforSpinCo
In addition to providing the cash equity needed to capitalize SpinCo, Lehman
also would need to finance at least some of the assets that it transferred to the new
2354See, e.g., email from Robert Ferguson, Barclays Capital, to Mike Keegan, Barclays Capital (Sept. 10,
2008)[BCIEX(S)00035195].
2355Id.
2356Email from Vincent Curotto, Sanford Bernstein, to Stuart Schwadron, Sanford Bernstein (Sept. 11,
2008)[SBSEC048150].
2357See,e.g.,id.(estimatingthatLehmanwouldhavetoraise$7.5billioninordertoadequatelycapitalize
the spinoff and maintain its leverage ratio); UBS, Notes regarding Lehmans commercial real estate
spinoff(Sept.11,2008)[SECUBS00663](estimatingthatLehmanwouldneedbetween$6billionand$9
billion in equity to fund SpinCo, taking a pretty good chunk of capital out of the good Lehman and
potentiallycaus[ing]ittoraisecommonequity).
649

entity.2358Lehmanexecutivesrecognizedfromtheoutsetthatitwouldbecriticaltofind
independentfinancingforthenewentity.2359WhilethespinoffwouldrelieveLehmans
balancesheetofthetransferredassets,LehmanwouldholdSpinCosnotesasFuld
noted to Goldfarb: We need to get others to finance [SpinCo] so it doesnt sit on our
balancesheet.2360
Lehman hoped to attract outside financing for SpinCo by tranching Lehmans
seller financing.2361 The initial goal was to sell $2 to $6 billion of the highestrisk,
highestreturnmezzaninetranchesofthedebt.2362ByAugust2008,LehmansProject
Green Acres team had reached out to selected investors,2363 mostly private equity
2358ExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atpp.68.
[LBHI_SEC07940_116854] (Clearly have to address financing of the assets which we would primarily
have to provide to Newco from the outset); email from Steven R. Hash, Lehman, to Erin M. Callan,
Lehman,etal.(Apr.14,2008)[LBHI_SEC07940_274912](Ithoughtwehaddecidedthestructurewould
not work because independent financing is not available); email from Steven R. Hash, Lehman, to
DanielKerstein,Lehman,etal.(June10,2008)[LBEXDOCID1475676]([P]roblemisfinancingandthe
assets thatgreg owns. Iethere is really noindependent financing for these assetsin the market today.
Nofinancingmeansnoactualbusinessplan).
2360Email from Richard S. Fuld, Jr., Lehman, to David Goldfarb, Lehman (July 19, 2008)
[LBHI_SEC07940_213011].
2362See Lehman, Project Green Talking Points for Potential Investors (Aug. 6, 2008) [LBEXDOCID
363782] (describing option to purchase up to 20% stake in postspin Lehman (via $5 billion forward
payment), conditional on purchase of meaningful portion ($34 billion) of SpinCo mezzanine
securities); see also email from David Goldfarb, Lehman, to Martin Kelly, Lehman, et al. (July 21, 2008)
[LBEXDOCID2997880](SpinCo...ifwegetoutsidepartytopurchasefullMezzpiece,56billionwe
canownallsenior20billandshareholdersownequityandwestillgettodeconsolidate.Right?).Accord
ExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atp.7.
2363Notably,McGeestatedthathewasnotawarewhetheranyoneatLehmanapproachedinvestorstotest
thewaterinthemarketplaceforSpinConotes,ormadeanyothereffortpriortotheSeptember10,2008
earningscalltolineupinvestorsforSpinCodebt.ExaminersInterviewofHughE.McGee,III,Aug.12,
2009,atpp.2425.
650

groups,aboutSpinCosmezzaninedebt.2364Lehmanalsohopedtosyndicatepartofthe
senior debt financing.2365 The rating agencies that reviewed the SpinCo plan in mid
August underscored the importance of Lehman being able to syndicate some of
SpinCosseniordebt.2366EileenFahey,amanagingdirectorofFitch,toldtheExaminer
that her preliminary conclusion was that Lehman would be left financing SpinCos
assetsandwouldstillbeonthehookforanySpinColosses.2367
In March 2008, Lehman had approached Buffett concerning a private
investment.2368 In midJuly 2008, Lehman again considered approaching Buffett about
2364See,Lehman,ProjectGreenAcresDailyUpdate(Aug.8,2008)[LBEXDOCID2253477],attachedtoe
mailfromSarahKadetz,Lehman,toLisaBeeson,Lehman,etal.(Aug.8,2008)[LBEXDOCID2151027];e
mailfromLisaBeeson,Lehman,toLarryWieseneck,Lehman,etal.(Aug.8,2008)[LBEXDOCID544666];
Lehman, Summary of Conversations with Potential Capital Providers (Aug. 27, 2008) [LBEXDOCID
947915](listingpotentialinvestorsincludingApollo,Blackstone,Carlyle,Cerberus,Colony,Fortress,J.E.
Roberts, Lone Star, Lubert Adler, OchZiff, Vornado, and Walton Street), attached to email from Alex
Kirk,Lehman,toMichaelGelband,Lehman(Aug.27,2008)[LBEXDOCID961894].
2365See email from David Goldfarb, Lehman, to Paolo R. Tonucci, Lehman, et al. (July 19, 2008)
[LBHI_SEC07940_404388] (Need some creative ways to fund Spinco. Best to get some relationships
whichdocommercialrealestatelendinginscale.Theycouldbuyseniorsormezzs.Startthinking,this
iskeychallengethatneedstobenailed);emailfromGerardReilly,Lehman,toIanT.Lowitt,Lehman,et
al.(July22,2008)[LBEXDOCID2997880]([S]ellingmezzcertainlyhelpsasitsupportsvalidityofcapital
structure.IfwecanfindotherSRdebtinmarketandgainsomecomfortonourspreadthenwecouldcall
it[aLevelIIasset].PlacingsomeSrisbest).AccordExaminersInterviewofRichardS.Fuld,Jr.,May6,
2009,atp.7.
2366See,e.g.,emailfromHughE.McGee,III,Lehman,toJeffreyL.Weiss,Lehman,etal.(Aug.13,2008)
[LBHI_SEC07940_406811] (forwarding Tonucci email summarizing a meeting with Fitch re: SpinCo:
[S]elling the senior debt ability to do so seemed important in their assessment of what had been
accomplished); email from Ian T. Lowitt, Lehman, to Hugh E. McGee, III, Lehman (Aug. 13, 2008)
[LBHI_SEC07940_364012] ([Rating agencies] dont think [SpinCos] operators will find alternative
sourcesoffinancingaseasilyasimpliedinourmodel.Willhavetoworkhardtoconvinceagenciesand
otherpotentialfunders.Mustmakesurethisisnot[G]oldfarboverexuberanceatworkhere).
2367ExaminersInterviewofEileenA.Fahey,Sept.17,2009,atp.6.
2368SeeinfraSectionIII.A.3.cofthisReport,whichdiscussesLehmanstalkswithBuffettingreaterdetail.
651

investing in SpinCo debt.2369 In late August or early September 2008, McGee called
MidAmericanEnergyHoldingsPresidentDavidL.Sokol,hopingtoenticeSokoleither
to have MidAmerican Energy Holdings invest in the SpinCo plan or to advocate the
plan to Buffett.2370 McDade and McGee showed Sokol Lehmans Gameplan
presentation,explainingthatLehmanwasreadytoexecutetheplanifLehmanhadan
investor.2371Sokolwasnotinterestedininvesting,butrelayedthebasicpremiseofthe
SpinCo plan to Buffett.2372 During that discussion, Buffett dismissed the idea as
unrealistic.2373
Lehman discussed the SpinCo plan in detail during its preannouncement
earningscallonSeptember10,2008,butitdidnotdiscussitseffortstosellportionsof
LehmansSpinCodebt,becausethesyndicationwasnotyetinplace.2374
2369Seeemail from Larry Wieseneck, Lehman, to Brad Whitman, Lehman, et al. (July 18, 2008)
[LBHI_SEC07940_404298](Weshouldconsidergettingthe[SpinCo]loanratedandpossiblywrappedby
Berkshire).
2370ExaminersInterviewofHughE.McGee,III,Aug.12,2009,atp.17;ExaminersInterviewofDavidL.
Sokol,Sept.22,2009,atp.2.
2371Lehman, The Gameplan (Sept. 2008) [LBHI_SEC07940_653681], attached to email from Hugh E.
McGee, III, Lehman, to David L. Sokol, MidAmerican Energy Holdings Co. (Sept. 4, 2008)
[LBHI_SEC07940_653680]; Examiners Interview of Hugh E. McGee, III, Aug. 12, 2009, at p. 17;
ExaminersInterviewofDavidL.Sokol,Sept.22,2009,atp.4.
2372Sokol does not recall specifically whether he communicated Lehmans SpinCo plan to Buffett;
however,BuffettrecalledSokolbriefinghimonthebasiccontoursoftheplanoratleast,something
they tossed out about a CRE spin. Examiners Interview of David L. Sokol, Sept. 22, 2009, at p. 3;
ExaminersInterviewofWarrenE.Buffett,Sept.22,2009,atp.4.
652

(iii) SECIssues
For SpinCo to work as planned, the SEC had to approve the accounting
treatment Lehman proposedto use.2375First, Lehmanhopedto avoid the requirement
thatSpinCoprovidethreeyearsofauditedfinancialstatementscoveringtheassetsthat
Lehmanwouldtransfer.2376Second,Lehmansoughttoavoidusingmarktomarketor
fairvalueaccountingofSpinCosloanassetsandsoughttoaccountforSpinCosdebt
securities on a hold to maturity basis.2377 Third, Lehman hoped to structure the
SpinCotransactioninsuchawaythatthespinoffwouldbetaxfreetoLehmanandits
shareholders.2378LehmanwasabletoobtainSECapprovalofthefirsttwogoalsbutthe
SECagreementeffectivelydoomedLehmanstaxtreatmentgoal.
a. AuditingandAccountingIssues
Lehmansaccountantsregardedpreparationofhistoricalfinancialstatementsfor
SpinCos Form 10 as a major problem.2379 SEC rules typically require a company to
2375See email from Daniel Kashdin, Lehman, to Daniel Kerstein, Lehman, et al. (July 11, 2008)
[LBHI_SEC07940_401374] (Likely that E&Y would require Lehman to preclear [SpinCo] transaction
withSEC);Lehman,SECDiscussionMaterials[Draft](July28,2008)[LBHI_SEC07940_404819];Lehman,
GreenAcresOverviewofPotentialAlternatives[Draft](July30,2008)[LBHI_SEC07940_405303].Accord
2376ExaminersInterviewofThomasH.Cruikshank,Oct.8,2009,atp.9.
2377Id.; Examiners Interview of David OReilly, Oct. 26, 2009, at p. 4; Examiners Interview of Paul A.
Hughson,Oct.28,2009,atpp.910.
2378See, e.g., Lehman, Key Execution Considerations for SpinOff [Draft] (July 11, 2008)
[LBHI_SEC07940_401591](TransactionlikelycanbestructuredastaxfreetoshareholdersifSpinCoisa
CCorp).AccordExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atp.7.
2379SeeemailfromMartinKelly,Lehman,toDavidGoldfarb,Lehman,etal.(July17,2008)[LBEXDOCID
560179] (Single largest issue here will be the form of financial statements required by the s e c if we
needtoprepareandhaveauditedaseparatesetoff[i]nancialsfortherealestatebusinessthatwillbea
huge undertaking); Lehman, SpinCo Talking Points for SEC [Draft] (Aug. 6, 2008) [LBEXDOCID
653

provide three years of audited financial statements for newly acquired real estate
operations.2380 Because of the number and diversity of the underlying CRE assets,
compilingthosestatementsforSpinCowouldbeahugeundertakingthatcoulddelay
SpinCosexecutionbeyondapracticaltimehorizon.2381
InAugust2008,LehmansoughtawaiverfromtheSEC.2382Lehmanarguedthat
complete historical documentation of the financial performance and administrative
costsofSpinCosnumerous,diverseassetssimplydidnotexist.2383Insteadofaudited
historicalfinancialstatements,Lehmanproposedtoprovideinvestorswithanaudited
opening balance sheet and up to three years of prospective financial statements, along
with specific information on individual assets that would be limited to type of
property, occupancy percentage, geographic location, square footage, acquisition cost,
indebtednessandpropertylevelcashflows.2384
1295521],attachedtoemailfromDanielKerstein,Lehman,toStevenBerkenfeld,Lehman(Aug.6,2008)
[LBEXDOCID1297492].
2380SeeLehman,SECTalkingPoints[Draft](Aug.8,2008)[LBEXDOCID851411],attachedtoemailfrom
MichaelJ.Langer,Lehman,toThomasA.Russo,Lehman,etal.(Aug.8,2008)[LBEXDOCID965295];see
also17C.F.R.210.314(2008),SECReg.SXRule314,SpecialInstructionsforRealEstateOperationsto
beAcquired.
2381EmailfromMartinKelly,Lehman,toDavidGoldfarb,Lehman(July17,2008)[LBEXDOCID560179];
Lehman,SpinCoProposedTermSheet[Draft](Aug.19,2008),atp.5[EYLELBHIKEYPERS3670025],
attached to email from Robert Downs, Sullivan & Cromwell, to Martin Kelly, Lehman, et al. (Aug. 19,
2008)[EYLELBHIKEYPERS3670025];ExaminersInterviewofRichardS.Fuld,Jr.,Apr.28,2009,atp.8.
2382SeeLehman,SECTalkingPoints[Draft](Aug.11,2008)[EYLELBHIKEYPERS0907480],attachedto
emailfromDaniel Kerstein, Lehman, to William Schlich,Ernst& Young, etal. (Aug.11,2008)[EYLE

LBHIKEYPERS0907479].
2383Id.AccordExaminersInterviewsofStevenBerkenfeld,Oct.5and7,2009,atp.14.
2384Lehman,SECTalkingPoints[Draft](Aug.11,2008)[EYLELBHIKEYPERS0907480],attachedtoe
mail from Daniel Kerstein, Lehman, to William Schlich, Ernst & Young, et al. (Aug. 11, 2008) [EYLE
LBHIKEYPERS0907479];Lehman,SpinCoProposedTermSheet(Aug.19,2008),atp.3[EYLELBHI
654

Following an initial meeting with the SEC on August 12, 2008, Lehman was
cautiously optimistic and concluded that the SEC was ready to be helpful in
waiving the requirement of three years of historical financials.2385 However, an
agreement was not reached quickly.2386 The SEC offered to grant Lehmans waiver
requestinexchangeforanagreementthatSpinCowouldusefairvalue,alsoknown
asmarktomarket,accounting.2387OnAugust20,2008,FuldreportedtotheBoardthat
LehmanhadresolvedallmajoraccountingissueswiththeSECapartfromthemark
tomarketaccountingquestion.2388
AsFuldindicatedtotheBoard,Lehmanssecondmajorchallengewastoobtain
theSECsagreementthatSpinCowouldnotneedtousemarktomarketorfairvalue
accounting(i.e.,SFAS157and159)inreportingthevalueofitscommercialrealestate
KEYPERS3670027],attachedtoletterfromJohnW.Bostelman,Sullivan&Cromwell,toJohnWhite,SEC
(Aug. 19, 2008) [EYLELBHIKEYPERS 3670025]. Lehmans outside accountants, Ernst & Young,
reportedly felt blindsided and put in the hot seat by the SECs expectation that Lehmans auditors
would certify SpinCos financial projections. See email from Kenneth T. Marceron, Ernst & Young, to
RandyG.Fletchall,Ernst&Young,etal.(Aug.13,2008)[EYLELBHIKEYPERS3669425](Inthisfact
pattern, the client would sell securities based solely on a financial forecast rather than any historical
financial statements. .. . I dont see practically how we could ever get there given the information that
wouldberequiredinordertodoaforecastevenifwewantedtoacceptthistypeofengagement).
2385EmailfromIanT.Lowitt,Lehman,toPaoloR.Tonucci,Lehman,etal.(Aug.12,2008)[LBEXDOCID
2642438].
2386Seeletter from Martin Kelly,Lehman, to Wayne Carnall,SEC, re: SEC request that Lehman address
why spinoff should not be regarded as the acquisition of a business and why SpinCo should not be
required to use fair value accounting (Aug. 21, 2008) [LBEXDOCID 1298065], attached to email from
Robert W. Downes, Sullivan & Cromwell, to Larry Wieseneck, Lehman, et al. (Aug. 21, 2008) [LBEX
DOCID1297924].
2387EmailfromDavidGoldfarb,Lehman,toLarryWieseneck,Lehman,etal.(Aug.27,2008)[LBEXSIPA
007017].
2388SeeLehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Aug.20,2008),atp.2
[LBEXAM003891].
655

assets.2389 Lehman executives believed that using hold to maturity accounting for
SpinCosassetswascriticaltoSpinCosfeasibility,butthatwouldrequireLehmantobe
apioneerinobtainingtheSECsagreementtoallowthataccountingtreatment.2390
OnAugust21,2008,LehmanpresenteditsrequesttotheSEC.2391Lehmanargued
thatunderU.S.GAAP,anentitythatcandemonstratetheintentandabilitytoholddebt
securities2392tomaturityisentitledtouseholdtomaturityaccountingforthoseassets,
aslongastheyarevaluedattheirfairvaluesatthetimeoftransfer.2393Inresponse,the
SECsoughtLehmansagreementtousemarktomarketaccountingbycitinginvestor
2389Examiners Interview of Richard S. Fuld, Jr., May 6, 2008, at p. 7; see also FairValue Measurements,
Statement of Fin. Accounting Standards No. 157 (Fin. Accounting Standards Bd. 2008); The Fair Value
Option for Financial Assets and Financial Liabilities, Statement of Fin. Accounting Standards No. 159
(Fin.AccountingStandardsBd.2008).
2390Examiners Interview of Richard S. Fuld, Jr., May 6, 2008, at p. 7; Examiners Interview of David
OReilly, Oct. 26, 2009, at p. 4; Examiners Interview of Paul A. Hughson, Oct. 28, 2009, at pp. 910;
2391Seeletter from Martin Kelly,Lehman, to Wayne Carnall,SEC, re: SEC request that Lehman address
why spinoff should not be regarded as the acquisition of a business and why SpinCo should not be
required to use fair value accounting (Aug. 21, 2008) [LBEXDOCID 1298065], attached to email from
Robert W. Downes, Sullivan & Cromwell, to Larry Wieseneck, Lehman, et al. (Aug. 21, 2008) [LBEX
DOCID1297924].
2392Whiletheholdtomaturityissueappliedspecificallytodebtsecuritieswhichwouldconstituteonly
10%ofSpinCosassets,Lehmanalsoarguedthatitshouldnotberequiredtousefairvalueaccounting
forthebulkoftheloanswhichwouldmakeupalmost70%ofSpinCosassets.Lehmanwantedtoaccount
for the loans at amortized cost with amortization of discount under the effective yield method and
subject to reserve for loan losses, or essentially the same method Lehman wanted to use for debt
securities.Seeid.atpp.1012.
2393Id.atp.2.([Itis]criticaltoSpincosassetmanagementphilosophy,aswellasinvestorsinSpinco,that
the accounting framework of Spinco reflect fundamental asset valuations realizable over longer time
horizons,asopposedtovaluationsreflectiveofcurrentmarketliquidity.ThisisthefoundationofSpinco
andthekeytoitssuccess....IfSpincoweresubjecttofairvalueaccounting,webelievethatitwouldbe
atacompetitivedisadvantagetoitspeersandwouldnotbeabletomanagetheassetsinafundamentally
different manner than how Lehman must manage the assets now and therefore would not be able to
maximizevalueforitsshareholders).Theletterdefinesholdtomaturityaccountingasvaluationat
amortized cost with amortization of discount or premium under the effective yield method and
recognitionofanyotherthantemporarydeclinesinvalueinearnings.Id.atp.10.
656

protection concerns and offering to grant Lehman other waivers instead (e.g., three
years historical financials, auditorreviewed financial projection, and updated
projectionsandfinancialstatements).2394
On August 28, 2008, Lehman reached an agreement with the SEC. SpinCos
initialbalancesheetwouldbepreparedatfairvalue.2395SpinCowouldnotusemarkto
marketaccountingforitsloanassetsbutinsteadwouldaccountforitsdebtsecuritieson
aholdtomaturitybasis(withprovisionsforexpectedloanlosses).2396SpinCowould
still value its equity securities at their market values.2397 The SEC also agreed not to
require SpinCo to file three years of audited historical financial statements.2398 David
2394SeeemailfromMartinKelly,Lehman,toThomasA.Russo,Lehman,etal.(Aug.27,2008)[LBEXSIPA
007017].Lehmanexecutivespushedback,arguingthatusingnonfairvalueaccountingwascriticalto
SpinCossuccessandthatLehmansproposedaccountingtreatmentwastherightanswer.Emailfrom
David Goldfarb, Lehman, to Larry Wieseneck, Lehman, et al. (Aug. 27, 2008) [LBEXSIPA 007017].
LehmanalsopressuredErnst&YoungtointervenewiththeSEConLehmansbehalf.Seeid.;emailfrom
DavidGoldfarb,Lehman,toWilliamSchlich,Ernst&Young(Aug.28,2008)[LBEXDOCID2997901].
2395See email from Martin Kelly, Lehman, to Larry Wieseneck, Lehman, et al. (Aug. 28, 2008) [EYLE
LBHIKEYPERS0907577];seealsoemailfromDavidGoldfarb,Lehman,toBethRudofker,Lehman,etal.
(Aug. 30, 2008) [LBHI_SEC07940_015928] ([T]he debt will be accounted for @ hold to maturity with
appropriationprovisionsforexpectedloanlosses,andequityinvestments@lowerofcostormarket.);e
mail from Martin Kelly, Lehman, to Daniel Kerstein, Lehman, et al. (Sept. 10, 2008)
[LBHI_SEC07940_916922](Morefactuallycorrectwouldbetosayitisnonmarktomarketaccounting.
Meaningloanaccountingforloans,nontrading(ienonMTM)securityaccountingforsecuritiesandreal
estateaccounting(lowerofcostorfairvaluelesscosttosell)forconsolidatedrealestate....WeMUST
NOTreferenceanydiscussionwithSECaroundthis).
2396 Email from David Goldfarb, Lehman, to Beth Rudofker, Lehman, et al. (Aug. 30, 2008)
[LBHI_SEC07940_015928].
2397Id.
2398See email from Martin Kelly, Lehman, to Larry Wieseneck, Lehman, et al. (Aug. 28, 2008) [EYLE
LBHIKEYPERS0907577].
657

Goldfarb laudedthe resultas a[g]reat answerforus.2399However,the terms of the
SECsagreementeffectivelywoulddoomLehmanshopesforataxfreespinoff.2400
b. TaxFreeStatus
AkeyadvantageoftheSpinCoidea,asoriginallyconceived,wasthatthespin
off would be taxfree to Lehmans shareholders.2401 From SpinCos earliest iteration,
Lehman worked to ensure that the spinoff transaction would qualify for taxfree
status.2402 As planning progressed, however, Lehmans effort to structure SpinCo to
avoid historical financials and marktomarket accounting complicated the taxfree
status of the spinoff.2403 In particular, Lehman considered organizing SpinCo as a
liquidating trust rather than an active business in order to avoid marktomarket
2399Email from David Goldfarb, Lehman, to Beth Rudofker, Lehman (Aug. 29, 2008) [LBEXDOCID
1609099].
2401I.R.S.CodeSection355permitsacorporationtodistributeequityownershipofasubsidiaryunderits
controltothecorporationsshareholders,taxfreetoboththeshareholdersandthecorporation,aslongas
boththespunoffsubsidiary(whichmaybenewlyformed)andthecontrollingcorporationeachremains
inthesameactivetradeorbusinessafterthedistribution.SeeI.R.C.355(2008).
2402SeeLehman,ManagingtoaBadAssetSolution[Draft](Apr.23,2008)[LBEXDOCID1400312](real
estatespinoffwouldbeTaxfreetoParentandtoshareholders);Lehman,GreenAcresSummaryof
Structural Alternatives (July 3, 2008), at p. 2 [LBHI_SEC07940_008342], attached to email from Brad
Whitman, Lehman, to Hugh E. McGee, III, Lehman (July 3, 2008) [LBHI_SEC07940_008341]; see also
Lehman, Discussion Materials for the Board of Directors [Draft] (July 19, 2008), at p. 10
[LBHI_SEC07940_404357] (SpinCo will need to be deemed a viable standalone operating business for
40Act,accountingpurposesandtoeffectataxfreedistribution).
2403See Lehman, Green Acres Overview of Potential Alternatives [Draft] (July 30, 2008)
[LBHI_SEC07940_405303](comparingspinoffasoperatingbusinessversusspinoffasliquidatingentity),
attached to email from Daniel Kerstein, Lehman, to Larry Wieseneck, Lehman, et al. (July 30, 2008)
[LBHI_SEC07940_405302];emailfromMichaelLanger,Lehman,toLarryWieseneck,Lehman,etal.(Aug.
10,2008)[EYLELBHIKEYPERS0850862](notingthatindrafttalkingpointsfortheSECwehavebeen
intentionallyvagueonoperatingcompanyvs.liquidatingtrusttokeepouralternativesopen).
658

accounting, but the liquidating trust structure threatened the taxfree status of the
spinoff.2404Lehmanwasnotabletoresolvethetaxissuebeforeitsbankruptcy.2405
(iv) ValuationofAssets
Toaccomplishthespinoff,theSECrequiredthatSpinCosinitialbalancesheet
showthefairvalueofthetransferredassets.2406AsearlyasJune2008,somemembersof
Lehmansrealestateinvestmentbankingteamworriedthattheassetsandtheirvalue
2404Seeid.;seealsoemailfromLarryWieseneck,Lehman,toHughE.McGee,III,Lehman(Aug.5,2008)
[LBHI_SEC07940_406125];emailfromMarkA.Walsh,Lehman,toKennethCohen,Lehman,etal.(Aug.
10, 2008) [LBHI_SEC07940_303607]; memorandum from Spencer Kagan, Lehman, to Mark A. Walsh,
Lehman,etal.,re:GreenAcresPreliminaryEstimatedLiquidatingTrustRatedDebtProceeds(Aug.8,
2008)[LBHISEC07940_303609];Lehman,FitchRatingsProjectGreenAcres[Draft](Aug.12,2008),atp.
3[LBEXDOCID612634](HowSpinCoWillWork:LiquidatingTrust).ButseeLehman,FitchRatings
Project Green Acres(Aug.12, 2008),atp. 3[LBEXDOCID 011904]; Lehman,SEC talking points [Draft]
(Aug.11,2008),atp.3[EYLELBHI_KEYPERSO0907480];Lehman,SpinCoProposedTermSheet(Aug.
19,2008),atp.1[EYLELBHIKEYPERS3670025];emailfromIanT.Lowitt,Lehman,toDanielKerstein,
Lehman,etal.(Aug.30,2008)[LBEXSIPA003759](Attheriskofstatingtheextremelyobvious,[a]key
issue[indecidingbetweenCCorporpartnership]isnotupsettingourSECagreement.Earlierinthee
mailchain,YoavWiegenfeld,Lehman,states:Ifwewanttodoataxfreespinforshareholderstheentity
willhavetobeaccorp.Weneedtodeterminewhetherwecandoataxfreespin,whichdependson(I)
identifyingaqualifyingactivetradeorbusiness(wediscussedAurora)and(ii)havingasignofffromthe
SECthathavingthisbusinessdoesntchangethefinancialreportingagreementwereachedwiththem);
Lehman,TheGameplan(Sept.2008),atp.4[LBHI_SEC07940_653637].
2405See, e.g., email from Larry Wieseneck, Lehman, to Shaun Butler, Lehman, et al. (Aug. 29, 2008)
[LBHI_SEC07940_651788]([W]ecannotrefertoSpincoasaLiquidatingTrust.Itcanneverbediscussed
asakintoonenotthatitisone.Itneitherisliquidatingno[r]isitatrust.Iwanttohighlightthisbecause
it is currently referenced as such in the document and this is a huge accounting issue. If it were a liq
trust,wewouldendupinaverybadplaceaccountingwise);Lehman,Q3FirmwideQ&ASummary
(no date), at p. 47 [LBHI_SEC07940_750660] (We are in the process of finalizing the tax and legal
structureoftheREIGlobalentity).AccordExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,at
pp.78(FuldrecalledthatSpinCohadtobeanonoperatingentitytoavoidmarktomarkettreatment,
butasaresult,thespinoffwasnolongertaxfree.FuldsaidthatLehmanneverresolvedthatissue).
2406SeeemailfromMartinKelly,Lehman,toThomasA.Russo,Lehman,etal.(Aug.27,2008)[LBEXSIPA
007017](termsofdealwithSECinclude[i]nitialopeningaudited[balancesheet]atfairvalue).
659

would be SpinCos greatest obstacle, not the structure or feasibility of the spinoff
itself.2407
McGeetoldtheExaminerthattheissuewasnotthevaluationsoftheassetsperse,
but rather the combination of the size and complexity of Lehmans CRE portfolio.2408
Moreover, as SpinCo planning progressed, the deteriorating real estate market made
asset valuations a moving target as Lehman modeled SpinCos operations as an
independent entity.2409 Lehman discussed aggressively writing down the assets pre
spin,recognizingthatthewritedownswouldreducethesizeoftheequityhole.2410In
August 2008, Lehman considered engaging a third party to perform an independent
valuationofSpinCosproposedassets.2411
2407Email from Steven R. Hash, Lehman, to Larry Wieseneck, Lehman (June 11, 2008)
[LBHI_SEC07940_398658];seealsoemailfromStevenR.Hash,Lehman,toDavidErickson,Lehman,etal.
(June10,2008)[LBEXDOCID1475677]([P]roblemisfinancingandtheassetsthatgregowns.[T]hereis
really no independent financing for these assets in the market today). But see, e.g., email from Larry
Wieseneck,Lehman,toHughE.McGee,III,Lehman(July11,2008)[LBHI_SEC07940_401362](Issueis
theuseofcashcapitalnotthemarks).
2408ExaminersInterviewofHughE.McGee,III,Aug.12,2009,atpp.2021;accordExaminersInterview
ofHerbertH.McDade,III,Sept.16,2009,atp.3(McDadedeniedthatLehmanmismarkeditsassets,and
asserted that by summer 2008 Lehmans commercial real estate portfolio was cleaner than any of its
competitorsandwouldhavebeenaprofitableinvestment).
2409Examiners Interview ofDavid OReilly, Oct.26, 2009,at p.4; see also email from LarryWieseneck,
Lehman,toTimothySullivan,Lehman,etal.(July18,2008)[LBHI_SEC07940_404327](Needtobuildin
slippageforamarkoncommercialprespin($2$3billion));Lehman,BreakevenComparisonBetween
Spin Off and Writedown (Aug. 6, 2008) [LBHI_SEC07940_406362] (comparing SpinCo with a 29%
writedownofcommercialrealestateassets).
2410SeeemailfromLarryWieseneck,Lehman,toHughE.McGee,III,Lehman,etal.(Aug.6,2008)[LBEX
DOCID2274043].AccordExaminersInterviewofLisaBeeson,Oct.23,2009,atp.9.
2411See Lehman, Project Green Acres Daily Update (Aug. 7, 2008) [LBEXDOCID 2253476] (Consider
engaging Blackstone (or other third party) to perform independent valuation . . . Responsibility[:]
Goldfarb).
660

SpinCo was seen by some as validation of their suspicion that Lehmans assets
werenotproperlyvalued.2412DavidEinhorn,PresidentofGreenlightCapital,toldthe
Examiner that the creation of SpinCo supported his contention that Lehman had not
beenmarkingdownitscommercialassets.2413EinhornbelievesthatLehmanseffortsto
spinoutitscommercialrealestateintoacompanywheretheassetsdidnothavetobe
marked to fair value revealed that Lehman had not been marking those assets to fair
value.2414
(c) BarclaysSpinCo
Lehman was not able to implement the SpinCo plan prior to Lehmans
bankruptcy. Nonetheless, Lehmans senior managers believed that SpinCo was an
innovative and elegant plan and that Lehman simply ran out of time before it could
execute SpinCo.2415 Lehmans management points to the SECs waiver of the
requirementofthreeyearsofauditedfinancialstatementsanditsapprovalofholdto
maturityaccountingassupporttoshowthatSpinCowouldhavebeenfeasible.2416
2412See,e.g.,emailfromDonBenningfield,BankofAmerica,toRochelleDobbs,BankofAmerica,etal.
(Sept.12,2008)[BofASEC00002774].AccordExaminersInterviewofDavidEinhorn,Nov.19,2009,atp.
10.
2413ExaminersInterviewofDavidEinhorn,Nov.19,2009,atp.10.
2414Id.
2415 Lehman, The Gameplan September 2008 (Sept. 2008), at p. 4 [LBEXDOCID 2727665]. Accord
Examiners Interview of Richard S. Fuld, Jr., May 6, 2009, at p. 6; Examiners Interview of Lisa Beeson,
Oct.23,2009,atp.9.
2416ExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atpp.78;ExaminersInterviewofPaulA.
Hughson,Oct.28,2009,atpp.910.
661

McGee, one of SpinCos primary architects, moved to Barclays following
Lehmansdemise.2417InSeptember2009,BarclayslauncheditsownSpinColikeentity,
selling $12.3 billion of highrisk credit assets to Protium Finance, a newly formed
partnershiprunbyformerBarclaysemployees.2418Barclaysstatedthatitwasseekingto
restructureasignificanttrancheofcreditmarketexposureinawaythatwouldsecure
reliablereturnsforitsshareholdersovertime.2419BarclaysprovidedProtiumwith$12.6
billionfirstlosssellerfinancing,meaningthatanypotentialupsidetotheassetssoldby
ProtiumwouldaccruesolelytoProtiumsindependentinvestors,nottoBarclaysorits
shareholders.2420 Nonetheless, analysts regarded the spinoff as beneficial to Barclays,
helpingitslashitsnetexposuretoriskycreditassets.2421InOctober2009,duringmarket
conditions much different than a year earlier, Barclays announced plans for a second
spinoffof$6.3billionincomplexcreditassets.2422
(5) PotentialStrategicPartners
Following the near collapse of Bear Stearns, Lehman reached out to numerous
potential partners regarding possible investments or mergers with Lehman. After
Lehman issued its second quarter 2008 financials, Fuld received increasingly blunt
2417SeeWilliamD.Cohan,TheHighestPaidManonWallStreet,TheDailyBeast,Jan.9,2009.
2418SeeJaneCroft&SamJones,BarclaysDeRiskDealLeavesAnalystsPuzzled,FT.com,Sept.16,2009.
2419Id.
2420Id.
2421Id.;TracyAlloway,BarclaysProtiumPurifiedBalanceSheet,FT.com,Nov.10,2009.
2422BarclaysSaidtoPlan$6.3BillionSpinOff,N.Y.Times,Oct.12,2009.
662

pressure from Paulson and Geithner to sell Lehman or find a strategic partner.2423
PaulsontoldtheExaminerthatheperceivedthatLehmansannouncementofitslossin
the second quarterof 2008convincedFuld that dramaticactionwasnecessarytosave
Lehman.2424AccordingtoPaulson,thereleaseofthenumbersservedasawakeupcall
toFuldwho,atthatpoint,appreciatedLehmansfragilityandcomprehendedthatthe
futureportendednothingbetter.2425However,PaulsondescribedFuldtotheExaminer
asbothoneofthemostoptimisticpeoplePaulsonhasevermetandapersonwhoheard
onlywhathewantedtohear.2426
Geithner explained to the Examiner that Lehman faced the difficult task of
havingto persuadeaninvestor orinvestorgroupto buy intoLehman just at the time
the souring economy made potential investors highly skittish about absorbing more
risk.2427 Geithner added: if you get in a position where you are late, then all of your
choicesarebadandalltheclassicavenuesyoucanusetomakeyourselfstrongermake
youlookweaker.Thatshowyougettothepointofnoreturn.2428
2423Examiners Interview of Henry M. Paulson, Jr., June 25, 2009, at p. 14; Examiners Interview of
TimothyF.Geithner,Nov.24,2009,atp.6.
2425Id.
2426Id.atp.6.
2428Id.Bytheendofthesummer,theNewYorkTimesDealbookblogwasopenlyasking,whenwill
Lehman Brothers die? Judging by the headlines, youd think the troubled investment bank would go
belly up any day now. See Andrew Ross Sorkin, Lehmans Woes Haunt the Last Days of Summer, N.Y.
Times(Aug.26,2008),availableathttp://dealbook.blogs.nytimes.com/2008/08/26/thestorylinesofthelast
daysofsummer.
663

(a) BuffettandBerkshireHathaway
(i) March2008
In late March 2008, McGee suggested that Lehman reach out to Buffett.2429
McGeehadapreexistingbankingrelationshipwithSokolofMidAmericanEnergy,2430
whichismajorityownedbyBuffettsBerkshireHathaway.EitherMcGeeorJosephG.
Sauvage, LBI ViceChairman, called Sokol to ask if Buffett would take Fulds call.2431
Jerry A. Grundhofer, who was about to join Lehmans Board, also asked Buffett if he
wouldtakeFuldscall.2432Buffettagreed.2433
Before calling Buffett, Fuld called Sokol on March 27, 2008.2434 That same day,
Lehmanpreparedadraftofaletter,tobesentbyFuldtoLehmanemployees,outlining
a $3.5 billion investment from Buffett in Lehmans preferred stock at a $54 per share
conversionprice.2435FuldtoldtheExaminerthathedidnotknowhowthatlettercame
to be prepared, and it does not appear that Fuld saw the draft.2436 Fuld also did not
recallBuffettindicatingawillingnesstoinvest$3.5billion.2437Buffettwassurprisedthat
2430At the time, Sokol was President of MidAmerican. In August 2009, Sokol became CEO of NetJets,
Inc.,anotherBerkshireHathawaysubsidiary.
2431ExaminersInterviewofDavidL.Sokol,Sept.22,2009,atp.3.
2432ExaminersInterviewofJerryA.Grundhofer,Sept.16,2009,atp.10.
2433ExaminersInterviewofRichardS.Fuld,Jr.,Sept.30,2009,atp.8;ExaminersInterviewofJerryA.
Grundhofer,Sept.16,2009,atp.10;ExaminersInterviewofWarrenE.Buffett,Sept.22,2009,atp.2.
2434RichardS.Fuld,Jr.,Lehman,CallLogs(Mar.27,2008)[LBHI_SEC07940_016916].
2435Email from Timothy Lyons, Lehman, to Scott J. Freidheim, Lehman (Mar. 27, 2008)
[LBHI_SEC07940_849386].
2436ExaminersInterviewofRichardS.Fuld,Jr.,Sept.30,2009,atpp.910.
2437Id.atp.10.
664

Lehmanhadpreparedadraftletterannouncingthedeal,becausehenevergotclosetoa
dealwithLehman.2438
Fuld and Buffett spoke on Friday, March 28, 2008. They discussed Buffett
investing at least $2 billion in Lehman.2439 Two items immediately concerned Buffet
duringhisconversationwithFuld.2440First,BuffettwantedLehmanexecutivestobuy
under the same terms as Buffett.2441 Fuld explained to the Examiner that he was
reluctanttorequireasignificantbuyinfromLehmanexecutives,becausetheyalready
receivedmuchoftheircompensationinstock.2442However,Buffetttookitasanegative
that Fuld suggested that Lehman executives were not willing to participate in a
significant way.2443 Second, Buffett did not like that Fuld complained about short
sellers.2444Buffettthoughtthatblamingshortsellerswasindicativeofafailuretoadmit
onesownproblems.2445
2439ExaminersInterviewofRichardS.Fuld,Jr.,Sept.30,2009,atp.10;ExaminersInterviewofWarrenE.
Buffett,Sept.22,2009,atp.4.
2441Examiners Interview of Richard S. Fuld, Jr., Sept. 30, 2009, at pp. 910; Examiners Interview of
WarrenE.Buffett,Sept.22,2009,atp.3.
2444Id. at p. 4. Paulson told the Examiner that he did not think that Buffett would be interested in
Lehman.PaulsontoldtheExaminerthathethoughtFuldssuggestionofBuffettasapotentialinvestor
indicatedthatFuldwasscared,butnotscaredenoughanddidnotappreciatethegravityofLehmans
situationinMarch2008.ExaminersInterviewofHenryM.Paulson,Jr.,June25,2009,atp.12.
665

Following his conversation with Buffett, Fuld asked Paulson to call Buffett,
which Paulson reluctantly did.2446 Buffett told the Examiner that during that call,
PaulsonsignaledthathewouldlikeBuffetttoinvestinLehman,butPaulsondidnot
loadthedice.2447
Buffett spent the rest of Friday, March 28, 2008, reviewing Lehmans 10K and
notingproblemswithsomeofLehmansassets.2448Buffettsconcernscenteredaround
Lehmans real estate and high yield investments, lendingrelated commitments,
derivatives and their related creditmarket risk, Level III assets and Lehmans
securitizationactivity.2449OnSaturday,March29,2008,Buffettlearnedofa$100million
probleminJapanthatFuldhadnotmentionedduringtheirdiscussions,andBuffettwas
concernedthatFuldhadnotbeenforthcomingabouttheissue.2450TheproblemsBuffett
sawinthe10KalongwithFuldsfailuretoalertBuffetttotheissueinJapancemented
BuffettsdecisionnottoinvestinLehman.2451
Atsomepointintheirconversations,FuldandBuffettalsodiscoveredthatthere
hadbeenamiscommunicationabouttheconversionprice.Buffettwasinterestedonly
2446ExaminersInterviewofHenryM.Paulson,Jr.,June25,2009,atp.12;ExaminersInterviewofRichard
S.Fuld,Jr.,Sept.30,2009,atp.8.
2448Id.atp.3.
2449Id.Buffettmadenotesonmanyofthe10KpagesaboutLehmansfinancials.Thosenotesillustrate
thatBuffetthadquestionsortookissuewithmuchofwhatLehmanwasreporting,ashestatedduringhis
interview.Additionally,BuffettseemstohavehadaheightenedfocusonLehmansrealestateandhigh
yieldassetsandonaccountingissuesrelatingtothestockprice,assets,orliabilities.Id.
2450Id.atpp.34.AccordExaminersInterviewofRichardS.Fuld,Jr.,Sept.30,2009,atp.10.
2451ExaminersInterviewofWarrenE.Buffet,Sept.22,2009,atp.4.
666

inconvertiblepreferredshares.2452BuffetttoldFuldthathewaswillingtoagreetoa$40
conversion price per share, while Fuld thought Buffett was offering to buy in at up
40, or 40% above the current market price, which would have been about $56 per
share.2453OnFriday,March28,2008,Lehmansstockclosedat$37.87.2454
FuldspoketoLehmansExecutiveCommitteeandseveralBoardmembersabout
his conversations with Buffett.2455 Lehman recognized that an investment by Buffett
wouldprovideastampofapproval.However,Lehmanalreadyhadbetteroffersfor
itsAprilcapitalraise,andLehmandidnotthinkitcouldgiveabetterdealtoBuffettat
thesametimeitgavealessattractivedealtoothers.2456
On Monday, March 31, 2008, before Buffett could tell Fuld that he was not
interested,FuldcalledBuffetttosaythatLehmancouldnotaccepthisterms.2457
(ii) LastDitchEffortwithBuffett
McGee contacted Sokol again in late August or early September 2008 and
outlined Lehmans Gameplan for survival, specifically SpinCo.2458 During a
2452Id.atp.2.
2454SeeYahoo!Finance,HistoricalLEHstockprices,availableathttp://finance.yahoo.com/q?s=LEHMQ.PK.
2455RichardS.Fuld,Jr.,Lehman,CallLogs(Mar.28Apr.3,2008)[LBHI_SEC07940_016911];Examiners
Interview of Richard S. Fuld, Jr., Sept. 30, 2009, at p. 11; Examiners Interview of Jerry A. Grundhofer,
Sept.16,2009,atp.10;ExaminersInterviewofJohnD.Macomber,Sept.25,2009,atp.20.
2457ExaminersInterviewofWarrenE.Buffett,Sept.22,2009,atp.4;ExaminersInterviewofRichardS.
2458Lehman, The Gameplan (Sept. 2008) [LBHI_SEC07940_653681], attached to email from Hugh E.
McGee, III, Lehman, to David L. Sokol, MidAmerican Energy Holdings Co., et al. (Sept. 4, 2008)
[LBHI_SEC07940_653680];ExaminersInterviewofDavidL.Sokol,Sept.22,2009,atp.4.
667

subsequent telephone call with Sokol, McGee explained the good bank/bad bank
scenarioandstatedthatLehmanwouldneedaninvestor.2459Sokolbelievedtheemail
andcallwereintendedtoinduceSokoltopassthatinformationontoBuffett,soSokol
briefed Buffett on SpinCo. Buffett thought the idea would not solve Lehmans
problems.2460
SometimeduringtheweekpriortoLehmansbankruptcy,McGeeagainreached
out to Sokol with what both Sokol and McGee described to the Examiner as a Hail
Marypass.2461McGeeasked,Doyouhaveanyideastosaveus?2462Sokol,whowas
bearhuntinginAlaskaatthetime,toldMcGeethathedidnot.2463
(b) KDB
(i) DiscussionsBegin
In late May 2008, Hana Financial Group (Hana) led a consortium of Korean
financialinstitutionsintalksconcerningapossibleinvestmentinLehman.2464According
toKDB,KDBstarteddiscussionswithLehmanandHanaconcerninganinvestmentin
Lehman through a consortium of Korean investors in early June 2008.2465 The
contemplatedconsortiumincludedKDB,KoreaInvestmentCorporation(KIC),Korea
2460Id.
2461Id.;ExaminersInterviewofHughE.McGee,III,Aug.12,2009,atp.16.
2463Id.
2464ExaminersInterviewofKunhoCho,Jan.7,2010,atp.5.
2465ExaminersInterviewofKDB,Oct.26,2009,atpp.67.
668

National Pension Service (KNPS) and Hana.2466 Hanas intended goal was for Hana
andKDBeachtoobtainapproximatelyfivepercentofLehman.2467Theanticipatedtotal
Koreaninvestmentwasbetween$3and$5billion.2468
Lehman and the Korean entities differed over the nature of a possible
investment.Lehmansdrafttermsheet,presentedtoitsExecutiveCommitteeonJune5,
2008,calledforparticipationbytheKoreanconsortiuminjointventuresforLehmans
funded and unfunded commitments, as well as real estate.2469 A revised version
circulatedonJune5,2008,indicatedthateachofthejointventureswouldinclude$10
2466SeememorandumfromKunhoCho,Lehman,toHughE.McGee,III,Lehman,etal.,re:Opportunity
Briefing and Key Issues for Investment by Korea Inc. Consortium in Lehman Brothers (May 29, 2008)
[LBEXDOCID1374131],attachedtoemailfromKunhoCho,Lehman,toDavidGoldfarb,Lehman(May
29,2008)[LBEXDOCID1466211].
2467KDB told the Examiner that in the first round of negotiations with Lehmanand Hana in early June
2008,HanawantedHanaandKDBtoeachobtainapproximately5%ofLehman,withaninvestmentof
approximately $3 billion. However, KDB said that it was not privy to all details because Hana was
leadingthenegotiations.ExaminersInterviewofKDB,Oct.26,2009,atp.7.BhattaltoldtheExaminer
thatHanacouldinvest$12billionbyitself,butcouldinvestupto$5billionwithaconsortiumofother
Korean banks. Examiners Interview of Jasjit Bhattal, Oct. 12, 2009, at p. 6. According to Kunho Cho,
while Lehman and the Korean consortium initially discussed a $5 billion investment, that number
fluctuatedthroughoutthediscussions.ExaminersInterviewofKunhoCho,Jan.7,2010,atp.7.Lehman
and Hana discussed a potential $5 billion investment. See memorandum from Kunho Cho, Lehman, to
HughE.McGee,III,Lehman,etal.,re:OpportunityBriefingandKeyIssuesforInvestmentbyKoreaInc.
ConsortiuminLehmanBrothers(May29,2008)[LBEXDOCID1374131],attachedtoemailfromKunho
Cho,Lehman,toDavidGoldfarb,Lehman(May29,2008)[LBEXDOCID1466211].
2468Id.
2469Lehman,StrategicRelationshipTermSheet[Draft](June5,2008)[LBHI_SEC07940_103438],attached
to email from Joseph M. Gregory, Lehman, to Jasjit Bhattal, Lehman, et al. (June 5, 2008)
[LBHI_SEC07940_103437](forwardingstrategicelementstermsheettoExecutiveCommittee).
669

billionworthofLehmanassets.2470Hanadeletedthosejointventureswhenitsentback
furtherrevisedtermsheets.2471
Jasjit Jesse Bhattal, the CEO of Lehman AsiaPacific, told the Examiner that
thosetermsheetswerenotrealtermsheetsbecausetheydidnotindicateapriceper
share or the nature of the security.2472 Rather, each side prepared the documents to
summarizewhathad beendiscussedandasabasisforfurtherdiscussions.2473Bhattal
did not recall the joint ventures ever becoming a sticking point in the negotiations.2474
ThomasA.Russo,LehmansChiefLegalOfficer,toldtheExaminerthatthetermsheets
were notformal term sheets, but instead were draftedforthepurposeofputting deal
pointsonpaper.2475Russodidnotrecallthejointventuresasbeingastickingpointin
the negotiations.2476 Although Russo did not believe the talks progressed to the point
where Hana commented on the term sheets,2477 documents reflect that Hana provided
commentsthatincluded deletingLehmanscommercialrealestatejointventuresfrom
2470Lehman,ElementsofStrategicRelationshipTermSheet[Draft](June5,2008),atp.2[LBEXDOCID
817385],attachedtoemailfromJayClayton,Sullivan&Cromwell,toBradWhitman,Lehman,etal.(June
5,2008)[LBEXDOCID941706].
2471Hana Investment Bank, Elements of Strategic Relationship [Draft] (June 4, 2008) [LBEXDOCID
1401999],attachedtoemailfromChanLee,HanaBank,toLarryWieseneck,Lehman,etal.(June4,2008)
[LBEXDOCID1527489](providingHanascommentstoStrategicElementstermsheet).
2472ExaminersInterviewofJasjitBhattal,Oct.12,2009,atp.9.
2473Id.
2474Id.
2475ExaminersInterviewofThomasA.Russo,Dec.1,2009,atpp.1011.
2476Id.atp.11.
2477Id.
670

thedeal.2478KunhoCho,headofLehmanAsiainvestmentbanking,recalleddiscussions
about the joint ventures but did not think they were a major focus of the
negotiations.2479
One of Hanas goals for an investment in Lehman was to induce Lehman to
makeSeoulitsAsianheadquarters,movingLehmanssophisticatedinvestmentbanking
operationstoSouthKorea.2480Lehmanwasnotwillingtoagree,becauseLehmanwas
unwilling to abandon its headquarters in Tokyo.2481 However, Lehman was willing to
makeSeoulacoheadquartersinAsia.2482
Lehmanhopedtoannounceaninvestmentatthesametimethatitannouncedits
second quarter losses.2483 Lehmans second quarter earnings call was originally
2478See Hana Investment Bank, Elements of Strategic Relationship [Draft] (June 4, 2008) [LBEXDOCID
1401999]attachedtoemailfromChanLee,HanaBank,toLarryWieseneck,Lehman,etal.(June4,2008)
[LBEXDOCID1527489].
2480ExaminersInterviewofJasjitBhattal,Oct.12,2009,atp.7;ExaminersInterviewofRichardS.Fuld,
Jr.,Sept.30,2009,atp.23;ExaminersInterviewofThomasA.Russo,Dec.1,2009,atp.9.
2481Id.
2482Id.
2483SeememorandumfromKunhoCho,Lehman,toHughE.McGee,III,Lehman,etal.,re:Opportunity
BriefingandKeyIssuesforInvestmentbyKoreaInc.ConsortiuminLehmanBrothers(May29,2008),at
p.2[LBEXDOCID1374131],attachedtoemailfromKunhoCho,Lehman,toDavidGoldfarb,Lehman
(May29, 2008)[LBEXDOCID 1466211]; email from Eric Felder,Lehman, to PaoloR. Tonucci, Lehman
(June 3, 2008) [LBEXDOCID 808343]; email from David Erickson, Lehman, to Hugh E. McGee, III,
Lehman(June4,2008)[LBEXDOCID224486];emailfromKunhoCho,Lehman,toHughE.McGee,III,
Lehman(June5,2008)[LBEXDOCID392569];emailfromBradWhitman,Lehman,toLarryWieseneck,
Lehman,etal.(June5,2008)[LBEXDOCID227666];emailfromScottJ.Freidheim,Lehman,toRichardS.
Fuld,Jr.,Lehman(June6,2008)[LBEXDOCID1165719].AccordExaminersInterviewofKunhoCho,Jan.
7,2010,atpp.67.However,JasjitBhattalexpresslystatedthathewasnotawareofanylinkbetweenthe
discussionswiththeKoreansinMayandJune2008,andLehmans$6billioncapitalraisethatLehman
completedonJune12,2008.ExaminersInterviewofJasjitBhattal,Oct.12,2009,atpp.78.
671

scheduledfortheweekofJune16,2008,butLehmanpreannounceditssecondquarter
resultsonJune9,2008.2484
According to KDB, when it learned that Hana was negotiating for less than a
majoritystakeinLehman,2485KDBquicklylostinterestintheeffort.2486Whentalkswith
the Korean group failed in June 2008, Lehman turned to other sources to raise capital
beforeannouncingsecondquarterresults.2487AlthoughnoconsortiumofKoreanbanks
investedinLehmaninJune2008,thetalksendedamicably.2488
LehmansnegotiationswithKDBinMayandJune2008becameimportantlater
in the year because of KDBs public statements. On June 2, 2008, Lehman and KDB
signed a Confidentiality Agreement (the KDB Confidentiality Agreement) covering
2484See,e.g.,StevenM.Sears,LehmanBros.isLosingMorethanMoney,BarronsOnline,June9,2008,available
athttp://online.barrons.com/article/SB121298433687756653.html.
2485Documents indicate that KIC also was reluctant to enter the transaction to buy a minority stake in
Lehman, but Jasjit Bhattal told the Examiner that KIC was not reluctant. Email from Brad Whitman,
Lehman,toLarryWieseneck,Lehman,etal.(June5,2008)[LBEXDOCID227666];ExaminersInterview
ofJasjitBhattal,Oct.12,2009,atpp.910.AccordingtoRusso,LehmandidnotfailtointerestKICinthe
investment.Rather,HanawasgoingtofronttheentireinvestmentinLehman.OnceHanapulledout,
HanasuggestedthatKICmightstillbeinterested.LehmanthenmadealastminutepitchtoKIC,butthat
wasunsuccessful.ExaminersInterviewofThomasA.Russo,Dec.1,2009,atp.12.KunhoChorecalleda
meetingwithKIC,buthebelieveditwasastandardpresentationforrelationshippurposes.Chodidnot
have meetings with individual members of the proposed Korean consortium, and when he spoke to
Hana,heassumedHanawasspeakingfortheentireconsortium.Chodidnotknowifsomemembersof
the consortium may have opposed the deal while others may have been in favor of it. Examiners
InterviewofKunhoCho,Jan.7,2010,atp.7.
2487KunhoChotoldtheExaminerthatthetalkswiththeKoreanentitiesatthatpointwereclearlylinked
toLehmansJunecapitalraise.HanawasholdingoutforbettertermsthanLehmanwasofferingtoother
participants. Unable to reach an agreement on price, Lehman raised capital from nonKorean sources.
ExaminersInterviewofKunhoCho,Jan.7,2010,atpp.67.
2488See email from Thomas A. Russo, Lehman, to Richard S. Fuld, Jr., Lehman, et al. (June 9, 2009)
[LBHI_SEC07940_212670].
672

thepartiesnegotiations.2489TheKDBConfidentialityAgreementprohibiteddisclosure
ofthefactthatyouareconsideringapossibletransactionwiththeCompany[,]...that
discussionsornegotiationsaretakingplaceconcerningapossibletransactioninvolving
the Company or any of the terms, conditions or other facts with respect thereto
(includingthestatusthereof)....2490
(ii) DiscussionsResume:SecondRoundofTalksbetween
KDBandLehman
Afterahiatus,talksbetweenLehmanandKDBresumedinlateJune2008.2491In
thenewround,KDBandHanawereinterestedinaninvestmentbankingjointventure
inSouthKorea,whileLehmanwasfocusedonjointventuresforLehmanscommercial
realestateandotherassets.2492FuldapprisedLehmansBoardofdevelopmentsrelated
toKDBduringaseriesofphonecalls.2493
The talks progressed to the point where, at the end of July 2008, Lehman
envisagedthataconsortiumofKoreanbanksledbyKDBwouldmakeatenderofferfor
2489Lehman, Confidentiality Agreement with Korea Development Bank (June 2, 2008) [LBEXDOCID
816276]. Lehman also signed a confidentiality agreement with Hana on June 2, 2008, and with KIC on
June5,2008.SeeLehman,ConfidentialityAgreementwithHanaFinancialGroup(June2,2008)[LBEX
DOCID816281];Lehman,ConfidentialityAgreementwithKoreaInvestmentCorporation(June5,2008)
[LBEXDOCID816279].
816276].
2491See email from Walter Heindl, Lehman, to Jasjit Bhattal, Lehman, et al. (June 30, 2008)
[LBHI_SEC07940_401001] (summarizing key points from meeting with KDB and Hana); email from
JeffreyL.Weiss,Lehman,toHughE.McGee,III,Lehman(June30,3008)[LBEXDOCID224507].
2492See email from Walter Heindl, Lehman, to Jasjit Bhattal, Lehman, et al. (June 30, 2008)
[LBHI_SEC07940_401001](summarizingkeypointsfrommeetingwithKI);emailfromBradWhitman,
Lehman,toJeffreyL.Weiss,Lehman,etal.(July6,2008)[LBHI_SEC07940_401267](discussingnextsteps
forrealestateanddebtpurchase).
2493RichardS.Fuld,Jr.,Lehman,CallLogs(Mar.15Sept.15,2008)[LBHI_SEC07940_016911].
673

approximately 50% of Lehman.2494 Bhattal recalled that the core of the deal was a $5
billion tender offer for up to 50% of Lehmans common stock.2495 Fuld recalled KDB
wanting 51% of Lehman through a tender offer, as well as significant portions of
Lehmans commercial real estate, residentials and leveraged loan assets.2496 Fuld told
theExaminerthatKDBchangeditsfocustoa49%acquisitionbecauseoflegalconcerns
thatwouldarisefromachangeinmajorityownership.2497
According to KDB, Lehman approached KDB in midJuly with a proposal
whereby KDB would obtain a controlling share of Lehman through a $5 to $6 billion
tender offer.2498 Lehman reportedly packaged that offer with a proposal that KDB
acquire some of Lehmans commercial real estate positions.2499 KDB was willing to
consideracquiringsomeofLehmanscommercialrealestatepositionsbutonlybecause
KDBthoughtthatitwouldbenecessarytodosoinordertoacquireacontrollingstake
inLehman.2500
On or about July 28, 2008, senior Lehman executives, including Fuld, McDade,
McGee, Bhattal and Cho met in Hong Kong with KDB Governor Euoo Sung Min and
otherKDBexecutives,aswellasGaryS.BarancikofPerellaWeinbergPartners,KDBs
[LBHI_SEC07940_028534].
2497Id.atp.24.
2499Id.
2500Id.
674

U.S. advisor.2501 Following those meetings, the parties agreed that KDB would begin
duediligenceinNewYork.2502ThesamegroupscheduledfollowupmeetingsinNew
YorkonAugust5and6,2008.2503
AttheJuly31,2008Boardmeeting,FuldupdatedtheBoardonmeetingswitha
potentialforeignpartner(mostlikelyKDB),notingthatduediligencewasunderway,
and that the transaction would be a tender offer for approximately 50% of Lehmans
common stock.2504 He also said that government approval in the potential partners
home country could impact the timeframe.2505 Fuld further noted that the parties
discussed possible joint ventures for commercial real estate, residential mortgages,
acquisitionfinanceandinvestmentbankinginthepartnershomecountry.2506
Fuld told the Examiner that in June 2008, Lehman directors John D. Macomber
and John F. Akers had warned him that Lehman never would sign a deal with KDB
because Korean companies historically dragged out discussions without ever
completing a deal.2507 Fuld said that at the end of the July 29, 2008 meeting, he was
beginning to think that Macomber and Akers were prescient in their warning.2508
2502ExaminersInterviewofKDB,Oct.26,2009,atp.10;ExaminersInterviewofKunhoCho,Jan.7,2010,
atp.8.
2503Id.
[LBHI_SEC07940_028534].
2505Id.
2506Id.
2508Id.atp.25.
675

Barancik, KDBs advisor, told the Examiner that Fuld was so aggressive in pushing
Lehmans commercial real estate assets that the August 2008 meetings were
uncomfortable.2509FuldtoldtheExaminerthathesuggestedthatifKDBdidnotwantto
investinLehman,itcouldinvestinCleanLehmanafterSpinCo,thatis,Lehmanafter
ittransferreditsilliquidcommercialrealestateassetstoSpinCo.2510
By August 6, 2008, after KDB had commenced due diligence, KDB had lost
interestinthetenderofferandjointventures.2511KDBwasconcernedthatLehmanhad
not taken sufficient writedowns on Lehmans commercial real estate positions and
residential mortgage assets.2512 KDB also expected that further writedowns would be
necessaryasrealestatemarketsdeteriorated.2513Inaddition,KDBhadconcernsabout
Lehmanshighyielddebtandhighyieldequityassets,whichKDBbelievedcouldturn
sour.2514 Those concerns led KDB to reject the idea of making a tender offer for a
significant stake in Lehman as the company currently was structured.2515 At the
2509ExaminersInterviewofGaryS.Barancik,Sept.25,2009,atp.4.
2511See email from Hugh E. McGee, III, Lehman, to Herbert H. McDade, III, Lehman (Aug. 5, 2008)
[LBHI_SEC07940_647147]; Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors

(Aug.6,2008),atpp.12[LBEXAM003877].AccordExaminersInterviewofKDB,Oct.26,2009,atpp.
1011.
2513Id.
2514Id.
2515Id.
676

August6, 2008 Board Meeting, Fuld reported that KDB no longer wanted to do a
transactionunlessLehmanspunoffitscommercialrealestate.2516
(iii) ThirdRoundofTalksbetweenKDBandLehman
AlmostassoonasthediscussionsregardingatenderofferendedinearlyAugust
2008, KDB, Lehman and Perella Weinberg worked to find a way for KDB to invest in
Clean Lehman.2517 Although KDB expressed interest in investing in Clean Lehman,
many difficult issues remained.2518 KDB did not want to assume any risk associated
withfuturewritedowns,didnotwantCleanLehmantoretainanyriskyassetsandwas
worried about how the SpinCo notes that would remain on Clean Lehmans balance
sheetwouldberated.2519KDBalsoneededtobeabletoobtainapprovalfromskeptical
Koreanregulators.2520
2516Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Aug. 6, 2008), at p. 1
[LBEXAM003877].
2517Cho told the Examiner that KDB proposed an investment in Clean Lehman following a spinoff of
LehmanscommercialrealestatetowardtheendofthemeetingsinNewYorkinearlyAugust2008.Only
whenKBDandLehmanwereunabletoagreeuponametricforvaluingCleanLehmandidthatroundof
negotiationsultimatelybreakdown.ExaminersInterviewofKunhoCho,Jan.7,2010,atp.9.
2518See email from Hugh E. McGee, III, Lehman, to Brad Whitman, Lehman, et al. (Aug. 13, 2008)
[LBHI_SEC07940_406804].
2519Id. For concernsabout the needfora truly clean CleanCo, see also email from Hugh E. McGee, III,
Lehman, to Larry Wieseneck, Lehman (Aug. 14, 2008) [LBHI_SEC07940_406900]; email from Arjay
Jensen, Perella Weinberg Partners, to Chan Lee, Hana Bank (Aug. 28, 2008) [PWP 00000806]. For
concernsabouttheSpinConotes,seealsoemailfromBradWhitman,Lehman,toMartinKelly,Lehman,
etal.(Aug.14,2008)[LBHI_SEC07940_406973];emailfromLarryWieseneck,Lehman,toBradWhitman,
Lehman (Aug. 19, 2008) [LBHI_SEC07940_407659]; email from Chan Lee, Hana Bank, to GaryS.
Barancik, Perella Weinberg Partners (Aug. 23, 2008) [PWP 00001054]; email from GaryS. Barancik,
PerellaWeinbergPartners,toChanLee,HanaBank(Aug.31,2008)[PWP00000707].
2520See email from Catherine Jones, Lehman, to Scott J. Freidheim, Lehman (Aug. 25, 2008)
[LBHI_SEC07940_856773](forwardingHeidiN.Moore,Lehman,TheToothFairyandtheRevengeoftheShort
Sellers, Wall St. J., Aug. 25, 2008); email from Hugh E. McGee, III, Lehman, to Jasjit Bhattal, Lehman
(Aug.29,2008)[LBHI_SEC07940_651737].
677

OnAugust31,2008,KDBsentLehmanaPreliminaryTermSheet,underwhich
KDBwouldmakea$6billioninvestmentinCleanLehman.2521KDBwouldreceivetwo
BoardseatsandwouldhavetheabilitytoremoveseniorexecutivesifLehmandidnot
meetperformancetargets.2522Shortlythereafter,KDBsentLehmanafinancialanalysis,
which showed Lehmans valuation of its own assets producing a purchase price of
$17.50 per share, while KDBs conservativecase valuation amounted to a purchase
price of $6.40 per share.2523 KDB thought $6.40 was a fair price, although it did not
expect Lehman immediately to accept that offer.2524 Cho told the Examiner that Min
warnedhimthatLehmanwouldbesurprisedbytheoffer.2525PerellaWeinbergthought
thatKDBshighlyconservativevaluationwasunrealistic.2526
Lehman executives have insisted that KDB never made an offer, either because
KDBwasnotauthorizedbytheKoreangovernmenttomakeanactionableoffer,oron
the basis that the Preliminary Term Sheet did not constitute an offer but rather an
outline to begin negotiations.2527 Indeed, the Preliminary Term Sheet expressly states
2521KDB, Project H Preliminary Term Sheet for Proposed Investment and the Strategic Relationship
[Draft](Aug.31,2008)[LBEXDOCID281214],attachedtoemailfromGaryS.Barancik,PerellaWeinberg
Partners,toHughE.McGee,III,Lehman,etal.(Aug.31,2008)[LBEXDOCID315383].
2522Id.
2523Hana Investment Bank, Scenario Analysis [Draft] (Sept. 1, 2008), at p. 2 [LBEXDOCID 407413],
attached to email from Arjay Jensen, Perella Weinberg Partners, to Hugh E. McGee, III, Lehman, et al.
(Aug.31,2008)[LBEXDOCID315396].
2527See email from Herbert H. McDade, III, Lehman, to Monique Wise, Lehman (Sept. 3, 2008)
[LBHI_SEC07940_653467];emailfromMoniqueWise,Lehman,toScottJ.Freidheim,Lehman(Sept.18,
678

thatitisnotanoffer.2528However,KDBhassaidininterviewsthatitwaspreparedto
proceed with the transaction at the $6.40 price had Lehman agreed to that price.2529
AlthoughKDBstill wouldhaveneededapprovalfromitsownboardofdirectorsand
fromSouthKoreanregulatorybodies,KDBbelievedthatitcouldhaveobtainedthose
permissions.2530 Barancik warned KDB about being unreasonably low in its starting
offer and stated to the Examiner that he had expected Lehman to reject KDBs $6.40
starting offer becauseit was well below market price at the time.2531 Indeed, Barancik
believed that KDBs offer was so low that, had Lehman accepted it, it would have
furtherdrivendownLehmanssharepriceandwouldhavebeendetrimentaltoKDB.2532
Lehman quickly rejected KDBs proposal but simultaneously suggested further
negotiations in New York.2533 Although KDB initially agreed to those talks, KDB did
notholdanyfurtherdiscussionswithLehman.2534KDBdecidedthattheglobalfinancial
situation was deteriorating and that, as a stateowned bank, it was no longer
2008)[LBHI_SEC07940_857773].AccordExaminersInterviewofRichardS.Fuld,Jr.,Sept.30,2009,atpp.
2627;ExaminersInterviewofHughE.McGee,III,Aug.12,2009,atpp.1719;ExaminersInterviewof
JasjitBhattal,Oct.12,2009,atp.15.
2528KDB, Project H Preliminary Term Sheet for Proposed Investment and the Strategic Relationship
[Draft](Aug.31,2008)[LBEXDOCID281214],attachedtoemailfromGaryS.Barancik,PerellaWeinberg
Partners,toHughE.McGee,III,Lehman,etal.(Aug.31,2008)[LBEXDOCID315383].
2530Id.
2531ExaminersInterviewofGaryS.Barancik,Sept.25,2009,atpp.56.
2532Id.
2533Letter from Jasjit Bhattal, Lehman, to Euoo Sung Min, Korea Development Bank, re: terms of
proposed deal (Sept. 1, 2008) [PWP 00001727] (letter stating Lehmans intention to continue pursuing
alternative paths); email from Jasjit Bhattal, Lehman, to Brad Whitman, Lehman, et al. (Sept. 1, 2008)
[LBHI_SEC07940_651987];ExaminersInterviewofJasjitBhattal,Oct.12,2009,atp.16.
atpp.1011.
679

appropriate for KDB to pursue Lehman.2535 Indeed, South Koreas currency, the won,
sank by as much as 6% in the first week of September 2008, and South Koreas stock
market declined by 12% from early August to early September 2008.2536 According to
Cho, the Korean government ordered KDB to terminate its discussions with Lehman
becauseofthepressureonthewon.2537KDBindicatedthatitrelayeditsdecisionnotto
continue talks with Lehman on September 2, 2008.2538 KDB did not inform Perella
Weinbergofitsdecisiontostopnegotiationsuntilafewdayslater,onSeptember3or4,
2008.2539
During Lehmans final week, as its stock price plummeted, Barancik tried to
renew negotiations betweenLehmanand KDB.Baranciktoldthe Examiner that KDB
stated that it was not interested.2540 Lehman, on the other hand, believed that Min of
KDBwascomingtoNewYorkforcontinuedmeetingsonSeptember3,2008.2541Those
atpp.1011.
2536See email from Michael Flaherty, Thomson Reuters, to undisclosed (Sept. 5, 2008) [LBEXDOCID
1388783] (article reporting turmoil in South Korean markets); Yahoo Finance, South Korean Won
historical chart (Aug. 1, 2008 Sept. 15, 2008), available at http://finance.yahoo.com/currencyinvesting
(followinvesting,currencies;thenenterKRWandfollowinteractivecharts).
2539Id.;ExaminersInterviewofGaryS.Barancik,Sept.25,2009,atp.6.
2541See email from Kunho Cho, Lehman, to Brad Whitman, Lehman, et al. (Sept. 1, 2008)
[LBHI_SEC07940_651987]; Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors

(Sept.3,2008),atp.2[LBEXAM003899].AccordExaminersInterviewofRichardS.Fuld,Jr.,Sept.30,
2009,atp.26;ExaminersInterviewofJasjitBhattal,Oct.12,2009,atp.16.
680

meetings never took place.2542 Lehmans Board met on September 3, 2008, and Fuld
informed the Board of the cancelled meeting with KDB.2543 Fuld told the Board that
financial concerns in the potential investors home country had prevented the
investment.2544
LehmansBoard was not informed that Lehman received the Preliminary Term
Sheet or that Lehman summarily had rejected KDBs proposal.2545 However, several
directorshaveindicatedthattermsheetsbythemselvesarepreliminaryin natureand
generallyshouldnotbepresentedtotheBoard.2546
(iv) KDBsSeptember9,2008Announcement
NotwithstandingtheprovisionsoftheKDBConfidentialityAgreement,2547South
Korean officials and KDB made a series of statements throughout August and early
September 2008 regarding the status of the negotiations between Lehman and KDB,
bothtothegeneralpublicandtoexecutivesatJPMorgan.
2542Examiners Interview of Richard S. Fuld, Jr., Sept. 30, 2009, at p. 26; Examiners Interview of Jasjit
Bhattal,Oct.12,2009,atp.16.
[LBEXAM003899].
2544Id.
2545ExaminersInterviewofMichaelL.Ainslie,Sept.22,2009,atp.11;ExaminersInterviewofRolandA.
Hernandez,Oct.2,2009,atpp.1920;ExaminersInterviewofDr.HenryKaufman,Sept.2,2009,atpp.
1718.
2546ExaminersInterviewofJerryA.Grundhofer,Sept.16,2009,atp.13;accordExaminersInterviewof
MichaelL.Ainslie,Sept.22,2009,atpp.1112;ExaminersInterviewofJohnD.Macomber,Dec.17,2009,
atp.4.
816276].
681

On August 22, 2008, a MarketWatch news article reported that Lehman shares
rose on news that a KDB spokesman confirmed that KDB was in talks with Lehman
aboutapotentialtransaction:Wearestudyinganumberofoptionsandareopentoall
possibilities, which could include (buying) Lehman.2548 The article also quotes a
Korean government official as saying that after reviewing Lehmans books in early
August, KDB decided that insolvency was a serious concern and a deal would be
risky.2549ThearticlecitesMinassayingthatitisnormalthatseveralnegotiationsand
rupturesoccurbeforeafinaldeal.2550
On August 22, 2008, a Reuters article reported that Lehman and KDB were
involved in negotiations, and attributed that fact to a KDB spokesperson.2551 Also on
August22,2008,MincalledJPMorgan,followinguponameetingthathadoccurreda
few days earlier, indicating that he wanted to pursue a significant investment in
LehmanandwasinterestedinJPMorganpossiblyadvisingKDB.2552
OnAugust25,2008,theWallStreetJournalquotedJunKwangwoo,theheadof
SouthKoreasFinancialServicesCommission,assayingthatitmightnotbeappropriate
2548See email from Timothy Sullivan, Lehman, to Hugh E. McGee, III, Lehman, et al. (Aug. 22, 2008)
[LBHI_SEC07940_408101](forwardingMarketWatcharticle).
2549Id.
2550Id.
2551Kim Yeonhee, S. Koreas KDB Says Buying Lehman a Possibility, Reuters, Aug. 22, 2008, available at
http://www.reuters.com/article/ousiv/idUSSEO26101520080822.
2552SeeemailfromOlivierdeGrivel,JPMorgan,toStevenD.Black,JPMorgan,etal.(Aug.22,2008)[JPM
20040005910].
682

forastateownedinstitutiontotakeonexcessiveburdens.2553Thenextday,anemail
from Steven Lim (JPMorgans Senior Country Officer and Managing Director,
Investment Banking for Korea) to Steven D. Black (JPMorgan coCEO), Dimon and
other JPMorgan executives recounted that JPMorgan had spoken to KDB and that the
statements from South Koreas Financial Services Commission were important; as a
result,KDBwantedtostoppursuingLehmanforthetimebeing.2554
On August 31, 2008, the Dow Jones Newswires reported that Jun Kwangwoo
had stated that KDB was considering a possible investment in Lehman Brothers as
well as other global banks.2555 Kwangwoo noted that KDB had not yet submitted a
plantotheregulatorybody,andthatgovernmentapprovalwouldtakemorethanaday
ortwo.2556
A September 1, 2008, email from Lim to Black, Dimon and other JPMorgan
executivesnotedthatLimhadcalledMinonAugust31,2008topersuadeMintoselect
JPMorgan as a financial advisor on the Lehman deal.2557 Min reportedly thanked
2553Email from Catherine P. Jones, Lehman, to Scott J. Freidheim, Lehman, et al. (Aug. 25, 2008)
[LBHI_SEC07940_856773].
2554Email from Steven Lim, JPMorgan, to Steven D. Black, JPMorgan, et al. (Aug. 26, 2008) [JPM2004
0005989]; email from Tim Main, JPMorgan, to Steven Lim, JPMorgan, et al. (Aug. 26, 2008) [JPM2004
0006015].
2555Email from Shelby Lauckhardt, Lehman, to Richard S. Fuld, Jr., Lehman (Sept. 1, 2008)
[LBHI_SEC07940_213366](forwardingDowJonesNewswiresarticle).
2556Id.
2557Email from Steven Lim, JPMorgan, to Steven D. Black, JPMorgan, et al. (Sept. 1, 2008) [JPM2004
0006139];emailfromStevenD.Black,JPMorgan,toJamieL.Dimon,JPMorgan,etal.(Sept.1,2008)[JPM
20040006152].
683

JPMorganforthefollowupbutsaidtherewereissuesthatneededtobesortedoutwith
theKoreangovernmentandLehmansassetquality.2558
On September 2, 2008, Min publicly confirmed that KDB was talking with
Lehman, stating that discussions were underway to form a consortium with private
banksas(we)believeitismoredesirabletoacquireLehmanBrothersjointlyratherthan
alone.2559
A September 3, 2008 Bloomberg article noted that KDB released an emailed
statementreporting:Wehavebeenreviewingacquiringanoverseasinvestmentbank,
includingLehmanBrothers,oranassetmanagementcompany,butnothingspecifichas
beendeterminedincludingwhethersuchadealwillsucceed.2560Lehmanmanagement
internallycommented atthetimethatKDBs confirmationoftalks raisedexpectations
andconditionedthemarketstoexpectthatLehmanwouldannounceastrategicpartner
bytheendofthethirdquarter.2561
2558Id.
2559Email from Anne Lui, Lehman, to Scott J. Freidheim, Lehman, et al. (Sept. 2, 2008)
[LBHI_SEC07940_857041]; see also email from Monique Wise, Lehman, to Herbert H. McDade, III,
Lehman, et al. (Sept. 2, 2008) [LBEXDOCID 224538]; email from David Erickson, Lehman, to Hugh E.
McGee, III, Lehman, et al. (Sept. 2, 2008) [LBEXDOCID 224548]; email from Randall Whitestone,
Lehman,toScottJ.Freidheim,Lehman,etal.(Sept.2,2008)[LBEXDOCID224642].
2560EmailfromFrankMackinney,JamesCairdAssetManagementGroup,toEricFelder,Lehman,etal.
(Sept.3,2008)[LBEXDOCID808050](forwardingarticle,BomiLim,etal.,HSBC,ChineseBanksinRaceto
Bid for Lehman, Chosun Reports, Bloomberg, Sept. 3, 2008); see also email from Michael Carrier, UBS, to
GlennSchorr,UBS,etal.(Sept.2,2008)[LBEXUBS00048970].
2561Email from Herbert H. McDade, III, Lehman, to Monique Wise, Lehman (Sept. 3, 2008)
[LBHI_SEC07940_653467].
684

On September 5, 2008, Lim again emailed Dimon, Black and other JPMorgan
executivesandstatedthathedidnotbelieveKDBwouldbeabletogetthedealdoneby
LehmansSeptember10,2008deadline.2562
That same day, JPMorgan decided that it needed additional collateral from
Lehman.2563Ataninternalmeeting,JPMorganexecutivesdiscussedthefactthatadeal
between Lehman and KDB did not seem to be moving forward.2564 JPMorgan
considered the status of Lehmans negotiations with KDB to be another instance of
Lehmansdeterioratingmarketposition.2565
On September 9, 2008, Jun Kwangwoo made a public statement, which was
confirmed by another government official, that talks between KDB and Lehman were
over.2566KDBdeclinedtocomment,althoughMinnotedthatKDBcouldbecomeoneof
AsiastopthreeinvestmentbankswithoutLehman.2567
2562EmailfromStevenLim,JPMorgan,toJamieL.Dimon,JPMorgan(Sept.5,2008)[JPM20040006258].
2563ExaminersInterviewofDonnaDellosso,Oct.6,2009,atp.2.
2564Id.
2565SeeSectionIII.A.5.bofthisReport,whichdiscussesKDBsimpactonJPMorganingreaterdetail.
2566JinYoungYook,KoreaFSC:KDB,LehmanInvestmentTalksHaveEnded,DowJonesInternationalNews,
Sept.9,2008[LBEXDOCID131058];SteveGoldstein,KoreanregulatorsaysKDBtalkswithLehmanended,
MarketWatch,Sept.9,2008[LBEXDOCID131059];EvanRamstad&JinYoungYook,TalksBetweenKDB,
LehmanOnPossibleInvestmentEnd,WallSt.J.Online,Sept.9,2008[LBEXDOCID224552].
2567Id.
685

On September 9, 2008, Lim emailed Dimon, Black and others at JPMorgan to
inform the group that KDBs Min had called him to confirm that KDB had ended
negotiationswithLehman.2568
On September 9, 2008, following the public disclosure that Lehmans
negotiations with KDB had terminated, many of Lehmans hedge fund clients pulled
out, shortterm creditors cut lending lines, and the cost of insuring Lehmans debt
surged by almost 200 basis points.2569 On the same day, Lehman executed amended
Security and Guaranty Agreements with JPMorgan at their insistence.2570 Citi also
sought a guarantee agreement to cover its exposure to LBI and so that Citi could
continuetoclearinAsia.2571
LehmansofficersbelievethatKDBsdisclosureshadastrongdownwardimpact
onLehmansstock.2572ThedeclineinLehmanssharepricewasadrivingforcebehind
the decision by Lehmans management to accelerate the third quarter earnings call.2573
FuldtoldtheExaminerthatonSeptember9,2008,hecalledKennethD.Lewis,BofAs
2568Email from Steven Lim, JPMorgan, to Jamie L. Dimon, JPMorgan, et al. (Sept. 9, 2008) [JPM2004
0006320].
2569SeeYalmanOnaran&JohnHelyar,LehmansLastDays,BloombergMarkets,January2009.
2570Id.
2571Id.AccordExaminersInterviewofThomasFontana,Aug.19,2009,atp.8.SeeSectionIII.A.5.cofthis
Report,whichdiscussesthoseagreementsingreaterdetail.
2572ExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atp.11;ExaminersInterviewofThomasA.
Russo,May11,2009,atp.7.
2573ExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atp.11;ExaminersInterviewofThomasA.
Russo,May11,2009,atp.7.
686

CEO, to advise Lewis of KDBs announcement and that the rating agencies were
makingnoise,thereforeLehmanwasgoingtopreannounce.2574
OnSeptember10,2008,priortoLehmanspreannouncementearningscall,KDB
publicly confirmed that talks were over, citing difficulties in the domestic and
internationalfinancialmarkets.2575
During a November 16, 2009 interview, Min said: We missed a very good
opportunity...IthinkwecouldhaveavoidedasituationwhereLehmancollapsedso
rapidly.2576Duringtheinterview,Minsaidthathehadbeenpreparedtoraisehisoffer
as high as $9 per share.2577 Min blamed the confidentiality agreement for preventing
KDB from explaining the proposed transaction to Korean regulators while the
negotiationswereongoing.2578
(c) MetLife
During 2008, Lehman contacted MetLife several times in an effort to raise
capital.2579 According to Steven A. Kandarian, MetLifes Executive Vice President and
2575See email from Shelby Lauckhardt, Lehman, to Richard S. Fuld, Jr., Lehman (Sept. 10, 2008)
[LBHI_SEC07940_213466] (forwarding headlinesabout mountingpressureagainst Lehman); Leo Lewis,
KoreaBlamesDifferencesforEndingLehmanTalks,TimesOnline,Sept.10,2008.
2576Bomi Lim, KDBs Min Rues Very Good Opportunity Missed in Lehman Failure, Bloomberg, Nov. 18,
2009.
2577Id.
2578Id.
2579ExaminersInterviewofStevenA.Kandarian,Sept.17,2009,atp.4.
687

CIO,atransactionneveroccurredbecauseMetLifedidnothaveenoughtimetoconduct
duediligenceonanyofthoseoccasions.2580
Kandarian watchedasLehmans stockpricefellfromapproximately $85.00 per
share to $12.50 per share.2581 Kandarian told the Examiner that he considered
purchasing Lehman at a distressed price, to provide it with a safe harbor during
tough times and then take it public in three to seven years once the markets had
recovered.2582 Fuld told the Examiner that he thought that MetLifes proposal to take
LehmanprivateandthenspinitbackoutwasanelegantsolutionandFuldwaswilling
togiveMetLifecontrolofLehmantodoso.2583BecauseKandarianexpectedthemarkets
todeteriorateintheshortterm,however,Kandarianwantedtomakesurethatanyprice
MetLife offered contained enough of a buffer that Lehman could sustain further
writedowns without MetLife taking a loss.2584 Shortly before July 23, 2008,2585
Kandarian communicated his idea to Steven M. Lessing, head of Lehmans private
client group.2586 Lehman then followed up and the parties arranged for subsequent
meetings.2587
2580Id.
2581Id.
2582Id.atp.5.
2585See MetLife, Calendarentry re: Lehman meeting (July23, 2008) [MLLEH 00012220]. Accord
ExaminersInterviewofStevenA.Kandarian,Sept.17,2009,atp.5.
2586KandariancouldnotrecallwhetherhecalledLessingorLessingcalledhim.ExaminersInterviewof
StevenA.Kandarian,Sept.17,2009,atp.5.
2587Id.
688

At Lehmans July 31, 2008 Board meeting, Fuld informed the Board about the
talkswithMetLife.FuldstatedthatMetLifehadbegunduediligenceandthatMetLife
hadthelikelyintentionofspinningitsinterestinLehmanbackoutafterthemarkets
improved.2588
On August 5, 2008, Lehman officers, including Fuld, met with MetLife
executives, including Kandarian.2589 According to Kandarian, Fuld explained at the
meetingthathedidnotliketheaspectsofMetLifesproposalthatcalledforMetLifeto
acquireacontrollingstakeofLehmanwiththeabilitytoappointamajorityofLehmans
Board.2590 That did not concern Kandarian, however. Kandarian told Lehman that
MetLifewasnotgoingtobeLehmansfirstchoice;instead,MetLifewasasafeharborin
a storm, and Lehman should think of MetLife as a backup.2591 According to Fuld,
KandarianneversaidthatLehmanshouldviewthedealasabackup,andFuldwas
morethanwillingtocedecontroltoMetLife.2592
MetLife began due diligence of Lehman. By August 12, 2008, MetLife had a
negative view concerning Lehmans assets, particularly its commercial real estate and
[LBEXAM003875].
2589See letter from Steven A. Kandarian, MetLife, to Richard S. Fuld, Jr., Lehman, et al. (Aug. 6, 2008)
[LBHI_SEC07940_741210].AccordExaminersInterviewofStevenA.Kandarian,Sept.17,2009,atp.5.
2590ExaminersInterviewofStevenA.Kandarian,Sept.17,2009,atpp.56.SeealsoemailfromStevenJ.
Goulart,MetLife,toStevenA.Kandarian,MetLife,etal.(Aug.13,2008)[MLLEH00012231];letterfrom
Steven A. Kandarian, MetLife, to Richard S. Fuld, Jr.,Lehman, et al., re: Meeting
[LBHI_SEC07940_741211].
2591ExaminersInterviewofStevenA.Kandarian,Sept.17,2009,atpp.56.
689

residential mortgage assets.2593 MetLife continued due diligence beyond that point
because it had reviewed only a small portion of Lehmans balance sheet. Kandarian
statedthatitalsowouldhavebeendifficulttoendMetLifesduediligenceinvestigation
so quickly for relationship reasons.2594 Nonetheless, MetLifes view of Lehman
remained negative.2595 MetLife decided that it would not have the buffer that
Kandarianwanted,especiallyafterfuturemarketdeterioration.2596
LehmanalsopitchedMetLifetoinvestineitherSpinCoorCleanCo.2597However,
basedonwhatMetLifehadseenofLehmansassets,MetLifewasnotinterestedinthose
alternatives.2598
On August 20, 2008, MetLife informed Lehman that it was not interested in a
deal.2599AttheBoardofDirectorsmeetinglaterthatday,FuldinformedtheBoardthat
2593Email from Mark Wilsmann, MetLife, to Steven A. Kandarian, MetLife, et al. (Aug. 12, 2008) [ML
LEH00072857];ExaminersInterviewofStevenA.Kandarian,Sept.17,2009,atpp.56.
2595Email from John Rosenthal, MetLife, to Steven A. Kandarian, MetLife (Aug. 13, 2008) [MLLEH
00030453]; email from John Rosenthal, MetLife, to Steven A. Kandarian, MetLife (Aug. 14, 2008) [ML
LEH 00031559]; M. Mazzola & J. Ellermeyer, MetLife, Preliminary View on LEH Private Equity and
AlternativeInvestmentHoldings(Aug.15,2008)[MLLEH00009589].
2597 See email from Hugh E. McGee, III, Lehman, to Jeffrey L. Weiss, Lehman, et al. (Aug. 20, 2008)
[LBHI_SEC07940_407903] (email subject line M is out. McGee adds that there was [n]ot enough
cushion after incorporating their view of CRE. Not even a player for cleanco.). Accord Examiners
InterviewofStevenA.Kandarian,Sept.17,2009,atp.9.
2598Id.
2599Email from Hugh E. McGee, III, Lehman, to Jeffrey L. Weiss, Lehman, et al. (Aug. 20, 2008)
[LBHI_SEC07940_407903];ExaminersInterviewofStevenA.Kandarian,Sept.17,2009,atp.10.
690

MetLifewasnolongerinterestedinadealwithLehmanlargelybecausetheproposed
transactionwastoolargeafinancialcommitmentforthisparty.2600
After Lehmans bankruptcy, Fuld had a breakfast meeting with Kandarian.2601
Fuld told the Examiner that at that meeting, Kandarian confirmed that the deal died
becauseMetLifealreadyhadsubstantialexposuretocommercialrealestateandcould
nottakeonLehmanscommercialrealestatepositionsaswell.2602
(d) ICD
InearlyAugust2008,LehmanconsideredInvestmentCorp.ofDubai(ICD)as
a potential investor for up to $250 million in SpinCo junior, or mezzanine, debt.2603
Talks between Lehman and ICD picked up, with an exchange of draft term sheets by
August22,2008.2604AttheAugust25,2008Boardmeeting,managementinformedthe
Boardthattherewouldbemeetingswithanewpotentialforeigninvestorinthecoming
days.2605
[LBEXAM003891].
2602Id.
2603SeeLehman,PotentialJuniorDebtInvestors(Aug.1,2008)[LBHI_SEC07940_012597].
2604See email from Hugh E. McGee, III, Lehman, to Carol Welter, Lehman (Aug. 20, 2008)
[LBHI_SEC07940_2221725];emailfromKelseySurbaugh,Lehman,toHughE.McGee,III,Lehman,etal.
(Aug.22,2008)[LBHI_SEC07940_408063];emailfromJeffreyL.Weiss,Lehman,toHerbertH.McDade,
III, Lehman, et al. (Aug. 24, 2008) [LBHI_SEC07940_650284]; email from Timothy Sullivan, Lehman, to
ScottJ.Freidheim,Lehman,etal.(Aug.27,2008)[LBHI_SEC07940_856902];emailfromLarryWieseneck,
Lehman,toBradWhitman,Lehman,etal.(Aug.28,2008)[LBHI_SEC07940_408482];emailfromKelsey
Surbaugh,Lehman,toGerardReilly,Lehman(Aug.29,2008)[LBHI_SEC07940_2159297].
[LBEXAM003898].
691

BySeptember2,2008,McGeedevelopedProjectIndigo,whichcalledforICD
to make a $2 billion postSpinCo investment in Lehman, and also to consider other
strategic partnership opportunities.2606 However, Rothschild Ltd., ICDs strategic
advisor, informed Lehman that ICD had concerns about the real estate market and
futurewritedowns.2607RothschildtoldLehmanthatICDwasinterestedininvestingin
LehmansIMDasabackup.2608
On September 4, 2008, ICD made two proposals to Lehman. Under the first
proposal,ICDwouldpaybetween$3.25billionand$4billionfor50.1%ofNB/IMD,
thatis,NB,theprivatewealthmanagementarmofLehmansInvestmentManagement
Division.2609 There is no evidence that Lehman responded to ICDs first proposal.
ICDssecondproposalwasa$3.25billioninvestmentinLehmanpreferredconvertible
shares after the spinoff of commercial real estate positions, conditioned on Lehman
raisinganadditional$3.25billionincapital,andrequiringprotectionforICDagainstup
to$2billioninwritedownsbyLehmanoverthenextyear.2610ICDproposedthat,inthe
2606See email from Ryan Morrell, Lehman, to Hugh E. McGee, III, Lehman, et al. (Sept. 2, 2008)
[LBHI_SEC07940_2222099].
2607See email from Ara Cho, Lehman, to Brad Whitman, Lehman, et al. (Aug. 20, 2008) [LBEXDOCID
210862]; email from Jeffrey L. Weiss, Lehman, to Hugh E. McGee, III, Lehman, et al. (Aug. 30, 2008)
[LBHI_SEC07940_651921]; email from Jeffrey L. Weiss, Lehman, to Herbert H. McDade, III, Lehman
(Sept. 2, 2008) [LBHI_SEC07940_652802]; email from Jeffrey L. Weiss, Lehman, to Hugh E. McGee, III,
Lehman,etal.(Sept.3,2008)[LBHI_SEC07940_653425].
2608See email from Jeffrey L. Weiss, Lehman, to Hugh E. McGee, III, Lehman, et al. (Sept. 3, 2008)
[LBHI_SEC07940_653425].
2609Lehman,ProjectGreenTransactionStructureProposal1(Sept.4,2008)[LBHI_SEC07940_408977].
2610Lehman,ProjectGreenTransactionStructureProposal2(Sept.4,2008)[LBHI_SEC07940_408980].
692

event of substantialwritedownsora ratingsdowngrade,ICD wouldhave theoption
fortwoyearstoconvertitsLehmansharesintosharesofIMD.2611
Fuld knew that ICD was interested in NB as collateral, but he did not recall
hearingthatICDwantedtheabilitytoobtainNeubergeratitsoption.2612Indeed,Fuld
could not understand how such a structure would be possible, as Neuberger was so
integratedintoLehmanthatitcouldnoteasilybecarvedout.2613
LehmanrespondedtoICDssecondproposalwithatermsheetthatattemptedto
protectICDagainstfuturewritedownsbutthatdidnotallowICDtoconvertitsshares
inLehmanintosharesinIMD.2614ManagementdidnotmentiontheICDtermsheetsto
the Board. However, several Board members informed the Examiner that discussing
termsheets,intheabsenceofafirm,fleshedoutoffer,wouldhavebeenawasteofthe
Boardstime.2615
ContactsbetweenLehmanandICDappeartohaveceasedbySeptember9,2008.
According to McGee, ICD said that it needed a time out after Lehmans stock
declinedbynearly50%inasingledayonSeptember9,2008.2616BySeptember14,2008,
2611Id.
2613Id.
2614Lehman, Green Term Sheet [Draft] (Sept. 5, 2008) [LBEXDOCID 612702], attached to email from
BradWhitman,Lehman,toFaisalMikou,InvestmentCorp.ofDubai,etal.(Sept.6,2008)[LBEXDOCID
741921].
2615ExaminersInterviewofJerryA.Grundhofer,Sept.16,2009,atp.13;ExaminersInterviewofMichael
L.Ainslie,Sept.22,2009,atpp.1112;ExaminersInterviewofJohnD.Macomber,Dec.17,2009,atp.4.
2616ExaminersInterviewofHughE.McGee,III,Aug.12,2009,atp.22.
693

Lazard listed ICD as a party that recently performed due diligence but was not
interestedinLehman.2617
(e) BankofAmerica
(i) InitialDiscussionsintheSummerof2008
In midJuly 2008, Lehman began talks with BofA regarding a potential merger
betweenLehmanandBofAsinvestmentbankingdivision,underwhichLehmanwould
own approximately twothirds of the resulting company.2618 On July 13, 2008, Curl,
BofAs Global Corporate Strategic Development and Planning Executive, met with
Fuld, McDade and H.Rodgin Cohen, Chairman of Sullivan & Cromwell, LLP, to
discussapotentialtransaction.2619Atthemeeting,FuldproposedadealinwhichBofA
would acquire a 30% interest in Lehman in exchange for BofAs investment banking
and advising businesses.2620 According to Fuld, the resulting entity would have been
twothirdsownedbyLehmanandonethirdownedbyBofA.2621CurlsaidthatFuldtold
him that the deal would be a good one for BofA because BofA was made up of
commercialbankers,notinvestmentbankers,andLehmanwasmoreexperiencedthan
BofA in managing a global investment firm.2622 Curl further stated that Fuld said that
2617Lazard, Situation Overview (Sept. 13, 2008) [LBHI_SEC07940_410298], attached to email from Brad
Whitman,Lehman,toHughE.McGee,III,Lehman,etal.(Sept.14,2008)[LBHI_SEC07940_410297].
2619ExaminersInterviewofGregoryL.Curl,Sept.17,2009,atp.5.
2620Id.atpp.56.
2622ExaminersInterviewofGregoryL.Curl,Sept.17,2009,atpp.56.
694

through the deal BofA could capitalize on Lehmans great brand, great future, and
robustclientlistinEurope.2623
Following the meeting, Curl was not in favor of the proposed deal for several
reasons.2624CurldidnotbelieveLehmanwasasprofitableasBofAintheareasthatthe
dealwouldinclude.2625HewasputoffbythefactthatLehmanwouldcontroltheentity
while BofA would retain only a 30% interest.2626 Curl also was concerned that the
proposaldidnotprovideBofAtheprotectionofanoptiontosellthestockatapreset
price.2627CurlsawLehmansproposalasariskypropositionthatwouldexposeBofAs
profitable businesses to Lehmans more vulnerable businesses, which had large risks
andfacedhugechallenges.2628CurlstatedthathetoldFuldthathedidnotbelievethe
dealwouldworkbutthathewouldpassitontoLewis.2629AccordingtoFuld,Curlwas
quitereceptivetotheidea,expressingconcernonlyaboutBofAnotbeingincontrolof
theresultantentity,whichFuldthoughtcouldbeworkedout.2630
CurltoldtheExaminerthathepresentedtheideatoLewisbut,likeCurl,Lewis
was not in favor of the deal because the logistics of the transaction would be quite
2623Id.
2624Id.atp.6.
2625Id.
2626Id.
2627Id.
2628Id.
2629Id.
695

difficult and BofA would not be in control of the resultant entity.2631 Lewis told the
Examinerthathewasnotinfavorofthedealbecauseitdidnotmakesensefinancially
forBofA.2632FuldrecalledbeinginformedthatLewiswasnotinfavorofthedeal.2633
(ii) TalksResumeinSeptember
Talks between Lehman and BofA resumed in late August or early September.
OnoraboutAugust26,2008,FuldhadaconversationwithLewisaboutSpinCo.2634Not
longafterthat,FuldmetwithLewisfollowingadinnerattheFRBNY.2635Duringthat
meeting,FuldexplainedSpinCoandLehmansplans.2636Lewis,Fuld,andGeithnerall
were aware beforehand that Fuld would meet with Lewis, but the meeting was
arranged in such a fashion as to avoid signaling to other attendees that they were
meeting.2637LewisrecalledthatFuldgavehimaheavysalespitchatthismeetingbut
does not remember what they specifically discussed.2638 Lewis told Fuld that he was
reluctant to proceed because BofA had been pursuing Merrill Lynch for some time.2639
FuldemphasizedthatBofAneededbankerstocoverretailclients,whichLehmancould
2631ExaminersInterviewofGregoryL.Curl,Sept.17,2009,atp.6;ExaminersInterviewofKennethD.
Lewis,Sept.24,2009,atp.3.
2632ExaminersInterviewofKennethD.Lewis,Sept.24,2009,atp.3.
2634Id. at p. 5. Fuld was uncertain of the date of the conversation but Fulds call logs indicate that on
August 26, 2008, he had a telephone call with Lewis accompanied by the description proposed deal.
RichardS.Fuld,Jr.,Lehman,CallLogs(Aug.26,2008),atp.63[LBHI_SEC07940_016973].
2635ExaminersInterviewofRichardS.Fuld,Jr.,Apr.28,2009,atp.5;ExaminersInterviewofKennethD.
Lewis,Sept.24,2009,atp.4.
2638Id.
696

provide.2640AccordingtoFuld,LewiswasinterestedandtoldFuldthathewouldspeak
withCurlaboutputtingtogetherateamfornegotiations.2641
SometimeafterSeptember1,2008,PaulsoncontactedCurltoexpresshisconcern
thatLehmancouldbecomeaseriousproblemandtoaskCurltolookintoLehmanand
see if there was any way BofA could help.2642 Curl responded that he was unsure of
whether BofA could help because, without knowing the specifics of the situation, the
transactionsoundeddifficult.2643EveninthefaceofPaulsonsrequest,BofAremained
reluctanttolookintoLehman.2644PaulsonstatedtotheExaminerthathetoldLewisto
buyLehman.2645PaulsonalsotoldtheExaminerthathewarnedFuldinSeptember2008
thatLehmancouldnotaffordtheluxuryoffindingthebestfitinabuyerasLehmans
survivalwasatstake.2646
2640Id.
2641Id.
2642ExaminersInterviewofGregoryL.Curl,Sept.17,2009,atp.7.Paulsondescribedhisjobduring
thistimeperiodas,amongotherthings,workingwithFRBNYpresidentTimothyGeithnertofinalizea
dealtosellLehmantoBankofAmericaorBarclays.ExaminersInterviewofHenryM.Paulson,Jr.,June
25,2009,atp.17.
2644Id.
2646Id. In John Macks October 14,2009 speech at Wharton Schoolof Business,Mack said that Paulson
urged Mack to sell Morgan Stanley to J.P. Morgan for $1 per share in the week following Lehmans
bankruptcy. Mack refused. John Mack, Leadership in Crisis, speech at Wharton School of Business
(Oct.14,2009),availableathttp://knowledge.wharton.upenn.edu/article.cfm?articleid=2357.
697

GovernmentofficialscontinuedtocallCurl,sayingthesituationatLehmanwas
notimprovingandaskingBofAtolookatLehman.2647OnSeptember8or9,2008,Curl
contacted Cohen, who previously had served as the intermediary in negotiations
betweenBofAandLehman,askinghimtobegintheprocessoflookingintoLehman.2648
CurltoldtheExaminerthatBofAbeganitsduediligenceofLehmanonSeptember9or
10,2008.2649
According to Fuld, he called Lewis again on September 9, 2008 after the news
brokethatLehmanwouldnotbedoingadealwithKDB.2650Duringthatconversation,
FuldinformedLewisthatLehmanwasplanningtopreannounceitsquarterlyearnings
and advised Lewis that the rating agencies were discussing possibly taking action
regarding Lehman.2651 Lewis told Fuld to keep him apprised of any developments
goingforward.2652FuldcalledLewisagainonSeptember11,2008,informinghimthat
the rating agencies were comforted by hearing that Lehman was negotiating with a
major bank.2653 Fuld told the Examiner that, during the September 11, 2008
conversation,heremarkedtoLewis,Youknowweregoingtodothisdeal,dontyou,
2647ExaminersInterviewofGregoryL.Curl,Sept.17,2009,atp.7.CurlalsostatedthatLewiswascalled
repeatedly with requests to look into Lehman, but Lewis disavowed any knowledge of pressure by
PaulsonoranyotherGovernmentofficialtolookintoLehman.Id.;ExaminersInterviewofKennethD.
Lewis,Sept.24,2009,atp.6.SeeAppendix15tothisReport,whichprovidesadaybydaydiscussionof
developmentswithBofA.
2649Id.
2650Id.
2651Id.
2652Id.
2653Id.
698

Ken?towhichLewisresponded,Yes,Ido,Dick.2654Lewissaidheneverindicatedto
Fuldthatadealwouldgetdone;Lewissaidhewasnoncommittal.2655
LewistoldtheExaminerthatheknewfromtheoutsetthathewouldagreetoa
dealonlyifitwashighlybeneficialfinanciallyforBofA,becauseBofAwouldgainlittle
strategic advantage from a transaction with Lehman.2656 By the end of Friday,
September 12, 2008, BofA was finishing due diligence,2657 concluding that Lehmans
valuationsofitscommercialrealestatepositionsweretoohigh.2658Moreover,BofAhad
uncoveredapproximately$65$67billionworthofLehmanassetsthatBofAsaiditdid
not want at any price.2659 Consequently, Lewis felt that any deal with Lehman would
not be financially advantageous for BofA,2660 and BofA was not willing to go forward
with Lehman without Government assistance.2661 Some members of the Bank of
AmericaduediligenceteamapparentlythoughtadealcouldbeprofitableforBankof
AmericabuttheydidnotsharethatopinionwithBofAseniormanagement.2662
2654Id.
2655ExaminersInterviewofKennethD.Lewis,Sept.24,2009,atpp.56.
2656Id.atp.4.
2657SeeemailfromDavidBelk,BofA,toWalterMuller,BofA,et.al.(Sept.12,2008)[BofASEC00003515].
2658See email from Don Benningfield, BofA, to Rochelle Dobbs, BofA, et al. (Sept. 12, 2008) [BofASEC
00002774].
2660Id.
2661Id.atp.6.
2662See,
e.g., email from Rochelle Dobbs, BofA, to Nigel Milner, BofA, (Sept. 13, 2008) [BofASEC
00003525]. Both Curl and Lewis denied that any members of the due diligence team had indicated to
them that they felt the deal would be financially advantageous for BofA. Examiners Interview of
GregoryL.Curl,Sept.17,2009,atp.10;ExaminersInterviewofKennethD.Lewis,Sept.24,2009,atp.5.
699

According to Lewis, he had heard prior to the morning of Saturday,
September13, 2008, that the Government would be unwilling to intervene to save
Lehman.2663Nonetheless,LewiscontactedPaulsontoinformhimthatwithoutsufficient
Governmentassistancetobalanceouttheunwantedassets,BofAcouldnotdoadealfor
Lehman.2664 Paulson was unwilling to offer such assistance to Lewis.2665 Although
PaulsontoldLewisthattheGovernmentwouldnotprovidetaxpayermoney,Paulson
wantedtoreconvenewithBofAlaterinthedaytodiscussotheroptions.2666
On the night of Friday, September 12, 2008, Fulds calls to Lewisto discuss the
statusofthetransactionbegangoingunanswered.2667FuldtoldtheExaminerthat,asof
Fridayevening,hedidnotyetsuspectanythingwasawry.2668
OntheafternoonofSaturday,September13,2008,BofAbegantalkswithMerrill
Lynch without informing anyone at Lehman.2669 According to Lewis, BofA had been
interestedinMerrillLynchforyearsand,onceitbecameevidentthatMerrillLynchwas
looking for a strategic partner, BofA pursued a deal.2670 According to Lewis, the deal
between BofA and Merrill Lynch did not interfere with a deal for Lehman.2671 Lewis
2664Id.
2665Id.
2668Id.
2670Id.
2671Id.
700

told the Examiner that by the time Merrill Lynch approached BofA about a potential
transaction, it was already apparent that a deal with Lehman probably would not
happen.2672BofAalreadyhadbroughthomeitsduediligenceteam.2673
Throughout the day on Saturday, September 13, 2008, Fuld continued to call
Lewis without getting a response.2674 Lewis wife eventually answered the phone and
saidthatifherhusbandwantedtotalktoFuld,hewouldreturnthecall.2675Lewistold
theExaminerthathedidnotanswerFuldscallsbecausehedidnotthinkFuldwasina
position to help move the transaction forward.2676 According to Lewis, the only way
that a transaction could have happened would have been for the Government to
provide the assistance requested.2677 Therefore, Lewis said, any conversations or
negotiationswithFuldwouldhavebeenadistraction.2678
FuldtoldtheExaminerthathebelievesLewiswasusingLehmanasabargaining
chip with the FRBNY regarding assistance the Federal Reserve had apparently
promised but never delivered in connection with Bank of Americas purchase of
Countrywide.2679 Curl told the Examiner that when Paulson contacted him in early
2672Id.
2673Id.
2675Id.
2677Id.
2678Id.
2679FuldtoldtheLehmanBoardofDirectorsonSeptember13,2008,whenitappearedthatnodealwith
BofA would happen, that BofA appeared to be playing a game of chicken with the Fed and the
701

September2008torequestthatBankofAmericalookintoLehman,Curlmentionedthe
CountrywidedealtoPaulson.2680CurlhadexpressedfrustrationtoPaulsonoverthefact
thattheGovernment had approvedtheCountrywide deal but later required remedial
steps to be taken regarding capital that negatively affected Bank of America.2681
According to Curl, Paulson said he believed that, if Curls account were correct, the
Governments actions had been inappropriate.2682 Paulson promised that the
Governmentwouldlookintothatissue.2683
On September 15, 2008, the Financial Times reported that Lewis declined to
comment on whether Bank of America had ever entertained any real interest in
acquiring Lehman Brothers.2684 When interviewed by the Examiner, Lewis stated
unequivocally that there was no quid pro quo regarding Bank of Americas concerns
relatedtoCountrywidewhenBofAlookedintoLehman.2685LewissaidthatBofAwould
nothavedoneanydealwithLehmanthatwasnotinBofAsinterestsfinancially.2686In
any event, after BofA had looked into Lehman, the Countrywide deal was not
Treasury.LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Sept.13,2008),atp.
1[LBEXAM003927];ExaminersInterviewofRichardS.Fuld,Jr.,Apr.28,2009,atpp.67.
2681Id.
2682Id.
2683Id.
2684GregFarrell,BofACorralstheThunderingHerd,TheFinancialTimes,Sept.15,2008.
2685ExaminersInterviewofKennethD.Lewis,Sept.24,2009,atp.7.Lewisexplainedthattheissueinthe
CountrywidedealwasbetweenBankofAmericaandtheFederalReserveanywayandthereforePaulson
andtheTreasurywouldnothavehadthepowertoreopenitevenifsuchabargainhadbeenstruck.Id.
2686Id.atpp.67.
702

reopened.2687 Neither Curl nor Lewis indicated that he felt any undue pressure to
consummateadealwithLehman.2688
(f) Barclays
On September 10, 2008, John Varley, Chief Executive Officer of Barclays,
contactedHectorSants,ChiefExecutiveoftheFinancialServicesAuthority(FSA),the
United Kingdoms equivalent of the SEC.2689 Varley advised Sants that Barclays was
considering a bid for Lehman.2690 The FSA did not object to the idea but stressed the
importance of Barclays keeping the FSA informed of the details and developments of
anyproposedtransaction.2691
On Thursday, September 11, 2008, Fuld informed the Board that he had not
heardfromBarclaysdirectly,buthadbeenadvisedofitspotentialinterestbytheFirms
regulators.2692 Fuld told the Examiner that, prior to that point, Fuld had at least two
conversations with Robert E. Diamond, president of Barclays.2693 During those
conversations, Diamond told Fuld that there was too much overlap to do a deal.2694
Sometime during the first two weeks of September, Terrence J. Checki, an Executive
2687Id.atp.7
2688Id.atpp.67;ExaminersInterviewofGregoryL.Curl,Sept.17,2009,atp.7.
2689FSA, Statement of the FSA (Jan. 20, 2010), 7. See Appendix 15 to this Report, which provides a
discussionofdevelopmentswithBarclaysbytheday.
2690Id.
2691Id.
[LBEXAM003918].
2694Id.
703

VicePresidentattheFRBNY,toldFuldthatBarclayswasinterestedinLehman.2695Fuld
calledDiamondandwasagaintoldtherewastoomuchoverlap.2696
Also on September 11, 2008, Varley informed the FSA that the Barclays board
would meet that day to consider whether Barclays should approach Lehman about a
possible deal.2697 Varley told Sants that Barclays would bid for Lehman if three
conditions were met: (1) there was a high degree of confidence that a deal could be
completedwiththenecessarysupportoftheFederalReservetoensurethis;(2)there
was liquidity support from the Federal Reserve; and (3) there was a discount on
Lehmans net asset values.2698 Sants responded that the FSAs review would focus on
the impact any transaction structure would have on Barclays liquidity and capital,
warningthattheFSAwouldnotapproveanycoreTier1numberbelowtheminimum
requirement.2699Laterthatday,CallumMcCarthy,thechairmanoftheFSA,contacted
GeithnertodiscussLehman.2700AccordingtotheFSA,Geithnerleftopenthepossibility
offederalassistanceforLehman.2701
OnSeptember12,2008,at9:00a.m.inNewYork,theBarclaysboardofdirectors
authorized its management to undertake due diligence to determine if there was an
2695Id.
2696Id.
2698Id.8.
2699Id.9.
2700Id.10.
2701Id.
704

opportunity for a transaction with Lehman.2702 Barclays management presented its
board two possible acquisition scenarios; both involved transactions that valued
Lehmansstockat$5pershare.2703VarleyinformedPaulsonthattheBarclaysboardwas
preparedtoconsiderapossiblebidforLehman.2704
PaulsonspoketoAlistairDarling,ChancelloroftheExchequer,onSeptember12,
2008.2705Duringthatconversation,PaulsontoldDarlingthattheFRBNYmightprovide
Barclays with regulatory assistance to support a transaction.2706 During the day,
discussionsbetweentheFSAandBarclaysfocusedonquantifyingthesizeandnatureof
Lehmans assets and their impact on Barclays capital ratios.2707 Barclays advised the
FSAthatitcontinuedtoseekunlimitedaccesstotheFRBNYdiscountwindowalthough
thereremaineddebatewithintheTreasuryastowhoshouldprovidethefunding.2708
On September 12, 2008, Fuld met with Diamond.2709 Atthat meeting, Fuld told
DiamondthatFuldwouldstepasideiftheydidadeal.2710Barclaysexpressedtwoareas
ofconcernaboutanypotentialdealwithLehman:longtermfundingandcertainrisky
2702TranscriptofdepositiontestimonyofRobertE.Diamond,InreLehmanBrothersHoldingsInc.,CaseNo.
0813555,Bankr.S.D.N.Y.Sept.11,2009,atp.24:922.
2703Barclays, Long Island Transaction Overview (Sept. 12, 2008), at p. 3[BCIEX(S)00053306_000001],
attachedtoemailfromRichardHaworth,Barclays,toJohnVarley,Barclays,etal.(Sept.12,2008)[BCI
EX(S)00053305].
2705Id.23.
2706Id.
2707Id.27.
2708Id.
2709Examiners Interview of Richard S. Fuld, Jr., Apr. 28, 2009, at p. 7. See Tom Junod, The Deal of the
Century,EsquireMagazine,Oct.2009,atp.157(placingthemeetingonFriday,Sept.12,2008).
705

assets.2711BarclaysanticipatedthattheFSAwouldshareitsconcerns.2712Between5:10
p.m. and 6:00 p.m., Varley and Diamond had a call with Paulson and Geithner to
discussthepotentialdeal.2713
Early that evening, Fuld informed the Board that Barclays recently had begun
due diligence, although there had notyet beenanydiscussionofstructureor price.2714
Fuld also informed the Board that Barclays would need stockholder approval for a
transaction.2715
On Saturday, September 13, 2008, Lehman and Barclays discussed a potential
dealthatFulddescribedaslifeafterSpinCobecausethecontemplatedpurchasedid
not include Lehmans commercial real estate assets.2716 Barclays board had set as a
condition precedent to any deal that Barclays would not take on any asset Lehman
plannedtoputinSpinCo.2717BarclaysboardalsoconditionedanydealontheFRBNYs
agreementtocontinuetomakethePrimaryDealerCreditFacility(PDCF)availableto
Lehman after a takeover. 2718 During the afternoon, Barclays advised the FSA that the
FRBNYhadaskedBarclaystoguaranteeLehmansobligationsduringtheperiodprior
2711SeeemailfromJohnVarley,Barclays,toRobertE.Diamond,Barclays,etal.(Sept.12,2008)[BCIEX
00078748].
2712Id.
2713SeeHenryM.PaulsonJr.,CallLogs(Sept.2008),availableathttp://www.scribd.com/doc/21221123/Too
BigToFailPaulsonCallLogsandCalendarSept2008.
[LBEXAM003920].
2715Id.
2718Id.33.
706

totheclosingofthetransaction.2719ThatguarantywouldmakeBarclaysresponsiblefor
Lehmansexistingandnewbusinessevenifthetransactionfailed.2720TheFSAsListing
Rules required the guaranty to be approved by Barclays shareholders.2721 Late in the
dayintheUnitedKingdom,VarleyadvisedSantsthatbecauseoftheguaranty,itwas
unlikelythatadealstructurecouldbefoundthatwouldsatisfyBarclaysboard.2722
OnSaturdayinNewYork,however,Cohen,McDadeandKirktoldFuldthatthe
approvaloftheFSAwouldnotbeanissue.2723FuldreportedtotheBoardonSaturday
afternoonthatBarclaysofferedtopurchasetheoperatingsubsidiariesofLehmanfor$3
billionandthatBarclayswouldguaranteeLehmansdebt.2724Lehmanwouldreceivethe
cashandwouldretainitscommercialrealestateassets,minorityinvestmentsinhedge
fund managers and limited partnership interests in Lehmansponsored private equity
funds.2725 On Saturday night, Fuld went home thinking that Lehman had a deal with
Barclays.2726 Cleary Gottlieb Stein & Hamilton (Cleary Gottlieb) attorney Robert
Davis,whorepresentedBarclaysduringthenegotiations,toldtheExaminerthathetoo
thoughtthatLehmanandBarclayshadreachedanagreementinprincipleonSaturday
2719Id.39.
2720Id.
2721Id.
2722Id.40.
2724 Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Sept. 12, 2008), at p. 1
[LBEXAM003920].
2725Id.
707

night.2727However,WilliamSchlich,theauditpartnerforErnst&Young,notedthatas
oflateSaturdaynight,therewasnodeal.2728Schlichdidnotthinkadealcouldgetdone
absentdrasticchangesbecause[t]hebuyersexpectationsandtheresultingneedof
financingfromthestreetweretoohigh.2729
OnSaturday,September13,2008,BarclaysreachedouttoBuffetttoaskwhether
Buffett would guarantee Lehmans operations until a LehmanBarclays deal closed.2730
BarclaysandBuffettdiscussedascenarioinwhichBuffettwouldprovide$5billionof
protection. Buffett expressed interest in that possibility, but Barclays did not pursue
it.2731
OnSundaymorningintheUnitedKingdom,theFSAandBarclaysdiscussedthe
FRBNYs requirement that Barclays guarantee Lehmans obligation.2732 The FSA
acknowledgedthattheoreticallyitcouldwaivetheshareholderapprovalrequirement,
but the FSA concluded that because no precedent existed, granting a waiver would
represent a compromise of one of the fundamental principles of the FSAs Listing
Regime.2733 During the early afternoon in the United Kingdom, Geithner called FSA
2727ExaminersInterviewofLindseeGranfieldandRobertDavis,Mar.10,2009,atpp.23;Transcriptof
deposition testimony of Herbert H. McDade, III, In re Lehman Brothers Holdings Inc., CaseNo. 0813555,
Bankr.S.D.N.Y.Sept.2,2009,atp.14:1015:5.
2728EmailfromWilliamSchlich,Ernst&Young,toCarmineDiSibio,Ernst&Young,etal.(Sept.14,2008)
[EYLELBHIKEYPERS4908879](updatingonthestatusofnegotiations).
2729Id.
2730ExaminersInterviewofWarrenE.Buffett,Sept.22,2009,atpp.45.
2731Id.
2733Id.
708

ChairmanMcCarthy.GeithnerreiteratedtheFRBNYsrequirementofaguarantyand
suggested that the urgency of the situation required a waiver of the shareholder
approvalrequirement.2734Laterthatafternoon,CoxalsocontactedMcCarthytodiscuss
waivingtheshareholderrequirement.McCarthycitedthelackofprecedentforsucha
waiver and noted that Barclays had yet to submit a formal proposal for the FSAs
review of the deal.2735 By 4:00 p.m. in the United Kingdom, Varley informed the FSA
thatdiscussionshadceased.2736
Lehmans management had scheduled a Board meeting for noon on Sunday,
September14,2008,butdelayedthemeetinguntil5:00p.m.inordertotrytocometo
some resolution at the FRBNY meetings.2737 At some point on Sunday, Fuld was told
thattheFSAwouldnotwaivetherequirementthataguarantyofLehmansobligations
required the approval of Barclays shareholders, and therefore the FSA would not
approvetheBarclaysdeal.2738FuldaskedPaulsontocallPrimeMinisterGordonBrown,
butPaulsonsaidhecouldnotdothat.2739FuldaskedPaulsontoaskPresidentBushto
call Brown, but Paulson said he was working on other ideas.2740 From that, Fuld
inferred that Paulson was going to call Buffett, although Paulson never mentioned
2734Id.47.
2735Id.54.
2736Id.
2738Id.
2739Id.
2740Id.
709

Buffetts name.2741 Fuld brainstormed about other means to contact and convince the
FSA to permit the deal, including having Jeb Bush, a Lehman advisor, ask President
BushtocallthePrimeMinister.2742
Paulson believed that Barclays wanted to do a deal with Lehman.2743 Indeed,
Paulson noted that Barclays had asked him to speak to Alistair Darling, the United
Kingdoms Chancellor of the Exchequer.2744 Paulson placed the call on Friday,
September12,2008.Duringthecall,PaulsonsaidChancellorDarlingdidnotmention
the need for a guaranty of Lehmans debts, but said that the FSA would not reject or
approve the deal. Paulson described Chancellor Darlings statement as a particularly
Britishwayofsayingno.2745
Fuld told the Examiner that in 2009, Fuld had a conversation with Riccardo
Banchetti, who had been jointCEO of Lehman Europe.2746 During that conversation,
Banchetti told Fuld that everyone knew that the FSA had no role in this at all and
wouldnothavebeeninapositiontograntanexemption.2747
2741Id.
2742Id.at10.
2744Id.
2745Id.
2747Id.
710

(6) GovernmentCommunications
Between the time of Bear Stearns near collapse in March and the end of May
2008, Fuld was in regular contact with both Paulson and Geithner. Fuld spoke with
Paulson no fewer than ten times during that period.2748 Similarly, Fuld spoke with
Geithneratleasteighteentimesduringthatsameperiod.2749Theconversationscovered
numerous topics. For example, Fuld apprised Paulson of market rumors, potential
transactions Lehman explored, and other general market updates.2750 Fulds
conversations with Geithner included market updates but also addressed Lehmans
capital raises, market rumors and Lehmans liquidity.2751 Between June and the first
week of September 2008 the final week before Lehmans bankruptcy Fulds call
logs indicate that he updated Geithner at least 23 times, and Paulson 24 times, on
variousissues,suchaspotentialstrategicpartners,SpinCoandthemarket.2752Paulson
told the Examiner that during August 2008, Paulson delegated contact with Lehman
and Fuld to his deputy, Ken Wilson, so that Paulson could focus on Fannie Mae and
Freddie Mac.2753 In addition, Lehman communicated with representatives of the SEC
regardingissuessuchasshortsellersandSpinCo.2754
2748RichardS.Fuld,Jr.,Lehman,CallLogs(Mar.15Sept.15,2008)[LBHI_SEC07940_016911].
2749Id.
2750Id.
2751Id.
2752Id.
2754See
supra Section III.A.3.c and infra Section III.A.3.c.6. of this Report, which discuss Lehmans
communicationswiththeGovernmentregardingSpinCoandshortsellersingreaterdetail.
711

(a) TreasuryDinner
OnApril11,2008,FuldandPaulsonbothattendedaG7dinnerinWashington,
D.C.,andFuldandPaulsonconversedatthedinner.2755AsFuldleftthedinner,hesent
an email to Russo, reporting that Fuld thought Lehman had a huge brand with
[T]reasury and that Treasury loved [Lehmans] capital raise.2756 Fuld told the
Examinerthathebelievedhisemailaccuratelyreflectedhisviewofhisconversations
with Paulson that night.2757 Paulson told the Examiner that he assumed that he gave
Fuldabigpat onthebackfor raisingcapital.Paulsondidnot recall discussing the
capitalraisewithFuldatthatpublicdinner.2758Fuldalsowalkedawayfromthedinner
believing that Paulson had a worried view of Merrill Lynch, implying that Paulson
remainedconfidentofLehman.2759Ontheotherhand,PaulsontoldtheExaminerthat
he had become concerned about Lehman when he heard about the Archstone
transactionin2007andthathisconcernsintensifiedafterBearStearnsnearcollapse.2760
2756Email from Richard S. Fuld, Jr., Lehman, to Thomas A. Russo, Lehman (Apr. 12, 2008)
[LBHI_SEC07940_033997].
2759Email from Richard S. Fuld, Jr., Lehman, to Thomas A. Russo, Lehman (Apr. 12, 2008)
[LBHI_SEC07940_033997].
712

(b) ShortSales
Short selling is frequently mentioned as a factor in the near collapse of Bear
Stearns.2761 On March 17, 2008, the SEC proposed a naked short selling antifraud
rule, Rule 10b21.2762 The SEC noted that although naked short selling as part of a
manipulativeschemealreadywasillegal,commentarytotheproposedRulestatedthat
the Rule would highlight the specific liability of people whose deception relates to
their intention or ability to deliver shares in time for settlement.2763 The SEC sought
commentstoitsproposedrulebyMay20,2008.
AfterBearStearnsnearlycollapsed,shortsellersbegantofocusonLehmanand
other banks. On March 20, 2008, Russocontacted Linda Thomsen, the SECs Head of
Enforcement,regardingrumorsofhedgefundstakinganotherrunatLehman.2764On
April 1, 2008, at Lehmans prompting, Erik R. Sirri, head of the SECs CSE program,
madeastatementatanannualconferenceregardingtheSECsviewoftheseriousness
ofrumorsandstockmanipulationinthecontextofshortsales.2765AttheApril15,2008
Board meeting, Lehmans management discussed Lehmans concerns regarding short
2761See,e.g.,MattTaibbi,WallStreetsNakedSwindle,RollingStone,Oct.14,2009.
2762NakedShortSellingAntifraudRule,73Fed.Reg.15376(proposedMar.17,2008)(tobecodifiedat
17C.F.R.240),availableathttp://www.sec.gov/rules/proposed/2008/3457511.pdf.
2763Id.
2764Email from Thomas A. Russo, Lehman, to Richard S. Fuld, Jr., Lehman, et al. (Mar. 20, 2008)
[LBHI_SEC07940_212208](forwardingdiscussionwithSECregardingshortsellers).
2765See email from Thomas A. Russo, Lehman, to Richard S. Fuld, Jr., Lehman, et al. (Apr. 1, 2008)
[LBHI_SEC07940_033699](reportingErikSirrisstatementregardingtheSECsviewofshortsellinginthe
contextofmarketmanipulation).
713

selling.2766 On May 21, 2008, at the Ira Sohn Conference, one day after the comment
periodfortheSECsproposedruleconcluded,EinhorngaveapresentationonLehman,
analyzingLehmansForm10Q,filedApril9,2008.2767Einhornannouncedthathewas
shortingLehmansstockbasedonhisbeliefthatthestockwasovervalued.2768
Before that presentation, Einhorn had corresponded with Callan in midMay
2008,aspartofwhathedescribedasfactcheckinginadvanceofhispresentationatthe
Ira Sohn Conference.2769 Einhorn focused on four major issues in his correspondence
with Callan and in his May 21, 2008 speech: (1) Lehmans disclosures regarding CDO
exposure and related writedowns; (2) the difference between the amount of Level III
assets disclosed in the Form 10Q filed in February 2008 and during Lehmans first
quarter 2008 earnings call; (3) Lehmans disclosure and valuation of its stake in KSK
Energy;and(4)LehmanswritedownsofitsCMBSassets.2770OnthedayofEinhorns
speech,Lehmansstockcloseddown$2.44,withitshighestvolumeoftheentiremonth
2766Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Apr. 15, 2008), at p. 8
[LBEXAM003654].
2767DavidEinhorn,GreenlightCapital,AccountingIngenuity,speechatIraW.SohnInvestmentResearch
Conference(May21,2008)[LBHI_SEC07940_336846].
2768Id.
2769See email from David Einhorn, Greenlight Capital, to Erin M. Callan, Lehman (May 20, 2008)
[LBHI_SEC07940_098608].
2770Id.; see also email from Eric Felder, Lehman, to Paolo R. Tonucci, Lehman, et al. (May 21, 2008)
[LBHI_SEC07940_336795](FelderemailreportingonEinhornsspeech).
714

ofMay2008.EinhornscriticismofLehmanandCallaniscommonlycitedasthereason
forCallansreplacementlessthanthreeweekslater.2771
Following the near collapse of Bear Stearns, Einhorn published a book, Fooling
SomeofthePeopleAlloftheTime,whichfocusedonAlliedCapital.ThomasC.Baxter,Jr.,
GeneralCounseltotheFRBNY,saidthatreadingEinhornsbookmadehimthinkthat
the FRBNY should pay more attention to short sellers concerns.2772 However, Baxter
didnotreachthatconclusionforthereasonthatLehmanwouldhavewanted,namely
topersuadetheGovernmenttoregulateshortsellers,butratherbecauseitappearedto
BaxterthatEinhornmayhavebeenshortingLehmanforgoodcause.Baxterwasunable
to say, however, whether anyone at the Federal Reserve followed up on Einhorns
criticismofLehmaninhisspeech.2773
BetweenMarch20,2008andJuly17,2008,LehmansenttheSEC,aswellasthe
FRBNY, more than twenty complaints about rumors and short sellers.2774 On July15,
2008,theSECissuedashorttermruleprohibitingshortsales.ThatruleexpiredonJuly
2771Examiners Interview of John F. Akers, Apr. 22, 2009, at p. 8; Examiners Interview of Jerry A.
Grundhofer,Sept.16,2009,atp.9;ExaminersInterviewofMichaelL.Ainslie,Sept.22,2009,atp.5.
2772ExaminersInterviewofThomasC.Baxter,Jr.,May20,2009,atpp.78.
2773Id.
2774See,e.g.,emailfromThomasA.Russo,Lehman,toTerrenceJ.Checki,FRBNY(July17,2008)[LBEX
AM057718];emailfromBethRudofker,Lehman,toIsraelFriedman,SEC,etal.(June17,2008)[LBEX
WGM1142544];emailfromBethRudofker,Lehman,toLauraVecchio,Lehman(May27,2008)[LBEX
WGM648855](forwardingemailsenttotheSECregardingEinhornandrumors);emailfromThomas
A. Russo, Lehman, to Richard S. Fuld, Jr., Lehman, et al. (Mar. 20, 2008) [LBHI_SEC07940_212208]
(forwarding discussion with SEC regarding short sellers); email from William Brodows, FRBNY, to
TimothyF.Geithner,FRBNY,etal.(July10,2008)[FRBNYtoExam.026728];LehmanBrothersHoldings
Inc.,MinutesofMeetingofBoardofDirectors(July14,2008),atp.2[LBEXAM003837].
715

29,2008.2775Morethantwomonthslater,theSECrespondedtothemassivedisruptions
in the market by issuing Rule 10b21, which became effective on October 17, 2008.2776
The rule specifically prohibited traders from deceiving brokers about the source of
sharesthatwouldbeusedtorepurchasesharessoldshort,ifthetraderfailedtodeliver
thesecuritywhendue.2777
(c) PossibilityofFederalAssistance
Since Lehmans bankruptcy, Paulson repeatedly has said that he never gave
Lehman reason to believe that it would receive a bailout in the event it became
necessary.InaJuly2,2008speechatChathamHouseinLondon,titledTheU.S.,The
WorldEconomyandMarkets,Paulsonnotedthat[b]ankruptcy[can]impose[]market
disciplineoncreditorsbutthatinatimeofcrisis,[bankruptcy]couldinvolveundue
market disruption.2778 After reviewing Paulsons remarks, Felder remarked in a
contemporaneousemailthatitappearedthatPaulsonwastryingtosetthestageto
closethePDCFbutwantedtohaveaplaninplaceincasethereisaninvestmentbank
thatfailsafterthePCDFclosed.2779PaulsontoldtheExaminerthathebelievedthathe
2775SEC, Press Release, SEC Enhances Investor Protections Against Naked Short Selling (July 15, 2008),
availableathttp://sec.gov/news/press/2008/2008143.htm.
2776SEC,NakedShortSellingAntifraudRule(Oct.14,2008)(codifying17C.F.R.242.10b21),available
athttp://sec.gov/rules/final/2008/3458774.pdf.
2777Id.
2778U.S.DepartmentofTreasury,HenryM.Paulson,Jr.,RemarksbyU.S.TreasurySecretaryontheU.S.
The World Economy and Markets speech before the Chatham House (July 2, 2008), available at
http://www.treas.gov/press/releases/ht1064.htm.
2779EmailfromEricFelder,Lehman,toIanT.Lowitt,Lehman,etal.(July2,2008)[LBEXDOCID067106].
716

may have discussed the possibility of bankruptcy with Fuld in July 2008.2780 Paulson
told the Examiner that, at the very least, he made clear to Fuld that the Government
wouldnotprovideabailoutforLehman.2781Ontheotherhand,FuldtoldtheExaminer
that while Paulson never gave him any assurance or reason to believe that the
Governmentwouldprovideassistance,Paulsonalsoneversaidanythingthatruledout
thepossibilityofGovernmentassistance.2782
ASeptember11,2008discussionbetweenGeithnerandFuldmayhaveplayeda
role in leading Fuld to believe that a federal bailout was possible. On Thursday,
September11,BaxtercalledRussoandsuggestedthatFuldstepdownfromtheBoard
of the FRBNY.2783 Fuld told the Examiner that after Russo told Fuld about the
conversation, Fuld called Geithner.2784 Geithner asked Fuld to step down from the
Board in case we have to do something for you or with you this weekend.2785
GeithnertoldtheExaminer thathe could notrecall making the statement,but hewas
certain he was careful not to imply that Lehman could expect the Federal Reserves
support.2786 Fuld reported that he walked away from his conversation with Geithner
2781Id.
2782ExaminersInterviewofRichardS.Fuld,Jr.,Apr.28,2009,atp.11;ExaminersInterviewofRichardS.
2783ExaminersInterviewofRichardS.Fuld,Jr.,Apr.28,2009,atp.11;ExaminersInterviewofThomas
Baxter,Jr.,Aug.31,2009.
2785Id.
2786ExaminersInterviewofTreasurySecretaryTimothyF.Geithner,Nov.24,2009,atp.9.
717

withthefeelingthat,ifitcamedowntoit,theFRBNYandGeithnerwouldbetherefor
Lehman.2787 A FRBNY meeting agenda dated September 10, 2008 also suggests that a
FRBNY representative was contemplating providing public funds for Lehman at the
timeoftheSeptember11,2008conversationbetweenGeithnerandFuld.2788
(7) LehmansBankruptcyPlanning
In August 2008, as the magnitude of third quarter losses became clear, Steven
Berkenfeld, Head of Lehmans Legal, Compliance and Audit Division, became
concernedaboutthepossibilityofaLehmanbankruptcy.2789BerkenfeldspoketoRusso
abouthiringbankruptcycounseltobegininitialpreparationsasaprecaution.2790Russo
refusedthatsuggestionbecauseheworriedthataleakwouldturnbankruptcyplanning
intoaselffulfillingprophecy.2791
PublicreportsimplythatnobankruptcyworkwasdonepriortoSeptember14,
2008.Thatisnotaccurate.OnSeptember10,2008,afterFannieMaeandFreddieMac
failed, Berkenfeld called Stephen J. Dannhauser, the chairman of Weil, Gotshal &
2788See FRBNY, Liquidation Consortium (Sept. 10, 2008) [FRBNY to Exam. 003517], attached to email
from Michael Nelson, FRBNY, to Christine Cumming, FRBNY, et al. (Sept. 10, 2008) [FRBNY to Exam
003516].AccordExaminersInterviewofWilliamBrodows,Aug.20,2009,atp.6;ExaminersInterviewof
JanH.Voigts,Aug.25,2009.
2789Examiners Interviews of Steven Berkenfeld, Oct. 5 and 7, 2009, at p. 21. See Appendix 15 to the
ReportwhichprovidesachronologicaldiscussionofLehmansprebankruptcyplanning.
2790Id.
2791Id.
718

MangesLLP(Weil),tobeginworktowardapossiblebankruptcyfiling.2792Berkenfeld
hadnotobtainedanyinternalauthorizationtomakethatcall.2793Russowasnotpleased
tohearaboutBerkenfeldscalltoWeil,becauseRussowasconcernedaboutaleakand
believed that bankruptcy was not a possibility.2794 Harvey R. Miller, the chairman of
Weilsbankruptcydepartment,firstbilledtimetoLehmanbankruptcypreparationon
September10,2008.2795
On Thursday, September 11, 2008, Weil attorneys began preparing the
documents necessary to file a Chapter 11 petition, including attendant motions,
resolutions,andaffidavits.2796Weilsworkcontinuedthroughtheweekend.2797
OnFriday,September12,2008,publishedreportscitedananonymousTreasury
sourceassayingthatPaulsonhadruledoutthepossibilityofanyGovernmentfinancial
assistancetoLehman.2798PaulsonconfirmedtotheExaminerthat,asofSeptember12,
2008,theTreasurydidnotplantooffersupporttoLehman.2799Thatsameday,MarkJ.
Shapiro, Lehmans cohead of restructuring, approached Russo about establishing a
2792SeeWeil,Gotshal&MangesLLP,TimeRecords(Sept.10,2008),atp.1[LBEXWGM1146447].Accord
ExaminersInterviewsofStevenBerkenfeld,Oct.5and7,2009,atp.21.
2793ExaminersInterviewsofStevenBerkenfeld,Oct.5and7,2009,atp.21.
2794ExaminersInterviewofThomasA.Russo,May11,2009,atpp.910.
2795Weil,Gotshal&MangesLLP,TimeRecords(Sept.10,2008),atp.1[LBEXWGM1146447].
2796Id.atpp.1,5,7,10,14,15,17and19.
2797Id.atpp.120.
2798See,e.g.,AnitaRaghavan,PaulsonBrothersonEitherSideofLehmanDivide,Forbes,Sept.12,2008.
719

bankruptcyremotetrustforemployeemedicalcostsandtaxes.2800Russowashesitant,
again due to a concern that any preparations for a bankruptcy would become a self
fulfilling prophecy, but Russo deferred to experts such as Shapiro, who were familiar
withbankruptcyrelatedissues.2801AssoonasRussobecameawareofWeilswork,he
informed the Board.2802 As a result, Miller was invited to make a presentation at the
telephonicSeptember12,2008Boardmeeting.2803AlthoughMillerdoesnotrecallbeing
physically present at a Board meeting until Sunday, September 14, 2008, Lehmans
Board minutes indicate that Miller advised the Board on Friday, September 12, 2008,
thatbankruptcywouldbeaverybadoptionunderthecircumstances.2804
AtalateafternoonmeetingonSeptember12,2008,RussoreportedtotheBoard
thattheFederalReserveisinterestedinhelpingtofacilitateanorderlywinddownand
avoid a bankruptcy.2805 Grundhofer and Kaufman told the Examiner that they were
concerned about the systemic risk if the Government allowed Lehman to fail.2806
Grundhofer believed that Lehman was too big and systemically important to fail and
2800SeeLehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Sept.13,2008),atp.2
[LBEXAM00392728].AccordExaminersInterviewofThomasA.Russo,May11,2009,atp.10.
2801ExaminersInterviewofThomasA.Russo,May11,2009,atp.10.
2802Id.
[LBEXAM003920].
2804Id.;ExaminersInterviewofHarveyR.Miller,Apr.23,2009,atp.5.
[LBEXAM003920](emphasisadded).
2806Examiners Interview of Jerry A. Grundhofer, Sept. 16, 2009, at p. 15; Examiners Interview of Dr.
HenryKaufman,Sept.2,2009,atp.20.
720

that Lehmans failure would have global consequences.2807 Akers did not expect the
Federal Reserve to abandon Lehman, because, according to Akers, Fuld had told the
BoardthattheFederalReservewouldassistLehman.2808
OnFridayevening,MillerreceivedacallfromJamesL.Bromley,anattorneyat
the law firm Cleary Gottlieb, which represented the Federal Reserve, requesting a
meeting.2809Bromleyexpressednourgencytomeetthatnight.2810
AtthenoonSaturday,September13,2008Boardmeeting,Russostatedthatthe
Federal Reserve believes that any bankruptcy filing by the Firm would be extremely
disruptive.2811 Late Saturday morning or early that afternoon, Weil attorneys Miller,
Lori R. Fife and Shai Y. Waisman met with six or seven Federal Reserve officials and
Bromley.2812
BythemorningofSunday,September14,2008,theFSAmadeclearthatitwould
not waive the shareholder vote requirement, killing the Barclays deal.2813 After the
Barclaysdealfellapart,PaulsontoldFuldthatPaulsonwascontinuingtoworkonsome
other things.2814 By the early afternoon of Sunday, September 14, 2008, Miller learned
2807ExaminersInterviewofJerryA.Grundhofer,Sept.16,2009,atp.15.
2808ExaminersInterviewofJohnF.Akers,Apr.22,2009,atp.12.
2809ExaminersInterviewofHarveyR.Miller,Apr.23,2009,atp.6.
2810Id.
[LBEXAM003927].
2813ExaminersInterviewofRichardS.Fuld,Jr.,Apr.28,2009,atpp.910.
2814Id.atp.9.
721

that things were not going well for Lehman at the FRBNY.2815 Weil attorneys Miller,
Fife,Dannhauser andThomasA.RobertswenttotheFRBNYtorepresent Lehman.2816
OnthewaytotheFRBNYmeeting,RobertsreceivedacallfromanotherWeilpartner
saying that Citibank had been told that Lehman was being liquidated and was
requestingthatWeilrepresentCitibank.2817
On September 14, 2008, the Federal Reserve issued a press release stating that
[t]he collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF)
hasbeenbroadenedtocloselymatchthetypesofcollateralthatcanbepledgedinthe
triparty repo systems of the two major clearing banks.2818 Upon learning of the
expansion of the PDCF window, Lowitt and Fuld initially believed that Lehmans
problemwassolvedandthatLehmanwouldbeabletoopeninEuropebyborrowing
from the PDCF.2819 However, Lehman soon learned that it was not eligible to use the
window.2820TheFRBNYlimitedthecollateralLBIcoulduseforovernightfinancingto
the collateral that was in LBIs box at JPMorgan as of Friday, September 12, 2008.2821
ThatrestrictionwasreferredtoastheFridaycriteri[on].2822
2816Id.
2817Id.
2818FederalReserve,PressRelease(Sept.14,2008),availableat
http://www.federalreserve.gov/newsevents/press/monetary/20080914a.htm, Sept. 14, 2008, last visited,

May26,2009.
2820Id.
2821Examiners Interview of Robert Azerad, Apr. 20, 2009, at p. 5; Examiners Interview of Christopher
Burke, July 7, 2009, at p. 3. An experimental allocation by Lehman to the PDCF on Monday morning
722

Fuld told the Examiner that on Sunday afternoon, Sirri, head of the SECs
Trading and Markets Division, called Fuld and asked him to promise [Sirri] one
thing,whichwasthatLehmanwouldnotfileforbankruptcyprotection.2823Notlong
afterthatconversationwithSirri,McDadecalledFuldfromthemeetingattheFRBNY
to tell him that the Fed has just mandated that we file for bankruptcy.2824 At the
FRBNY,BaxtersaidthatLehmanneededtofilebymidnightthatnight.2825Millerasked
why and objected that it could not happen by midnight.2826 He said that a Lehman
bankruptcywouldbringgreatdestabilizationinthemarket,bringtradingtoahalt,
andresultinArmageddon.2827Inresponse,theGovernmentrepresentativestoldthe
Lehman representatives that it was decided and there were cars available to return
themtoLehmansbuilding.2828
AfterLehmansexecutivesreturnedfromthemeetingattheFederalReserve,the
Board meeting resumed and discussed the Feds direct and authoritative statements
showedatleast$72billionofeligibleLehmansecuritiesbeingsweptintothePDCFsystem.Seeemail
from John N. Palchynsky, Lehman, to Craig L. Jones, Lehman et al. (Sept. 15, 2008) [LBEXDOCID
076981];seealsoLehman,PDCFScheduleofEligibleSecurities(Sept.14,2008)[LBEXDOCID405695].
2822Examiners Interview of Robert Azerad, Apr. 20, 2009, at p. 5; Examiners Interview of Christopher
Burke, July 7, 2009, at p. 3. According to Azerad, this restriction prevented Lehman from posting the
range of collateral to the PDCF that other firms were allowed to post after September 15, 2008.
Examiners Interview of Robert Azerad, Apr. 20, 2009, at p. 5; see also email from Timothy Lyons,
Lehman,toIanT.Lowitt,Lehman(Sept.14,2008)[LBEXDOCID070210](statingthefedislettingthe
othereighteenbrokerdealersfundamuchbroaderrangeofcollateralthanus).
2824Id.atp.13.
2826Id.
2827Id.
2828Id.atp.8.
723

thattheywantedtheCorporationtofileunderChapter11thatevening.2829Duringthe
meeting,Cox,Baxter,BrianG.Cartwright(SECGeneralCounsel)andAlanL.Beller(a
Cleary Gottlieb partner who represented the Federal Reserve and SEC) called in and
asked to speak with the Board.2830 In response to questions from Board members
regardingthenecessityoffiling,Mr.Bellerstatedthattheviewoftheregulatorsasto
the appropriateness of a bankruptcy filing was expressed at the meeting with the
FederalReservethatafternoon,butthatthecallersdidnotwanttoinfluencetheBoards
exerciseofitsfiduciaryduties.2831AccordingtoBaxter,thepurposeofthecallwasto
emphasize that a bankruptcy filing by LBHI made sense but that the ultimate
decisionwasfortheBoard.2832Further,BaxtertoldtheExaminerthathemadethepoint
thatopeningonMondaywasnotanoptionbecauseofthechaosinthemarkets.2833
The Boards initial reaction to the Governments call was anger.2834
Nonetheless, the Board discussed the advantages and disadvantages of a bankruptcy
filing.2835TheBoarddiscussedwhetheradelayinfilingwouldallowtimebettertoplan
[LBEXAM003932].
2830Id.atp.4.
2831Id.atpp.45.
2832ExaminersInterviewofThomasC.Baxter,Jr.,May20,2009,atp.11.
2833Id.
2834Examiners Interview of John F. Akers, Apr. 22, 2009, at pp. 1314; Examiners Interview of Jerry A.
Grundhofer,Sept.16,2009,atp.16.
[LBEXAM003932].
724

and prepare Lehman to operate under Chapter 11 and prepare a more complete
filing.2836
Lehmansbankruptcycounsel,Miller,saidthathedidnotthinktherushedfiling
had an adverse impact on the estate.2837 On the other hand, Alvarez and Marsal later
asserted that as much as $75 billion in value was destroyed by the form of Lehmans
bankruptcy.2838 For example, Bryan P. Marsal told the Examiner that the bankruptcy
resulted in the loss of 70% of $48 billion of receivables from derivatives that could
otherwisehavebeenunwound.2839
OneimportantconsiderationfortheBoardwastheanticipateddifficultyLehman
would have meeting payment obligations on Monday.2840 The Board questioned
whetherasubstantialamountofthecollateralpledgedtoJPMorgancouldberecovered
prior to filing.2841 The Board also noted the clear preference of the Government that
Lehmanfilethatnight,theFederalReservesunwillingnesstofinanceLehmanandthe
ultimateinevitabilityofabankruptcyfilingunderthecircumstances.2842Kaufmanwasa
2836Id.
2837Examiners Interview of Harvey R. Miller, Apr. 23, 2009, at p. 9. Miller did concede that more
advance notice and planning could have avoided JPMorgan taking approximately $500 million in
collateral.Milleralsosaidthatmorevaluecouldhavebeenreceivedbyliquidatingcontractsinamore
orderlyfashion.Id.
2838Jeffrey McCracken, Lehmans Chaotic Bankruptcy Filing DestroyedBillions in Value, WallSt. J.(Dec.29,
2008),atA10.
2839ExaminersInterviewofBryanP.Marsal,Dec.14,2009,atp.2.
[LBEXAM003932].
2841Id.
2842Id.
725

proponentofcallingtheGovernmentsbluffbyopeningonMonday,2843buttheBoard
concluded that filing for bankruptcy immediately was the appropriate course of
action.2844
After discussion, the Board unanimously resolved to file for bankruptcy
protection under Chapter 11 of the Bankruptcy Code.2845 Weil began filing around
1:30a.m.onMonday,September15,2008.2846
2843Examiners Interview of Henry Kaufman, Sept. 2, 2009, at p. 19; Examiners Interview of Jerry A.
Grundhofer,Sept.16,2009,atp.16.
[LBEXAM003932].
2845Id.
726

x
:
:
etal., :
Debtors. :
x
REPORTOF

Jenner&BlockLLP
353N.ClarkStreet
Chicago,IL606543456
3122229350

919ThirdAvenue
37thFloor
NewYork,NY100223908
2128911600


VOLUME3OF9
Section III.A.4: Repo 105
EXAMINERSREPORT
TABLEOFCONTENTS
(SHORTFORM)
VOLUME1
Introduction...................................................................................................................................2
C. SystemsAccess..............................................................................................................33
SectionIII.A.1:Risk
b) Facts..................................................................................................................58
c) Analysis .........................................................................................................163
VOLUME2
2. Valuation ..............................................................................................................203
Portfolio .........................................................................................................215
Book................................................................................................................266
Positions.........................................................................................................356
Portfolio .........................................................................................................527
Positions.........................................................................................................568
DebtPositions ...............................................................................................583
ii

Stearns............................................................................................................622
VOLUME3
4. Repo105................................................................................................................732
b) Introduction ..................................................................................................750
Transactions ..................................................................................................764
oftheFirm .....................................................................................................914
iii

VOLUME4
a) Introduction ................................................................................................1482
iv

VOLUME5
(SecondBullet) ...................................................................................................1912
2. Facts .....................................................................................................................1965
5. Conclusions ........................................................................................................2063
vi

x
:
:
etal., :
Debtors. :
x
REPORTOF

TABLEOFCONTENTS
4. Repo105................................................................................................................732
b) Introduction ..................................................................................................750
Transactions ..................................................................................................764
(1) TheGenesisofLehmansRepo105Programin2001 ......................765
(2) Repo105TransactionsVersusOrdinaryRepoTransactions .........766
(a) LehmansAccountingTreatmentofRepo105
TransactionsVersusOrdinaryRepoTransactions .................. 768
(b) LehmansAccountingPolicyforRepo105Transactions........ 775
(c) TheAccountingPurposeoftheLargerHaircut ....................... 777
(d) LehmanDidNotRecordaCashBorrowingbut
RecordedaDerivativeAssetinaRepo105Transaction......... 781
(3) AnatomyofRepo105TransactionsandtheLinklatersTrue
SaleOpinionLetter ...............................................................................782
(4) TypesofSecuritiesUsedinRepo105Transactions .........................793
(5) ProductControllersManuallyBookedRepo105
Transactions ...........................................................................................797
(1) LehmanManagementsFocusinLate2007onReducingthe
FirmsReportedLeverage....................................................................802
(a) LehmansCalculationofNetLeverage ..................................... 804
(2) ByJanuary2008,LehmanDecidedtoCutitsNetLeveragein
Investors .................................................................................................805
(a) BartMcDade,asNewlyAppointedBalanceSheetCzar,
LehmansUseofRepo105Transactions ................................... 809
(b) McDadeBecamePresidentandCOOonJune12,2008
andAuthorizedtheReductionofRepo105Usage.................. 819
(3) TheMarketsIncreasedScrutinyoftheLeverageof
InvestmentBanks..................................................................................822
(a) TheCostofDeleveraging ............................................................ 825
727

(4) StickyInventoryandFIDsBalanceSheetBreaches
HamperedLehmansAbilitytoManageItsNetLeverage.............828
(5) DeleveragingResultedinIntensePressureatQuarterEndto
MeetBalanceSheetTargetsforReportingPurposes .......................843
(6) LehmansEarningsCallsandPressReleaseStatements
RegardingLeverage..............................................................................845
(a) AnalystsStatementsRegardingLehmansLeverage ............. 850
(1) LehmanDidNotDiscloseItsAccountingTreatmentForor
UseofRepo105TransactionsinItsForms10Kand10Q .............853
(a) LehmansOutsideDisclosureCounselWasUnawareof
LehmansRepo105Program ...................................................... 855
(2) LehmansRepo105PracticeImprovedtheFirmsPublic
BalanceSheetProfileatQuarterEnd.................................................856
(a) ContemporaneousDocumentsConfirmThatLehman
SheetandReverseEngineerItsLeverage.................................. 859
(b) WitnessStatementstotheExaminerRegardingtheTrue
PurposeofLehmansRepo105Practice.................................... 867
(3) QuarterEndSpikesinLehmansRepo105UsageAlso
SuggesttheTruePurposeofLehmansRepo105Practice
WasBalanceSheetManipulation .......................................................870
(4) Repo105TransactionsServedNoBusinessPurposeOther
ThanBalanceSheetReduction ............................................................877
(a) Repo105TransactionsCameataHigherCostThan
OrdinaryRepoTransactions ....................................................... 877
(b) WitnessesAlsoStatedThatFinancingWasNottheReal
MotiveforUndertakingRepo105Transactions ...................... 882
(1) TheRepo105ProgramExposedLehmantoPotential
ReputationalRisk..............................................................................884
(2) LehmansRepo105PracticeHadaMaterialImpacton
LehmansNetLeverageRatio .............................................................888
(a) LehmanSignificantlyExpandedItsRepo105Practicein
Late2007andEarly2008 ............................................................. 890
728

(3) BalanceSheetTargetsforFIDBusinessesWere
UnsustainableWithouttheUseofRepo105Transactions .............899
(4) RatingAgenciesAdvisedtheExaminerthatLehmans
Information ............................................................................................902
(5) GovernmentRegulatorsHadNoKnowledgeofLehmans
Repo105Program.................................................................................910
(a) OfficialsfromtheFederalReserveBankWouldHave
Transactions................................................................................... 910
(b) SecuritiesandExchangeCommissionCSEMonitors
WereUnawareofLehmansRepo105Program ...................... 913
oftheFirm .....................................................................................................914
(1) RichardFuld,FormerChiefExecutiveOfficer .................................917
(2) LehmansFormerChiefFinancialOfficers .......................................921
(a) ChrisOMeara,FormerChiefFinancialOfficer ....................... 921
(b) ErinCallan,FormerChiefFinancialOfficer ............................. 930
(c) IanLowitt,FormerChiefFinancialOfficer............................... 937
(3) LehmansBoardofDirectors...............................................................945
(1) Ernst&YoungsComfortwithLehmansRepo105
AccountingPolicy .................................................................................948
(2) TheNettingGrid ...............................................................................951
(a) QuarterlyReviewandAudit....................................................... 953
(3) Ernst&YoungWouldNotOpineontheMaterialityof
LehmansRepo105Usage ...................................................................954
(4) MatthewLeesStatementsRegardingRepo105toErnst&
Young......................................................................................................956
(5) AccountingMotivatedTransactions..................................................962
(1) Materiality ..............................................................................................963
(a) WhetherLehmansRepo105TransactionsTechnically
ColorableClaimExists ................................................................. 964
729

(2) DisclosureRequirementsandAnalysis .............................................967

(a) DisclosureObligations:RegulationSKandtheMD&A ....... 968
(b) DutytoDisclose ............................................................................ 972
(c) LehmansPublicFilings............................................................... 973
(i) SummaryofLehmans2000through2007Public
Filings.................................................................................... 974
(ii) Lehmans2007Form10K,FirstQuarter2008Form
10Q,andSecondQuarter2008Form10Q..................... 977
a. TreatmentofRepoTransactionsandSFAS140....... 978
b. NetLeverage................................................................. 980
c. Derivatives .................................................................... 981
d. AReaderofLehmansForms10Kand10Q
WouldNotHaveBeenAbletoAscertainThat
LehmanEngagedinTemporarySalesUsing
LiquidSecurities........................................................... 984
(d) ConclusionsRegardingLehmansFailuretoDisclose ............ 985
(3) ColorableClaims...................................................................................990
(4) FiduciaryDutyClaims .........................................................................991
(a) BreachofFiduciaryDutyClaimsAgainstBoardof
Directors ......................................................................................... 991
(b) BreachofFiduciaryDutyClaimsAgainstSpecific
LehmanOfficers............................................................................ 992
(i) RichardFuld......................................................................... 996
a. ThereIsSufficientEvidencetoSupporta
FindingBytheTrierofFactThatFuldWasat
LeastGrosslyNegligentinCausingLehmanto
FileMisleadingPeriodicReports............................... 997
(ii) ChrisOMeara.................................................................... 1002
a. ThereIsSufficientEvidenceToSupporta
ColorableClaimThatOMearaWasatLeast
GrosslyNegligentinAllowingLehmantoFile
MisleadingFinancialStatementsandEngagein
MaterialVolumesofRepo105Transactions.......... 1007
b. ThereIsSufficientEvidenceToSupporta
ColorableClaimThatOMearaBreachedHis
FiduciaryDutiesbyFailingtoInformthe
730

BoardandHisSuperiorsofLehmansRepo105
Practice......................................................................... 1009
(iii) ErinCallan.......................................................................... 1013
FindingBytheTrierofFactThatCallan
BreachedHerFiduciaryDutiesbyCausing
LehmantoMakeMateriallyMisleading
Statements ................................................................... 1017
b. ThereIsSufficientEvidencetoSupporta
ColorableClaimThatCallanBreachedHer
FiduciaryDutyofCarebyFailingtoInformthe
BoardofDirectorsofLehmansRepo105
Program ....................................................................... 1019
(iv) IanLowitt ........................................................................... 1021
(c) Remedies ...................................................................................... 1024
(5) MalpracticeClaimsAgainstErnst&Young ...................................1027
(a) BackgroundandLegalStandards ............................................ 1028
(i) ProfessionalStandards ..................................................... 1028
(ii) CommonLawStandards ................................................. 1031
(b) ThereIsSufficientEvidencetoSupportaColorable
ClaimThatErnst&YoungWasNegligent ............................. 1032
(i) MalpracticeinFailuretoAdviseAuditCommittee
ofRepo105ActivityandLeesAllegations................... 1033
(ii) Lehmans2008Forms10Q.............................................. 1040
(iii) Lehmans2007Form10K................................................ 1048
(iv) EffectonPriorFilings ....................................................... 1050
(v) CausationandDamages................................................... 1051
(c) PossibleDefenses ........................................................................ 1053
731

4. Repo105
a) Repo105ExecutiveSummary
Lehman employed offbalance sheet devices, known within Lehman as Repo
105andRepo108transactions,totemporarilyremovesecuritiesinventoryfromits
balance sheet, usually for a period of seven to ten days, and to create a materially
misleadingpictureofthefirmsfinancialconditioninlate2007and2008.2847Repo105
transactions were nearly identical to standard repurchase and resale (repo)
transactions that Lehman (and other investment banks) used to secure shortterm
financing, with a critical difference: Lehman accounted for Repo 105 transactions as
sales as opposed to financing transactions based upon the overcollateralization or
higherthannormalhaircutinaRepo105transaction.2848ByrecharacterizingtheRepo
105transactionasasale,Lehmanremovedtheinventoryfromitsbalancesheet.2849
2847Unlessotherwisenoted,theReportusesthetermRepo105torefertobothRepo105andRepo108
transactions.Lehmantreatedthetwotransactionsidenticallyunderthesameinternalaccountingpolicy
andbothtransactionssharedthesameanatomy.TheydifferedonlyinthatRepo105transactionsutilized
fixed income securities and required a minimum five percent overcollateralization amount (i.e., a
minimumof$105worthofsecuritiesinexchangefor$100cashborrowed)whileRepo108transactions
utilized equities securities and required a minimum eight percent overcollateralization amount (i.e., a
minimumof$108worthofsecuritiesinexchangefor$100cashborrowed).
2848Sale and repurchase agreements (repos) are agreements where one party transfers an asset or
securitytoanotherpartyascollateralforashorttermborrowingofcash,whilesimultaneouslyagreeing
to repay the cash and take back the collateral at a specific point in time. When the repo transaction
matures,theborrowerrepaysthefundsplusanagreeduponinterestrateandtakesbackitscollateral.As
explained in Section III.A.4.d.2.c of the Report, overcollateralization amounts, or haircuts, in Repo 105
transactionswerehigherthanthetypicalhaircutappliedtoordinaryreposusingsimilarsecurities.
2849LehmanBrothersHoldingsInc.,AccountingPolicyManualRepo105andRepo108(Feb.13,2008),at
p. 2 [LBEXDOCID 3213297]; ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENTS OF LIABILITIES, Statement of Financial Accounting Standards No. 140, 2, 98 (Fin.
AccountingStandardsBd.2000)(SFAS140).TheaccountingforaRepo105transactionbeganwiththe
732

LehmanregularlyincreaseditsuseofRepo105transactionsinthedayspriorto
reporting periods to reduce its publicly reported net leverage and balance sheet.2850
Lehmans periodic reports did not disclose the cash borrowing from the Repo 105
transactioni.e.,althoughLehmanhadineffectborrowedtensofbillionsofdollarsin
thesetransactions,Lehmandidnotdisclosetheknownobligationtorepaythedebt.2851
Lehman used the cash from the Repo 105 transaction to pay down other liabilities,
thereby reducing both the total liabilities and the total assets reported on its balance
sheetandloweringitsleverageratios.2852Thus,LehmansRepo105practiceconsistedof
a twostep process: (1) undertaking Repo 105 transactions followed by (2) the use of
sameentriesasanordinaryrepo;additionalentrieswerethenmadetorecharacterizetheRepo105froma
securedfinancingtoasaleofaninventorysecurity.
2850SeeSectionsIII.A.4.f.24andIII.A.4.g.2ofthisReport.
2851SeeSectionsIII.A.4.d.2.dandIII.A.4.j.2.cofthisReport.
2852ExaminersInterviewofMartinKelly,Oct.1,2009,atp.7(statingthatincomingcashfromRepo105
transactionswasusedtopaybusinessexpenses);ExaminersInterviewofEdwardGrieb,Oct.2,2009,at
pp. 1314 (stating that cash received in Repo 105 transactions was used to pay off other liabilities);
ExaminersInterviewofMatthewLee,July1,2009,atp.14(explainingthatinorderforLehmantorealize
thebenefittoitsleverageratiosasaresultofRepo105transactions,thefirmhadtousethecashreceived
topayoffadifferentliability);emailfromAnurajBismal,Lehman,toMarieStewart,Lehman,etal.(Dec.
5,2007)[LBEXDOCID3223384](statingtheeffectofRepo105onnetleverageratio,whichcouldonlybe
impactedifLehmanusedRepo105cashtopaydowndifferentliabilities).GiventhatLehmanundertook
$38.6billion,$49.1billion,and$50.38billionofRepo105transactionsatquarterendfourthquarter2007,
firstquarter2008,andsecondquarter2008,respectively,Lehmansdisclosuresofitscashholdingsateach
quarterend further strengthens the witness statements and other evidence that Lehman used the Repo
105cashborrowingforotherbusinesspurposes,includingtopaydownothershorttermliabilities.See
LehmanBrothersHoldingsInc.,AnnualReportfor2007asofNov.30,2007(Form10K)(filedonJan.29,
2008),atp.86(LBHI200710K)(reportingthatLehmanhad$7.286billionincashandcashequivalents
onNovember30,2007);LehmanBrothersHoldingsInc.,QuarterlyReportasofFeb.29,2008(Form10Q)
(filedonApr.9,2008),atp.5(LBHI10Q(filedApr.9,2008))(reportingthatLehmanhad$7.564billion
incashandcashequivalentsonFebruary29,2008);LehmanBrothersHoldingsInc.,QuarterlyReportas
ofMay31,2008(Form10Q)(filedonJuly10,2008),atp.5(LBHI10Q(filedJuly10,2008))(reporting
thatLehmanhad$6.513billionincashandcashequivalentsonMay31,2008).WhileLehmansRepo105
transactions spiked at quarterends, Lehmans ordinary repo balances dropped off significantly during
thesametimeperiods.SeeDuff&Phelps,Repo105BalanceSheetAccountingEntryandLeverageRatios
Summary(Oct.2,2009),atp.5.
733

Repo 105 cash borrowings to pay down liabilities, thereby reducing leverage. A few
daysafterthenewquarterbegan,Lehmanwouldborrowthenecessaryfundstorepay
thecashborrowingplusinterest,repurchasethesecurities,andrestoretheassetstoits
balancesheet.2853
LehmanneverpubliclydiscloseditsuseofRepo105transactions,itsaccounting
treatmentforthesetransactions,theconsiderableescalationofitstotalRepo105usage
in late 2007 and into 2008, or the material impact these transactions had on the firms
publiclyreportednetleverageratio.2854AccordingtoformerGlobalFinancialController
Martin Kelly, a careful review of Lehmans Forms 10K and 10Q would not reveal
2853Duff & Phelps, Repo 105 Balance Sheet Accounting Entry and Leverage Ratios Summary (Oct. 2,
2009),atp.4;seealsoLehmanBrothersHoldingsInc.,AccountingPolicyManualRepo105andRepo108
(Feb.13,2008),atp.2[LBEXDOCID3213297].
2854ExaminersInterviewofMarieStewart,Sept.2,2009,atp.15;ExaminersInterviewofMartinKelly,
Oct.1,2009,atp.9;ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.14;ExaminersInterviewof
MatthewLee,July1,2009,atp.15;seealsoSectionsIII.A.4.f.1andIII.A.4.j.2.cdofthisReport(discussing
LehmansForms10Kand10Q).InitsForms10Kand10Q,Lehmandefineditsnetleverageratioas
net assets divided by tangible equity capital. Lehman defined net assets as total assets excluding: (1)
cashandsecuritiessegregatedandondepositforregulatoryandotherpurposes;(2)securitiesreceivedas
collateral;(3)securitiespurchasesunderagreementstoresell;(4)securitiesborrowed;and(5)identifiable
intangibleassetsandgoodwill.LBHI200710K,atp.63;LBHI10Q(filedApr.9,2008),atp.72;LBHI10
Q (filed July 10, 2008), at p. 88. Lehman calculated tangible equity capital by including stockholders
equityandjuniorsubordinatednotesandexcludingidentifiableintangibleassetsandgoodwill.SeeLBHI
200710K(Nov.30,2007),atp.63;LBHI10Q(filedApr.9,2008),atp.72;LBHI10Q(filedJuly10,2008),
atp.88.Incontrast,Lehmansleverageratiowasgenerallycomputedbysimplydividingtotalassets
by stockholders equity. The Examiners conclusion that Lehman never disclosed its Repo 105 practice
was confirmed by several Lehman witnesses, including two former Global Financial Controllers who
oversawthepreparationoftheForms10Kand10Q.ExaminersInterviewofMartinKelly,Oct.1,2009,
at p. 9; Examiners Interview of Edward Grieb, Oct. 2, 2009, at p. 14.; see also Section III.A.4.j.2 of this
Report,infra(containingExaminersanalysisofLehmansForm10KandForm10Qdisclosures).This
ReportdoesnotreachthequestionwhetherLehmansRepo105transactionstechnicallycompliedwith
the relevant financial accounting standard, SFAS 140. As set forth below, the answer to that question
does not impact whether there is sufficient evidence to support a colorable claim regarding Lehmans
failure to disclose its Repo 105 practice and whether that failure rendered the firms periodic reports
materiallymisleading.
734

Lehmans use of Repo 105 transactions.2855 Lehman failed to disclose its Repo 105
practice even though Kelly believed that the only purpose or motive for the
transactions was reduction in balance sheet; felt that there was no substance to the
transactions; and expressed concerns with Lehmans Repo 105 program to two
consecutive Lehman Chief Financial Officers Erin Callan and Ian Lowitt advising
themthatthelackofeconomicsubstancetoRepo105transactionsmeantreputational
risktoLehmanifthefirmsuseofthetransactionsbecameknowntothepublic.2856In
additiontoitsmaterialomissions,Lehmanaffirmativelymisrepresentedinitsfinancial
statementsthatthefirmtreatedallrepotransactionsasfinancingtransactionsi.e.,not
salesforfinancialreportingpurposes.2857
Startinginmid2007,Lehmanfacedacrisis:marketobserversbegandemanding
thatinvestmentbanksreducetheirleverage.2858Theinabilitytoreduceleveragecould
leadtoaratingsdowngrade,whichwouldhavehadanimmediate,tangiblemonetary
impact on Lehman.2859 In a September 2007 email comparing Lehmans net leverage
2856Id.atpp.710.
2857TheNotestoLehmansConsolidatedFinancialStatementsforeachperiodstatedthatLehmantreated
[r]epurchaseandresaleagreementsascollateralizedagreementsandfinancingsforfinancialreporting
purposes.SeeLBHI200710K,atp.97;LBHI10Q(filedApr.9,2008),atp.13;LBHI10Q(filedJuly10,
2008), at p. 16. The Notes further stated that Other secured borrowings principally reflect transfers
accountedforasfinancingsratherthansalesunderSFAS140.LBHI200710K,atp.97;LBHI10Q(filed
Apr.9,2008),atp.13;LBHI10Q(filedJuly10,2008),atp.16.
2858Examiners Interview of Michael McGarvey, Sept. 11, 2009, at pp. 56; Mark Jickling, Averting
FinancialCrisis,CRSReportforCongress,at79(Mar.10,2008,updatedonOct.8,2008).
2859Adowngradeinanissuerscreditratinghasasignificantnegativeimpactonthefinancialpositionof
acompanylikeLehman.See,e.g.,emailfromIanT.Lowitt,Lehman,toHerbertH.(Bart)McDadeIII,
735

ratiotoBearStearns,PaoloTonucci,LehmansGlobalTreasurer,wrotethatLehmans
net leverage calculation was intended to reflect the methodology employed by S&P
who were most interested and focused on leverage.2860 In midtolate 2007, top
Lehmanexecutivesfromacrossthefirmfeltpressuretoreducethefirmsleveragefor
quarterlyandannualreports.2861InresponsetoTonuccisSeptember2007email,Ryan
Traversari, Senior Vice President for External Reporting, wrote that the question of
netleverageratiohascomeupmultipletimesinthe20secondsthatIvebeenhere
largely from [thenCFO] OMeara, Freidheim, Lowitt, Corporate Strategy, Investor
Relationsandthelike.2862
ByJanuary2008,LehmanCEOFuldorderedafirmwidedeleveragingstrategy,
hoping to reduce the firms positions in commercial and residential real estate and
Lehman (June 30,2008) [LBHI_SEC07940_643543] (One notch downgrade requires1.7 bn; and 2 notch
requires 3.4 bn of additional margin posting.). Counterparties may respond to a downgrade by
demandingthattheissuerpostadditionalcashcollateraltosecureitsobligations.SeeAmadouN.R.Sy,
The Systemic Regulation of Credit Rating Agencies and Rated Markets 89 (Intl Monetary Fund,
Working Paper, 2009) (noting that brokerdealers may use credit ratings to determine acceptable
counterparties, as well as collateral levels for outstanding credit exposure); email from Ian T. Lowitt,
Lehman, to Eric Felder, Lehman (July 5, 2008) [LBEXDOCID 071263] (stating that a downgrade will
affectlinesandwillingnessofcounterpartiestofundsecured).SomeofLehmansderivativecontracts
had builtin triggers permitting counterparties to require additional cash collateral in the event of a
downgrade.SeealsoLehman,GlobalTreasuryDowngradeEffectonCashCapitalFacilities(June3,2008)
[LBHI_SEC07940_513314](attachedtoemailfromAmberishRatanghayra,Lehman,toPaoloR.Tonucci,
Lehman,etal.(June3,2008)[LBHI_SEC07940_513312]);seealsoAppendix13,Survival,atpp.13.
2860EmailfromPaoloR.Tonucci,Lehman,toMarieStewart,Lehman,etal.(Sept.10,2007)[LBEXDOCID
1695576].
2861Email from Ian T. Lowitt, Lehman, to Gerard Reilly, Lehman, et al. (Sept. 7, 2007) [LBEXDOCID
1357178]; email from Ryan Traversari, Lehman, to Paolo R. Tonucci, Lehman, et al. (Sept. 11, 2007)
[LBEXDOCID1695576];seeSectionsIII.A.4.e.13,6ofthisReport(discussingimportanceofnetleverage
forpublicperceptionofLehmanandforreportingpurposes)
2862Email from Ryan Traversari, Lehman, to Paolo R. Tonucci, Lehman (Sept. 11, 2007) [LBEXDOCID
1695576].
736

leveraged loans in particular by half.2863 In the words of one internal Lehman
presentation,Reducingleverageisnecessarytoremoverefinancingriskandwinback
theconfidenceofthemarket,lenders,andinvestors.2864
Fuld recalled that Lehman had to improve its net leverage ratio by selling
inventory because there was a perception issue with raising equity.2865 Selling
inventory,however,proveddifficultinlate2007andinto2008because,startinginmid
2007, many of Lehmans inventory positions had grown increasingly sticky i.e.,
difficulttosellwithoutincurringsubstantiallosses.Moreover,sellingstickyinventory
atreducedpricescouldhaveledtoalossofmarketconfidenceinLehmansvaluations
forinventoryremainingonthefirmsbalancesheetsincefiresalepricingwouldreveal
thatLehmanhadalotofairin[its]marks.2866
In light of these factors, Lehman relied at an increasing pace on Repo 105
transactionsateachquarterendinlate2007andearly2008.Lehmansexpansionofits
Repo 105 program mitigated, in part, the adverse impact its increasingly
sticky/illiquid inventory comprised mostly of the leveraged loans and residential
and commercial real estate positions Fuld wanted to exit was having on the firms
2864ErinCallan, Lehman, Lehman Brothers Leverage Analysis (Apr. 7, 2008), at p. 1 [LBEXDOCID

1401225].
2865ExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,atp.27.AccordingtoFuld,ifLehmanhad
raised equity, it would have improved net leverage, but would not have fixed Lehmans underlying
problem.Id.FuldstatedthathewantedLehmantoimproveitsnetleveragebysellingassets.Id.
2866ExaminersInterviewofTreasurySecretaryTimothyF.Geithner,Nov.24,2009,atpp.78.
737

publiclyreportednetleverageandnetbalancesheet.2867Anearly2007documentfrom
LehmansarchivesconcludingthatRepo105offersalowcostwaytooffsetthebalance
sheetand leverage impactofcurrent marketconditions,furtherstatedthat [e]xiting
largeCMBS positionsinRealEstateandsubprimeloansin Mortgages beforequarter
end would incur large losses due to the steep discounts that they would have to be
offeredatandcarrysubstantialreputationriskinthemarket....ARepo105increase
would help avoid this without negatively impacting our leverage ratios.2868 While
Lehman did not utilize Repo 105 transactions for selling sticky inventory, the firms
expanded use of Repo 105 transactions at quarterend impacted Lehmans publicly
reportednetleverageratio.2869
2867SeeSectionIII.A.4.e.4ofthisReport(discussingstickyinventory).Theconceptofnetbalancesheet
is usedinterchangeably with net assets in thisReport. The net asset calculation beginswith total
assets as reported for GAAP purposes in Lehmans Forms 10K and 10Q. From there, Lehman
subtracted certain assets to arrive at net assets: (i) cash and securities segregated and on deposit for
regulatoryandotherpurposes;(ii)collateralizedlendingagreements(e.g.,securitiesLehmanisholdingas
collateralforaloanmadetoathirdparty);and(iii)identifiableintangibleassetsandgoodwill.SeeLBHI
200710K,atpp.30,61.
2868Joseph Gentile, Lehman, Proposed Repo 105/108 Target Increase for 2007 (Feb. 10, 2007), at p. 1
[LBEXDOCID 2489498] (attached to email from Joseph Gentile, Lehman, to Edward Grieb, Lehman
(Feb.10,2007)[LBEXDOCID2600714]).
2869Asdiscussedinfraatpp.84346,LehmanattemptedtomovelessliquidinventoryintotheRepo105
program, but was unable to find willing counterparties. As discussed in Section III.A.4.d.2.a of this
Report,atthemomentofaRepo105transaction,Lehmanreduceditsinventoryassetsbutreceivedcash,
therebyhavinganetneutraleffectontotalassets.BecauseLehmandidnotreflectthecashborrowingon
its balance sheet as a liability (as it did in ordinary repo transactions), at the moment of a Repo 105
transaction,thetransactionalsohadanetneutraleffectontotalliabilities.Lehman,however,usedthe
cash borrowing in Repo 105 transactions to pay different shortterm liabilities, thereby reducing both
total assets and total liabilities. By engaging in Repo 105 transactions and using the cash borrowings,
Lehmanreduceditsreportedleverageratios.
738

In this way, unbeknownst to the investing public, rating agencies, Government
regulators,andLehmansBoardofDirectors,Lehmanreverseengineeredthefirmsnet
leverageratioforpublicconsumption.Notably,duringLehmans2008earningscallsin
whichittouteditsleveragereduction,analystsfrequentlyinquiredaboutthemeansby
which Lehman was reducing its leverage.2870 Although CFO Callan told analysts that
Lehmanwastryingtogivethegroupagreatamountoftransparencyonthebalance
sheet, she reported that Lehman was reducing its leverage through the sale of less
liquidassetcategoriesbutsaidnothingaboutthefirmsuseofRepo105transactions.2871
Despite the belief of Lehman personnel that none of the firms peer investment
banks still used similar accounting methods for repo transactions to arrive at their
leverage numbers, to which Lehmans reported net leverage was compared, Lehman
temporarilyreduceditsnetbalancesheetatquarterendthroughitsRepo105practice
byapproximately$38.6billioninfourthquarter2007,$49.1billioninfirstquarter2008,
and$50.38billioninsecondquarter2008.2872
2870SeeSectionIII.A.4.e.6ofthisReport.
2871See Final Transcript of Lehman Brothers Holdings Inc. First Quarter 2008 Earnings Call (Mar. 18,
2008), at p. 13 [LBHI_SEC07940_7277784]; see also Final Transcript of Lehman Brothers Holdings Inc.
Fourth Quarter 2007 Earnings Call (Dec. 13, 2007), at p. 7 [LBHI_SEC07940_7222291]; Transcript of
LehmanBrothersHoldingsInc.PreliminarySecondQuarter2008EarningsCall(June9,2008),atpp.34,
12[LBHI_SEC07940_2554480].
2872Numerous Lehman witnesses and internal Lehman emails stated that by December 2007, Lehman
personnel believed that Lehman was the last of its peer investment banks to use Repo 105type
transactions. The Examiner has not verified whether other CSE firms at one time used this type of
transaction but later ceased. Martin Kelly (former Global Financial Controller), Anuraj Bismal (former
SeniorVicePresidentBalanceSheetGroup),MarieStewart(formerGlobalHeadofAccountingPolicy),
andMichaelMcGarvey(FIDFinance)saidthattheybelievedLehmanwastheonlyCSEfirmengagingin
739

LehmanfirstintroduceditsRepo105programinapproximately2001.2873Unable
tofindaUnitedStateslawfirmthatwouldprovideitwithanopinionletterpermitting
thetruesaleaccountingtreatmentunderUnitedStateslaw,LehmanconducteditsRepo
105 program under the aegis of an opinion letter the Linklaters law firm in London
wrote for LBIE, Lehmans European brokerdealer in London, under English law.2874
Accordingly, if United Statesbased Lehman entities such as LBI and LBSF wished to
engageinaRepo105transaction,theytransferredtheirsecuritiesinventorytoLBIEin
orderforLBIEtoconductthetransactionontheirbehalf.2875
While not referenced or incorporated into Lehmans internal Repo 105
AccountingPolicy,seniorLehmanmanagementsetlimitsonthetotalamountbywhich
Repo105typetransactionsbylate2007.ExaminersInterviewofMarieStewart,Sept.2,2009,atp.14;
Examiners Interview of Michael McGarvey, Sept. 11, 2009, at p. 11; Examiners Interview of Anuraj
Bismal,Sept.16,2009,atp.7;ExaminersInterviewofMartinKelly,Oct.2,2009,atp.8.InaDecember
2007email,Bismalwrote:[W]aschattingwithexlehmanemployee[CarlosLo]atMerrillyesterdayhe
is in their balance sheet group he told me that they do not use repo 105, to which Marie Stewart
replied,Thenthatmeanswearetheonlyoneleftwhodoes.EmailfromMarieStewart,Lehman,to
AnurajBismal,Lehman,etal.(Dec.5,2007)[LBEXDOCID3223386].InaJanuary2008email,McGarvey
wrote: By the way we are now the only large firm on the street that uses Repo 105. Email from
MichaelMcGarvey,Lehman,toClementBernard,Lehman(Jan.30,2008)[LBEXDOCID2796630].Ina
May 2008 email to OMeara (thenChief Risk Officer), Ryan Traversari (Senior Vice President External
Reporting) reported that Citigroup and JPMorgan likely do not do Repo 105 and Repo 108 which are
UKbased specific transactions on opinions received by LEH from Linklaters. This would be another
reason why LEHs daily balance sheet is larger intramonth then at monthend. Email from Ryan
Traversari,Lehman,toChristopherM.OMeara,Lehman,etal.(May16,2008)[LBEXDOCID574498].In
sum,itwaswidelybelievedwithinLehmanbylate2007thatitwastheonlyfirmusingRepo105type
transactionstoreducebalancesheetandimpactthefirmsnetleverageratio.
2873SeeSectionIII.A.4.d.1ofthisReport.
2874SeeSectionIII.A.4.d.3ofthisReportandAppendix17,Repo105Appendix.
2875AsexplainedinSectionIII.A.4.d.3ofthisReport,UnitedStatesbasedLehmanentitiesengagedonly
inRepo105,andnotinRepo108transactions.RegardlessofwhichLehmanentitytransferredsecurities
ineitheraRepo105orRepo108transaction,thebalancesheetandleveragereductionbenefitwasfirm
wide,asLehmanranitsbusinessonaconsolidatedbasis.
740

thefirmcouldreduceitsbalancesheetonanygivendayusingRepo105transactions.2876
In July 2006, the limit was set at 1x leverage for Repo 105 transactions, or $17
billion.2877Combinedwitha$5billionlimitforRepo108transactions,Lehmansfirm
wide cap on combined Repo 105/108 transactions was $22 billion in the summer of
2006.2878AsofJanuary2008,thefirmwidecaponcombinedRepo105/108transactions
at quarterend was $25 billion, though in fact, Lehman exceeded the cap by
approximately$25billioninfirstandsecondquarter2008.2879Beginninginmid2007
theverytimethatthemarketbegantoparticularlyfocusoninvestmentbanksleverage
Lehman breached its internal limit on Repo 105 activity at every quarterend,
2876Examiners Interview of Paolo R. Tonucci, Sept. 16, 2009, at p. 27; Examiners Interview of Edward
Grieb,Oct.2,2009,atp.8.
2877Lehman,GlobalBalanceSheet,OverviewofRepo105(FID)/108(Equities)(July2006),atp.2[LBEX
WGM748489].WhenquestionedaboutthecalculationoftheRepo105limitsetoutintheGlobalBalance
Sheet Overview Presentation, former Lehman Financial Controller Ed Grieb could not recall the
calculationofthelimitorwhetherthe1xleverageor$17billiondefinitionreferredtooneofLehmans
leverageratiosor,rather,totangibleequitycapital.ExaminersInterviewofEdwardGrieb,Oct.2,2009,
atp.9.LehmansForm10QfromthesameperiodastheGlobalBalanceSheetOverviewPresentation
showsthatLehmanstangibleequitycapitalwas$17.4billionandthatthefirmsnetleverageratiowas
13.8,suggestingthatthesettingofLehmansRepo105limitmayhavebeentiedtotangibleequitycapital.
LehmanBrothersHoldingsInc.,QuarterlyReportasofMay31,2006(Form10Q)(filedonJuly10,2006),
at p. 58 (LBHI 10Q (filed July 10, 2006)). The Global Balance Sheet Overview Presentation itself
suggested that tangible equity is the appropriate measure of leverage. Lehman, Global Balance Sheet,
OverviewofRepo105(FID)/Repo108Equities(July2006),atp.5[LBEXWGM748489];seealsoDuff&
Phelps,Repo105/108Usagevs.LimitComment(Oct.16,2009),atp.1.Theconclusionthat1xleverage
means that the Repo 105 limit was 1 x the tangible equity metric is also supported by the fact that the
denominatorof Lehmansnet leverageratiois tangible equity. Duff & Phelps,Repo 105/108Usage vs.
Limit Comment (Oct. 16, 2009), at p. 1 & n. 4. The setting of the Repo 105 limit at 1 x tangible equity
impliesthatLehmanmanagementauthorizedRepo105usagetoreduceLehmansnetleverageratioby
uptoonemultiple,or1.0.Id.atp.2.
WGM748489].
2879Email from Sigrid Stabenow, Lehman, to Clement Bernard, Lehman, et al. (Jan. 25, 2008) [LBEX
DOCID1853428](requestingthatRepo105limitof$20billionbeexpandedto$23billion).
741

temporarilyremovingasmuchas$50.38billioninsecuritiesinventoryfromitsbalance
sheetinsecondquarter2008.2880
LehmandramaticallyrampedupitsuseofRepo105transactionsinlate2007and
early 2008 despite concerns about the practice expressed by Lehman officers and
personnel. In an April 2008 email asking if he was familiar with the use of Repo 105
transactions to reduce net balance sheet, Bart McDade, Lehmans former Head of
Equities(20052008)andPresidentandChiefOperatingOfficer(JuneSeptember2008),
replied:Iamveryaware...itisanotherdrugweron.2881Aweekearlier,McDade
hadrecommendedtoLehmansExecutiveCommitteethatthefirmsetacapontheuse
ofRepo105transactions.2882AseniormemberofLehmansFinanceGroupconsidered
Lehmans Repo 105 program to be balance sheet windowdressing that was based
on legal technicalities.2883 Other former Lehman employees characterized Repo 105
2880Lehman,TotalRepo105/108Trend(Feb.20,2008)[LBHI_SEC07940_1957956](statingtotalRepo105
usageforAugust30,2007,closeofthirdquarter2007,was$36.4billion);Lehman,TotalRepo105&Repo
108 Report (Dec. 5, 2007) [LBEXDOCID 3219746] (attached to email from Anuraj Bismal, Lehman, to
MarieStewart,Lehman,etal.(Dec.5,2007)[LBEXDOCID3223384]andstatingthattotalfirmwideRepo
105 usage on Nov. 30, 2007 was $38.634 billion); Lehman, Total Repo 105 & Repo 108 Report (June 11,
2008)[LBEXDOCID2078195](attachedtoemailfromKristieWong,Lehman,toMartinKelly,Lehman
(June11,2008)[LBEXDOCID2325872]andstatingthattotalfirmwideRepo105usageonFeb.29,2008
was$49.102billionandonMay30,2008was$50.383billion).Notethatin2008,May31wasaSaturday.
Assetforthbelow,theExaminerconcludesthattheevidencesupportstheexistenceofcolorableclaims
arising from Lehmans failure to disclose its Repo 105 practice and the impact these transactions had on
Lehmanspubliclyreportednetleverageandbalancesheet.
2881Email from Herbert H. (Bart) McDade III, Lehman, to Hyung Lee, Lehman (Apr. 3, 2008) [LBEX
DOCID1570783].
2882ExaminersInterviewofHerbertH.(Bart)McDadeIII,Jan.28,2010,atpp.34.
2883EmailfromMichaelMcGarvey,Lehman,toJormenVallecillo,Lehman(July2,2008)[LBEXDOCID
3379145].
742

transactions as an accounting gimmick and a lazy way of managing the balance
sheet.2884
In addition to the firmwide cap on total Repo 105 usage, management created
two related rules loosely known within Lehman as (1) the 80/20 or continual use
ruleand(2)the120%rule.2885Theserulesprescribed,respectively,aminimallevelof
continualuseofRepo105transactionsthroughoutthequarterandamaximumvolume
of Repo 105 transactions at quarterend.2886 Former Financial Controller Ed Grieb
described the purpose of the rules: to make sure there was a legitimate business
purposeforRepo105transactions.2887
Lehmandidnotactuallyfollowtheseselfimposedrules.Thatisnotsurprising,
sincenowitnesswasabletoprovidearationalbusinessexplanationforthearbitrary1x
leverage,continualuse,and120%rules.IfRepo105transactionsmadegoodbusiness
2884ExaminersInterviewofMurtazaBhallo,Sept.14,2009;ExaminersInterviewofMarieStewart,Sept.
2,2009,atp.7.
2885ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.13;Lehman,GlobalBalanceSheetOverview
ofRepo105(FID)/108(Equities)(July2006),atp.2[LBEXWGM748489](Repo105transactionsmustbe
executedonacontinualbasisandremaininforcethroughoutthemonth.Tomeetthisrequirement,the
amount outstanding at any time should be maintained at approximately 80% of the amount at month
end.[perChrisOMearaandEdGrieb.]);emailfromMichaelMcGarvey,Lehman,toKentaroUmezaki,
Lehman,etal.(Aug.17,2007)[LBEXDOCID1635769](Theguidelineformonthendusageofrepo105is
thatitshouldnotexceed120%ofyourdailyaverage.).
2886See Lehman, Global Balance Sheet Overview of Repo 105 (FID)/108 (Equities) (July 2006), at p. 2
[LBEXWGM748489](Repo105transactionsmustbeexecutedonacontinualbasisandremaininforce
throughout the month. To meet this requirement, the amount outstanding at any time should be
maintainedatapproximately80%oftheamountatmonthend.[perChrisOMearaandEdGrieb.]);e
mail from Michael McGarvey, Lehman, to Kentaro Umezaki, Lehman, et al. (Aug. 17, 2007) [LBEX
DOCID1635769](Theguidelineformonthendusageofrepo105isthatitshouldnotexceed120%of
yourdailyaverage.).
2887ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.13.
743

senseontheirown,therewouldbenoapparentreasontoarbitrarilyrestricttheamount
of such transactions to 1x leverage or to impose intramonth limits to ensure that the
amount of the transactions at reporting periods did not spike to more than 120% of
averageusage.Noreason,thatis,excepttokeepthetransactionsundertheradar,by
limitingtheirtotalandtheamountofaquarterendspike.
Lehmans Fixed Income Division (FID), in particular, employed Repo 105
transactions to reach quarterend balance sheet targets set by senior Lehman
management in connection with the firmwide effort to reduce net leverage. For
example,fourdayspriortothecloseoffiscalyear2007,JerryRizzieriwasinsearchofa
way to meet his balance sheet target and wrote to Mitchell King: Can you imagine
whatthiswouldbelikewithout105?2888WhenFIDsbalancesheetwasabovetargetin
thedaysleadinguptothecloseofthefirstquarter2008,aseniorfinancialofficerwithin
that division warned that the division was looking at selling what ever we can and
also doing some more repo 105.2889 Similarly, the head of the Liquid Markets group
within FID wrote at the same quarterend regarding the groups balance sheet: We
2888 Email from Jerry Rizzieri, Lehman, to Mitchell King, Lehman (Nov. 26, 2007) [LBEXDOCID
3232804].
2889EmailfromClementBernard,Lehman,toMartinPotts,Lehman,etal.(Feb.28,2008)[LBEXDOCID
1854189].
744

haveadesperatesituationandIneedanother2billionfromyou,eitherthroughRepo
105oroutrightsales.Costisirrelevant,weneedtodoit.2890
Lehmans reliance upon Repo 105 transactions for quarterend balance sheet
relief continued into Lehmans second quarter 2008. In an email titled Q2 balance
sheet anddatedMay 21,2008 tendaysbeforeLehmanssecond quarterclose the
head of the Liquid Markets group wrote: Do as much as you can in Repo 105 in
response to the question Do u thk we can be flexible beyond $3bn in 105?2891 In
anotherMay21,2008email,theheadofLiquidMarketsasked:Arewegoingtomake
the FID Europe [balance sheet] target, which elicited the response: V close . . .
anythingthatmovesisgetting105d.2892
Several additional contemporaneous emails retrieved from Lehman archives
succinctlysetforthLehmanspurposeforundertakingRepo105transactions:
[T]hefirmhasafunctioncalledrepo105wherebyyoucanrepoaposition
foraweekanditisregardedasatruesaletogetridofnetbalancesheet.2893
We have been using Repo 105 in the past to reduce balance sheet at the
quarterend.2894
2890Email from Kaushik Amin, Lehman, to Kieran Higgins, Lehman (Feb. 28, 2008) [LBEXDOCID
3234351].
2891Email from Kaushik Amin, Lehman, to Thomas Siegmund, Lehman (May 21, 2008) [LBEXDOCID
756545].
2892Email from Kieran Higgins, Lehman, to Kaushik Amin, Lehman (May 21, 2008) [LBEXDOCID
3234382].
2893EmailfromAnthonyJawad,Lehman,toAndreaLeonardelli,Lehman(Feb.29,2008)[LBEXDOCID
224902].
2894Email from Raymond Chan, Lehman, to Paul Mitrokostas, Lehman, et al. (July 15, 2008) [LBEX
DOCID3384937].
745

When pressed to identify any legitimate business purpose for Lehmans use of
Repo 105 transactions, certain witnesses noted the secured shortterm financing
afforded by the transactions. While one outcome of Repo 105 transactions was that
Lehman received financing in exchange for collateral which was not reflected in
Lehmans periodic reports as a borrowing or liability a Repo 105 transaction was a
moreexpensivewayforLehmantosecuresuchshorttermfinancingascomparedtoan
ordinary repo transaction. Lehman had the ability to conduct an ordinary repo
transactionusingthesamesecuritiesandwithsubstantiallythesamecounterpartiesas
inRepo105transactions,atalowercost.2895Assuch,thesamewitnesseswhoidentified
afinancingpurposeforRepo105transactions,aswellasseveralotherformerLehman
personnel,uniformlyacknowledgedthattheoverarchinggoalofRepo105transactions
was to meet net balance sheet targets i.e., reduce the net asset component (the
numerator) of the net leverage ratio calculation in connection with the filing of
Lehmans financial statements. While the Examiner found a large number of
contemporaneous documents that talk about the use of Repo 105 transactions to
manage the balance sheet and meet leverage targets, few, if any, contemporaneous
documents describe any other purpose for those transactions. Repo 105 transactions
werenotusedforabusinesspurpose,butinsteadforanaccountingpurpose:toreduce
Lehmanspubliclyreportednetleverageandnetbalancesheet.
2895ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.6.
746

As set forth more fully below, the Examiner concludes that a fact finder could
findthatLehmansfailuretodiscloseitsuseofRepo105transactionstoimpactitsbalance
sheet at a time when both the market and senior Lehman management were keenly
focused on the reduction of Lehmans firmwide net leverage and balance sheet, and
particularly in light of the specific volumes at which Lehman undertook Repo 105
transactionsatquarterendinfourthquarter2007,firstquarter2008,andsecondquarter
2008,materiallymisrepresentedLehmanstruefinancialcondition.
AtrieroffactcouldfindthatLehmansuseoftensofbillionsofdollarsofRepo
105transactionsatquarterendinlate2007andearly2008renderedthefirmsfinancial
statementsandrelateddisclosuresmateriallymisleading. Indeed,auditwalkthrough
paperspreparedbyLehmansoutsideauditor,Ernst&Young,2896regardingtheprocess
forreopeningoradjustingaclosedbalancesheetstated:Materialityisusuallydefined
as any item individually, or in the aggregate, that moves net leverage by 0.1 or more
(typically $1.8 billion).2897 Repo 105 moved net leverage not by tenths, but by whole
points.2898
2896Ernst&YoungrefersonlytoErnst&YoungLLP(i.e.,Ernst&YoungNorthAmerica)unlessstated
otherwise.
2897Ernst&Young,LBHI/LBIWalkthroughTemplateforBalanceSheetCloseProcess(Nov.30,2007),at
p.14[EYLELBHICORPGAMX07033384];seealsoSectionIII.A.4.g,whichdiscussesandanalyzesthe
materialityofRepo105transactions.
2898SeeSectionIII.A.4.g.2ofthisReport;emailfromAnurajBismal,Lehman,toMarieStewart,Lehman,
etal.(Dec.5,2007)[LBEXDOCID3223384](statingthatLehmanwouldbeatnetleverageof18.0x[vs
say16.3x]withoutrepo105/8).
747

Lehmans publicly reported net leverage ratio for November 30, 2007 (fourth
quarter2007),February29,2008(firstquarter2008),andMay31,2008(secondquarter
2008) was 16.1x, 15.4x and 12.1x, respectively.2899 Without the balance sheet benefit of
Repo 105 transactions, Lehmans net leverage ratios for the same periods would have
been17.8x,17.3xand13.9x,respectively:2900
Date Repo105 ReportedNet Leverage Difference

Usage Leverage WithoutRepo
105
Q42007 $38.6B2901 16.12902 17.82903 1.7
Q12008 $49.1B2904 15.42905 17.32906 1.9
Q22008 $50.38B 2907 12.12908 13.92909 1.8
2899LBHI200710K,atp.64;LBHI10Q(filedApr.9,2008),atp.72;LBHI10Q(filedJuly10,2008),atp.
89.
2009),atp.8;seealsoSectionIII.A.4.g.2oftheReport(discussingimpactofLehmansRepo105practiceon
Lehmansnetleverageratio).
2901Lehman, Total Repo 105/108 Trend (Feb. 20, 2008) [LBHI_SEC07940_1957956] (stating that fourth
quarter 2007 Repo 105 usage was $38.634 billion); see also Lehman, Global Consolidated Balance Sheet
(Final) (Nov. 30, 2007) [LBEXDOCID 3439086] (stating that fourth quarter 2007 Repo 105 usage was
$38.634billion).NotethatmanyinternalLehmandocuments,suchastheGlobalConsolidatedBalance
Sheet, used a Repo 105 heading to refer to both Repo 105 and Repo 108 usage. In such documents,
Repo108usagemaybedisaggregatedfromtheRepo105usagebyidentifyingthelineitemforEquities.
Repo105transactionsusingEquitiesinventorywereactuallyRepo108transactions.
2902SeeLBHI200710K,atpp.29,64.
2009),atp.8.
2904Lehman,TotalRepo105&Repo108Report(June11,2008)[LBEXDOCID2078195](statingthatfirm
wideRepo105usagewas$49.102billionatcloseoffirstquarter2008,Feb.29,2008).
2905SeeLBHI10Q(filedApr.9,2008),atp.72.
2009),atp.8.
2907Lehman,TotalRepo105&Repo108Report(June11,2008)[LBEXDOCID2078195](statingthatfirm
wideRepo105usagewas$50.3834billionatcloseofsecondquarter2008,May30,2008).NotethatMay
31in2008wasaSaturday.
2908SeeLBHI10Q(filedJuly10,2008),atp.89.
2009),atp.8.
748

Lehmans directors, the rating agencies, and Government regulators all of
whom were unaware of Lehmans use of Repo 105 transactions have advised the
Examiner that Lehmans Repo 105 usage was material or significant information that
theywouldhavewantedtoknow.2910TheExaminerconcludesthatsufficientevidence
exists for a trier of fact to find that Lehmans quarterend Repo 105 practice was
materialandshouldhavebeendisclosed.2911
Because Lehman treated Repo 105 transactions as sales rather than financing
transactions, accounting rules did not require Lehman to record the liabilities arising
from the cash borrowings in Repo 105 transactions. Nevertheless, there is sufficient
evidencetosupportadeterminationthatdisclosureoftheobligationtorepurchasethe
securitiesandrepaythecashborrowingwasrequiredintheManagementsDiscussion
andAnalysis(MD&A)sectionofLehmanspubliclyfiledfinancialstatementsbecause
therepurchasewasaknowneventthatwasreasonablylikelytooccurandwouldhave
hadamaterialeffectonthecompanysfinancialconditionorresultsofoperations.2912A
trieroffactcouldfurtherfindthatbyfailingtodisclosethetensofbillionsofdollarsof
Repo105transactionsandcashborrowings,LehmansdisclosuresintheLiquidityand
2910See Sections III.A.4.g.45 and III.A.4.h.3 of this Report (discussing rating agencies, Government
regulatorsandLehmanBoardofDirectors).
2911See Sections III.A.4.j.2.ad of this Report (explaining disclosure requirements and providing
ExaminersconclusionsregardingLehmansdisclosures).
2912SeeSectionIII.A.4.j.2ofthisReport(discussingandanalyzingdisclosurerequirements).
749

Capital Resources Section of the MD&A were deficient.2913 In addition, Lehmans
description of its net leverage was misleading because it omitted disclosing that the
ratiowasreducedbymeansoftemporary,accountingmotivatedtransactions.2914
The Examiner concludes that there is sufficient evidence to support a colorable
claimthat:(1)certainofLehmansofficersbreachedtheirfiduciarydutiesbyexposing
Lehman to potential liability for filing materially misleading periodic reports and (2)
Ernst & Young, the firms outside auditor, was professionally negligent in allowing
those reports to go unchallenged. The Examiner concludes that colorable claims of
breachoffiduciarydutyexistagainstRichardFuld,ChrisOMeara,ErinCallan,andIan
Lowitt, and that a colorable claim of professional malpractice exists against Ernst &
Young.2915
b) Introduction
Sale and repurchase agreements (repos) are agreements in which one party
transfersassetstoanotherpartyascollateralforashorttermborrowingofcash,while
simultaneouslyagreeingtorepaythecashandtakebackthecollateralataspecificpoint
intime.2916Whentherepotransactionmatures,theborrowerrepaysthefundsplusan
2913SeeSectionIII.A.4.j.2ofthisReport(discussingandanalyzingdisclosurerequirements).
2914SeeSections4.g.2and4.j.2.coftheReport(discussingimpactofRepo105practiceonnetleverageratio
andLehmanspublicfilings,respectively).
2915SeeSectionsIII.A.4.j.4.bandIII.A.4.j.5ofthisReport(discussingevidencesupportingcolorableclaims
againstcertainLehmanofficersandErnst&Young).
2916See ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF
LIABILITIES, Statement of Financial Accounting Standards No. 140, 96 (Fin. Accounting Standards Bd.
2000) (Government securities dealers, banks, other financial institutions and corporate investors
750

agreed upon interest rate or other charge and takes back its collateral. Repo
transactions are widely used by financial institutions and are a legitimate tool for
raisingshorttermfunding.
Likeotherlargeinvestmentbanks,Lehmanengaged,onadailybasis,intensof
billions of dollars of repo transactions in its normal course of business for financing
purposes (ordinary repo or traditional repo transactions). Lehman accounted for
theseordinaryrepotransactionsasfinancingtransactions.2917Accordingly,inLehmans
traditionalrepotransactions:
The transferred securities inventory remained on Lehmans balance sheet

duringthetermoftherepo.
Because the inventory remained on Lehmans balance sheet, the incoming

borrowedcashincreasedLehmanstotalassets.
Total liabilities also increased because Lehman recorded a corresponding

liabilityrepresentingitsobligationtorepaytheborrowedcash.
While simplified and for illustrative purposes only, the five illustrations that
follow demonstrate the impact of an ordinary repo transaction and a Repo 105
transactiononLehmansbalancesheetandleverageratios.
commonly use repurchase agreements to obtain or use shortterm funds. Under those agreements, the
transferor (repo party) transfers a security to a transferee (repo counterparty or reverse party) in
exchangeforcashandconcurrentlyagreestoreacquirethatsecurityatafuturedateforanamountequal
tothecashexchangedplusastipulatedinterestfactor.).
2917Lehman reported in its Forms 10Q and 10K that it treated repurchase (repo) transactions as
financingtransactionsforaccountingandreportingpurposes.SeeLBHI200710K,atp.97;LBHI10Q
(filedApr.9,2008),atp.13;LBHI10Q(filedJuly10,2008),atp.16.
751

Illustration1
AssumethissimplifiedbalancesheetforLehman:

Assets(inmillions) Liabilities

Cash 7,500 ShortTermBorrowings 200,000
FinancialInstruments 350,000 CollateralizedFinancings 325,000
Collateralized
Agreements 350,000 LongTermBorrowings 150,000
Receivables 20,000 Payables 98,000
Other 72,500 StockholdersEquity 27,000

Total 800,000 800,000

GrossLeverage2918 30
NetLeverage2919 17

Illustration2,below,showstheimpactofanordinaryrepoonLehmansbalance
sheetandleverageratios.
2918Grossleverage,forillustrativepurposesinthissetofexamplesonly,iscalculatedastotalassetsdividedby
stockholdersequity.
2919Forillustrativepurposesinthissetofexamplesonly,asimplifieddefinitionofnetleverageisused:net
leverage=(totalassetscollateralizedagreements)dividedbystockholdersequity.
752

Illustration2
IfLehmanexecutes$50billionoftypicalrepotransactionswith$50billion
of its financial instruments, those instruments remain on the balance sheet;
Lehman receives a $50 billion cash borrowing, increasing its cash position; and
Lehmanrecords$50billionofadditionalcollateralizedfinancingliabilities;atthe
momentoftherepotransactions,totalbalancesheetandleverageincrease:


Collateralized

Total 850,000 850,000

GrossLeverage 31
NetLeverage 19

Illustration3,below,showstheimpactofanordinaryrepofollowedbytheuseof
thecashborrowingtopaydownliabilities.
753

Illustration3
AssumingLehmanweretousethe$50billioncashborrowingfromtypical
repo transactions to pay off current liabilities, the effect on the balance sheet
would be neutral no net increase in total assets/liabilities, and no effect upon
leverage:2920


Collateralized

Total 800,000 800,000

GrossLeverage 30
NetLeverage 17
Although Lehman publicly reported that it treated all repo transactions as
financing transactions for accounting purposes,2921 Lehman booked Repo 105
transactions as sales under the Financial Accounting Standards Boards Statement of
2920ThisisnottosuggestthatLehmanregularlyusedthefundsreceivedinatypicalrepotransactionto
paydownliabilities.IntheNotestoitsConsolidatedFinancialStatements,forexample,Lehmanstated
We enter secured borrowing and lending transactions to finance inventory positions, obtain securities
forsettlementandmeetclientsneeds.SeeLBHI200710K,atp.110.
2921SeeLBHI200710K,atp.97(statingthatLehmantreatsrepotransactionsasfinancingtransactionsfor
reportingpurposes);LBHI10Q(filedApr.9,2008),atp.13(same);LBHI10Q(filedJuly10,2008),atp.
16(same);seealsoLehman,GlobalBalanceSheetOverviewofRepo105(FID)/108(Equities)(July2006),at
p. 1 [LBEXWGM 748489] (Repo transactions are normally recorded on the balance sheet as
financings.).
754

Financial Accounting Standards No. 140 (SFAS 140), Accounting for Transfers and
ServicingofFinancialAssetsandExtinguishmentsofLiabilities.2922
SFAS140governs,inpart,whentorecognizeatransferofassetsasafinancing
transactionor,alternatively,asasale.2923AlthoughSFAS140moreoftenisdiscussedin
the context of securitization transactions, a particular provision of SFAS 140
specifically SFAS 140.98 permits the transferor of assets in a repo agreement to
accountfortherepotransactionasasalewithaforwardpurchasecommitmentifthe
transaction satisfies certain criteria.2924 As an accounting matter, and consistent with
Lehmans publicly reported statements, the vast majority of repo transactions do not
satisfy SFAS 140s criteria to recharacterize the repo transaction as a sale and thereby
movethetransferredinventoryoffbalancesheet.2925
2922AsdiscussedmorefullyatSectionIII.A.4.d.2.coftheReport,the105and108descriptionsreferto
thehaircutnecessaryforLehmantoaccountforthetransactionasasaleunderSFAS140.Lehman
utilized treasuries, agencies, and other government securities in Repo 105 transactions and utilized
equitiessecuritiesinRepo108transactions.SeeSectionIII.A.4.d.4ofthisReport.
2923ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF
LIABILITIES, Statement of Financial Accounting Standards No. 140, 2, 98 (Fin. Accounting Standards
Bd.2000)(SFAS140).IssuedinJune2009andeffectiveasofthebeginningofeachreportingentitys
first annual reporting period that begins after November 15, 2009, SFAS 160 and SFAS 167 amended
certainaspects of SFAS140. SeeACCOUNTING FOR TRANSFERS OF FINANCIAL ASSETS, AN AMENDMENT OF
FASB STATEMENT NO. 140, Statement of Financial Accounting Standards No. 166 (Fin. Accounting
Standards Bd. 2009); AMENDMENTS TO FASB INTERPRETATION NO. 46(R), Statement of Financial
AccountingStandardsNo.167(Fin.AccountingStandardsBd.2009).
2924See SFAS 140, 98; see also Section III.A.4.j.2.c.ii.a of this Report (discussing Lehmans disclosures
regardingsecuritizationactivitiesandSFAS140).
2925Paragraph 208 of SFAS 140 notes that sale treatment for repo transactions is unusual. Specifically,
Paragraph 208 provides, [P]articipants in the very large markets for repurchase agreements and
securitieslendingtransactionsare,forthemostpart,unaccustomedtotreatingthosetransactionsassales,
and a change to sale treatment would have a substantial impact on their reported financial position.
SFAS140,208.
755

The recharacterization of a repo transaction from a financing or borrowing
transactiontoasaletransactionpursuanttoSFAS140leadstoseveralconsequences:
The transferred securities inventory are derecognized, i.e., considered sold

andremovedfromthe transferors/sellers balance sheet during the term of
the repo even though the transferor/seller is required to repurchase the
inventoryatafuturedate.2926
Additionally, when a repo transaction is recharacterized as a sale, the

transferor/seller does not record a liability representing its obligation to
repay the borrowed funds.2927 In other words, the borrowing is not
reflected on the balance sheet, even though the economic substance of the
transaction is a borrowing, and thus, the transferors total liabilities do not
increase.2928
Although the transferors inventory decreases, at the moment of the

transaction the transferors total assets remain unchanged because the
transferorreceivescashborrowingsinexchangeforthesecuritiesinventory.
Consequently, Lehmans Repo 105 transactions removed securities inventory
from Lehmans balance sheet for the duration of the repo typically seven to ten
days.2929 At the moment of the Repo 105 transaction, Lehman received cash.2930 Thus,
2926SeeSFAS140,11.a(Uponcompletionofatransferoffinancialassetsthatsatisfiestheconditionsto
be accounted for as a sale (paragraph 9), the transferor shall: a. Derecognize all assets sold.); see also
AppendixE:GlossaryofSFAS140(Derecognize:Removepreviouslyrecognizedassetsorliabilitiesfrom
thestatementoffinancialposition.).
2927SeeSFAS140,98(Ifthecriteriainparagraph9aremet,includingthecriterioninparagraph9(c)(1),
the transferor shall account for the repurchase agreement as a sale of financial assets and a forward
repurchase commitment, and the transferee shall account for the agreement as a purchase of financial
assetsandaforwardresalecommitment.).
2928Id.
2929ExaminersInterviewofTejalJoshi,Sept.15,2009,atp.4;ExaminersInterviewofMarkGavin,Sept.
24, 2009, at p. 4; Examiners Interview of John Feraca, Oct. 9, 2009, at p. 5; Examiners Interview of
MatthewLee,July1,2009,atp.13.
2930Lehman,GlobalBalanceSheetOverviewofRepo105(FID)/108(Equities)(July2006),atp.1[LBEX
WGM 748489]; Examiners Interview of Edward Grieb, Oct. 2, 2009, at pp. 1314 (stating that cash
receivedinRepo105transactionswasusedtopayoffotherliabilities);ExaminersInterviewofMatthew
Lee,July1,2009,atp.14(explainingthatinorderforLehmantorealizethebenefittoitsleverageratiosas
756

althoughLehmanreduceditsinventory,theincomingcashresultedinnochangetothe
volumeofLehmanstotalassets.2931BecauseLehmanbookedRepo105transactionsas
salesunderSFAS140,ratherthanasfinancings,itdidnotrecordanyliabilitiesarising
from the obligation to repay the shortterm funding secured by a Repo 105
transaction.2932Consequently,asdemonstratedinIllustration4,below,Lehmanwasalso
abletoborrowtensofbillionsofdollarswithoutdisclosingtheborrowing.
a result of Repo 105 transactions, the firm had to use the cash received to pay off a different liability);
Duff&Phelps,ExplanationofRepo105AccountingLedgerEntriesandTradingSystemOutput(Jan.5,
2010), at p. 2. In addition, as explained in Letter from Linklaters, to Lehman Brothers International
(Europe),re:RepurchaseTransactionsunderaGlobalMasterRepurchaseAgreement(May21,2006),2.4
[LBEXLBIE000001],SectionIII.A.4.d.2.aofthisReportandAppendix17,Repo105Appendix,duringthe
term of the Repo 105 transaction as in a typical repo transaction Lehman continued to receive the
incomestreamarisingfromthetransferredsecuritiesduringthetermofthetransaction.
2009),atp.3;ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.1314(statingLehmanusedRepo
105cashborrowingtopayotherliabilities);ExaminersInterviewofMatthewLee,July1,2009,atp.14
(explaining that in order for Lehman to realize the benefit to its leverage ratios as a result of Repo 105
transactions,thefirmhadtousethecashreceivedtopayoffadifferentliability).
2009),atpp.34.
757

Illustration4
IfLehmanexecutes$50billionofRepo105transactions,ratherthantypical
repos, the transaction is recharacterized as a sale and $50 billion of financial
instruments, considered sold, are removed from the balance sheet;2933 Lehman
receives $50 billion in cash, exchanging one form of asset for another, so total
assetsareunchanged;Lehmanrecordsnoliabilitytoreturnthecashborrowingso
liabilitieslikewiseremainunchanged;atthemomentoftheRepo105transactions,
leverageisunaffected:


Collateralized

Total 800,000 800,000

GrossLeverage 30
NetLeverage 17

2933AsdiscussedingreaterdetailinSectionIII.A.4.d.2.dofthisReport,Lehmancreateda$5derivative
assetforevery$105worthofsecuritiesremovedfromitsbalancesheetinaRepo105transaction.Forthe
sakeofsimplification,Illustrations3and4donotincludethe$5derivative.
758

Lehman used the borrowed funds from Repo 105 transactions to pay down
shorttermliabilitiessuchasordinaryrepotransactions,asinIllustration5,below.2934By
doingso,Lehmanreduceditstotalassets,therebyreducingitsleverageratios.
2934ExaminersInterviewofMartinKelly,Oct.1,2009,atp.7(statingthatincomingcashfromRepo105
transactionswasusedtopaybusinessexpenses);ExaminersInterviewofEdwardGrieb,Oct.2,2009,at
pp. 1314 (stating that cash received in Repo 105 transactions was used to pay off other liabilities);
ExaminersInterviewofMatthewLee,July1,2009,atp.14(explainingthatinorderforLehmantorealize
thebenefittoitsleverageratiosasaresultofRepo105transactions,thefirmhadtousethecashreceived
topayoffadifferentliability);seeemailfromAnurajBismal,Lehman,toMarieStewart,Lehman,etal.
(Dec.5,2007)[LBEXDOCID3223384](statingthatLehmanwouldhaveanetleverageof18.0xinsteadof
16.3x without Repo 105, which indicates that Lehman used Repo 105 cash to pay down different
liabilities). Given that Lehman undertook $38.6 billion, $49.1 billion, and $50.38 billion of Repo 105
transactionsatquarterendfourthquarter2007,firstquarter2008,andsecondquarter2008,respectively,
Lehmansdisclosuresofitscashholdingsateachquarterendfurtherstrengthensthetestimonyandother
evidence that Lehman used the cash borrowing from Repo 105 transactions to pay down shortterm
liabilities. See LBHI 2007 10K, at p. 86 (reporting that Lehman had $7.286 billion in cash and cash
equivalents on November 30, 2007); LBHI 10Q (filed Apr. 9, 2008), at p. 5 (reporting that Lehman had
$7.564billionincashandcashequivalentsonFebruary29,2008);LBHI10Q(filedJuly10,2008),atp.5
(reporting that Lehman had $6.513 billion in cash and cash equivalents on May 31, 2008). While
Lehmans Repo 105 transactions spiked at quarterends, Lehmans ordinary repo balances dropped off
significantlyduringthesametimeperiods.Duff&Phelps,Repo105BalanceSheetAccountingEntryand
LeverageRatiosSummary(Oct.2,2009),atp.5.
759

Illustration5

In a Repo 105 transaction, Lehman uses the cash it generates to reduce
traditionalborrowings,suchasordinaryrepos(collateralizedfinancingsinthe
examplebelow).ByapplyingthecashfromaRepo105transactiontopaydown
liabilitiessuchasordinaryrepos,Lehmanreducesitsbalancesheetandleverage.


Collateralized

Total 750,000 750,000

GrossLeverage 28
NetLeverage 15
Whenthe Repo105transaction matured,Lehmanborrowed funds to repaythe
Repo 105 cash borrowing plus interest and the previously transferred securities
inventoryreturnedtoLehmansbalance sheetassecuritiesinventory.2935Accordingly,
totalassetsandtotalliabilitiesincreased.
Although it is undisputed that Lehman received cash as part of Repo 105
transactions, the documents and witness testimony reveal that the financing Lehman
WGM748489];Duff&Phelps,Repo105BalanceSheetAccountingEntryandLeverageRatiosSummary
(Oct. 2, 2009), at p. 4; Duff & Phelps, Explanation of Repo 105 Accounting Ledger Entries and Trading
SystemOutput(Jan.5,2010),atp.5.
760

receivedunderaRepo105transactionwasnottherealorprimarypurposeforentering
intoRepo105transactions.Lehmancouldhaveobtainedthesamefinancingatalower
cost by engaging in ordinary repo transactions with substantially the same
counterpartiesusingthesameassetsinvolvedinRepo105transactions.2936
LehmansprimarymotiveforundertakingtensofbillionsofdollarsinRepo105
transactions at or near each quarterend in late 2007 and 2008 was to temporarily
removethesecuritiesinventoryinvolvedfromitsbalancesheetinordertoreportlower
leverage and net leverage ratios than Lehman actually had.2937 Numerous witnesses
told the Examiner that Lehmans motive for undertaking a Repo 105 transaction, as
opposedtoanordinaryrepo,turnedsolelyonLehmansneedtomanagethefirmwide
balancesheetandeffectthepubliclydisclosedleverage.2938
2937Leverageistherelationshipofacompanystotalassetstostockholdersequity.LBHI200710K,atp.
30. Lehman believed that net leverage based on net assets and tangible equity capital was a more
meaningfulmeasureofleverage.SeeLBHI200710K,atpp.30,63.Lehmandefinednetleverageratio
asnetassetsdividedbytangibleequitycapital.Id.Lehmansnetassetcalculationbeginswithtotal
assets as reported for GAAP purposes in Lehmans Forms 10K and 10Q. From there, Lehman
subtracted certain assets in order to arrive at net assets: (i) cash and securities segregated and on
depositforregulatoryandotherpurposes;(ii)collateralizedlendingagreements(i.e.,securitiesLehman
is holding as collateral for a loan made to a thirdparty); and (iii) identifiable intangible assets and
goodwill.Seeid.atp.30.
2938Examiners Interview of Tejal Joshi, Sept. 15, 2009, at pp. 4, 6 (stating that Repo 105 allowed us to
treat trades of positions that would be financing trades as true sales instead and that at quarterend
therewasamadscrambletomeetbalancesheettargetsthroughuseofRepo105);ExaminersInterview
ofPaoloR.Tonucci,Sept.16,2009,atp.27(statingthatattheendofreportingperiods,Lehmandeployed
Repo105transactionstonetdownitsbalancesheet);ExaminersInterviewofMarkGavin,Sept.24,2009,
atp.4(statingpurposeofRepo105transactionswasbalancesheetmanagement);ExaminersInterview
ofMartinKelly,Oct.1,2009,atp.7([T]heonlypurposeormotiveforthe[Repo105transactions]was
reductioninbalancesheet.);ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.11(statingRepo
105 transactions were used to bring balance sheet in line with targets); Examiners Interview of John
Feraca,Oct.9,2009,atpp.6,10(ItwasuniversallyacceptedthroughouttheentireinstitutionthatRepo
761

From2001,whenLehmanfirstbeganusingRepo105transactions,2939untilearly
tomid2007, Lehman engaged in a relatively consistent volume of Repo 105
transactions,includingatquarterend,generallywithinarangeofbetween$20and$25
billion.2940 Lehman also maintained internal rules based on senior managements
judgment,ratherthananyaccountingrequirementlimitingthetotalfirmwideuseof
Repo105transactionsto$22billion,laterincreasedto$25billion.2941
In midtolate 2007, however, Lehman increased dramatically the volume of
firmwideRepo105transactionsatquarterend.Byfirstquarter2008,thedollarvalue
105 was used for balance sheet relief at quarter end); Examiners Interview of Joseph Gentile, Oct. 21,
2009, at p. 6 (stating that Repo 105 was a balance sheet management mechanism, a tool that could be
usedtoreduceLehmansnetbalancesheet);ExaminersInterviewofClementBernard,Oct.23,2009,at
p.7(Repo105wasamechanismFIDreliedontogetitsbalancesheetdown);ExaminersInterviewof
MatthewLee,July1,2009,atp.15(statingRepo105transactionsdrivenbymanagementsimperativeto
reverseengineerleverageratio).
2939Though Repo 105 started in 2001, Lehman did not initiate Repo 108 transactions, used for equities
securities,untilMay2006.SeeLehman,GlobalBalanceSheetOverviewofRepo105(FID)/108(Equities)
(July2006),atp.4[LBEXWGM748489].
2940Id. (showing Repo 105 monthend trend between January 2005 and May 2006 of between
approximately $11 billion and $21 billion); Joseph Gentile, Lehman, Proposed Repo 105/108 Target
Increasefor2007(Feb.10,2007),atp.1[LBEXDOCID2489498](attachedtoemailfromJosephGentile,
Lehman,toEdwardGrieb,Lehman(Feb.10,2007)[LBEXDOCID2600714]andshowingdailytotalRepo
105 usage for December 1, 2006 through February 2, 2007 remained between approximately $14 billion
and$24billion).
2941See,e.g.,Lehman,GlobalBalanceSheetOverviewofRepo105(FID)/108(Equities)(July2006),atp.2
[LBEXWGM 748489] (setting Repo 105 limit at $17 billion and Repo 108 limit at $5 billion); Joseph
Gentile,Lehman,ProposedRepo105/108TargetIncreasefor2007(Feb.10,2007),atp.1[LBEXDOCID
2489498] (attached to email from Joseph Gentile, Lehman, to Edward Grieb, Lehman (Feb. 10, 2007)
[LBEXDOCID 2600714] and proposing to increase $22 billion combined Repo 105/108 limit to $25
billion);emailfromSigridStabenow,Lehman,toClementBernard,Lehman,etal.(Jan.25,2008)[LBEX
DOCID 1853428] (requesting that Repo 105 limit of $20 billion be expanded to $23 billion); Examiners
InterviewofAndrewJ.Morton,Sept.21,2009,atpp.4,22(statingRepo105limitsestablishedatinception
of program in 2001); Examiners Interview of Edward Grieb, Oct. 2, 2009, at pp. 910; Examiners
InterviewofJohnFeraca,Oct.9,2009,atp.10;ExaminersInterviewofJosephGentile,Oct.21,2009,atp.
7.TheRepo105limitwasamanagementdecision,wasnotbasedonaccountingrules,andwasnotpart
ofLehmansinternalRepo105AccountingPolicy.
762

of assets that Lehman temporarily removed from its balance sheet at quarterend
through Repo 105 transactions was $49 billion.2942 Lehman escalated its Repo 105
activitydespiteitsunderstandingthatitspeerinvestmentbankstowhomLehmans
leveragewascompareddidnotusesimilardevices.2943
Lehman greatly expanded its Repo 105 program at a time when market
observers increased their focus on the leverage of investment banks and Lehman
management placed increased pressure on the businesses within the firm to reduce
their net assets. CEO Fuld noted that marketplace perceptions of Lehman precluded
Lehmanfromimprovingitsnetleverageratiobymeansofraisingequity.2944Moreover,
as Lehmans inventory grew increasingly illiquid, it became difficult to sell without
reducing prices and incurring losses or calling into question Lehmans marks for
inventoryremainingonitsbalancesheet.2945
2942SeeLehman,TotalRepo105&Repo108Report(June11,2008)[LBEXDOCID2078195](attachedtoe
mailfromKristieWong,Lehman,toMartinKelly,Lehman(June11,2008)[LBEXDOCID2325872]and
showingtotalfirmwideRepo105usageatMay30,2008).
2943Examiners Interview of Marie Stewart, Sept. 2, 2009, at p. 14; Examiners Interview of Michael
McGarvey, Sept. 11, 2009, at p. 11; Examiners Interview of Anuraj Bismal, Sept. 16, 2009, at p. 7;
ExaminersInterviewofMartinKelly,Oct.1,2009,atp.7;ExaminersInterviewofMatthewLee,July1,
2009,atp.14;seealsoemailfromAnurajBismal,Lehman,toMarieStewart,Lehman,etal.(Dec.5,2007)
[LBEXDOCID3223386];emailfromMichaelMcGarvey,Lehman,toClementBernard,Lehman(Jan.30,
2008) [LBEXDOCID 2796630]; email from Ryan Traversari, Lehman, to Christopher M. OMeara,
Lehman,etal.(May16,2008)[LBEXDOCID574498];emailfromMichaelMcGarvey,Lehman,toJormen
Vallecillo,Lehman(July2,2008)[LBEXDOCID3379145].
763

Transactions
As part of the Examiners investigation of internal Lehman audits of risk
management controls, the Examiner became aware of Lehmans Repo 105 offbalance
sheet effect. As the Examiner obtained a critical mass of information regarding
Lehmans use of these transactions and the firms motive in undertaking them at
increasingvolumesinlate2007and2008,itbecameapparentthatLehmansuseofRepo
105 transactions intersected with several issues involved in the Examiners
investigation, including the directive that the Examiner investigate whether there are
colorableclaimsforbreachoffiduciarydutiesbyofficersanddirectors.2946Asdescribed
infra, the Examiner concludes that a colorable claim of breach of fiduciary duty exists
against certain Lehman officers namely, Richard Fuld, Chris OMeara, Erin Callan,
andIanLowitt.
The Examiner further concludes that a colorable claim of professional
malpracticeexistsagainstErnst&Young.2947
DocketNo.0813555(JMP),InreLehmanBrothersHoldingsInc.,No.0813555,atp.3(Bankr.S.D.N.Y.Jan.
16,2009).
2947 Ernst & Youngs conduct in connection with Lehmans failure to disclose its use of Repo 105
transactions falls within the Courts January 16, 2009 directive that the Examiner perform the duties
specifiedinsections1106(a)(3)and(4)oftheBankruptcyCode.Id.at5.Sections1106(a)(3)and(4)of
theBankruptcyCodeprovidethattheExaminershallinvestigatetheacts,conduct,assets,liabilitiesand
financialconditionofthedebtor[and]theoperationofthedebtorsbusinessandfileastatementofany
investigation . . . including any fact ascertained pertaining to fraud, dishonesty, incompetence,
misconduct,mismanagement,orirregularityinthemanagementoftheaffairsofthedebtor,ortoacause
ofactionavailabletotheestate.11U.S.C.1106(2006).
764

d) ATypicalRepo105Transaction
(1) TheGenesisofLehmansRepo105Programin2001
Lehman initiated its Repo 105 program sometime in 2001, soon after SFAS 140
tookeffectinSeptember2000.2948Atthattime,headsofvariousLehmanbusinessunits
fromNewYorkandLondon,andrepresentingseveralofthefirmsbusinessdivisions
andgroups,includingCredit,Treasury,ProductControl,AccountingPolicy,Legal,and
Compliance,convenedtoassesshowLehmancoulduseSFAS140tomanageitsbalance
sheet.2949 Lehmans outside auditors and lawyers participated in the firms review of
SFAS140.2950Indeed,LehmanvettedtheconceptofaSFAS140repotransactionwithits
outsideauditor,beforethefirmformalizedaRepo105accountingpolicyandapproved
Repo105transactionsforusebyfirmpersonnel.2951
2948ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.7;ExaminersInterviewofJohnCoghlan,Nov.
11,2009,atp5.LehmanaddedRepo108transactionstotheprograminMay2006.SeeLehman,Global
Balance Sheet, Lehman, Overview of Repo 105 (FID)/108 (Equities) (July 2006), at p. 4 [LBEXWGM
748489](Repo108forequitysecuritieswasintroducedasatMay2006[$0.6B].).
2949Examiners Interview of John Feraca, Oct. 9, 2009, at p. 7. While he did not dispute Feracas
recollection,JohnCoghlan,formerHeadofPrimeServicestowhomFeracadirectlyreported,recalledthat
Lehman developed its Repo 105 policy and began engaging in Repo 105 transactions in approximately
2001, after senior management at the firm had grown aware that other peer Consolidated Supervised
Entities (CSE) firms were undertaking similar offbalance sheet repo transactions. Examiners
InterviewofJohnCoghlan,Nov.11,2009,atp.5.
2950Examiners Interview of John Feraca,Oct. 9, 2009, at p. 7. Asked directly to name the auditors and
lawyers, Feraca did not recall the specific identities of the firms or individuals. Although Lehman
acquiredtruesaleopinionletters,asrequiredbySFAS140,fromtheLinklaterslawfirm(discussedmore
fully below), the evidence referencing Linklaters opinion letters is silent on the issue of Linklaters
involvementatthedevelopmentstageofLehmansRepo105program.
2951Id.
765

Several months of internal meetings and discussions occurred before Lehman
finalized the structure of its Repo 105 program.2952 Ultimately, Lehman designed the
model structure for a Repo 105 transaction and drafted an official, internal Lehman
Accounting Policy that covered what became known at the firm as Repo 105, and
eventuallyincludedRepo108,transactions.2953LehmansAccountingPolicyManual
for Repo 105 transactions was distributed to all business people within the firm.2954
Repo105transactionsfirmwidehadtocomplywiththispolicy.
(2) Repo105TransactionsVersusOrdinaryRepoTransactions2955
Generally,[r]epurchaseAgreements,orrepos,aretheprimaryinstrumentsused
by [United States] brokerdealers to finance their inventory positions.2956 Repo
2953Id. Lehmans Accounting Policy Manual for Repo 105 and Repo 108 is reprinted in its entirety in
Appendix17,Repo105Appendix.
McGarvey,Sept.11,2009,atp.7;ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.7.
2955Repotransactionsarecharacterizeddifferentlyunderbankruptcy,tax,insurance,andsecuritieslaw.
That is, some bodies of law characterize repo transactions as sales, while others characterize repo
transactionsasloansorsecuredtransactions.Forexample,inbankruptcydisputesbetweencreditorsand
debtorswhereaclaiminvolvesanallegedbreachofthedutytoliquidatethesecuritiestransferredina
repo transaction in a commercially reasonable manner, the Southern District of New York held that a
repotransactionwasasaleratherthanasecuredloan,therebysuggestingthatarepotransactionshould
be governed by Article 8 of the Uniform Commercial Code (the UCC) as opposed to Article 9 of the
UCC.GranitePartners,L.Pv.Bear,Stearns&Co.,Inc.,17F.Supp.2d275,302(S.D.N.Y.1998).Ontheother
hand, for purposes of tax law, the United States Supreme Court has held that repo transactions are
securedloansratherthansales.NebraskaDeptofRevenuev.Loewenstein,513U.S.123,13031(1994).An
analysisofthecharacterizationofrepotransactionsunderlawisbeyondthescopeofthisReport,which,
with respect to Lehmans Repo 105 program, focuses on the accounting treatment of Repo 105
transactions, the treatment of Repo 105 transactions for financial reporting purposes, and Lehmans
disclosureobligations.
2956Lehman,RepoManual(Nov.8,2005),atp.6[LBEXLL1175483].TheRepoManualwasaninternal
Lehmanpublicationintendedasareferenceguideforsalespeopleengaginginrepotransactions.
766

transactions consist of two legs.2957 In the first leg, Lehman would transfer securities
inventorytoarepolenderinreturnforcash.2958Inthesecondleg,Lehmanwouldrepay
the cash amount plus interest, and the repo lender would return the securities
inventory.2959 The difference between the value of the securities inventory transferred
and the cash received is referred to as the haircut on the repo transaction. As
explained in detail below, in an ordinary repo transaction involving liquid securities
during the late 2007 and 2008 time period, the haircut third parties typically required
was approximately 2% while in a Repo 105 or Repo 108 transaction, the haircut
involvedwasrequiredtobeatleastfivepercentoreightpercent,respectively,andwas
oftenmore.2960
2957SeeLehman,RepoManual(Nov.8,2005),atp.7[LBEXLL1175483].
2958See Examiners Interview of Marie Stewart, Sept. 2, 2009, at p. 8; Examiners Interview of Michael
McGarvey,Sept.11,2009,atp.7.
2959SeeLehman,RepoManual(Nov.8,2005),atp.7[LBEXLL1175483].
2960ExaminersInterviewofMarkGavin,Sept.24,2009,atp.7;ExaminersInterviewofJohnFeraca,Oct.
9,2009,atp.6;seeLehman,GlobalBalanceSheet,OverviewofRepo105(FID)/108(Equities)(July2006),
atp.2[LBEXWGM748489].
767

(a) LehmansAccountingTreatmentofRepo105Transactions
VersusOrdinaryRepoTransactions
For accounting and financial reporting purposes consistent with Lehmans
policyasdisclosedin itspubliclyfiledstatementsthesubstanceofanordinaryrepo
transactionisashorttermborrowingorfinancingtransaction.2961Thetransferorinan
ordinary repo transaction, also known as the repo borrower, receives cash, but the
ordinaryrepotransactionalsocreatesaliabilityforthetransferortorepaytheamount
2961See Lehman, Global Balance Sheet, Overview of Repo 105 (FID)/108 (Equities) (July 2006), at p. 1
[LBEXWGM748489](Repotransactionsarenormallyrecordedonthebalancesheetasfinancings.);see
also Section III.A.4.j.2.c.ii.a of the Report (discussing Lehmans characterization of repo transactions for
purposesoffinancialreportinginForms10Kand10Q).
768

of cash borrowed.2962 Accordingly, the accounting impact of an ordinary repo on the
transferorsbalancesheetistoincreaseboth:(1)totalassets,asaresultoftheincoming
cash,and(2)totalliabilities,byanamountcorrespondingtotheobligationtorepaythe
cash.2963 Typically the repo borrower in an ordinary repo continues to receive the
income from the coupon payments of the securities that serve as collateral for the
borrowingofcashfromthetransferee.2964
When an ordinary repo transaction matures, that is, the term ofthe transaction
expires,thetransferorrepaysthecashtothetransfereeandthetransferee,alsoknown
as a repo lender, returns to the transferor the securities held as collateral.2965 The
effectofthematuringoftheordinaryrepotransactiononthetransferorsbalancesheet
2962SeeDuff&Phelps,Repo105BalanceSheetAccountingEntryandLeverageRatiosSummary(Oct.2,
2009),atp.2.
2963Id.;seealsoSFAS140100(Repurchaseagreementsthatdonotmeetallthecriteriainparagraph9
shallbetreatedassecuredborrowings.).
2964See, e.g., Master Repurchase Agreement (September 1996 Version) between Lehman Brothers Inc.,
Lehman Commercial Paper Inc. and Lehman Brothers International(Europe)(Oct. 6,1998), 5 Income
Payment[LBEXAM333493](statingthatreposellerisentitledtoreceiveallincomepaidordistributed
onorinrespectofthetransferredsecuritiestothefullextentitwouldbesoentitledifthesecuritieshad
not been sold); Master Repurchase Agreement (September 1996 Version) between Dresdner Bank AG,
New York Branch and Lehman Brothers Inc., Lehman Commercial Paper Inc. (July 19, 2002, 1998), 5
Income Payment [LBEXAM 334017] (same); Master Repurchase Agreement (September 1996 Version)
between Lehman Brothers Inc. and Bank for International Settlements (Aug. 14, 1998), 5 Income
Payment[LBEXAM333532](same).cf.LehmanBrothers,RepoManual(Nov.8,2005),atp.15[LBEXLL
1175483] (stating that for its standard repo transactions, Lehman uses BMA Master Repurchase
Agreement,whichincludesinterestpaymentterms).TheSupremeCourtsdecisioninNebraskaDeptof
Revenue v. Loewenstein, in which the Court held that repo transactions were secured loans rather than
sales,notedthattheinterestchargedbytherepolenderbearsnorelationtothecouponinterestpaidor
accruingonthesecuritiesduringthetermoftherepo.513U.S.123,131(1994).Thefactthatthecoupon
interestonthesecuritiescontinuedtoflowtotherepoborrowerwasonefactortheCourtconsideredin
holdingthatrepotransactionsweresecuredloansratherthansalesundertaxlaw.Id.at130.
2965Lehman,RepoManual(Nov.8,2005),atp.7[LBEXLL1175483].
769

istoreduceboth:(1)totalassets,asaresultoftherepaymentoftheborrowedcash,and
(2)totalliabilities,becausetheobligationtorepayhasbeenextinguished.2966
Consistent with the firms disclosures in its financial statements, Lehman
recorded ordinary repo transactions as secured lending or financing transactions.2967
Accordingly,whenLehmanengagedinanordinaryrepotransactionastransferor,the
securitiesthatLehmantransferredremainedonLehmansbalancesheetasinventory,a
subsetoftotalassets.2968
Repo 105 transactions were structurally and substantively identical to ordinary
repotransactions;indeed,LehmanusedthesamedocumentationtoexecutebothRepo
105 and ordinary repo transactions, and these transactions were conducted with the
samecollateralandsubstantiallythesamecounterparties.2969Specifically,inaRepo105
2009),atp.2.
WGM748489](Repotransactionsarenormallyrecordedonthebalancesheetasfinancings.);LBHI2007
10K,atp.97(statingthatLehmantreatsrepotransactionsascollateralizedagreementsandfinancingsfor
financial reporting purposes); LBHI 10Q (filed Apr. 9, 2008), at p. 13 (same); LBHI 10Q (filed July 10,
2008), at p. 16 (same); see also Duff & Phelps, Explanation of Repo 105 Accounting Ledger Entries and
Trading System Output (Jan. 5, 2010), at p. 3 (stating that Lehmans accounting systems recorded repo
transactionsasfinancingtransactionsandthatmanualinterventionrequiredtorecharacterizetherepoas
asale(i.e.,aRepo105)).
2968SeeSFAS140,100(Repurchaseagreementsthatdonotmeetallthecriteriainparagraph9shallbe
treatedassecuredborrowings.).
2969JohnFeraca,whoranLehmansSecuredFundingDeskwhichwasresponsibleforexecutingordinary
repoandRepo105transactions,statedthatwithmostcounterparties,Lehmanhadcapacitytodoeither
anordinaryrepooraRepo105transaction;thatnothingpreventedLehmanfromengaginginastandard,
overnightrepotransactionusingthesameassetswiththesamecounterpartybutatalowerhaircut;and
that Lehman used the same GMRA for ordinary repo and Repo 105 transactions with the same
counterparty.ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.6MarkGavin,whoworkedfor
LBIEs Secured Financing Desk believed that a single GMRA, which governed both ordinary repo and
770

transaction,justasinanordinaryrepotransaction,Lehmanwouldtransfersecuritiesto
a repo lender in exchange for shortterm financing.2970 Additionally, in a Repo 105
transaction, just as in an ordinary repo transaction, Lehman, as the borrower, was
obligatedtorepurchasethesecuritiespostedascollateral(stateddifferently,torepay
thecashborrowing)uponmaturationoftherepo.2971
During the term of a Repo 105 transaction, as with a typical ordinary repo
transaction,Lehmancontinuedtoreceivethestreamofincome(thecouponpayments)
from the securities transferred in a Repo 105 transaction.2972 As in an ordinary repo
transaction, Lehman was charged interest on the cash borrowing in a Repo 105
transaction.2973LehmanpaidtherepointerestseparatelyuponthecompletionofaRepo
Repo105transactions,wasinplaceformanyofLehmanscounterparties.ExaminersInterviewofMark
Gavin,Sept.24,2009,atp.6.
2009),atp.3.
2971ExaminersInterviewofMichaelMcGarvey,Sept.11,2009,atp.9;ExaminersInterviewofMatthew
Lee,July1,2009,atp.10(statingthatLehmanrepurchasedtheinventoryapproximately4to5daysafter
newquarterbegan).
2972TheMay2001Linklaterstruesaleopinionletter,discussedingreaterdetailbelow,makesclearthatin
thetransactionscontemplatedundertheletter,incomereceivedduringthetransactionperiodbytherepo
buyer (i.e., Lehmans United Kingdom counterparty in the case of Repo 105 transactions) from the
transferredsecuritieswouldbepaidorotherwisecreditedtothereposellers(i.e.,LBIE)accountbythe
buyer. Letter from Linklaters, to Lehman Brothers International (Europe), re: Repurchase Transactions
under a Global Master Repurchase Agreement (May 21, 2006), 2.4 [LBEXLBIE 000001]. The Global
MasterRepurchaseAgreements,uponwhichtheLinklatersletterisbased,alsocontainwordingtothis
effect. See, e.g., Global Master Repurchase Agreement (2000 Version) between Lehman Brothers
International (Europe) and Barclays Bank PLC (May 4, 2006), 5 Interest Payment [LBEXAM 333643];
Global Master Repurchase Agreement (2000 Version) between Lehman Brothers International (Europe)
and Fortis Bank NV/SA (July 16, 2004), 5 Interest Payment [LBEXAM 334046]; Global Master
Repurchase Agreement (1995 Version) between CS First Boston Limited and Lehman Brothers
International(Europe)(Jan.3,1996),5InterestPayment[LBEXAM333769].
2973SeeSFAS14096(Governmentsecuritiesdealers,banks,otherfinancialinstitutions,andcorporate
investors commonly use repurchase agreements to obtain or use shortterm funds. Under those
771

105transaction(i.e.,whenthetermexpired),justasLehmanwouldonallordinaryrepo
transactions.2974 Accordingly, Lehman would debit an interest expense income
statementitem.2975
Despite the identical structure and substance of ordinary repos and Repo 105
transactions, the latter received critically different accounting treatment: Lehman
treated Repo 105 transactions as sales of financial assets for accounting purposes
underSFAS140,whichineffectenabledLehmantomovethesecuritiesinventoryoffits
balance sheet during the term of the Repo 105 transaction; with the reduction in
inventory, the net impact of the incoming cash from a Repo 105 transaction was that
totalassetsremainedunchanged.2976
Under SFAS 140, A transfer of financial assets . . . in which the transferor
surrenders control over those financial assets shall be accounted for as a sale to the
agreements, the transferor (repo party) transfers a security to a transferee (repo counterparty or
reverseparty)inexchangeforcashandconcurrentlyagreestoreacquirethatsecurityatafuturedatefor
an amount equal to the cash exchanged plus a stipulated interest factor.); see also Duff & Phelps,
ExplanationofRepo105AccountingLedgerEntriesandTradingSystemOutput(Jan.5,2010),atp.5.
2974Duff&Phelps,ExplanationofRepo105AccountingLedgerEntriesandTradingSystemOutput(Jan.
5,2010),atp.5.
2975Id.Atthetransactionallevel,eachrepoordinaryorRepo105hadaspecificinterestratecharge.
But, all the interest charges were rolled up into one number (interest expense) that appeared in the
incomestatementofLehmansreportedfinancials.
2976LehmanBrothersHoldingsInc.,AccountingPolicyMemo,Repo105andRepo108(Feb.13,2008),at
pp. 12 [LBEXDOCID 3213297] (attached to email from Marie Stewart, Lehman, to Martin Kelly,
Lehman (Apr. 10, 2008) [LBEXDOCID 3223687]; Lehman Brothers Holdings Inc., Accounting Policy
ManualRepo105andRepo108(Sept.9,2006),atpp.12[LBEXDOCID3213286](attachedtoemailfrom
Marie Stewart, Lehman, to Martin Kelly, Lehman, etal. (Dec.5,2007) [LBEXDOCID 3223386]; Lehman
Brothers Holdings Inc., Accounting Policy Manual Repo 105 (Dec. 1, 2004), at pp. 12 [LBEXDOCID
647239] (attached to email from Kieran Higgins, Lehman, to Kaushik Amin, Lehman (Nov. 21, 2007)
[LBEXDOCID738606]).
772

extent that consideration other than beneficial interests in the transferred assets is
received in exchange.2977 SFAS 140 also states that The transferor has surrendered
controlovertransferredassetsifandonlyifallofthefollowingconditionsaremet:
The transferred assets have been isolated from the transferor put
presumptively beyond the reach of the transferor and its creditors, even in
bankruptcyorotherreceivership.
Eachtransferee hastherighttopledge or exchangethe assets(or beneficial

interests) it received, and no condition both constrains the transferee (or
holder) from taking advantage of its right to pledge or exchange and
providesmorethanatrivialbenefittothetransferor.
Thetransferordoesnotmaintaineffectivecontroloverthetransferredassets
througheither(1)anagreementthatbothentitlesandobligatesthetransferor
to repurchase or redeem them before their maturity or (2) the ability to
unilaterally cause the holder to return specific assets, other than through a
cleanupcall.2978
If a repo transaction satisfies each of these three criteria, the repo transferor is
deemed to have surrendered control of the transferred collateral, and consequently,
SFAS 140 permits the transferor to account for the transaction as a sale of financial
2977ACCOUNTING TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF

FOR
LIABILITIES, Statement of Financial Accounting Standards No. 140, 9 (Fin. Accounting Standards Bd.
2000)(SFAS140).
2978SFAS140,9.
773

assets and a forward purchase commitment.2979 Lehman determined that its Repo 105
transactionsmetthesecriteriaandaccountedforthemaccordingly.2980
Consequently,recharacterizingaRepo105transactionasasalehadthefollowing
immediateconsequences:
Unlike in an ordinary repo transaction, the securities that Lehman

transferred in a Repo 105 transaction to the repo lender did not remain on
Lehmansbalancesheetassecuritiesinventoryduringthetermoftherepo.
Instead, Lehman removed the securities from its balance sheet, thereby
reducingsecuritiesinventory(oneclassofasset)onitsbalancesheet.2981
Althoughtherewasareductionininventory,totalassetsremainedthesame
as a result of the incoming cash.2982 Thus, unlike an ordinary repo
transaction,inwhichbothtotalassetsandtotalliabilitiesincrease,Lehmans
total assets and total liabilities did not increase as the result of a Repo 105
transaction.2983
At the moment of a Repo 105 transaction, because total assets and total
liabilities were unchanged, Lehmans leverage ratios also remained
unaffectedeventhoughLehmanhadborrowed,intheaggregate,billionsof
dollars.
2979SFAS140,11;Lehman,GlobalBalanceSheet,OverviewofRepo105(FID)/108(Equities)(July2006),
p. 1 [LBEXWGM 748489]; Lehman Brothers Holdings Inc., Accounting Policy Manual, Repo 105 and
Repo108(Sept.9,2006),atp.1[LBEXDOCID3213293](attachedtoemailfromAnurajBismal,Lehman,
toMartinKelly,Lehman,etal.(Mar.6,2008)[LBEXDOCID3223442].
2980LehmanBrothersHoldingsInc.,AccountingPolicyManual,Repo105andRepo108(Sept.9,2006),at
pp. 12 [LBEXDOCID 3213293] (attached to email from Anuraj Bismal, Lehman, to Martin Kelly,
Lehman,etal.(Mar.6,2008)[LBEXDOCID3223442].
2981Id.;seealsoDuff&Phelps,Repo105BalanceSheetAccountingEntryandLeverageRatiosSummary
(Oct.2,2009),atpp.34.
2009),atp.3.
2983Lehmans total assets were reduced when Lehman engaged in a Repo 105 transaction because
Lehman both removed the inventory from the balance sheet and used the incoming Repo 105 cash for
otherbusinesspurposes,includingtopayoffotherliabilities(ratherthanhavingthecashremainonthe
firmsbalancesheet).
774

Moreover,unlikeinanordinaryrepotransactionwhereliabilitiesincreased
because Lehman recorded the obligation to repay the cash borrowing, in a
Repo 105 transaction, Lehman did not record any obligation to repay the
cashborrowing.2984
But Lehmans Repo 105 practice had two steps. While the first step had no
impactuponnetleverage,insteptwoLehmanusedthecashborrowingfromRepo105
transactions to pay down different liabilities and thereby reduce the firms reported
leverageratios.2985
(b) LehmansAccountingPolicyforRepo105Transactions
After Lehman established its Repo 105 program in 2001, the firm published an
internal Repo 105 Accounting Policy.2986 All Repo 105 transactions firmwide were
requiredtocomplywiththispolicy.2987
2009),atp.3.
2985ExaminersInterviewofMartinKelly,Oct.1,2009,atp.7;ExaminersInterviewofEdwardGrieb,Oct.
2,2009,atp.9;ExaminersInterviewofMatthewLee,July1,2009,atp.14;seealsoemailfromAnuraj
Bismal, Lehman, to Marie Stewart, Lehman, et al. (Dec. 5, 2007) [LBEXDOCID 3223384] (stating Repo
105seffectonnetleverageratio,whichcanonlybeimpactedifLehmanusedRepo105cashtopaydown
different liabilities); Duff & Phelps, Repo 105 Balance Sheet Accounting Entry and Leverage Ratios
Summary (Oct. 2, 2009),at pp. 45. Inaddition, Lehmans public disclosures state that it held between
approximately$6to$7billioncashatquarterendswhenLehmanundertook$38.6billion,$49.1billion,
and$50.38billionofRepo105transactionsinfourthquarter2007,firstquarter2008,andsecondquarter
2008,respectively,alsodemonstratingthatLehmandidnotholdtheincomingRepo105cashborrowing
butuseditforotherbusinesspurposes,includingtopaydownliabilities.SeeLBHI200710K,atp.86
(reportingthatLehmanhad$7.286billionincashandcashequivalentsonNovember30,2007);LBHI10
Q(filedApr.9,2008),atp.5(reportingthatLehmanhad$7.564billionincashandcashequivalentson
February29,2008);LBHI10Q(filedJuly10,2008),atp.5(reportingthatLehmanhad$6.513billionin
cashandcashequivalentsonMay31,2008).
2986Lehman Brothers Holdings Inc., Accounting Policy Manual Repo 105 and Repo 108 (Sept. 9, 2006)
[LBEXDOCID3213286](attachedtoemailfromMarieStewart,Lehman,toMartinKelly,Lehman,etal.
(Dec.5,2007)[LBEXDOCID3223386]).
2987TheExaminerhasreproducedLehmansRepo105AccountingPolicyinitsentiretyinAppendix17,
Repo105Appendix.
775

Excerptedhereiscertainofthepolicysmorepertinentlanguage:
ThePolicyacknowledgedthatLehmantreatedordinaryrepotransactionsas
securedfinancingtransactionsbuttreatedRepo105transactionsassales
ofinventoryandforwardagreementstorepurchase.2988
Repo 105 and Repo 108 transactions refer to repos with a counterparty in
which we sell securities valued at a minimum of 105% (for fixed income
securities)or108%(forequitysecurities)ofthecashreceived.Thatis,wesell
fixedincomesecuritieswithafairvalueofatleast$105inexchangefor$100
ofcashforRepo105,andequitysecuritieswithafairvalueofatleast$108in
exchangefor$100ofcashforRepo108.2989
Repo105andRepo108contractstypicallyareexecutedbyLehmanBrothers
International (Europe) (LBIE) because true sale opinions can be obtained
under English law. We generally cannot obtain a true sale opinion under
U.S.law.2990
Recharacterizationofarepofromasecuredfinancingtransactiontoasale
of inventory and a forward to repurchase assets is allowed only if we can
demonstratewehaverelinquishedcontrolofthetransferredassets.2991
When [certain identified] criteria are met, the assets transferred are
removedfromourbalancesheetandanassetunderaderivativecontractis
2988LehmanBrothersHoldingsInc.,AccountingPolicyManualRepo105andRepo108(Sept.9,2006),at
2989Id. Although Lehmans Accounting Policy required an 8% haircut for a Repo 108 transaction, Ed
Grieb (former Lehman Global Financial Controller) had approved as a general matter a 7% haircut for
Repo108transactions.SeeemailfromMarieStewart,Lehman,toChristopherMcEwan,Lehman,etal.
(July13,2006)[LBEXDOCID3234337]([B]ackinMaywehadagreedthatitwasOKtodoRepo108at
107....Ihaverecleared107withEdGriebandheisfine.).
p.1[LBEXDOCID3213290](attachedtoemailfromAnurajBismal,Lehman,toMartinKelly,Lehman,et
al. (Dec. 5, 2007) [LBEXDOCID 3223389]); cf. email from John Feraca, Lehman, to Michael McGarvey,
Lehman (Apr. 17, 2008) [LBEXDOCID 3213321] (stating that in order to proceed with a Repo 105
transaction, [y]ou have to get approval from both Finance and Legal and that you need a true sale
legal opinion for the repo agreement and the entity you operate from and affirmation that your
counterpartoperatesinanenforceablelegaljurisdiction....).
776

recorded to reflect that we will repurchase, under a forward contract, the

transferredassets.2992
(c) TheAccountingPurposeoftheLargerHaircut
The labels Repo 105 and Repo 108 referred to Lehmans haircut on the
transaction.Ahaircutin a repotransactionisthedifferencebetweenthevalueof the
collateralusedtosecureaborrowingandtheamountofcashthatisborrowed.2993
The five percent minimum required haircut in a Repo 105 transaction (or eight
percentminimuminaRepo108transaction)wasgreaterthanthehaircutLehmanfaced
in an ordinary repo transaction involving treasurytype securities, which witnesses
indicatedwastypicallyapproximately2%.2994However,thelargerhaircutinRepo105
transactions was an essential component for Lehman to avail itself of SFAS 140
accountingtreatment.
UnderSFAS140,recharacterizingarepofromafinancingtransactiontoasaleof
inventory requires the transferor to demonstrate that it has relinquished control over
2992Id.
2993SeeBusinessDefinitionforHaircut,availableat
http://www.allbusiness.com/glossaries/haircut/49486231.html(lastvisitedJan.3,2010).
Foreach$100LehmanborrowedinaRepo105transactionitneededtotransfer$105ofcollateral
toitscounterparty(lender),i.e.,itovercollateralizedtheborrowingbyfivepercent.Assuch,inaRepo
105 transaction in which Lehman borrowed $100 and posted $105, the haircut was actually ($105
$100)/ $105 = 4.76%. However, for purposes of discussion in this Report, we refer to the five percent
overcollateralizationasafivepercenthaircut.Similarly,thehaircutonaRepo108transactionwas
actually ($108 $100)/$108 = 7.4%, but for purposes of this discussion, we refer to the eight percent
overcollateralizationasaneightpercenthaircut.
2994ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.6;seealsoAgreementbetweenLehman,FRBNY
andJPMorganre:CustodialUndertakinginConnectionwithMasterOpenMarketAgreement,Schedule
of Eligible Securities, Margin Percentage column (Sept. 14, 2008) [JPM2004 0055343] (showing repo
collateralhaircutsatthetime).
777

thetransferredassets.2995 Paragraphs47through49, 217,and218 ofSFAS140contain
the relevant discussion of control.2996 The FASB determined that to maintain
effectivecontrol,thetransferormusthaveboththecontractualrightandthecontractual
obligationtoreacquiresecuritiesthatareidenticaltoorsubstantiallythesameasthose
concurrently transferred.2997 [T]he transferors right to repurchase is not assured
unless it is protected by obtaining collateral sufficient to fund substantially all of the
costofpurchasingidenticalreplacementsecuritiesduringthetermofthecontract.2998
Paragraph218ofSFAS140furtherprovided:
Judgmentisneededtointerpretthetermsubstantiallyallandotheraspects
ofthecriterionthatthetermsofarepurchaseagreementdonotmaintain
effective control over the transferred asset. However, arrangements to
repurchaseorlendreadilyobtainablesecurities,typicallywithasmuchas
98percentcollateralization(forentitiesagreeingtorepurchase)oraslittle
as 102 percent overcollateralization (for securities lenders), valued daily
andadjustedupordownfrequentlyforchangesinthemarketpriceofthe
securitiestransferredandwithclearpowerstousethatcollateralquickly
in the event of default, typically fall clearly within that guideline. The
Board believes that other collateral arrangements typically fall well
outsidethatguideline.2999

FOR
LIABILITIES, Statement of Financial Accounting Standards No. 140 (Fin. Accounting Standards Bd. 2000)
(SFAS140).
2996SFAS140,4749,217218.
2997SFAS140,217(emphasisinoriginal).
2998SFAS140,218.
2999Id. (emphasis in original). In other words, the FASB believed that when the collateralization was
between 98% and 102%, a repo borrower maintained effective control over transferred assets and
consequentlytheassetscouldnotbemovedofftheborrowersbalancesheet.
778

Likeordinaryrepos,Repo105transactionsincludedacommitmentfromLehman
to repurchase the assets/securities upon the maturation of the repo.3000 But a general
repurchase commitment is not dispositive of control for purposes of a SFAS 140
analysis. Consistent with SFAS 140 and FASBs implementation guide for SFAS 140,
Lehman interpreted SFAS 140 to mean that the greater haircuts Lehman applied to
Repo 105 transactions established the requisite relinquishment of control of the assets
involvedinthetransactions.3001
Specifically, if Lehman had the ability to fund substantially all of the cost of
purchasingthesameorsubstantiallythesamereplacementassets,Lehmanwouldbe
viewedashavingthemeanstoreplacetheassetsandwasthereforeconsiderednot
tohaverelinquishedcontroloftheassets.3002Lehmandetermined,however,thatunder
therule,itdidnothavetheabilitytofundsubstantiallyallofthecostofrepurchasing
theassetsbecauseofthedifferenceviathelargerhaircutbetweenthevalueofthe
assets/securities transferred and the funding Lehman borrowed in a Repo 105
3000Examiners Interview of Ian T. Lowitt, Oct. 28, 2009, at pp. 1011; Examiners Interview of Matthew
Lee,July1,2009,atp.14.TheboilerplatecontractusedinRepo105transactionstheGMRAcouldalso
beusedinordinaryrepotransactions.
3001SFAS140218.SeealsoFASB StaffImplementationGuidance,GuidetoImplementationofStatement
140 on Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,
questions45and46(issuedFebruary2001,lastrevisedMarch2006).
3002SeeLehmanBrothersHoldingsInc.,AccountingPolicyManualRepo105andRepo108(Sept.9,2006),
atp.2[LBEXDOCID3213286](attachedtoemailfromMarieStewart,Lehman,toMartinKelly,Lehman,
etal.(Dec.5,2007)[LBEXDOCID3223386]).
779

transaction. Therefore, Lehman effectively relinquished control of the assets for
purposesofaSFAS140analysis.3003
At bottom, Lehman applied a higher haircut to what otherwise could be an
ordinary repotransactionin ordertoavailitselfofthe accounting classification under
SFAS140.3004Thus,LehmansuseofRepo105transactionsclearly...wasaneffortto
reducebalancesheet.Tradershadbalancesheetlimitsandthiswasonewaytheycould
meetthem.3005CounterpartiestoLehmansRepo105transactionsdidnotnecessarily
orevenusuallyrequireoraskforahigherfivepercentoreightpercenthaircutona
Repo 105 or Repo 108 transaction.3006 Lehman posted more collateral in a Repo 105
transaction for the same loan it could acquire through an ordinary repo in order to
achievetheoffbalancesheettreatmentforthecollateral.3007
3003Lehmans internal Repo 105 Accounting Policy provided, [W]e have retained control of the
transferred assets if a fixed income security is margined at less than 105% of the cash received or an
equity security is margined at less than 107% of the cash received. Lehman Brothers Holdings Inc.,
Accounting Policy Manual Repo 105 and Repo 108 (Sept. 9, 2006), at p. 2 [LBEXDOCID 3213293]
(attached to email from Anuraj Bismal, Lehman, to Martin Kelly, Lehman, et al. (Mar. 6, 2008) [LBEX
DOCID 3223442]). It continued: Transfers in which we transfer fixed income securities valued at a
minimumof105%ofthecashreceivedandequitysecuritiesataminimumof107%ofthecashreceived
areconsideredtobesalesandaforwardtorepurchaseratherthansecuredfinancingtransactions.Id.
3004ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.6.Inbothanordinaryrepotransactionanda
Repo105transaction:(1)thecollateralusedeventuallyreturnedtoLehman;(2)thesameassetscouldbe
usedforeitheranordinaryrepotransactionoraRepo105transaction;and(3)withmostcounterparties,
LehmanhadcapacitytodoeitheranordinaryrepotransactionoraRepo105transaction.Id.
3005Id.
3006Id.
3007Id.(statingthatLehmanofferedthefivepercentoreightpercenthaircuttoitscounterpartiesbecause
Lehmanwantedtoremovethesecuritiesfromitsbalancesheet).
780

(d) LehmanDidNotRecordaCashBorrowingbutRecordeda
DerivativeAssetinaRepo105Transaction
Unlike an ordinary repo transaction, Lehman did not record the borrowing of
cash from a Repo 105 transaction even though Lehman was obliged to repay the
borrowing.3008 Instead, Lehman established a long inventory derivative asset
representingtheobligation underaforward contract to repurchase thefull amount of
securities sold.3009 As Lehmans internal Repo 105 Accounting Policy explained,
assumingLehmanborrowed$100cashinexchangeforapledgeof$105offixedincome
collateral, Lehman booked a $5 derivative, which represented Lehmans obligation to
repurchasethesecuritiesattheendofthetermoftherepotransaction.3010The$5arose
3008SeeSFAS14098(Ifthecriteriainparagraph9aremet,includingthecriterioninparagraph9(c)(1),
the transferor shall account for the repurchase agreement as a sale of financial assets and a forward
repurchase commitment, and the transferee shall account for the agreement as a purchase of financial
assets and a forward resale commitment.). As discussed above, ordinary repo transactions are
consideredfinancingorborrowingtransactions.SeeLehman,GlobalBalanceSheetOverviewofRepo105
(FID)/108(Equities)(July2006),atp.1[LBEXWGM748489].Inadditiontotheincomingcash(anasset),
in an ordinary repo transaction, the repo borrower also records a liability (the obligation to repay the
borrowed cash). See SFAS 140 100 (Repurchase agreements that do not meet all the criteria in
paragraph9shallbetreatedassecuredborrowings.).IftheRepo105transactiontechnicallyqualified
fortruesaleaccountingunderSFAS140,Lehmanwasnotrequiredforaccountingpurposestorecorda
liability, although the economic reality was that Lehman had borrowed cash it had to repay. Instead,
LehmanrecordedthecashproceedsoftheRepo105transactionasanasset(cash),butrecharacterized
this secured financing as a sale of the securities used as collateral for the borrowing, resulting in a
reductiontoitsSecuritiesInventorybalance.LehmanBrothersHoldingsInc.,AccountingPolicyManual
Repo 105 and Repo 108 (Sept. 9, 2006), at p. 2 [LBEXDOCID 3213293] (attached to email from Anuraj
Bismal,Lehman,toMartinKelly,Lehman,etal.(Mar.6,2008)[LBEXDOCID3223442]).Thus,theRepo
105deviceallowedLehmantoborrowtensofbillionsofdollarsincashwithoutreflectingtheborrowing
onitsbalancesheet.
p. 2 [LBEXDOCID 3213293], at p. 3 (attached to email from Anuraj Bismal, Lehman, to Martin Kelly,
Lehman,etal.(Mar.6,2008)[LBEXDOCID3223442])(Wehaveareceivableunderaderivativecontract
becausewearerequiredtorepurchaseunderaforwardcontract$105worthofsecuritiesforpaymentof
only$100.)(emphasisadded).
3010Id.
781

fromthefactthatwhenitcametimetorepurchasethepledgedsecurities,Lehmanpaid
$100 cash for $105 worth of securities.3011 The transaction therefore had a $5 value to
Lehman reflecting themarketvalueofthe overcollateralizationamount of theRepo
105 transaction.3012 Because it had a positive fair value of $5, the derivative was
recordedasanassetunderSFAS133.3013
(3) AnatomyofRepo105TransactionsandtheLinklatersTrue
SaleOpinionLetter
In addition to the required haircut, Lehman had to take one additional step to
qualifyRepo105transactionsassalesandenjoythebalancesheetandleveragerelief
afforded by that classification. Lehman had to either originate these transactions or
conductthemthroughLehmanBrothersInternational(Europe)(LBIE)inLondon.
Broadly speaking, Lehman effected Repo 105 transactions through LBIE
employingtwoalternativestructures(dependingupontheoriginofthesecuritiesthat
Lehman ultimately transferred to the counterparty).3014 To understand the reason for
3011Id.
3012Id.
3013Ernst&YoungworkpapersfromLehmanssecondquarter2008showthatErnst&Youngreviewed
thevalueofLehmansRepo105derivatives.SeeErnst&Young,FairValueofOTCDerivativeContracts
byMaturityasofMay31,2008(July8,2008)[EYSECLBHIWP2Q08000535];seealsoemailfromJared
Pedowitz, Ernst & Young, to James Billingham, Ernst & Young (Apr. 24, 2008), at p. 4 [EYLELBHI
KEYPERS03736420373645](IamcurrentlyworkingontheQ1FairValueofOTCDerivativeContracts
intheMD&A....[W]eneedtoverify...theRepo105population....[W]ouldyoubeabletoconfirmthe
$4.818 bn balance is consistent with your teams review of this area?); Ernst & Young, Repo 105 Pivot
Table [EYLELBHIKEYPERS 0373646] (showing total value of Repo 105/108 derivatives was $4.818
billion). See Section III.A.4.j.2.c.ii.c of this Report for discussion of Lehmans deficient disclosures
regardingtheRepo105derivative.
3014ThisdiscussionislimitedtoRepo105transactions,anddoesnotincludeRepo108transactions.
782

Lehmansalternativestructuresrequiresabriefdetourbackthroughtherequirements
ofSFAS140.
In order for a repo transferor to be deemed to have surrendered control of an
asset under SFAS 140 so as to achieve true sale treatment under SFAS 140 and
remove the transferred securities from the transferors balance sheet the transferred
assetsmustbeisolatedfromthetransferor,thatis,putpresumptivelybeyondthereach
of the transferor and its creditors, even in the event of the transferors bankruptcy.3015
TobeisolatedunderSFAS140,theremusthavebeenatruesaleatlaw.3016Typically,to
meetthisrequirement,thetransferorobtainsatruesaleopinionletter.3017
LehmansinternalRepo105AccountingPolicyechoedtheSFAS140requirement
that the transaction [be] a true sale at law.3018 The problem was that Lehman was
unabletoobtainatruesaleopinionfromaUnitedStateslawyer.LehmansRepo105
Accounting Policy states: We generally cannot obtain a true sale opinion under U.S.

FOR
LIABILITIES,StatementofFinancialAccountingStandardsNo.140,9.a.(Fin.AccountingStandardsBd.
2000)(SFAS140).
3016AuditingguidanceprovidesthatAdeterminationaboutwhethertheisolationcriterionhasbeenmet
tosupportaconclusionregardingsurrenderofcontrolislargelyamatteroflaw.Thisaspectofsurrender
of control, therefore, is assessed primarily from a legal perspective. Using the Work of a Specialist:
Auditing Interpretations of Section 336, AU 9336.01, The Use of Legal Interpretations as Evidential
Matter to Support Managements Assertion that a Transfer of Financial Assets Has Met the Isolation
CriterioninParagraph9(a)ofSFAS140(Pub.Co.AccountingOversightBd.2001)[UsingtheWorkofa
Specialist:AuditingInterpretationsofSection336,AU9336].
3017[S]incetheisolationaspectofsurrenderofcontrolisassessedprimarilyfromalegalperspective,the
auditor usually will not be able to obtain persuasive evidence in a form other than a legal opinion.
UsingtheWorkofaSpecialist:AuditingInterpretationsofSection336,AU9336.21.
p.1[LBEXDOCID3213293](attachedtoemailfromAnurajBismal,Lehman,toMartinKelly,Lehman,et
al.(Mar.6,2008)[LBEXDOCID3223442]).
783

law;ReposgenerallycannotbetreatedassalesintheUnitedStatesbecauselawyers
cannotprovideatruesaleopinionunderU.S.law.3019Lehmanwasabletogetatrue
sale opinion from the Linklaters law firm in London, in several iterations, under the
lawsoftheUnitedKingdom.3020
The Linklaters letter was addressed to LBIE, and analyzes repo transactions
executedundera1995or2000versionofaGlobalMasterRepurchaseAgreementunder
English law, as applied by English courts.3021 The Linklaters letter provides [t]his
3019Id.SeveralwitnessessimilarlyrecalledthatLehmanwasunabletoobtainatruesaleopinionfroma
lawfirmbasedintheUnitedStatesrelatedtoLehmansRepo105transactions.ExaminersInterviewof
Marie Stewart, Sept. 2, 2009, at p. 13; Examiners Interview of Edward Grieb, Oct. 2, 2009, at p. 7;
ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.8;ExaminersInterviewofJohnCoghlan,Nov.11,
2009,atp.9;ExaminersInterviewofMatthewLee,July1,2009,atp.15.
3020See generally Letter from Linklaters, to Lehman Brothers International (Europe), re: Repurchase
Transactions under a Global Master Repurchase Agreement (May 31, 2006) [LBEXLBIE 000001].
Lehmans internal Repo 105 Accounting Policy and an internal PowerPoint presentation referenced
severaliterationsoftheLinklatersopinionletterandwitnessesstatethatLehmanrefreshedtheLinklaters
letter on more than one occasion. See Lehman, Global Balance Sheet Overview of Repo 105 (FID)/108
(Equities) (July 2006), at p. 3 [LBEXWGM 748489] (stating that true sale opinion letter for GMRA was
first obtained in May 2001, updated in September 2004, and further updated in May 2006); Lehman
BrothersHoldingsInc.,AccountingPolicyManualRepo105andRepo108(Sept.9,2006),atp.1[LBEX
DOCID 3213293] (stating that Linklaters has issued opinions under a GMRA); Examiners Interview of
Anuraj Bismal, Sept. 16, 2009, at p. 8 (stating that Ed Grieb refreshed the Linklaters letter). Though
Lehmanrefreshedtheletterseveraltimes,theExaminerhasbeenabletolocateonlyoneversionofthe
Linklaters letter, dated May 31, 2006. The May 2006 Linklaters Letter is reproduced at Appendix 17,
Repo105Appendix.
3021LetterfromLinklaters,toLehmanBrothersInternational(Europe),re:RepurchaseTransactionsunder
a Global Master Repurchase Agreement (May 31, 2006) [LBEXLBIE 000001]; see also Lehman Brothers
Holdings Inc., AccountingPolicy ManualRepo105andRepo108 (Sept.9,2006),at p.1 [LBEXDOCID
3213293](ThispolicyaddressesrepotransactionsexecutedintheUKunderaGlobalMasterRepurchase
Agreement (GMRA) provided the counterparty resides in a jurisdiction covered under English law.
The UK law firm of Linklaters has issues us true sale opinions covering Repo 105 and Repo 108
transactionsdocumentedunderaGMRAunderEnglishlaw.);Lehman,GlobalBalanceSheetOverview
ofRepo105(FID)/108(Equities)(July2006),atp.1[LBEXWGM748489](ArepounderaGlobalMaster
Repurchase Agreement [GMRA] is a true sale); id., at 3 (stating legal opinion in place for GMRA).
LehmansinternalRepo105AccountingPolicylikewisestatedthatRepo105andRepo108contractsare
typicallyexecutedbyLehmanBrothersInternational(Europe)(LBIE)becausetruesaleopinionscanbe
784

opinion is addressed to you [LBIE] solely for your benefit and that [i]t is not to be
transmittedtoanyoneelse,nor isit tobe relied upon byanyoneelseor for anyother
purpose. . . .3022 The letter stated, however, that a copy of this opinion may be
obtainedunderEnglishlaw.LehmanBrothersHoldingsInc.,AccountingPolicyManualRepo105and
Repo108(Sept.9,2006),atp.1[LBEXDOCID3213293].LehmanacquiredlegalopinionsfromLinklaters
coveringotherformsofcontractstheOSLA(OverseasSecuritiesLendingAgreement),GESLA(Master
GiltEdgedStockLendingAgreement)andGMSLA(GlobalMasterSecuritiesLendingAgreement)but
thesewereneverused.Lehman,GlobalBalanceSheetOverviewofRepo105(FID)/108(Equities)(July
2006),atp.3[LBEXWGM748489];LehmanBrothersHoldingsInc.,AccountingPolicyManualRepo105
andRepo108(Sept.9,2006),atp.1[LBEXDOCID3213293].Therequirementofatruesaleopinionletter
waswellknownthroughoutthefirm.SeeemailfromJohnFeraca,Lehman,toAnnieLin,Lehman(Apr.
17,2008)[LBEXDOCID3347035](YouhavetogetapprovalfrombothFinanceandLegallocallybefore
youproceedonthis.Iftheyneedassistance,theycanworkwiththeirrespectivecounterpartsinLondon
andNY.Effectivelyyouneedatruesalelegalopinionfortherepoagreementandtheentityyouoperate
fromandaffirmationthatyourcounterpartoperatesinanenforceablelegaljurisdiction.Doubtwehave
one from LBAU. Then you need to get approval from Finance. As such, I know LBIE and the GMRA
agreement used by it are ok. You can do back to back repos with LBIE who can in turn repo to third
parties.Notidealthough.);seealsoemailfromBrettBeldner,Lehman,toJigneshDoshi,Lehman,etal.
(Dec. 13, 2007) [LBEXDOCID 3383368] (transmitting Repo 105 Accounting Policy and stating beside
getting in contact with Europe legal to make sure you can get the true sale opinion, you also should
probably get John Feraca and Mike McGarvey into the loop. They deal with Repo 105 from both a
structure/capacity side (John) and the Product Control side (Mike) and can probably direct you to the
propercontactstoaddressanylegal/operationalquestions.).AllRepo105transactionswereundertaken
pursuant to a GMRA or Global Master Repurchase Agreement, which is published by PSA and the
International Securities Market Association, used for international repo agreements, and governed by
English law, though parties may modify the governing law. See Appendix 17, Repo 105 Appendix
(discussingGMRAincontrasttoMRA,orMasterRepurchaseAgreement).
aGlobalMasterRepurchaseAgreement(May31,2006),atp.8[LBEXLBIE000001].Despitethatexpress
conditionandtheexpressacknowledgementinLehmansRepo105AccountingPolicythatLehmanwas
unable to obtain a true sale opinion under United States law, Lehmans financial officers were
unconcerned that a significant portion of Lehmans firmwide Repo 105 transactions utilized
securities/assets that were owned by and originated from United Statesbased Lehman entities. John
FeracarecalledindifferenceamongLehmanmidlevelmanagementtothedivergencebetweenEnglish
andAmericanlawthatpreventedaUnitedStateslawfirmfromissuingLehmanatruesaleopinionfor
Repo105transactions.ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.8(statingtherewasnever
any angst about it). Feraca recalled that Lehmans inability to get a true sale opinion under United
Stateslawwasdiscussedasearlyas2001,whenLehmanfirstdesigneditsRepo105program.Id.Feraca
didnotrecallanyLehmanemployeeundertakingananalysisofwhetheranintercompanyrepobetween
a United Statesbased Lehman entity and LBIE, conducted solely for purposes of executing a Repo 105
transaction,compliedwithLehmansinternalRepo105AccountingPolicy.Id.EdGrieb,formerGlobal
Financial Controller, was aware that Lehman was unable to get a United States true sale opinion to
785

provided by Lehman Brothers to its auditors for the purpose of preparing the firms
balancesheets.3023TheLinklatersletterdidnotcontainanyreferencetoUnitedStates
GAAPorSFAS140.3024
Although the Linklaters letter was written for the exclusive benefit of LBIE, a
significantvolumeofLehmansRepo105transactionswasexecutedforthebenefitand
using the securities of one or more United Statesbased Lehman entities, such as LBI
andLBSF,basedinNewYork.3025
Consequently, there were two alternative structures for Repo 105 transactions:
(1) a LBIEonly Repo 105 or Repo 108 transaction, executed by LBIE in London using
securities owned by LBIE, and (2) a Repo 105 transaction using securities that were
owned by, and originated from, a United Statesbased Lehman entity such as LBI or
LBSF.3026
engage in Repo 105 transactions and that this fact was explicitly referenced in Lehmans Repo 105
Accounting Policy. Examiners Interview of Edward Grieb, Oct. 2, 2009, at p. 7. Grieb also knew that
some volume of assets was transferred to LBIE from United Statesbased Lehman entities for the sole
purpose of executing Repo 105 transactions. Id. When the Examiner asked whether Grieb was ever
concerned that in the face of not being able to acquire a United States true sale opinion, United States
basedLehmanentitiestransferredinventorytoLBIEforinclusioninRepo105transactionsonitsbehalf,
GriebansweredItneverraisedaconcernbecauseIneverlinkedtheissuesinmyhead.Id.
aGlobalMasterRepurchaseAgreement(May31,2006)[LBEXLBIE000001],atpp.89.
3024Seegenerallyid.
3025See Section III.A.4.d.3 of this Report. Furthermore, the volume of Repo 105 transactions using LBI
securities,forthebenefitofLBIsbalancesheet,grewsignificantlyafterlate2007.
3026United Statesbased Lehman entities generally engaged in Repo 105, rather than Repo 108
transactions.Repo108transactionswerelimitedtoequitiessecurities.SeeLehman,GlobalBalanceSheet
Overview of Repo 105 (FID)/108 (Equities) (July 2006), at p. 4 [LBEXWGM 748489]; Lehman Brothers
Holdings Inc., AccountingPolicy ManualRepo105andRepo108 (Sept.9,2006),at p.1 [LBEXDOCID
3213304].
786

The anatomy of a Repo 105 transaction involving assets that originated on the
booksofLBIEwasidenticaltotheanatomyofanordinaryrepotransaction,exceptthe
Repo 105 transaction carried a greater haircut. In this type of Repo 105 transaction,
LBIE transferred $105 or $108 worth of securities it owned to its counterparty in
exchangefor$100incash.3027LBIEthenusedthe$100incashtopaydownothershort
termliabilities.3028
WhentheRepo105transactionmatured,LBIErepaidthecashplusinterestand
receiveditscollateralback.3029BecauseLehmanwasaconsolidatedbusinessandLBIEs
financialresultswererolledintotheconsolidatedfinancialstatementsLBHIfiledinthe
United States, the LBIEonly Repo 105 practice impacted LBHIs publicly reported
balancesheetandleverageratios.3030
3027TheonlydifferencebetweentheanatomyofastandardrepoandaRepo105transactionisthehaircut
orovercollateralization;structurally,standardrepoandRepo105transactionsareidentical.
3028SeeLBIERepo105FlowDiagram,infra;Duff&Phelps,Repo105BalanceSheetAccountingEntryand
LeverageRatiosSummary(Oct.2,2009),atpp.45;ExaminersInterviewofEdwardGrieb,Oct.2,2009,at
p. 9; Examiners Interview of Martin Kelly, Oct. 1, 2009, at p. 7; Examiners Interview of Matthew Lee,
July1,2009,atp.14;LBHI200710K,atp.86(reportingthatLehmanhad$7.286billionincashandcash
equivalents on November 30, 2007); LBHI 10Q (filed Apr. 9 2008), at p. 5 (reporting that Lehman had
$7.564billionincashandcashequivalentsonFebruary29,2008);LBHI10Q(filedJuly10,2008),atp.5
(reportingthatLehmanhad$6.513billionincashandcashequivalentsonMay31,2008).
3029SeeLBIERepo105FlowDiagram,infra;Duff&Phelps,Repo105BalanceSheetAccountingEntryand
LeverageRatiosSummary(Oct.2,2009),atpp.68.
3030ExaminersInterviewofMarieStewart,Sept.2,2009,atp.11;ExaminersInterviewofKaushikAmin,
Sept.17,2009,atp.8;ExaminersInterviewofErnst&Young,Oct.16,2009,atp.11(statementofWilliam
Schlich).
787

When a United Statesbased Lehman entity undertook a Repo 105 transaction,
that entity transferred securities valued at a minimum of $105 to LBIE via an
intercompany repo transaction.3031 No haircut was applied to the intercompany repo
between the United Statesbased Lehman entity and LBIE.3032 Upon receiving the
securitiesinventoryfromtheUnitedStatesbasedLehmanentity,LBIEwouldexecutea
3031Examiners Interview of Michael McGarvey, Sept. 11, 2009, at p. 9; Examiners Interview of Mark
Gavin,Sept.24,2009,atpp.67;ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.8;seealsoDuff&
Phelps,ExplanationofRepo105AccountingLedgerEntriesandTradingSystemOutput(Jan.5,2010),at
p.1.
WGM748489].
788

Repo 105 transaction with a European counterparty using those securities.3033 The
minimumhaircutforthetransactionbetweenLBIEandthecounterparty,whichwasthe
actualRepo105transaction,wasfivepercent.3034
LBHIprovidedLBIEwithanadditional$5cashinorderforLBIEtothentransfer
$105 in cash to the United Statesbased Lehman entity in exchange for its securities
inventory.3035TheUnitedStatesbasedLehmanentityusedthe$105incasheithertopay
for the repoed securities inventory or, more likely, to pay down its shortterm
liabilities.3036Whenthetermoftherepoexpired,LBIErepurchasedthesecuritiesfrom
theRepo 105counterparty andthen returned thesecurities to the United Statesbased
Lehmanentitythroughanintercompanyrepo.3037
3033Examiners Interview of Michael McGarvey, Sept. 11, 2009, at p. 9; Examiners Interview of Mark
Gavin,Sept.24,2009,atpp.56;ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.8.
WGM748489];LehmanBrothersHoldingsInc.,AccountingPolicyManualRepo105andRepo108(Sept.
9,2006),atpp.12[LBEXDOCID3213293].
WGM748489].
3036ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.9;ExaminersInterviewofMartinKelly,Oct.
1, 2009, at p. 7; Examiners Interview of Matthew Lee, July 1, 2009, at p. 14; LBHI 2007 10K, at p. 86
(reportingthatLehmanhad$7.286billionincashandcashequivalentsonNovember30,2007);LBHI10
Q(filedApr.9,2008),atp.5(reportingthatLehmanhad$7.564billionincashandcashequivalentson
February29,2008);LBHI10Q(filedJuly10,2008),atp.5(reportingthatLehmanhad$6.513billionin
cashandcashequivalentsonMay31,2008).
[LBEXWGM748489].Infact,Repo105transactionsusingUnitedStatesbasedsecuritiescouldinclude
twointercompanyrepotransfers:firstfromLBSFtoLBI,andthenLBItoLBIE.
789

Numerous documents from Lehmans archives and numerous witness
statementsbearoutthatwhenaUnitedStatesbasedLehmanentitysoughttoemploy
Repo105transactionstoremovesecuritiesinventoryfromitsbalancesheetatquarter
end, the United Statesbased Lehman entity would book the Repo 105 transactions
through LBIE using an intercompany repo transaction.3038 A substantial volume of
3038See, e.g., Email from Kaushik Amin, Lehman, to Thomas Siegmund, Lehman, et al. (Aug. 23, 2006)
[LBEXDOCID2786869](Wehaveadditional$2.5BlninRepo105thatthefirmhassignedoffon....
So,letsmaxoutthecapacity.WeshouldbeabletousesomeofthecollateralfromtheAgencybusiness
intheUS.);emailfromAnthonyJawad,Lehman,toTerryBurke,Lehman(Mar.3,2008)[LBEXDOCID
224902]([W]heneverIdo105forledgersbasedinnyweneverdoaledgertransferforthe105part,the
truesaleisrecognizedandthelongcashaccountdebited.);emailfromMichaelMcGarvey,Lehman,to
JerryRizzieri,Lehman(Feb.20,2008)[LBEXDOCID3235353](McGarvey:Forquarterendbalancesheet
doyoustillfeelRatesAmericaswillbeabletomaketarget?Rizzieri:CanwegetmoreRepo105?);e
mailfromJerryRizzieri,Lehman,toChazGothard,Lehman,etal.(Feb.20,2008)[LBEXDOCID3385847]
(IknowyouworkwithMitchKing[UnitedStatesAgencyDesk]tosecuremorerepo105financingfor
agencyproduct.Iwouldliketoknowifwecouldcontinuetopushthecapacityhigher.Wearelikelyto
usemoreagencyproductascollateralandmightevenusesomeTIPSanddiscountnotes.);emailfrom
MarkGavin,Lehman,toJohnFeraca,Lehman,etal.(Feb.29,2008)[LBEXDOCID098494](Repo105on
790

USTsAgencies,TIPS,AidBondsforQendjustshyof$18bln.);emailfromMarkNeller,Lehman,to
MarcSilverberg,Lehman,etal.(Mar.4,2008)[LBEXDOCID3234667](respondingtorequestforlistof
confirmed quarterend Repo 105 trades done out of LBI, Lehmans New Yorkbased brokerdealer,
sendingTotalRepo105&Repo108Reportasattachment[LBEXDOCID3219760],andinstructingifyou
filter for Sum Americas you should see all your anticipated benefits); email from Michael McGarvey,
Lehman,toClementBernard,Lehman,etal.(Mar.13,2008)[LBEXDOCID2794226](Wehavefailedon
3bnofrepo105toUBSforthisweeksroll....Thisisanopsissuethatoccurssometimesduetothetime
differencebetweenNYandLondon.IftherepodeskinLondondoesa105tradeandthosebondsarenot
insittinginLBIsboxwecanfail....);emailfromJeffMichaels,Lehman,toPhilMorgan,Lehman,etal.
(May22,2008)[LBEXDOCID3385953](statingthattheRepo105pointpeopleintheUnitedStatesare
Mitch King in Front Office Trading, Michael McGarvey in Finance Control, and Tejal Joshi in Balance
Sheet Management); email from Michael McGarvey, Lehman, to Mark Gavin, Lehman, et al. (Feb. 28,
2008)[LBEXDOCID810932](sendingLondondeskalistofcorporatebondsheldinNY(allaboveBBB
and 10 mm in market value) available for any additional Repo 105 capacity we can find contained in
attachedscheduleofsecurities[LBEXDOCID791568]);emailfromChazGothard,Lehman,toJamesW.
Hraska, Lehman, et al. (Oct. 1, 2007) [LBEXDOCID 3233264] (transmitting attached lists of Repo 105
tradesfromUnitedStatesAgencyDeskwithMizuho[LBEXDOCID3219676andLBEXDOCID3235916],
Barclays [LBEXDOCID 3235823], UBS [LBEXDOCID 3235853]); email from Michael McGarvey,
Lehman, to Jerry Rizzieri, Lehman (Nov. 5, 2007) [LBEXDOCID 3233300] (transmitting lists of United
States Agency Desk Repo 105 trades [LBEXDOCID 3235736, LBEXDOCID 3235807, LBEXDOCID
3235832,LBEXDOCID3235928]andstatingthat[w]ewilltrytogetashighaspossibleformonthend,
i.e.,endoffiscalyear2007);emailfromMarkGavin,Lehman,toJamesW.Hraska,Lehman,etal.(Dec.4,
2007) [LBEXDOCID 3385990] (transmitting lists [LBEXDOCID 3369462, LBEXDOCID 3369531, LBEX
DOCID3369532,LBEXDOCID3369537]ofRepo105tradesforUnitedStatesAgencyDesk).TejalJoshi,
MichaelMcGarvey,MarkGavin,MitchKing,EdGriebandotherwitnessesstatedthatLBIwasinvolved
in Lehmans Repo 105 program. Examiners Interview of Michael McGarvey, Sept. 11, 2009, at p. 9;
ExaminersInterviewofTejalJoshi,Sept.15,2009,atp.7;ExaminersInterviewofMitchellKing,Sept.21,
2009,atpp.56,8;ExaminersInterviewofMarkGavin,Sept.24,2009,atpp.56;ExaminersInterviewof
Edward Grieb, Oct. 2, 2009, at pp. 78; Examiners Interview of Kaushik Amin, Sept. 17, 2009, at p. 8;
ExaminersInterviewofMarieStewart,Sept.2,2009,atp.13.Inordertoeffectuatetimelytransfersof
securitiesfromUnitedStatesbasedLehmanentitiestoLBIE,LehmansNewYorkdeskanditsLondon
(LBIE) desk communicated regularly. The United States desk did not use the Repo 108 mechanism,
which was used on European Equities securities. Each Friday, Marc Silverberg, an analyst assigned to
LehmansAmericasRatestradingdeskinNewYork(withinLehmansFixedIncomeDivision),compiled
listsofsecurities/assetsthatLehmansAmericasRatesbusinesswantedtomakeavailableforuseinRepo
105 transactions through LBIE the following week. Email from Marc Silverberg, Lehman, to Chaz
Gothard, Lehman, et al. (Aug. 3, 2007) [LBEXDOCID 3232701] (transmitting schedule of United States
Agency Desk Repo 105 trades for Aug. 8, 2007 through Aug. 15, 2007 [LBEXDOCID 3235803]); email
from Marc Silverberg, Lehman, to Mitchell King, Lehman, et al. (Feb. 26, 2008) [LBEXDOCID 3234639]
(transmittingattachedlistofUnitedStatesAgencyDeskcollateralusedinRepo105transactions[LBEX
DOCID3235977;LBEXDOCID3235986]);emailfromMarcSilverberg,Lehman,toMichaelMcGarvey,
Lehman,etal.(Mar.4,2008)[LBEXDOCID3233386](transmittingattachedlistsofRepo105tradesfrom
United States Agency Desk [LBEXDOCID 3232665, LBEXDOCID 3235775, LBEXDOCID 3236009,
LBEXDOCID 3236010, and LBEXDOCID 3236012]); email from Marc Silverberg, Lehman, to Mark
Gavin,Lehman,etal.(Nov.27,2007)[LBEXDOCID3232772](transmittinglists[LBEXDOCID3219744,
LBEXDOCID 3235939] of additional collateral United States Agency Desk wished to use for Repo 105
791

Lehmans firmwide Repo 105 transactions at each quarterend in late 2007 through
mid2008involvedassetsthatoriginatedwithaUnitedStatesbasedLehmanentity.3039
Specifically:
fourthquarter2007:$8.3036billion3040
transactionsoveryearend);emailfromMarcSilverberg,Lehman,toChazGothard,Lehman,etal.(Mar.
28, 2008) [LBEXDOCID 3232669] (transmitting list [LBEXDOCID 3236024] of United States Agency
DesksRepo105trades).LehmantradersbasedinNewYorkCitycreatedthelistsofpotentialRepo105
securities,whichtheygavetoSilverbergeachweek.SilverbergthensenttheliststoLehmansLondon
trading desk each Friday, in hopes that LBIE could find Repo 105 capacity among counterparties.
According to one document of confirmed, executed Repo 105 trades for securities from New Yorks
tradingdesk,theRatesAmericasbusiness(oneunitwithinLehmansFID)alonewasabletoreduceits
quarterendbalancesheetinfirstquarter2008by$14.871billionthroughtheuseofRepo105transactions.
Email from Mitchell King, Lehman, to Jeff Michaels, Lehman (May 20, 2008) [LBEXDOCID 3233043]
(transmittingRatesAmericaRepo105Q1Rolllist[LBEXDOCID3235728]oftrades,byledger,cusip,
description of securities, face value, and repo value). On occasion, Michael McGarvey, the former
FinanceControllerinLehmansFixedIncomeDivision,compiledlistsofUnitedStatessecuritiesavailable
for potential use in Repo 105 transactions. Email from Michael McGarvey, Lehman, to Jeff Michaels,
Lehman, et al. (May 22, 2008) [LBEXDOCID 3385955] (The attached asset list [LBEXDOCID 3369637]
showsallavailablecollateralbycusip,whathasalreadybeensentouton105(includingsubs)andwhat
willbesentout.Pleaseletusknowofanyadditionalcollateralthatyouwanttosendout.).
3039SeeLehman,TotalRepo105&Repo108Report(Dec.5,2007)[LBEXDOCID3219746](attachedtoe
mail from Anuraj Bismal, Lehman, to Marie Stewart, Lehman, et al. (Dec. 5, 2007) [LBEXDOCID
3223384]);Lehman,TotalRepo105&Repo108Report(June11,2008)[LBEXDOCID2078195](attached
toemailfromKristieWong,Lehman,toMartinKelly,Lehman(June11,2008)[LBEXDOCID2325872].
MichaelMcGarvey,theformerFinanceControllerinLehmansFID,saidthatacertainvolumeofRepo
105tradeswereexecutedusingassetsthatwereheldinU.S.tradingbooks.ExaminersInterviewof
MichaelMcGarvey,Sept.11,2009,atp.9.Consequently,accordingtoMcGarvey,theRepo105benefit
appliedtoaU.S.tradingdesk.Id.McGarveystatedthattheUnitedStatesbasedsecuritieswereusually
agencies,bullets,FannieandFreddie.Id.McGarveyalsostatedthataLehmanNewYorktradingdesk
wouldbookanintercompanyrepo,transferringthesecuritiestoLBIsboxinLondon.Id.JohnFeraca,
whoformerlyworkedintheSecuredFundingDeskofLehmansPrimeServicesGroup,similarlystated
that a certain volume of assets used in Lehmans Repo 105 transactions originated in New York at a
United Statesbased Lehman entity,and landed on the books of LBIE by means of an intercompany
transfer between LBI and LBIE, before LBIE transferred the assets to a thirdparty via the Repo 105
transaction.ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.8.Feracasaidthatthisprocesswas
wellknowninFinanceandAccountingPolicy,completelyuptheranks.Id.McGarveysandFeracas
description of the mechanics of how a United Statesbased Lehman entity engaged in Repo 105
transactions,usinganintercompanyrepowithLBIE,isconsistentwithbothflowdiagramsofRepo105
transactions contained in internal Lehman documents and descriptions from other witnesses. See
Lehman,GlobalBalanceSheetOverviewofRepo105(FID)/108(Equities)(July2006),atp.1[LBEXWGM
748489].
792

firstquarter2008:$14.889billion3041
secondquarter2008:$13.6307billion.3042
(4) TypesofSecuritiesUsedinRepo105Transactions
Lehmans Repo 105 Accounting Policy required that the assets used in a Repo
105 transaction be readily obtainable, meaning that a market must exist where the
assets are either traded on a formal exchange or are considered liquid and trade in a
market where price quotations either are published or are obtainable through another
verifiable source.3043 The Linklaters opinion letter for Repo 105 transactions
conditioned its opinion on the assumption that the Purchased Securities consist of
liquidsecurities,sothattheBuyercouldeasilydisposeofthePurchasedSecuritiesand
acquireequivalentsecuritiesifitwished.3044
3040SeeLehman,TotalRepo105&Repo108Report(Dec.5,2007)[LBEXDOCID3219746](attachedtoe
3223384]).TheUnitedStatesentitiesengagedin$8.3036billionofRepo105transactions,outofaglobal
totalof$29.916billionRepo105onlyor$38.634billioncombinedRepo105/108.Id.
mailfromKristieWong,Lehman,toMartinKelly,Lehman(June11,2008)[LBEXDOCID2325872]).The
UnitedStatesentitiesengagedin$14.889billionofRepo105transactionsoutofaglobaltotalof$42.200
billionRepo105onlyor$49.102billioncombinedRepo105/108.Id.
mailfromKristieWong,Lehman,toMartinKelly,Lehman(June11,2008)[LBEXDOCID2325872]).The
UnitedStatesentitiesengagedin$13.6307billionofRepo105transactionsoutofaglobaltotalof$44.536
billionofRepo105onlyor$50.383billioncombinedRepo105/108.Id.
3043See,e.g.,LehmanBrothersHoldingsInc.,AccountingPolicyManual,Repo105andRepo108(Sept.9,
2006),atp.2[LBEXWGM754598].
a Global Master Repurchase Agreement (May 31, 2006), at p. 2 [LBEXLBIE 000001]. See Appendix 17,
Repo105Appendix.
793

The liquidity requirement for Repo 105 transactions was widely known
throughout Lehman.3045 Lehman had intermittent controls in place to ensure that
LehmanpersonneltransferredonlyliquidsecuritiesaspartofRepo105transactions,as
required by Lehmans Repo 105 Accounting Policy.3046 Contemporaneous documents
reveal that employees within Lehmans Product Control group periodically would
identify securities that had been included erroneously in Repo 105 transactions. For
example, in October 2007, one Lehman employee wrote: Having spoken to Product
ControlthefollowingpositionsshouldnothavebeenincludedforRepo105benefitas
they related to Failed Sale Gross Up for Windermere 11 and 12. . . . Going forward,
3045AnurajBismal,aformerSeniorVicePresidentinLehmansBalanceSheetGroup,explainedthatthe
requirement in Lehmans internal Repo 105 Accounting Policy that only highly liquid securities or
govies could be used in Repo 105 transactions was well known throughout the firm. Examiners
InterviewofAnurajBismal,Sept.16,2009,atp.10;ExaminersInterviewofHerbertH.BartMcDade
III,Sept.16,2009,atp.4(statingonlyhighlyliquidsecuritiescouldbeusedinRepo105/108);Examiners
Interview of Ian T. Lowitt, Oct. 28, 2009, at p. 14 (same); email from Thomas Siegmund, Lehman, to
Kaushik Amin, Lehman (May 2, 2008) [LBEXDOCID 601783] ([I]nternal accounting set rules on what
papercanbe105edinthepast,wehadtousethemostliquidpaper....thetruesaleopinionislinked
toliquidityandqualityofpaperthelowerliquidityandquality,thedeeperthediscountwouldhaveto
beandconsequentlythemoreexpensivetheexercise.).
3046ExaminersInterviewofAnurajBismal,Sept.16,2009,atp.9(explainingthatLehmansBalanceSheet
Group would intermittently ask theguysin Europe to check that the securities wereliquid). Bismal
characterizedthistestingasasnapshottestthatwasnotaregularthing.Id.Forexample,inJune
2008,MartinKellyreceivedacollateralqualitytestingreport.SeeLehman,Repo105CollateralQuality
Testing(May30,2008)[LBEXDOCID2057755](attachedtoemailfromKristieWong,Lehman,toMartin
Kelly,Lehman(June11,2008)[LBEXDOCID2325872]);seealsoLehman,Repo108Checklist(June1,2008)
[LBEXDOCID2078196](attachedtoemailfromKristieWong,Lehman,toMartinKelly,Lehman(June
11,2008)[LBEXDOCID2325872]).TheMay2008CollateralQualityTestreportedthatnearly95%ofthe
securities Lehman utilized in Repo 105 transactions were rated investment grade by S&P, Moodys,
Fitch, or DBRS Ratings Services. Lehman, Repo 105 Collateral Quality Testing (May 30, 2008) [LBEX
DOCID2057755].Lessthan1%ofthesecuritieshadnoratingsinformationavailable.Id.Asimilartest
fromMay2007reportedthat8.27%ofthetestedRepo105securitieswereratedinvestmentgradebyS&P,
Moodys,Fitch,orDBRS,andthat80.74%oftheremainingsecuritieshadsimilarcompanyInvestment
grade ratings. Lehman, Repo 105 Collateral Quality Testing (May 31, 2007) [LBEXDOCID 2464013]
(attachedtoemailfromDivyeshChokshi,Lehman,toAnurajBismal,Lehman,etal.(Oct.2,2007)[LBEX
DOCID2687082]).
794

ProductControlwilladviseusofallpositionsrelatingtotheFAS140FailedSaleGross
Up.3047
Inaddition,documentaryevidencesuggeststhatasGlobalHeadofAccounting
Policy, Marie Stewart, was consulted on new applications of the Repo 105
mechanism.3048StewartsaidthatitwasverytypicalofpeopleintheFrontOfficetotry
to apply the Repo 105 mechanism to new situations, such as when FID Asia tried to
includeAustraliansecuritiesinaRepo105transaction.3049
3047EmailfromDivyeshChokshi,Lehman,toAnurajBismal,Lehman,etal.(Oct.2,2007)[LBEXDOCID
2687082]; see also Lehman, Real Estate Europe Product Schedule (Oct. 2, 2007) [LBEXDOCID 2717917]
(attachedtoemailfromDivyeshChokshi,Lehman,toAnurajBismal,Lehman,etal.(Oct.2,2007)[LBEX
DOCID 2687082] and listing Windermere product names). The failed SFAS 140 true sale accounting
treatmentoftheWindermereproductswasreporteduptotheGlobalHeadofAccountingPolicy.Seee
mailfromMarieStewart,Lehman,toToddWeiner,Lehman,etal.(Oct.23,2007)[LBEXDOCID3223368].
3048For example, when Mark Cosaitis hoped to use the Repo 105 mechanism to get failed sales
deconsolidated, Stewart was involved, along with Ernst & Young and Ed Grieb, in denying him
permission. See email from Brett Beldner, Lehman, to Marie Stewart, Lehman, et al. (Aug. 17, 2008)
[LBEXDOCID3223803];emailfromMarieStewart,Lehman,toMarkCosaitis,Lehman,etal.(Aug.17,
2008)[LBEXDOCID3223806];seealsoemailfromToddWeiner,Lehman,toAnnieLin,Lehman(Apr.17,
2008)[LBEXDOCID739685](Allnewrepo105activityneedstobediscussedwithMarieStewartand
MartinKellyinNewYork.).
3049ExaminersInterviewofMarieStewart,Sept.2,2009,atp.10;emailfromAnnieLin,Lehman,toTodd
Wiener,Lehman,etal.(Apr.16,2007)[LBEXDOCID739685](askingwhetherLehmanBrothersAustralia
Ltd. (LBAU) could do a back to back position transfer between LBAU and LBIE in order to benefit
from repo 105 rule); email from Marie Stewart, Lehman, to Annie Lin, Lehman, et al. (Apr. 17, 2008)
[LBEXDOCID 739685] (You cannot do Repo 105 in Australia. We will not approve it even if it
technically works. I will explain further when I am back from vacation . . . .); email from Thomas
Siegmund, Lehman, to Kaushik Amin, Lehman (Apr. 17, 2008) [LBEXDOCID 739685] (As B/S will be
supertight,Ineedtomakesurewemakebestuseof105:Iwanttoinvestigatewhether105mechanics
can apply to Aussie paper. An answer like below, no . . . will explain when back from vac is
unacceptableinanycircumstancesandreallyoutoflineinthecurrentsituation!).
795

For the vast majority of Repo 105 transactions, Lehman used relatively liquid
securities, but, there were certain exceptions.3050 Notably, these same securities could
havebeenusedinordinaryrepotransactionsaswell.
Most securities Lehman used in Repo 105 transactions were governmental in
nature,suggestingacertainlevelofliquidity.3051Indeed,thevastmajorityofsecurities
LehmanutilizedinRepo105transactionswereinvestmentgrade,withallbutafewof
3050See,e.g., email from Clement Bernard, Lehman, to Roger Nagioff, Lehman, et al. (Nov. 20, 2007)
[LBEXDOCID173748](IntheUSwebelievethatmostofourAgencypositionswillbeoutthrough105
transactions); email from Dominic Gibb, Lehman, to Mark Cosaitis, Lehman, et al. (Feb. 28, 2008)
[LBHI_SEC07940_1829372](Jockandhisteamareaggressivelyworkingtoobtainrepo105fundingfor
all eligible govvies positions. If they are successful then we will have $23 bn of assets on Repo 105 at
quarterend....ThiswouldleaveFIDwithanetbalancesheetof$51.7bn,$4.7bnabovetheFIDlimit...
.).Certaindocuments,however,suggestthatLehmanperhapsattemptedtouselessliquidcollateralin
Repo 105 transactions. See email from Michael McGarvey, Lehman, to Gerard Reilly, Lehman, et al.
(Aug. 17, 2007) [LBEXDOCID 3213312] (There was call this morning with John Feraca on getting
Mortgagesouton105.LondonisgoingtoshowsomeexamplesoffixedAAAnonagencymortgagesto
Mizuho(whowehaveagoodrelationshipwith)toseeiftheywouldbeopentotakingthem.Basedon
Mizuhos reaction we are going to meet again Monday to determine [how] much we can do.); email
from Kentaro Umezaki, Lehman, to Christopher M. OMeara, Lehman, et al. (Aug. 17, 2007) [LBEX
DOCID 1533678] (John Feraca is working on Repo 105 for our IG mortgage and real estate assets to
reduceourQ3balancesheet....HewilltestthewatersabitinLondonwithonecounterparty.).
3051Governmental securities were used in Repo 105 transactions only. Repo 108 transactions utilized
equitiessecurities.Governmentalsecuritytypeincludes,butisnotlimitedto,governments,treasuries,
and agencies. Agencies included Freddie Mac, Fannie Mae, and Federal Home Loan Bank System
securities. See email from Michael McGarvey, Lehman, to Jeff Michaels, Lehman, et al. (May 22, 2008)
[LBEXDOCID 482311] (transmitting list [LBEXDOCID 472396] of all available collateral for Repo 105,
includingFreddieMacandFannieMae).Bylatesummer2008,however,Repo105counterpartieswere
unwilling to accept Freddie Mac securities. Email from Marc Silverberg, Lehman, to Chaz Gotthard,
Lehman, et al. (Aug. 7, 2008) [LBHI_SEC07940_1742976] (stating that Freddie Mac had been removed
fromaRepo105counterpartyslistbecauseitisnolongeracceptablecollateraltopostfor105.).Some
internalLehmanemailsfromwithintheLiquidMarketsdivisionreferredtocertainagencysecuritiesas
sticky,buttheuseofthatterminsuchemailswouldnothaveindicatedilliquidity,onlythatcertain
agency securities were more difficult to sell than others. See email from Jeff Michaels, Lehman, to
Kaushik Amin, Lehman (July 30, 2008) [LBEXDOCID 613324] (stating balance sheet allocation[] . . .
[which]isreallyabottomupprocessaboutwhohasstickyinventory.ObviouslyintheUSitisagencies..
. . and transmitting graph of Agency Desk gross and net balance sheet preRepo 105 [LBEXDOCID
775856] and graph of Euro Inflation Desk gross and net balance sheet preRepo 105 [LBEXDOCID
775857]).
796

the securities falling within the A to AAA range.3052 In addition, the majority of
Lehmans Repo 105 securities fit within Level 1 under SFAS 157s Fair Value Level
GAAPrequiredreportingcategories.3053
Lehman also used the following volumes of nongovernment securities in
Repo105transactions:3054
November 30, 2007: $4.8 billion (out of a total of $29.9 billion in Repo 105
transactions),or16%ofthetotalRepo105volume;
February 29, 2008: $4.8 billion (out of a total of $41.8 billion in Repo 105
transactions),or11%ofthetotalRepo105volume;and
May 30, 2008: $4.2 billion (out of a total of $44.5 billion in Repo 105
transactions),or9%ofthetotalRepo105volume.
(5) ProductControllersManuallyBookedRepo105Transactions
Repo105transactionsbeganasordinaryreposbookedinthesametradingand
accounting systems as ordinary repos.3055 Lehmans electronic accounting systems
3052Duff&PhelpsReport,Repo105SecurityLiquidityAnalysis(Oct.21,2009),atp.5.
3053Id. at p. 6. The valuation of Level 1 assets under SFAS 157 requires the use of directly observable
inputs, i.e., quoted prices in active markets for identical assets or liabilities accessible on the valuation
date.FAIRVALUEMEASUREMENTS,StatementofFin.AccountingStandardsNo.157,24(Fin.Accounting
Standards Bd. 2006) (SFAS 157). The valuation of Level 2 assets requires the use of directly or
indirectlyobservablepricesinactivemarketsforsimilarassetsorliabilities,quotedpricesforidenticalor
similar items in markets that are not active and inputs other than quoted prices such as yield curves,
credit risks, and volatilities. SFAS 157, 28. The valuation of Level 3 assets requires the use of
unobservable inputs that reflect managements own assumptions about the assumptions that market
participantswouldmake.SFAS157,30.
3054Duff & Phelps Report, Repo 105 Security Liquidity Analysis (Oct. 21, 2009), at p. 3. Note that the
figureslistedreportonlythevolumesofRepo105transactionsthatLehmanengagedinatquarterendfor
the reported period. The figures do not include the volume of Repo 108 transactions that Lehman
undertookatthequarterendperiods.
3055Duff&Phelps,ExplanationofRepo105AccountingLedgerEntriesandTradingSystemOutput(Jan.
5,2010),atp.3.
797

automaticallytreatedallrepotransactionsasfinancingtransactions,i.e.,borrowings.3056
Since the accounting and trading systems were not designed to treat any repo
transactions as sales, a manual intervention into Lehmans electronic books and
records systems was necessary to recharacterize Repo 105 borrowings as sales for
accountingpurposes.3057
The financial results of LBIEs business operations rolled up into LBHIs
consolidatedfinancialstatementsfiledintheUnitedStates.Lehmanentitiesaroundthe
worldmaintainedtheirbooksandrecordsusingUnitedStatesGAAPprinciples.3058In
addition, LBIE and LBSF product controllers were responsible for transactional
policingandbookingRepo105transactionsmanuallyandinamannerthatcomplied
withUnitedStatesGAAP.3059
3056Examiners Interview of Marie Stewart, Sept. 2, 2009, at pp. 910; Examiners Interview of Michael
McGarvey, Sept. 11, 2009, at p. 9; Examiners Interview of Matthew Lee, July 1, 2009, at p. 13; Duff &
Phelps,ExplanationofRepo105AccountingLedgerEntriesandTradingSystemOutput(Jan.5,2010),at
p.3.
3057Examiners Interview of Marie Stewart, Sept. 2, 2009, at pp. 910; Examiners Interview of Michael
McGarvey,Sept.11,2009,atp.9;Duff&Phelps,ExplanationofRepo105AccountingLedgerEntriesand
TradingSystemOutput(Jan.5,2010),atp.3.
3059Id.atp.11;Duff&Phelps,ExplanationofRepo105AccountingLedgerEntriesandTradingSystem
Output(Jan.5,2010),atp.3(citingstatementsofLBSFControllerMichaelMontellaandLBHIController
Clifford Feibus that LBSF manual adjustments were made in New York and LBIE manual adjustments
doneinLondon);seealsoemailfromGerardReilly,Lehman,toKentaroUmezaki,Lehman,etal.(Sept.4,
2007)[LBEXDOCID3232534](statingthatMcGarvey,aproductcontroller,isourpointon[Repo105]
from finance); email from Marie Stewart, Lehman, to Todd Weiner, Lehman (Sept. 7, 2007) [LBEX
DOCID 3223832] (responding to Weiners request for internal Accounting Policy Manual for Repo 105
transactionstocirculate...amongstourcolleaguesinProductControl...apparentlymorefolkslooking
to use Repo 105, by transmitting a copy of manual [LBEXDOCID 3213300] and writing that certain
peopleinLondonP[roduct]C[ontrol]havehadthispolicyforever);emailfromMarieStewart,Lehman,
toGaryBachman,Lehman,etal.(Nov.21,2007)[LBEXDOCID3223383](FeracaknowsallaboutRepo
105/108 and makes sure we keep by the rules. Also, FYI that weve had a few problems with people
798

Consequently, when LBIEs financial statements rolled up into LBHIs
consolidated financial statements, no conversion to United States GAAP was
claimingRepo105/108benefitrecentlywhentheyshouldnothave.);emailfromJohnFeraca,Lehman,
to Marie Stewart, Lehman (Nov. 22, 2007) [LBEXDOCID 3223383] (Conceptually yes I am the point
person for the business. But Product Controllers in London are responsible for the day to day
transactionalpolicing...keepinmindIamnotreviewingthetransactionaldetailonadaytodaybasis
nor making final decisions on what remains off balance sheet.). Gerard Reilly, Global Product
Controller, appointed McGarvey, a product controller for Finance in FID to be the point person for
LehmansRepo105program.ExaminersInterviewofMichaelMcGarvey,Sept.11,2009,atp.10;seealso
email from Michael McGarvey, Lehman, to Gerard Reilly, Lehman (Sept. 4, 2007) [LBEXDOCID
3232534](WehavebeenreviewingwiththeLondonrepodeskandfinanceonaregularbasis(Wehave
roughly80%ofthemonthend105balanceoutstandingfortheentiremonthalthoughthedailyaverage
has been slipping.) Well stay in front of it for the rest of the year.). When businesses within FID
anticipated breaching their balance sheet limits, they would ask McGarvey for additional Repo 105
capacity. Email from Jerry Rizzieri, Lehman, to Michael McGarvey, Lehman (Feb. 20, 2008) [LBEX
DOCID3235353](McGarvey:ForquarterendbalancesheetdoyoustillfeelRatesAmericaswillbeable
tomaketarget?Rizzieri:CanwegetmoreRepo105?).DocumentaryevidenceshowsthatMcGarvey
regularly reported to Clement Bernard, CFO for FID, about Repo 105 policy, volumes and actual
transactions.See,e.g.,emailfromMichaelMcGarvey,Lehman,toPaulMitrokostas,Lehman,etal.(June
3,2008)[LBEXDOCID3235388](reportingtoBernardandothersthatFIDNetBalanceSheetforsecond
quarter 2008 was $213.8 billion, $5.1 billion under target, and that the firmwide Repo 105 benefit for
second quarter 2008 was $50.9 billion); email from Michael McGarvey, Lehman, to Clement Bernard,
Lehman, et al. (Jan. 30, 2008) [LBEXDOCID 2796630] (We have repo 105 funding benefit trades on
constantlyinthenormalcourseofbusinessbecauseaccountingpolicystipulatesitmustbearegularway
fundourpositions.Weincreasethebalancesformonthendbuttrytokeepitwithin120percentofthe
average daily usage. . . . I have a meeting Thursday with Mark Cositis and the London Repo desk to
determine client appetite for Q1.); email from Michael McGarvey, Lehman, to Clement Bernard,
Lehman (Feb. 28, 2008) [LBEXDOCID 810932] (Given the critical balance sheet situation we are
currentlyinIveattachedalistofcorporatebondsheldinNY...availableforanyadditionalRepo105
capacity we can find.). Notably, only days before Lehmans bankruptcy filing, Gerard Reilly asked
MichaelMcGarveytoremoveallreferencestoRepo105fromathirdquarterscheduleofallofLehmans
USgovernmentsecurities.SeeemailfromGerardReilly,Lehman,toMichaelMcGarvey,Lehman,etal.
(Sept.12,2008)[LBEXDOCID641537].BernardandAminwereamongtherecipientsoftheemail.Prior
toClementBernardsassumptionoftheroleofFIDChiefFinancialOfficer,McGarveyreportedontotal
Repo105trends.SeeLehman,GlobalRepo105/108Trend(Aug.2007)[LBEXDOCID3219672](attached
to email from Michael McGarvey, Lehman, to Steven Becker, Lehman, et al. (Aug. 17, 2007) [LBEX
DOCID3221344]);emailfromMichaelMcGarvey,Lehman,toClementBernard,Lehman,etal.(Mar.13,
2008) [LBEXDOCID 2794226] (Bernard: Do you know what is happening here on these repo 105?
McGarvey:Repoopshasworkedthroughmostofitandwehavedeliveredallbut750mm.Thisisan
opsissuethatoccurssometimesduetothetimedifferencebetweenNYandLondon.Iftherepodeskin
Londondoesa105tradeandthosebondsarenotsittinginLBIsboxwecanfail....).
799

required.3060 LBHI did not subsequently verify that the Repo 105 entries manually
entered by LBIE employees complied with United States GAAP.3061 With a UK legal
opinion[i.e.,theLinklatersletter]thatcoveredthe[Repo]105[transactions],[Repo]105
[transaction]swouldberespectedasasaleinthebooksoftheentitiesdoingthemand
bookingtheminUSGAAP.3062
In short, Lehman undertook transactions in a foreign jurisdiction (the United
Kingdom) that purported to comply with SFAS 140, where Lehman was unable to
obtain a SFAS 140 true sale opinion from a United States law firm, and Lehman then
relied upon the nonUnited Statesbased Lehman entity to ensure that the transaction
compliedwithUnitedStatesGAAP.
e) ManagingBalanceSheetandLeverage
Startinginmid2007,marketparticipantsbegantomorecarefullyscrutinizethe
leverage of investment banks.3063 Consequently, in 2007, top Lehman executives
pressured the firms businesses to reduce balance sheet and leverage in order to meet
marketexpectationsandavoidaratingsdowngrade.3064ByJanuary2008,RichardFuld
3061Id.
3062Id.atp.12.
3063Examiners Interview of John Coghlan, Nov. 11, 2009, at p. 11 (recalling medias focus on the
appropriatenessofhighleverageamongfinancialinstitutionsandthatoncethemarketwasfocusedon
leverage, Lehman executives believed Lehman should deleverage); Examiners Interview of Richard S.
Fuld,Jr.,Sept.25,2009,atp.8(statingthatoneofthemotivationsbehindhisdesiretoreducenetleverage
wasthatratingagenciesfocusedonthenetleverageratio).
3064ExaminersInterviewofAnurajBismal,Sept.16,2009,atp.5(statingthattheleverageratiotargetwas
absolutely about how rating agencies would view Lehman and that leverage was the most critical
800

madeastrategicdecisionthatLehmanwouldembarkuponafirmwideefforttoreduce
its balance sheet and lower the firmwide net leverage ratio by selling assets.3065 But
many of Lehmans inventory positions had by then become increasingly sticky or
difficult to sell without incurring substantial losses. It is against this backdrop of
increasedmarketfocusonleveragethatLehmansignificantlyincreaseditsquarterend
useofRepo105transactions.
topicforseniorLehmanmanagementinlate2007and2008).Adowngradeinanissuerscreditratinghas
asignificantnegativeimpactonthefinancialpositionofacompanylikeLehman.See,e.g.,Emailfrom
IanT.Lowitt,Lehman,toHerbertH.(Bart)McDadeIII,Lehman(June30,2008)[LBHI_SEC07940_643543]
(One notch downgrade requires 1.7 bn; and 2 notch requires 3.4 bn of additional margin posting.).
Counterpartiesmayrespondtoadowngradebydemandingthattheissuerpostadditionalcashcollateral
tosecureitsobligations.SeeAmadouN.R.Sy,TheSystemicRegulationofCreditRatingAgenciesand
RatedMarkets89(IntlMonetaryFund,WorkingPaper,2009)(notingthatbrokerdealersmayusecredit
ratings to determine acceptable counterparties, as well as collateral levels for outstanding credit
exposure); email from Ian T. Lowitt, Lehman, to Eric Felder, Lehman (July 5, 2008) [LBEXDOCID
071263](statingthatadowngradewillaffectlinesandwillingnessofcounterpartiestofundsecured.).
Some of Lehmans derivative contracts had builtin triggers permitting counterparties to require
additionalcashcollateralintheeventofadowngrade.LehmanBrothersHoldingsInc.,CurrentReport
asofMay31,2008(Form10Q)(filedonJuly10,2008)(LBHI10Q(filedJuly10,2008));seealsoLehman,
Global Treasury Downgrade Effect on Cash Capital Facilities 3Jun08 (June 2008)
[LBHI_SEC07940_513314],attachedtoemailfromAmberishRatanghayra,Lehman,toPaoloR.Tonucci,
Lehman,etal.(June3,2008)[LBHI_SEC07940_513312];seealsoAppendix13,Survival,atpp.13.
3065Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at pp. 2627 (stating that as part of
deleveragingeffortsin2008,FuldwantedLehmantobringallofitsinventorypositionsdown,exceptthe
matchedbook,thathewasconcernedwithreducingnetleveragebecauseratingagencieswereconcerned
withnetleverage,andthathewantedtoreducenetleveragebyreducingassets);ExaminersInterviewof
RichardS.Fuld,Jr.,Nov.19,2009,atpp.89(statingthatafterChristmas2007,Fuldgavecleardirectiveto
McDadetobringbalancesheetdownandthatFuldsfocuswasonlessliquidassets,i.e.,leveragedloans,
residentialsecurities,andCRE);ExaminersInterviewofRichardS.Fuld,Jr.,Dec.9,2009,atp.10(stating
that he did not want to reduce the balance sheet in the matched book or ontherun governments, but
rather,inCMBSandRMBS).
801

(1) LehmanManagementsFocusinLate2007onReducingthe
FirmsReportedLeverage
Inmidtolate2007,seniormanagementbegantoconsiderthebalancesheetand
leverage ratios as important metrics followed by investors and the rating agencies.3066
Lehmans Ryan Traversari (Senior Vice PresidentExternal Reporting) wrote in
September 2007 to Tonucci that the question of net leverage ratio has come up
multiple times in the 20 seconds that Ive been here largely from [CFO] OMeara,
Freidheim,Lowitt,CorporateStrategy,InvestorRelationsandthelike.3067
3066See,e.g.,emailfromEdwardGrieb,Lehman,toChristopherM.OMeara,Lehman,etal.(Dec.7,2007)
[LBEXDOCID 3759517] (discussing net assets and leverage with Grieb, OMeara, Callan, Tonucci and
Kelly); LBHI 10Q (filed Apr. 9, 2008), at p. 65 (During the 2008 quarter, the Company operated in a
liquidity,funding,andcapitalenvironmentcharacterizedbyconstrainedmarketliquiditydriveninpart
by balance sheet and leverage concerns.); email from Ryan Traversari, Lehman, to Paolo R. Tonucci,
Lehman,etal.(Sept.10,2007)[LBEXDOCID1695576](comparingLehmansnetleverageratiotothatof
Bear Stearns, Tonucci wrote that Lehmans net leverage calculation was intended to reflect the
methodologyemployedbyS&Pwhoweremostinterestedandfocusedonleverage).Atleastuntillate
2007, Lehmans Finance Committee comprised of the firms Chief Financial Officer (in chronological
order, Christopher M. OMeara, Erin M. Callan, and Ian T. Lowitt), Paolo Tonucci, Head of the firms
Fixed Income Division (inchronological order, Michael Gelband,Roger Nagioff, and Andrew Morton),
plusotherseniorexecutivessetfirmwidebalancesheettargetsandleverageratiotargets.Examiners
Interview of Marie Stewart, Sept. 2, 2009, at p. 7; Examiners Interview of Michael McGarvey, Sept. 11,
2009,atp.5;ExaminersInterviewofTejalJoshi,Sept.15,2009,atp.5;ExaminersInterviewofAnuraj
Bismal,Sept.16,2009,atp.5;ExaminersInterviewofKaushikAmin,Sept.17,2009,atp.5;Examiners
InterviewofMitchellKing,Sept.21,2009,atp.5;ExaminersInterviewofMartinKelly,Oct.1,2009,atp.
11;ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.9;ExaminersInterviewofJosephGentile,Oct.
21,2009,atp.5;seealsoLehman,TreasuryOctober2007BalanceSheetandLeverageRatioTargets(Oct.
19,2007)[LBEXDOCID3215540](attachedtoemailfromLisaKennish,Lehman,toMichaelMcGarvey,
Lehman, et al. (Oct. 19, 2007) [LBEXDOCID 3233628]); email from Anuraj Bismal, Lehman, to Marie
Stewart,Lehman,etal.(Dec.21,2007)[LBEXDOCID3223846](Thefinancecommitteedoessetbalance
sheettargetsforeachandeverymonthend.).InapproximatelyMarch2008,however,BartMcDadewas
named Lehmans balance sheet czar, tasked with setting and implementing balance sheet targets for
Lehman to control leverage. Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at p. 26;
ExaminersInterviewofErinM.Callan,Oct.23,2009,atp.3;ExaminersInterviewofRichardS.Fuld,Jr.,
Nov.19,2009,atp.8.
3067Email from Ryan Traversari, Lehman, to Paolo R. Tonucci, Lehman, et al. (Sept. 11, 2007) [LBEX
DOCID1695575](emphasisadded).
802

InaSeptember7,2007emailtoOMearaandLowitt,Reillywrote:weneedto
keepthepressureonandgetthefirmsleveragetoagoodspotforyearend.Atleastwe
needtorestrictwhatinventorylinesitcanbeusedfor.3068LowittagreedwithReillys
suggestionandsaidthatLehmanneed[ed]togettighteronB/S.3069Lowittcontinued:
IammoreworriedabouthowleveragenumberwillbeacceptedbythemarketthanChris
[OMeara]is.3070
Also in September 2007, OMeara reported to the Finance and Risk Committee
that Lehmans net leverage ratio was in line with Lehmans peers.3071 Managements
presentationregardingthenetleveragemetricnoted:
In the past, leverage was the key measure of equity adequacy. Between
2003 and 2006 we significantly reduced leverage. Low leverage was
positively viewed by rating agencies and contributed to our 2005
upgrades. In 2006 and 2007, we worked with the regulatory and rating
agenciestoimplementmoreaccurateadequacymeasures.Asaresult,we
arecomfortablewithallowingourleveragetoincrease.3072
In a November 2007 email, OMeara, thenLehman CFO, wrote to Reilly, I
realizewereinatoughspotgivenmkt,butweshouldbepressuringeverywheretotry
3068EmailfromGerardReilly,Lehman,toChristopherM.OMeara,Lehman,etal.(Sept.7,2007)[LBEX
DOCID1357178]
3069Email from Ian T. Lowitt, Lehman, to Gerard Reilly, Lehman, et al. (Sept. 7, 2007) [LBEXDOCID
1357178]
3070Id.(emphasisadded).
Committee of Lehman Board of Directors (Sept. 11, 2007), at pp. 2, 30 [WGM_LBEX_02247] (with
Weliksons Handwritten Notes); Lehman Brothers Holdings Inc., Finance and Risk Committee Minutes
(Sept.11,2007),atpp.23[LBEXAM067018].
3072 Lehman, Presentation on Risk, Liquidity, Capital and Balance Sheet Update to Finance and Risk
803

to end year in good way on balance sheet . . . especially since the revs are not
materializing.3073 Upon becoming Global Financial Controller on December 1, 2007,
Martin Kelly studied net leverage ratio components and the definition of net assets
acrosspeerfirms.3074
(a) LehmansCalculationofNetLeverage
Under Lehmans definition of net leverage ratio, Lehman divided net assets by
tangible equity, as a more meaningful calculation and a more useful measure of
leverage,becauseitexcludedcertainlowrisk,noninventoryassets.3075InitsForms10
Kand10Q,Lehmandefinednetassetsastotalassetsexcluding:(1)cashandsecurities
segregatedandondepositforregulatoryandotherpurposes;(2)securitiesreceivedas
3073Email from Christopher M. OMeara, Lehman, to Gerard Reilly, Lehman (Nov. 20, 2007) [LBEX
DOCID578184].
3074Lehman, Components of Net Leverage Across Peer Firms Report (Dec. 7, 2007) [LBEXDOCID
3299584](attachedtoemailfromAnurajBismal,Lehman,toMartinKelly,Lehman,etal.(Dec.7,2007)
[LBEXDOCID3306110];Lehman,ComponentsofNetLeverageAcrossPeerFirmsGraph(Dec.7,2007)
[LBEXDOCID3328581](attachedtoemailfromAnurajBismal,LehmantoMartinKelly,Lehman,etal.
(Dec.7,2007)[LBEXDOCID3306110];emailfromMarieStewart,Lehman,toMartinKelly,Lehman,et
al.(Dec.7,2007)[LBEXDOCID3306112](Iunderstandthateveryonenegotiatestheirowndefinitionof
netassetswithratingagenciesandanytimeIhaveaskedaboutthishistoricallyIsensedhesitancyforus
torenegotiateourdefinition.IhadmentionedtoMartin[Kelly]earlierthisweekthatPaolo[Tonucci]and
Ed[Grieb]couldgivehimbackgroundonwhyourcalculationisdifferentfromourpeers.);emailfrom
AnurajBismal,Lehman,toMartinKelly,Lehman,etal.(Dec.7,2007)[LBEXDOCID3759517](reporting
toKellythatfirmsnetleveragewas16.2x).RecallthatLehmancalculatednetassetsbysubtractingfrom
total assets: cash and securities segregated and on deposit for regulator and other purposes; securities
under agreement to resell; identifiable intangible assets and goodwill; securities received as collateral;
securitiesborrowed.Thatsumwasdividedbytangibleequitycapital,whichwascalculatedbyadding
totalstockholdersequityandjuniorsubordinatednotesandsubtractingidentifiableintangibleassetsand
goodwill.SeeLBHI200710K,atp.30;LBHI10Q(filedApr.9,2008),atp.70;LBHI10Q(filedJuly10,
2008), at p. 56; Lehman, Components of Net Leverage across Peer Firms (Dec. 7, 2007) [LBEXDOCID
3299584].
88.
804

collateral; (3) securities purchased under agreements to resell; (4) securitiesborrowed;
and (5) identifiable intangible assets and goodwill.3076 Lehman calculated tangible
equity capital by including stockholders equity and junior subordinated notes and
excludingidentifiableintangibleassetsandgoodwill.3077
The net leverage ratio calculation a brutal, rudimentary measurement3078
did not capture the quality of the assets,3079 and was therefore an expedient
measurement for Lehman to utilize given the firms sticky inventory. As Clement
Bernard,formerFIDCFOwroteinearly2008:[T]hefirmistryingtomoveawayfrom
net leverage. However, they cannot do that until the quality of assets improve ie we
reduceourexposuretostickyassetslikeMortgagesandRealEstate.3080
(2) ByJanuary2008,LehmanDecidedtoCutitsNetLeveragein
Investors
By no later than January 2008, Fuld was focused on net leverage and balance
sheetreduction.SoonafterRogerNagioffreplacedMichaelGelbandasHeadofFIDin
3076LBHI200710K,atp.63;LBHI10Q(filedApr.9,2008),atp.72;LBHI10Q(filedJuly10,2008)atp.
88.
3077LBHI200710K,atp.63;LBHI10Q(filedApr.9,2008),atp.72;LBHI10Q(filedJuly10,2008)atp.
88.
3078ExaminersInterviewofAnurajBismal,Sept.16,2009,atpp.67.
3079Id. at pp. 67; see also U.S. Securities and Exchange Commission Office of Inspector General, Report
No. 446A, SECs Oversight of Bear Stearns and Related Entities: The Consolidated Supervised Entity
Program (Sept. 25, 2008), at p. 93 ([A] leverage ratio is a crude measure and implicitly assumes that
every dollar of balance sheet involves the same risk whether due to a treasury bond or an emerging
marketequity....Finally,aleveragelimitcreatesanincentiveforfirmstomoveexposuresoffbalance
sheet....).
3080Email from Clement Bernard, Lehman, to Andrew J. Morton, Lehman, et al. (Feb. 1, 2008) [LBEX
DOCID1853655](emphasisadded).
805

May 2007,FuldauthorizedNagioff to bringdown positions inleveraged loans.3081 By
theendof2007,Fuldexpressedincreasingconcernabouttheeconomy.3082Accordingto
Fuld, in early 2008 he instructed Bart McDade, who would replace Joe Gregory and
become Lehmans President and Chief Operating Officer in June 2008, to bring down
Lehmansnet balancesheet andnet leverageratio.3083Fuldatvarious times described
thebalance sheetreductionasapplying to:(1) allpositionsexcept matchedbook;and
(2) less liquid assets, such as leveraged loans, RMBS, CMBS, and CRE.3084 Fuld and
other members of senior firm management were concerned with reducing Lehmans
large net balance sheet, i.e., the inventory that Lehman owned, because the rating
agenciesonlylookedatLehmansnetleverage.3085
RichardS.Fuld,Jr.,Nov.19,2009,atpp.89;ExaminersInterviewofRichardS.Fuld,Jr.,Dec.9,2009,at
p.10.
RichardS.Fuld,Jr.,Nov.19,2009,atp.8;ExaminersInterviewofRichardS.Fuld,Jr.,Dec.9,2009,atp.
10;emailfromHerbertH.(Bart)McDadeIII,Lehman,toHerbertH.(Bart)McDadeIII,Lehman(Jan.14,
2008) [LBEXDOCID 3101094] ([L]earning how to say no againdel[e]vering the balance sheet by 3
turns); email from Larry Wieseneck, Lehman, to Michael Konigsberg, Lehman, et al. (Mar. 19, 2008)
[LBHI_SEC07940_390282] (The firm is asking Bart McDadeto represent the firms interests as the
BalanceSheetCzarthepointpersonforthefirmsExecCommrelativetotheuseofbalancesheetand
capital).
3084Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at pp. 2627 (recalling that Fuld told
McDadetobringdownallpositionsexceptmatchedbook);ExaminersInterviewofRichardS.Fuld,Jr.,
Nov,19,2009,atp.8(statingthathisfocuswasonbringingdownlessliquidassets,i.e.,leveragedloans,
RMBS,CMBS,andCRE);ExaminersInterviewofRichardS.Fuld,Jr.,Dec.9,2009,atp.10(statingthathe
did not instruct McDade to bring down matched book or ontherun government securities as part of
directivetoreducebalancesheet).
3085ExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,atp.27.Fuldrecalledthatratingagencies
lookedatnetleveragebecausegrossbalancesheetincludedmatchedbook.Id.Matchedbookiswhere
atraderreversesinandreposoutcollateraltothesameordifferentdates.Lehman,RepoManual(Nov.
8,2005),atp.16[LBEXLL1175483].Whenthematuritiesofthereversereposandreposarethesame,
806

Contemporaneous documents from the Lehman archives confirm that senior
management at all levels were critically focused on reducing Lehmans firmwide
leveragebeginninginearly2008,includingfocusingontheimpactleveragehadonthe
firmsratings:
Two weeks before the close of Lehmans first quarter 2008 on February 29,
2008, Erin Callan, thenCFO, wrote to Tonucci, Reilly and Martin Klein,
wouldlovetoseethetargetprojection[fornetleverage]at15.1.3086Reilly
forwardedCallansmessagetoAndrewMorton,theheadofLehmansFixed
Income Division, stating Would be great if fid could come in lower as
leverage could be 1 of the few bright spots for the quarter.3087 Morton
replied,Willpulloutallthestops.3088
InaMarch19,2008email,LarryWieseneckreportedonastepthefirmis
takingtomoreactivelymanagethebalancesheetusageacrossthefirm.3089
Hecontinued:ThefirmisaskingBartMcDade(HeadofGlobalEquities)to
represent the firms interests as the Balance Sheet Czar the point person
for the firms Exec Comm relative to the use of balance sheet. He will
coordinatewiththetradingdesksandbankingbusinessesacrossthefirmas
itrelatestomanagingbalancesheetsdowntotargetlevels.Thiswillinsure
thatwearedisciplined.3090
he or she is said to be running a matched book. But, in reality, most matched books are actually
mismatchedinthatatraderwillreverseincollateraltodateswhicharedifferentthanthosematurities
on the corresponding repos. Id. A trader does this to profit from future shifts in interest rates that
mightoccurbetweentheunmatchedmaturitiesonthereversereposandrepos.Id.Tobeclear,Repo
105 transactions were not matched book transactions. See also email from Robert Azerad, Lehman, to
EdwardGrieb,Lehman,etal.(Mar.27,2008)[LBEXDOCID3184420](commentinguponexternalblogs
critiqueofLehmansleverageratioscalculationandbalancesheet).
3086EmailfromErinM.Callan,Lehman,toPaoloR.Tonucci,Lehman,etal.(Feb.15,2008)[LBEXDOCID
1729329].
3087Email from Gerard Reilly, Lehman, to Andrew J. Morton, Lehman (Feb. 15, 2008) [LBEXDOCID
1729329].
3088Email from Andrew J. Morton, Lehman, to Gerard Reilly, Lehman (Feb. 15, 2008) [LBEXDOCID
1729329].
3089Email from Larry Wieseneck, Lehman, to Michael Konigsberg, Lehman, et al. (Mar. 19, 2008)
[LBHI_SEC07940_390282].
3090Id.
807

InaMarch27,2008email,KenCohenwrote:Weareverymuchinneedof
balancesheet.Wemustmovethingsoffbytheendofthequarter.Ineedyou
alltogobacktoclientsandofferthemdiscountstomovethingsoff.Wehave
alotofwoodtochopinashortperiodoftimebutwecantaffordtofail.If
thismeansleavingp&lonthetablesobeit.Ifyouhavequestionsgetbackto
mebutweHAVETODOTHIS!!3091
StatementsofnumerousseniorLehmanpersonnelalsoconfirmthatLehmanwas
focusedonthenetleverageratioandthereductionofnetassetsbeginninginlate2007:
Tonucci recalled that McDade wanted to bring down Lehmans firmwide

balancesheetbyafewturns.3092
McDade,whowasnamedbalancesheetczarinMarch2008andwhobecame
PresidentandCOOinJune2008,saidthatdeleveragingwasabsolutelya
criticalissuetoLehmaninearly2008.3093
Ed Grieb, Lehmans former Global Financial Controller, stated that the

focus on balance sheet and net leverage gained much more importance
beginninginmid2007.3094
Murtaza Bhallo, Business/Risk Manager in Proprietary Trading Group for

Liquid Markets, said that beginning in 2007, there was a squeeze on
Lehmans balance sheet, and that Lehman personnel were worried about
reportingthelevelofLehmansassetsagainstLehmansequity(i.e.,leverage
ratio).3095
Anuraj Bismal, a former Senior Vice President in Lehmans Balance Sheet

Group,saidthatLehmansmeetingofitsleverageratiotargetwasthemost
critical piece (a very hot topic) for senior management by the end of
2007.3096 Bismal said that balance sheet targets and leverage ratio targets
3091Emailfrom Ken Cohen, Lehman, to Carmine Visone, Lehman (Mar. 27, 2008) [LBEXDOCID
1374413].SeeSectionIII.A.5.e.2oftheReportforfurtherdiscussionofLehmansdeleveragingefforts.
3093ExaminersInterviewofHerbertH.BartMcDadeIII,Jan.28,2010,atp.5.
3095ExaminersInterviewofMurtazaBhallo,Sept.14,2009,atp.3.
3096ExaminersInterviewofAnurajBismal,Sept.16,2009,atp.5.
808

were absolutely about how rating agencies would view Lehman, and also
creditorsandtheinvestingpublic.3097
John Feraca, the former head of the Secured Funding Desk in Lehmans
Prime Services group, said that in late 2007, as the industry was changing
and entering a crisis period, Lehman made certain commitments to
deleverage.3098
Marie Stewart, Lehmans former Global Head of Accounting Policy,

confirmed that Lehman set balance sheet targets with any eye to reaching
certain leverage ratios that rating agencies used to measure and gauge
Lehmansperformance.3099
(a) BartMcDade,asNewlyAppointedBalanceSheetCzar,
LehmansUseofRepo105Transactions
Bart McDade, who spent 25 years at Lehman, served as Lehmans CoGlobal
Head of FID from 2002 through 2005 and Global Head of Equities from 2005 until
2008.3100InMarch2008,whileremainingGlobalHeadofEquities,McDadetookonthe
additionalroleofbalancesheetczarorbalancesheetpointperson,fortheExecutive
Committee.3101McDadelaterbecameLehmansPresidentandChiefOperatingOfficer,
replacingJoeGregoryinJune2008.3102
3097Id.
3100ExaminersInterviewofHerbertH.BartMcDadeIII,Sept.16,2009,atp.1.
3102Id.atp.5.
809

According to Fuld, McDade had full authority to reduce firmwide net
leverage.3103 Although Lehmans Treasury and Finance groups previously had set
balance sheet targets,3104 beginning in approximately March 2008, Gregory, Lehmans
thenPresidentandCOO,assisted McDade withdetermining thebalance sheet targets
firmwide.3105AlthoughFulddidnotspecificallydirectGregoryandMcDadeonwhich
Lehman divisions should have their balance sheet reduced, Fuld wanted to see the
balancesheetreduction,particularlyinlessliquidassetclasses,i.e.leveragedloansand
residentialandcommercialrealestate.3106
McDade took his responsibilities as balance sheet point person very
seriously.3107 He viewed his mission as to coordinate Lehmans balance sheet
issues.3108 McDade wanted to organize, coordinate, and influence.3109 Bear Stearns
had just nearly collapsed and McDade knew that Lehman had tough assets on its
3103ExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,atpp.2627(statingthatFuldinstructed
McDade to bring down all of Lehmans positions except for matched book in order to get net leverage
downtothelowteens);ExaminersInterviewofRichardS.Fuld,Jr.,Nov.19,2009,atpp.23(statingthat
Fuld told McDade, after Christmas 2007, to bring down net leverage by half and that Fuld did not
specifically direct Gregory and McDade on which divisions should have their balance sheets brought
down); Examiners Interview of Richard S. Fuld, Jr., Dec. 9, 2009, at p. 10 (stating that Fuld wanted
reductionsinplacesthatLehmanwasvulnerable,suchasRMBSandCMBS).
3104ExaminersInterviewofMichaelMcGarvey,Sept.11,2009,atp.5.
3105ExaminersInterviewofRichardS.Fuld,Jr.,Nov.19,2009,atpp.89.
3106Id.
3107Examiners Interview of Herbert H. Bart McDade III, Jan. 28, 2010, at p. 7; email from Larry
Wieseneck,Lehman,toMichaelKonigsberg,Lehman(Mar.19,2008)[LBHI_SEC07940_390282].
3109Id.atp.7.
810

balancesheet.3110Inhisroleasbalancesheetczar,McDadecreatedaDailyBalanceSheet
and Disclosure Scorecard report in order to have greater transparency with respect to
the balance sheet.3111 The Daily Scorecard was widely disseminated among senior
Lehman management from April through September 2008 and routinely contained
referencestotheimpactRepo105transactionshadonLehmansdailybalancesheet.3112
3110Id.atp.3.
3111Id.atpp.89(statingalsoIneededadailyscorecardtoknowwhereIwantedtopushonbalance
sheetissues).
3112See,e.g.,Lehman,BalanceSheetandDisclosureScorecardforTradeDateApril7,2008(Apr.9,2008),
atp.9[LBEXDOCID520619](attachedtoemailfromTalLitvin,Lehman,toHerbertH.(Bart)McDade
III, Lehman, et al. (Apr. 9, 2008) [LBEXDOCID 523578] and showing consolidated FID and Equities
balance sheet reduced by $18.527 billion and Prime Services balance sheet reduced by $4.458 billion
throughRepo105transactionsasofApril7,2008);Lehman,BalanceSheetandDisclosureScorecardfor
TradeDateApril8,2008(Apr.10,2008),atp.9[LBEXDOCID520620](attachedtoemailfromTalLitvin,
Lehman, to Herbert H. (Bart) McDade III, Lehman, et al. (Apr. 10, 2008) [LBEXDOCID 523579] and
showing consolidated FID and Equities balance sheet reduced by $18.853 billion and Prime Services
balance sheet reduced by $4.562 billion through Repo 105 transactions as of April 8, 2008); Lehman,
BalanceSheetandDisclosureScorecardforTradeDateApril9,2008(Apr.10,2008),atp.9[LBEXDOCID
251339](attachedtoemailfromTalLitvin,Lehman,toHerbertH.(Bart)McDadeIII,Lehman,etal.(Apr.
10, 2008) [LBEXDOCID 258560] and showing consolidated FID and Equities balance sheet reduced by
$19.688billionandPrimeServicesbalancesheetreducedby$4.548billionthroughRepo105transactions
asofApril9,2008);Lehman,BalanceSheetandDisclosureScorecardforTradeDateApril10,2008(Apr.
14,2008),atp.9[LBEXDOCID251342](attachedtoemailfromTalLitvin,Lehman,toHerbertH.(Bart)
McDade III, Lehman, et al. (Apr. 14, 2008) [LBEXDOCID 275231] and showing consolidated FID and
Equities balance sheet reduced by $19.967 billion and Prime Services balance sheet reduced by $4.491
billion through Repo 105 transactions as of April 10, 2008); Lehman, Balance Sheet and Disclosure
ScorecardforTradeDateApril11,2008(Apr.14,2008),atp.9[LBEXDOCID251344](attachedtoemail
fromTalLitvin,Lehman,toHerbertH.(Bart)McDadeIII,Lehman,etal.(Apr.14,2008)[LBEXDOCID
258562]andshowingconsolidatedFIDandEquitiesbalancesheetreducedby$20.260billionandPrime
Services balance sheet reduced by $4.517 billion through Repo 105 transactions as of April 11, 2008);
Lehman, Balance Sheet and Disclosure Scorecard for Trade Date May 12, 2008 (May 13, 2008), at p. 1
[LBEXLL 1950262] (attached to email from Tal Litvin, Lehman, to Herbert H. (Bart) McDade III,
Lehman,etal.(May13,2008)[LBEXDOCID3187357]andstatingRatesdecreasedby$(5.0B)fromprior
day due to . . . increased Repo 105 usage. . . .); Lehman, Balance Sheet and Disclosure Scorecard for
TradeDateMay22,2008(May27,2008),atp.1[LBEXLL1950706](attachedtoemailfromTalLitvin,
Lehman, to Herbert H. (Bart) McDade III, Lehman, et al. (May 27, 2008) [LBEXDOCID 275984] and
statingGlobalratesnetbalancesheetdecreased($2.0B),predominantlyduetoanincreaseinRepo105
benefit. . . .); Lehman, Balance Sheet and Disclosure Scorecard for Trade Date May 28, 2008 (May 30,
2008), at p. 1 [LBEXLL 1950670] (attached to email from Tal Litvin, Lehman, to Herbert H. (Bart)
811

Inonehisfirstactsasbalancesheetpointperson,andinconnectionwithhisplan
to aggressively reduce Lehmans firmwide balance sheet, McDade requested that
Lehman convene a special meeting of the Executive Committee on Friday, March 28,
2008, at 9:00 a.m.3113 The entire Executive Committee, except Fuld, as well as ex officio
membersIanLowittandScottFriedheim,attendedthemeeting.3114
Broadlyspeaking,McDadesgoalgoingintotheMarch28meetingwastohave
theExecutiveCommitteecometogetherandagreeaboutthedirectionLehmanwould
pursue,atleastfromthebalancesheetperspective.3115Morespecifically,McDadesaid
that his purpose in seeking a special meeting of the committee was to request Joe
McDade III, Lehman, et al. (May 30, 2008) [LBEXDOCID 275995] and stating Global rates net balance
sheetdecreasedby($3.1B)primarilyduetoadecreaseinAmericasdrivenbyanincreasedutilizationof
Repo105withintheAgencybusiness);Lehman,BalanceSheetandDisclosureScorecardforTradeDate
May29,2008(May30,2008),atp.1[LBEXLL1950658](attachedtoemailfromTalLitvin,Lehman,to
Herbert H. (Bart) McDade III, Lehman, et al. (June 2, 2008) [LBEXDOCID 011127] and stating Global
Ratesnetbalancesheetdecreased($6.5B)...[t]hedecreaseinEuropeiscomingfromincreasedutilization
of Repo 105); Lehman, Balance Sheet and Disclosure Scorecard for Trade Date June 18, 2008 (June 20,
2008)[LBEXLL1950514](attachedtoemailfromTalLitvin,Lehman,toHerbertH.(Bart)McDadeIII,
Lehman, et al. (June 20, 2008) [LBEXDOCID 275942] and stating that Global rates net balance sheet
decreaseddriven by a[n] . . . increase in Repo 105 utilization. . . .); Lehman, Balance Sheet and
Disclosure Scorecard for Trade Date August 13, 2008 (Aug. 14, 2008) [LBEXLL 782812] (attached to e
mail from Tal Litvin, Lehman, to Herbert H. (Bart) McDade III, Lehman, et al. (Aug. 14, 2008) [LBEX
DOCID4214810]andstatingthatGlobalratesnetbalancesheetdecreased...drivenbyanincreasein
Repo105benefit....);Lehman,BalanceSheetandDisclosureScorecardforTradeDateAugust25,2008
(Aug. 26, 2008) [LBEXLL 782924] (attached to email from Tal Litvin, Lehman, to Herbert H. (Bart)
McDade III, Lehman, et al. (Aug. 26, 2008) [LBEXDOCID 079536] and stating that Global Rates net
balancesheetdecreased...drivenbyanincreaseinrepo105usage....);Lehman,BalanceSheetand
mail from Tal Litvin, Lehman, to Herbert H. (Bart) McDade III, Lehman, et al. (Aug. 29, 2008) [LBEX
DOCID275880]andstatingthatGlobalrates[netbalancesheet]wasdown...drivenbyincreasedRepo
105benefit....).
3113ExaminersInterviewofHerbertH.BartMcDadeIII,Jan.28,2010,atp.3.AccordingtoMcDade,
Lehmans Executive Committee usually met only on Mondays or Tuesdays. Id. The March 28, 2008
meetingtodiscussfirmwidebalancesheetissuesoccurredonaFriday.
3114Id.atp.4.
3115Id.atp.3.
812

Gregorys approval to institute the balance sheet reduction recommendations that
McDadepresentedatthemeeting.3116
The night before the March 28, 2008 Executive Committee meeting, McDades
assistant3117 circulated two documents to the entire Executive Committee, Lowitt, and
the assistants to Executive Committee members: (1) a meeting agenda, which listed
seven total items, including Repo 105/108, Delever v Derisk and Limit
Accountability;3118and(2)aBalanceSheetandCashCapitalUpdate.3119McDadeand
Gerard Reilly prepared the two documents to be discussed at the March 28 Executive
Committeemeeting.3120
At the March 28 Executive Committee meeting, McDade presented the Balance
SheetandCashCapitalUpdatedocument.3121McDadetriedtolayoutveryspecifically
the firmwide balance sheet for the Executive Committee. We wanted to focus the
ExecutiveCommitteeonthosethingsthatimpactedthefirmsnetleverageandbalance
3116Id.
3117Emailfrom Patricia Lombardi, Assistant to Herbert H. (Bart) McDade III, Lehman, to Lehman
BrothersExecutiveCommitteeMembers,Lehman,etal.(Mar.28,2008)[LBEXDOCID120929].
3118Lehman Brothers, Executive Committee Meeting Material, Agenda (Mar. 28, 2008) [LBEXDOCID
115827](attachedtoemailfromPatriciaLombardi,AssistanttoHerbertH.(Bart)McDadeIII,Lehman,to
LehmanBrothersExecutiveCommitteeMembers,Lehman,etal.(Mar.28,2008)[LBEXDOCID120929]).
3119HerbertH.(Bart)McDadeIII,Lehman,BalanceSheetandCashCapitalUpdate(Mar.27,2008)[LBEX
DOCID 095961] (attached to email from Patricia Lombardi, Assistant to Herbert H. (Bart) McDade III,
Lehman, to Lehman Brothers Executive Committee Members, Lehman, et al. (Mar. 28, 2008) [LBEX
DOCID120929]).
3121Id.
813

sheet.3122 With respect to net balance sheet limits, McDade wanted to impose
accountability,meaningthathewantedallatthefirmtostickwithinthoselimits.3123
McDadespecificallyrecalleddiscussingwithExecutiveCommitteememberson
March 28, 2008 Lehmans use of Repo 105 transactions.3124 The Balance Sheet and
Capital Update document expressly reported that Lehmans quarterend Repo 105
usageforfirstquarter2008was$49.1billion.3125Asbalancesheetpointperson,McDade
had no authority to authorize a firmwide cap on Lehmans use of Repo 105
transactions.3126 But McDade recommended to the Executive Committee during the
meeting that Lehman cap or limit its firmwide Repo 105 usage at a certain dollar
amount.3127 McDade said that in order to make the seismic change he wanted to
accomplishwiththebalancesheetinMarch2008,Lehmanhadtomakebigchanges,
which included significantly reducing or ceasing the firms use of Repo 105
3122Id.atp.4.
3122Id.
3123Id.atp.3.
3124ExaminersInterviewofHerbertH.BartMcDadeIII,Jan.28,2010,atpp.34.
3125HerbertH.(Bart)McDadeIII,Lehman,BalanceSheetandCashCapitalUpdate(Mar.27,2008),atpp.
12[LBHI_SEC07940_628517];ExaminersInterviewofHerbertH.BartMcDadeIII,Jan.28,2010,atp.
3; see also email from Jennifer Fitzgibbon, Lehman, to Leonard Sciutella, Lehman, et al. (Mar. 28, 2008)
[LBEXDOCID 1854825] (transmitting Balance Sheet and Cash Capital Update presentation and stating
attached balance sheet presentation discussed in todays executive committee meeting. . . . Reviewed
withBart[McDade]yesterday).DuringhisfirstInterviewwiththeExaminer,McDadesaidthathewas
surprisedwhentheExamineradvisedhimthatLehmanreduceditsnetbalancesheetatquarterendof
secondquarterof2008bymorethan$50.38billionusingRepo105transactions.ExaminersInterviewof
Herbert H. Bart McDade III, Sept. 16, 2009, at p. 4. McDade said he thought that the volume of
LehmansquarterendRepo105usagewasnohigherthan$20billion.Id.
3126ExaminersInterviewofHerbertH.BartMcDadeIII,Jan.28,2010,atpp.34.
3127Id.
814

transactions.3128 From McDades perspective, Lehmans traders should have sold
inventorytoreducebalancesheet,ratherthanengageinRepo105transactions.3129
OnApril2,2008,McDadereceivedanemailthatsaidNotsureyouarefamiliar
withRepo105butitisusedtoreducenetbalancesheetinourgovernmentbusinesses
around the world.3130 McDade responded that he considered Lehmans use of Repo
105 transactions to be undisciplined, another drug we r on.3131 McDade wanted
Lehmans traders to exercise more discipline: [T]raders knew that they could get
access to balance sheet through these more costly transactions, meaning Repo 105
transactions.3132 In other words, when traders found it hard to sell sticky assets or
wantedtoavoidsellingthematadiscount,theyknewthattheycouldrentthebalance
sheet,accordingtoMcDade,byremovingcertaininventorytemporarilythroughRepo
105transactionswhileallowingotherinventorytoremainonthebalancesheetandstill
3128Id.
3129Id.
3130 Email from Hyung Lee, Lehman, to Herbert H. (Bart) McDade III, Lehman (Apr. 3, 2008) [LBEX
DOCID1570783].
3131SeeemailfromHerbertH.(Bart)McDadeIII,Lehman,toHyungLee,Lehman(Apr.3,2008)[LBEX
DOCID 1570783]; see also email from Herbert H. (Bart) McDade III, Lehman, to Andrew J. Morton,
Lehman(Apr.3,2008)[LBEXDOCID1570784](explainingthatthefactthatLehmansnetbalancesheet
could increase at quarterend if it could not find Repo 105 counterparty is exactly why the drug is a
problem).
3132ExaminersInterviewofHerbertH.BartMcDadeIII,Jan.28,2010,atp.6.KaushikAminrecalled
McDadestatingthatLehmanshouldusefewerRepo105transactions;Aminbelievedthiswasbecauseof
asensewithinLehmanthat[Repo105]mightnotmeetarigoroustestinthemarketplace.Examiners
InterviewofKaushikAmin,Sept.17,2009,atp.8.
815

reach Lehmans balance sheet targets.3133 McDade wanted traders to sell assets rather
thanrentthebalancesheet.3134
Although McDades Balance Sheet and Cash Capital Update presentation was
discussedattheMarch 28,2008Executive Committee meeting,3135duringatimewhen
Erin Callan was a member of the Executive Committee and Lowitt sat as an ex officio
member,whenquestionedbytheExaminer,neitherCallannorLowittcouldrecallthe
actual volume of quarterend Repo 105 usage in late 2007 and 2008, or whether the
ExecutiveCommitteediscussedLehmansRepo105usage.3136OnApril9,2008,twelve
3134Id.
3135EmailfromJenniferFitzgibbon,Lehman,toLeonardScicutella,Lehman,etal.(Mar.28,2008)[LBEX
DOCID1854825](transmittingcopyofLehman,BalanceSheetandCashCapitalUpdate(Mar.27,2008)
[LBEXDOCID1698670]andstatingplease[see]attachedbalancesheetpresentationdiscussedintodays
executivecommitteemeeting);seealsoemailfromGerardReilly,Lehman,toPaoloR.Tonucci,Lehman,
et al. (Mar. 28, 2008) [LBEXDOCID 124422] (transmitting copy of Lehman, Balance Sheet and Cash
CapitalUpdate(Mar.27,2008)[LBEXDOCID095966]andstatingThisisthebsdocforexeccointhe
morning); email from Gerard Reilly, Lehman, to Martin Kelly, Lehman, et al. (Mar. 28, 2008) [LBEX
DOCID2636182](transmittingcopyofLehman,BalanceSheetandCashCapitalUpdate(Mar.27,2008)
[LBEXDOCID 2489767] and stating This was the exec b[alance] s[heet] pres[entation]); Examiners
InterviewofHerbertH.BartMcDadeIII,Jan.28,2010,atpp.23.
3136ExaminersInterviewofErinM.Callan,Oct.23,2009,atpp.17,19(statingthatshebelievedLehmans
Repo105usagewas$20billionandthatshedidnotrecallbeingpartofanydiscussionsregardinglimits
onRepo105usage);ExaminersInterviewofIanT.Lowitt,Oct.28,2009,atpp.11,13(statingthathewas
not present at any Executive Committee meeting atwhich Repo105 was discussed and that he had no
recollection of focusing on Lehmans Repo 105 usage, including the $25 billion third quarter target);
Examiners Interview of Richard S. Fuld, Jr., Nov. 19, 2009, at p. 7 (stating that he did not attend any
Executive Committee meeting where Repo 105 was discussed and stating he had no knowledge of
LehmansRepo105usage).AndrewMorton,whoservedontheExecutiveCommitteebeginninginJune
2008,however,recalledthatLehmanusedRepo105transactionstoreduceitsnetbalancesheetandthat
thesewerewidelyused,widelyunderstoodtransactions.ExaminersInterviewofAndrewJ.Morton,
Sept.21,2009,atp.4.
816

daysafterMcDadespresentationtotheExecutiveCommittee,CallansignedLehmans
quarterlyreport.3137
FollowingFuldsdirective,andinconnectionwithMcDadesbalancesheetpoint
personrole,GregoryandMcDadesatdownwithLehmandivisionheadsanddiscussed
targetsforassetclassesandbusinesslines.3138GregoryandMcDadefrequentlychecked
in with division heads in mid 2008 regarding their progress in meeting balance sheet
targets,andprovidedupdatestoFuld,althoughnotonaverygranularlevel.3139Fuld
recalled that Gregory was comfortable with the progress Lehman was making in
bringingdownitsbalancesheetandFuldsaidthathebelievedLehmanwasmeetingits
balancesheettargetsbysellingilliquidassets.3140
Other documents contemporaneous to McDades presentation to the Executive
Committee demonstrate that the issue of balance sheet and leverage reduction was
beingdiscussedatthehighestlevelsofseniorLehmanmanagement:3141
An April 1, 2008 internal Lehman presentation by Eric Felder, thenUnited

States Head of Credit Products, highlighted how the markets mood and
perceptionofriskhadchanged,andLehmanstartedtopenalizebrokersfor
maintaining high leverage.3142 According to the presentation: brokers will
3137LBHI,10Q(filedApr.9,2008),atp.92.
3139Id.
3140Id.
3141ExaminersInterviewofRichardS.Fuld,Jr.,Sept.25,2009,atp.8(statingthatratingagenciescared
aboutnetleverageratio).
3142Eric
Felder, Lehman, Untitled Internal Presentation [Draft] (Apr. 1, 2008), at pp. 710
[LBHI_SEC07940_085870].
817

be forced to delever to maintain ratings and access to lowcost debt.3143

Indeed, a ratings downgrade could lead to counterparty demands that
Lehmanpostadditionalcollateralforsecuredfinancing.3144
An April 2008 Leverage Analysis report sent to Tonucci and Reilly

compared Lehmans first quarter 2008 leverage ratios and balance sheet by
business with the same measurements for Lehmans fourth quarter 2003.3145
It also compared Lehmans and its competitors net leverage ratios and net
assets.
TwoweeksbeforethecloseofLehmanssecondquarter2008in May2008, and
following a meeting with Fidelity, Callan wrote to Gregory and Fuld about Fidelitys
feedback:
[W]emaygetaveryshortleashifweshowupwitharoughquarterifwe
do not get the balance sheet exercise completed. No matter what, the
skepticsarefocusedonourbalancesheetandthatisthekeytothefuture....I
knowwearesayingitoverandoverbutweHAVEtodeliveronthebalance
sheetreductionthisquarterandcannotgiveanyroomtoFIDforslippage.3146
At the close of Lehmans second quarter in May 2008, and in connection with
MortonsGlobalFIDmeetingonbalancesheetissues,Freidheim,aLehmanManaging
Director,wrotetoLowittandMortonaboutthematerialityofLehmansbalancesheet
reduction:
3144Email from Ian T. Lowitt, Lehman, to Eric Felder, Lehman (July 5, 2008) [LBEXDOCID 071263]
(statingthatadowngradewillaffectlinesandwillingnessofcounterpartiestofundsecured);Amadou
N.R.Sy,TheSystemicRegulationofCreditRatingAgenciesandRatedMarkets89(IntlMonetaryFund,
Working Paper, 2009) (noting that brokerdealers may use credit ratings to determine acceptable
counterparties,aswellascollaterallevelsforoutstandingcreditexposure).
3145Lehman, Leverage Analysis Report (Apr. 4, 2008) [LBEXDOCID 103786] (attached to email from
RobertAzerad,Lehman,toPaoloR.Tonucci,Lehman,etal.(Apr.4,2008)[LBEXDOCID125281]).
3146Email from Erin M. Callan, Lehman, to Richard S. Fuld, Jr., Lehman, et al. (May 13, 2008)
[LBHI_SEC07940_034732](emphasisadded).
818

RegardingbalancesheetreductionIwouldnotsaywehavereducedthe
balancesheetandbroughtitdownfrom15.6to12.6thatismaterialnon
publicinformationandeveryone(themarket)islookingforthenumberetc.
andinaforumofthousandsofpeopleisnotsrmgmtandleakpossibility
is very high). however you can say whatever erin has said it is a
significantaccomplishmentthatwehavedeleveragedthebalancesheetso
quickly + positioned ourselves for future . . . I would not use the
number.3147
(b) McDadeBecamePresidentandCOOonJune12,2008and
AuthorizedtheReductionofRepo105Usage
Lehman used $50.38 billion of Repo 105 transactions at the end of the second
quarter on May 30, 2008, up slightly from the previous quarter.3148 Upon becoming
Lehmans President and COO on June 12, 2008, McDade was finally empowered to
authorize a firmwide reduction in Repo 105 usage.3149 On June 17, 2008, Reilly
circulated to McDade, Lowitt, Andrew Morton (Head of FID), and Chris OMeara a
document entitled Balance Sheet and Key Disclosures that incorporated McDades
plan to reduce Lehmans firmwide Repo 105 usage by half from $50 billion to $25
billion in third quarter 2008.3150 In response to Reillys circulation of the presentation
announcingthatLehmansfirmwideRepo105usagewouldbecutby50%inthethird
3147EmailfromScottJ.Freidheim,Lehman,toIanT.Lowitt,Lehman,etal.(May30,2008)[LBEXDOCID
1906851](emphasisadded).
3148See,e.g.,Lehman,BalanceSheetandKeyDisclosures20083QTargets[Draft](June16,2008),atp.3
[LBHI_SEC07940_641516].
3150Lehman, Balance Sheet and Key Disclosures 2008 3Q Targets [Draft] (June 16, 2008), at p. 3 [LBEX
DOCID 3363493] (attached to email from Gerard Reilly, Lehman, to Herbert H. (Bart) McDade III,
Lehman, et al. (June 17, 2008) [LBEXDOCID 3383643]); see also email from Gerard Reilly, Lehman, to
HerbertH.(Bart)McDadeIII,Lehman,etal.(Aug.17,2008)[LBEXDOCID4517376](Repo105should
be25babouthalfofwhatitwaslastquarter.).
819

quarter2008,MortoncomplainedthattheproposedbalancesheettargetforFIDinthird
quarter2008wasidenticaltothesecondquartertarget,butwiththeRepo105limitcut
in half, the Rates business of FID would not survive.3151 Reilly responded to Morton:
ThinkthisismostconservativecaseandinitiallyBart[McDade]hadaviewofkeeping
totalassetsflatbutthatwastwoweeksagoandmayhavechanged.3152
McDade, Reilly, Lowitt, Morton and OMeara met to discuss the Balance Sheet
and Key Disclosures document in June 2008.3153 McDade recalled that he brought
OMeara back in the [balance sheet] process to help in light of OMearas past
experienceasCFO.3154
McDade discussed the Balance Sheet and Key Disclosures document with
Richard Fuld in June 2008.3155 McDade specifically walked Fuld through the
3151Email from Andrew J. Morton, Lehman, to Gerard Reilly, Lehman (June 17, 2008) [LBEXDOCID
4553451].
3152Email from Gerard Reilly, Lehman, to Andrew J. Morton, Lehman (June 17, 2008) [LBEXDOCID
4553451].
3153EmailfromChristopherM.OMeara,Lehman,toHerbertH.(Bart)McDadeIII,Lehman,etal.(June
17, 2008) [LBEXDOCID 033813] (replying to receipt of Balance Sheet and Key Disclosures 2008 3Q
Targets[Draft](June16,2008)andstatingthatmeetingisbeingsetuptodiscusstheBalanceSheetand
Key Disclosure 2008 3Q Targets document); email from Gerard Reilly, Lehman, to Herbert H. (Bart)
McDadeIII,Lehman,etal.(June19,2008)[LBEXDOCID2962369](transmittingLehman,BalanceSheet
andKeyDisclosures20083QTargets(June19,2008)[LBEXDOCID2932594]andstating[u]pdatedfrom
our meeting). One email suggests that the Executive Committee approved the reduction soon
thereafter.SeeemailfromJenniferFitzgibbon,Lehman,toFrancisPearn,Lehman,etal.(June23,2008)
[LBEXDOCID1856501](transmittingLehman,BalanceSheetandKeyDisclosures20083QTargets(June
19,2008)[LBEXDOCID1698850]andstating[a]ttachedisfinalbalancesheetandcertainkeydisclosure
targetsfor3Q.Shouldbeapprovedbyexeccommtoday).
3154ExaminersInterviewofHerbertH.BartMcDadeIII,Jan.28,2010,atp.8
3155Id.atp.5.
820

presentation....3156McDadediscussedpagethreeofthepresentationwithFuld,which
identified that Lehman used $38.6 billion, $49.1 billion, and $50.3 billion of Repo 105
transactions,atquartersendfourthquarter2007,firstquarter2008,andsecondquarter
2008, respectively.3157 McDade said that, as referenced on page three of the Balance
SheetandKeyDisclosuresdocument,healsotoldFuldthathe(McDade)recommended
that Lehman reduce its firmwide Repo 105 usage to $25 billion in the third quarter
2008.3158
McDadeobservedthatFuldwasfamiliarwiththetermRepo105.3159McDade
recalled that Fulds response to the entire document was good, good, good; he was
nodding approval and that Fuld was supportive of reducing the firms use of Repo
105.3160Morespecifically,regardingMcDadesrecommendationtocutLehmansuseof
Repo105inhalfinthethirdquarter2008,McDaderecalledFuldasked,Isitdoable?Is
itnecessary?Ifso,[Fuld]said,godoit.3161McDadeconcludedthatFuldknewabout
theaccountingofRepo105.3162
DuringtheJunemeetingwithFuldovertheBalanceSheetandKeyDisclosures
document, McDade and Fuld discussed that Lehmans need to deleverage was
3156Id.
3157Id.
3158Id.
3160Id.
3161Id.atp.6.
3162Id.
821

absolutely a critical issue to Lehman.3163 On July 10, 2008, a few weeks after
discussing the Balance Sheet and Key Disclosures document with McDade, Fuld
signed Lehmans quarterly report.3164 Fuld denied any recollection of conversations
with McDade or other members of Lehmans Executive Committee regarding Repo
105.3165
(3) TheMarketsIncreasedScrutinyoftheLeverageofInvestment
Banks
In midtolate 2007, Lehman faced a growing challenge: the market began
demanding that investment banks shrink their balance sheet and lower their
leverage.3166 Before mid2007, rating agencies, media, and outside analysts who
3163Id.atp.5.
3164LBHI,10Q(filedJuly10,2008),atp.160.
3166ExaminersInterviewofMichaelMcGarvey,Sept.11,2009,atp.6;MarkJickling,AvertingFinancial
Crisis,CRSReportforCongress,at18(Mar.10,2008,updatedonOct.8,2008)(explainingthatthemarket
begandemandingthatinvestmentbankslowertheirbalancesheetandreduceleverage).Balancesheet
management, which refers to the manner in which firms control the size of their balance sheet, is
importanttofirmsfornumerousreasons,includingtheimpactbalancesheethasonleverage.Examiners
InterviewofMichaelMcGarvey,Sept.11,2009,atpp.56;ExaminersInterviewofPaoloR.Tonucci,Sept.
16, 2009, at p. 26 (stating that balance sheet targets were driven by what managers considered a good
rangeforleverage);ExaminersInterviewofIanT.Lowitt,Oct.28,2009,atpp.3031;emailfromIanT.
Lowitt,Lehman,toRogerNagioff,Lehman(Apr.16,2007)[LBEXDOCID175349](transmittingbalance
sheet management policy [LBEXDOCID 148914] and 2007 Balance Sheet Targets and Usage). The
purposeofbalancesheetmanagementatLehmanwastocontrolthefirmsleverageratios.Examiners
InterviewofAnurajBismal,Sept.16,2009,atp.5.Capitaladequacy,asthatphraseisusedvisvislarge
investmentbanks,iscommonlymeasuredusingaleverageratio,whichdividessomemeasurementofthe
investment banks assets by the capital equity in the bank, to determine the risk profile and relative
solvency of the entity. See LBHI 2007 10K, at pp. 30, 63; Duff & Phelps, Repo 105 Balance Sheet
Accounting Entry and LeverageRatiosSummary (Oct. 2, 2009), 2009,at p. 6. Thus, in order to control
leverage,Lehmansbalancesheettargetswerereverseengineered,workingbackwardfromthefirms
leverageratiotarget.ExaminersInterviewofMatthewLee,July1,2009,atp.15;ExaminersInterviewof
MichaelMcGarvey,Sept.11,2009,atp.5;ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atp.6.
Thereisnothingnecessarilyimproperaboutbalancesheetmanagement;itisanormalbusinesspractice
822

observed Lehman focused on the firms revenues and profit and loss, P&L.3167
Sometime in mid2007, however, those same outside rating agencies and analysts
pronounced the metrics of an investment banks balance sheet and capital at least as
important,ifnotmore,thanrevenueandP&L.3168Thebreakdownofsecuritizationand
structuredfinancemarketsinlate2007intensifiedbalancesheetpressuresonbanks.3169
usedbymanyinstitutions.AsdiscussedintheExaminersConclusions,balancesheetmanagementdone
inawaythatmateriallymisrepresentsthetruefinancialpositionofthecompanycan,however,giverise
toacolorableclaim.
3167Mike Shedlock, MISHs Global Economic Trend Analysis, Bank Balance Sheets and Earnings,
http://globaleconomicanalysis.blogspot.com/2007/09/bankbalancesheetsandearnings.html (Sept. 30,

2007,1:38PM);ExaminersInterviewofMichaelMcGarvey,Sept.11,2009,atp.6.
3168See, e.g., Ben Bernanke, Chairman of the Bd. of Governors of the U.S. Fed. Reserve Sys.,The Recent
Financial Turmoil and its Economic and Policy Consequences, Address at the Economic Club of New
York3(Oct.15,2007),availableat:
http://www.federalreserve.gov/newsevents/speech/bernanke20071015a.htm (stating that strains in
financialmarketspromptedbankstobecomeprotectiveoftheirliquidityandbalancesheetcapacity);
TobiasAdrianandHyunSongShin,Liquidity,MonetaryPolicy,andFinancialCycles,CURRENTISSUESIN
ECON.&FIN.(Jan.Feb.2008),at4,availableathttp://www.nyfrb.org/research/current_issues(discussing
how financial institutions chief tool in adjusting leverage is collateralized borrowing and lending (i.e.,
repoandreverserepoagreements)andthatintimesofmarketturmoil,financialinstitutionstrytolower
their leverage); The Economic Outlook: Hearing Before H. Comm. on the Budget, 110th Cong. (Jan. 17,
2008) (statement of Ben Bernanke, Chairman of the Bd. of Governors of the U.S. Fed. Reserve Sys.),
availableat:http://www.federalreserve.gov/newsevents/testimony/bernanke20080117a.htm;MarkJickling,
Averting Financial Crisis, CRS Report for Congress, at 18 (Oct. 8, 2008, updated on Mar. 21, 2009)
(explainingthatthemarketbegandemandingthatinvestmentbankslowertheirbalancesheetandreduce
leverage);ExaminersInterviewofMichaelMcGarvey,Sept.11,2009,atp.6.
3169Timothy F. Geithner, President, Fed. Reserve Bank of N.Y., Reducing Systemic Risk In A Dynamic
FinancialSystem,RemarksattheEconomicClub,NewYorkCity,NewYork,(June9,2008),availableat
http://www.newyorkfed.org/newsevents/speeches/2008/tfg060809.html (The funding and balance sheet
pressures on banks were intensified by the rapid breakdown of securitization and structured finance
markets.Bankslostthecapacitytomoveriskierassetsofftheirbalancesheets,atthesametimetheyhad
tofund,ortopreparetofund,arangeofcontingentcommitmentsoveranuncertaintimehorizon.);see
alsoDianeHinton,Standard&PoorsRatingsDirect,LiquidityManagementInTimesOfStress:HowThe
MajorU.S.BrokerDealersFare(Nov.8,2007),atpp.23[LBHI_SEC07940_439424](Recentdisruptions
in the subprime market and its contagion effects into the leveraged finance, assetbacked commercial
paper (ABCP), and CDO spaces have substantially curtailed market liquidity. The sudden loss of
appetite for subprime and other highyield exposure has significantly narrowed these markets, while
uncertaintyregardingassetvaluationsleftmanyinstitutionsunabletounwindexposuresatfairmarket
prices....Asaresult,themarketsfortheseassetshaveconsiderablyshrunk.).
823

One analyst wrote in late September 2007: [Banks] net incomes this quarter dont
matter.Andtheydontmatterbecauseofonesimpleruleforfinancialservicesfirms:
The income statement is the past. The balance sheet is the future. . . . At the top of a credit
cycle,theincomestatementforafinancialinstitutionshowsthebestoftimesbutburied
inthebalancesheetistheworstoftimestocome.3170
The markets increased focus on balance sheet and leverage only intensified in
2008.3171 Rating agencies, analysts, and the media became more concerned about the
typesofinventoryinvestmentbanks,includingLehman,maintainedontheirrespective
balancesheets,thesizeofabanksbalancesheet,andhowmuchofitsbalancesheetsa
firmused.3172Forexample,followingthenearcollapseofBearStearnsinMarch2008,an
editorial columnist asked the question Will Citibank Survive? and answered by
3170Mike Shedlock, MISHs Global Economic Trend Analysis, Bank Balance Sheets and Earnings,
http://globaleconomicanalysis.blogspot.com/2007/09/bankbalancesheetsandearnings.html (Sept. 30,
2007, 1:38 PM) (emphasis added); see also Cong. Research Serv., 110th Cong., Financial Crisis? The
LiquidityCrunchofAugust20077(CRSReportRL34182)(DarrylE.Getter,etal.)(statingthatmarket
optimismandunderestimationofriskencouragedtheoveruseofleverage,orborrowedmoney,toboost
returns); Mark Jickling, Averting Financial Crisis 6, CRS Report for Congress (Mar. 10, 2008) (As its
capitallosesvalue,thefirmmustshrinkitsbalancesheettomaintainagivenleverageratio.Asfirmssell
assetstoreducebalancesheetexposure,assetpricesaredrivendown.).
3171EmailfromPeterEavis,WallStreetJournal,toKerrieCohen,Lehman(Mar.18,2008)[LBEXDOCID
1610003](askingLehmantoexplainitsnetleveragecalculation);LBHI10Q(filedApr.9,2008),atp.65
(During the 2008 quarter, the Company operated in a liquidity, funding, and capital environment
characterized by constrained market liquidity driven in part by balancesheetandleverageconcerns.);
JohnHilsenrath,etal.Goldman,MorganScrapWallStreetModel,BecomeBanksinBidtoRideOutCrisis,Wall
St.J.(Sept.22,2008)atA1(reportingthattheworldnolongertolerateshighleverageandthatanalysts
feltthatinvestmentbanksreliedtooheavilyonshorttermborrowedmoney).
824

examiningCitisbalancesheet[and]ignoringitsincomestatementbecauseinacrisis,
futurecashflowisbasicallyirrelevanttoabankssurvivalandneedforliquidity.3173
The market turned its focus to the leverage of investment banks in midtolate
2007,justasLehmanfounditincreasinglydifficulttosellitsstickyinventory.3174Asa
consequence, by late 2007, the highest levels of Lehman senior management placed
increasingemphasisonreducingthebalancesheetandreducingLehmansleverage.3175
ThisconcertedeffortbyseniorLehmanmanagementwasdonewithaneyetowards
theratingagenciesviewsofLehman.3176
(a) TheCostofDeleveraging
In order to reduce its net leverage, Lehman could have either decreased the
numerator used in its net leverage ratio calculation (i.e., net assets), or increased the
denominator by raising equity.3177 Fuld acknowledged that although raising equity
3173James Turk, Will Citibank Survive?, Financial Sense, Mar. 17, 2008,
http://www.financialsense.com/editorials/turk/2008/0317.html; see also Systemic Regulation, Prudential
Matters, Resolution Authority and Securitization: Hearing Before H. Comm. on Financial Servs., 111th
Cong. 3 (Oct. 29, 2009) (statement of Jane DArista, Americans for Financial Reform) (explaining how
excessiveleveragethroughoutthefinancialsystemmadeinstitutionsvulnerabletoanyeventthatmight
threatentheirabilitytorolloverthefundingthatsupportedtheirinflatedbalancesheets).
3175Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at p. 8. Fuld explained that he made
strategicdecisionstoreduceLehmansbalancesheetandbringdownthenetleverageratiotoimprove
marketperceptionsofLehman.
3176ExaminersInterviewofMichaelMcGarvey,Sept.11,2009,atpp.5,8;ExaminersInterviewofAnuraj
Bismal,Sept.16,2009,atp.5;seealsoLehman,LehmanPresentationtoRatingAgencies[Draft](May12,
2008),atp.20[LBEXDOCID3192668](attachedtoemailfromKevinThatcher,Lehman,toIanT.Lowitt,
Lehman, et al. (May 21, 2008) [LBEXDOCID 3200389] and stating that [i]n an effort to reduce Q2 08
leverageratios,theFirmisundergoingadeleveragingexercisewhichwillbedrivenbyspecificbalance
sheetreductionscoupledwithcapitalraising).
825

could also reduce the net leverage ratio, Lehman had to improve its net leverage by
reducing its net assets (i.e., selling inventory) because there was a perception issue
withraisingequity.3178Ifweraisedequity,wewouldhavebroughtthe[netleverage
ratio] number down, but would not have really fixed anything.3179 Accordingly, to
meetitsgoalofreducingthefirmwidenetleverageratio,Lehmansoughttoreduceits
netassets.3180
Reducing net assets through outright sales, however, also came at a cost to
Lehman. First, the sale of many of its inventory positions would result in substantial
lossestoLehman.AninternalLehmanPowerPointpresentationthatCFOErinCallan
prepared in early April 2008, entitled Leverage Analysis, illustrates this point.3181
Lehmansgrowthinnetbalancesheethasbeenweightedtowardmortgagesandloans.
Deleveragingwillrequiresellingtheseassets,whichwillresultinlossesforLehman....
Reducingleverageisnecessarytoremoverefinancingriskandwinbacktheconfidence
of the market, lenders, and investors.3182 Winning back the confidence of the market
was necessary, in part, because [a]fter initially declining, Lehman Brothers net
3178Id.
3179Id.
3180Id.;ExaminersInterviewofClementBernard,Oct.232009,atp.12.ClementBernardmadeasimilar
pointasFuldregardingLehmansroutetoreducingitsnetleverageratio.BernardstatedthatLehman
could easily have reduced its gross balance sheet by reducing matched book, but that reducing net
balancesheetwasmoredifficultasitrequiredLehmaneithertosellassetsorengageinadditionalRepo
105transactions.
3181ErinM.Callan,Lehman,LehmanBrothersLeverageAnalysis(Apr.7,2008),atp.1[LBEXDOCID
1401225] (attached to email from Edward Grieb, Lehman, to Edward Grieb, Lehman (Apr. 5, 2008)
[LBEXDOCID1542476]).
3182Id.atp.1.
826

leverage...ha[d]creptbacktowardsthehigherendofthepeergroupinrecentyears,
signalinghigherrisk.3183LehmanschangeinNetLeverage[wa]ssmall,butweighted
towards illiquid assets like mortgages and loans.3184 In fact, the composition of
Lehmans Level 3 assets was 60% mortgages.3185 Callan reported the potential cost to
Lehmanofdeleveraging:moving$22billionofilliquidassetswouldhavecostLehman
anestimated$750million.3186
In addition to the losses Lehman would incur by selling sticky assets at fire
saleprices,deleveragingalsoraisedtheadditionalproblemsofmarketperceptionand
valuation.3187AsSecretaryTimothyGeithnerexplainedtotheExaminer,sellingsticky
assetsatdiscountscouldhurtLehmanbyrevealingtothemarketthatLehmanhada
lotofairin[its]marksandtherebyfurtherdrainingconfidenceinthevaluationofthe
assetsthatremainedonLehmansbalancesheet.3188
3183Id.atp.5.
3184Id.atp.7.
3185Id.atp.9.
3186ErinM.Callan,Lehman,LehmanBrothersLeverageAnalysis(Apr.7,2008),atp.12[LBEXDOCID
1401225].
3187ExaminersInterviewofSecretaryTimothyF.Geithner,Nov.24,2009,atpp.78.
3188Id.; see also The Economic Outlook: Hearing Before H. Comm. on the Budget, 110th Cong. (Jan. 17,
2008) (statement of Ben Bernanke, Chairman of the Bd. of Governors of the U.S. Fed. Reserve Sys.),
available at: http://www.federalreserve.gov/newsevents/testimony/bernanke20080117a.htm (explaining
that as financial institutions came under pressure in 2007 and 2008 to remove hardtovalue products
from balance sheet of special purpose entities and onto their own balance sheet, banks balance sheets
swelledwithilliquid,stickyinventory).
827

(4) StickyInventoryandFIDsBalanceSheetBreaches
HamperedLehmansAbilitytoManageItsNetLeverage
LehmanexpandeditsRepo105practiceinthecontextofanincreasinglysticky
balancesheet.InFebruary2007,JosephGentile,FIDsthenChiefFinancialOfficerwho
reported directly to Gerard Reilly, sent a proposal to Ed Grieb, thenGlobal Financial
Controller,petitioningGriebtoincreasethefirms$22billioncombinedfirmwideRepo
105/108 limit to $25 billion.3189 Gentiles February 2007 request provided three
interrelatedreasonswhyLehmanshouldincreaseitsinternalRepo105limit:
Lehmans Real Estate Group likely would not be able to conduct its
Windermere securitization ($2B) in first quarter 2007 and Lehmans
Mortgages Group will have a great deal of difficulty in selling sub prime
loans (5.0bn), adversely affecting balance sheet. Exiting these position[s]
wouldbeimpossibleorprohibitivelycostly.3190
Repo 105 offers a low cost way to offset the balance sheet and leverage
impactofcurrentmarketconditions.3191
LehmanwouldhavesignificantdifficultyexitinglargepositionsinitsReal
Estate and Mortgage Groups without incur[ring] large losses due to the
steep discounts that they would have to be offered at and [the] substantial
reputation risk in the market as it would suggest a serious issue with our
Mortgage/RealEstateconcentrations.ARepo105increasewouldhelpavoid
thiswithoutnegativelyimpactingourleverageratios.3192
3189Joseph Gentile, Lehman, Proposed Repo 105/108 Target Increase for 2007 (Feb. 10, 2007) [LBEX
DOCID 2489498] (attached to email from Joseph Gentile, Lehman, to Edward Grieb, Lehman (Feb. 10,
2007)[LBEXDOCID2600714]).RecallthataJuly2006OverviewofRepo105/108Presentationstatedthat
GriebandCFOChrisOMearawereresponsibleforsettingLehmanslimitsonRepo105activityat$17
billionandRepo108activityat$5billionforatotalof$22billionincombinedRepo105/108limits.
DOCID2489498].
3191Id.
3192Id.; see also email from Heidimarie Echterman, Lehman, to Gerard Reilly, Lehman (Feb. 23, 2007)
[LBEXDOCID1620265](Netleverageisdown1turnvsnumberdiscussedatthismorningsFOC(15.5x
828

Subsequent Lehman emails indicate that Lehman raised the combined Repo
105/108limitinFebruary2007by$3billion,from$22billionto$25billion.3193
As it became increasingly difficult in 2007 for Lehman to exit certain positions,
Lehmans maneuverability with respect to meeting balance sheet and leverage targets
diminished.3194ThisputadditionalpressureonmoreliquidbusinesseswithinLehman
toreducebalancesheet,asexemplifiedbyGentilesFebruary2007requesttoGrieb.3195
now15.4xvstarget14.8x).Doyouthinkwewillbeabletogetbelowthisforquarterend?Ihavenothad
anydiscussionwithChrisonthisdoweneedtoalerthim?).EchtermanforwardedthisemailtoPaolo
Tonucci, thenTreasurer, adding: Sorry I meant to copy you its all in IRP and Real Estate. They are
lookingtodomoreRepo105andselldownpositions.GelbandhasbeenalertedbyJoe[Gentile].Id.
3193EmailfromJosephGentile,Lehman,toMichaelGelband,Lehman,etal.(Feb.21,2007)[LBEXDOCID
4553218] (I have been able to get a temp limit of 3 bn for repo 105 activity, which covers known real
estateissues....);emailfromJosephGentile,Lehman,toGerardReilly,Lehman(Feb.21,2007)[LBEX
DOCID4553220](respondingtoquestionWheredidthe3bncomefrom?bywriting:Wespokewith
griebandhewasokwithatemporaryexcessionof$3....);emailfromMichaelMcGarvey,Lehman,
toAnurajBismal,Lehman,etal.(May9,2007)[LBEXDOCID3223356](17bnwastheyearendlimitfor
FID.InQ1JoeGentilespoketoEdwardGriebaboutraisingitto20bn(basedontheattacheddoc)and
accordingtoJoeEdagreed.).
2007)[LBEXDOCID2600714]);emailfromSigridStabenow,Lehman,toEricAddington,etal.Lehman
(Feb.1,2008),[LBHI_SEC07940_1840953](TheFIDbusinessanalysisteam...review[ed]howFIDis
usingitsbalancesheet.Thepurpose[ofthereview]is...togiveclarityonwhatismovablebalancesheet
in the current envt and . . . to address the Q1 balance sheet limit issues were facing. . . . [T]he global
problem that FID is facing [is] that they are expected to be $15 bn over limit.. . . The stickiness of real
estate&securitizedproductsinamericasandeuropearecreatingissues.);emailfromClementBernard,
Lehman, to Andrew J. Morton, Lehman, et al. (Feb. 4, 2008) [LBEXDOCID 1849805] (discussing firm
widenetleverageratio,FIDssticky/illiquid/Level3inventory,thepercentageofFIDsbalancesheetthat
thisstickyinventoryconstitutes,andthatLevel3assetshaveincreasedalotin2007due[to]someassets
becominglessobservable).Lehmanmanagementmonitoredandassessedwhetherthedollarvalueof
itsassets(thenumeratorinthenetleverageratioequationusedatLehman)wasatanappropriatelevel
by setting balance sheet targets for the firm, specific business units, and even for individual traders.
ExaminersInterviewofMichaelMcGarvey,Sept.11,2009,atpp.56;ExaminersInterviewofTejalJoshi,
Sept.15,2009,atp.5;ExaminersInterviewofAnurajBismal,Sept.16,2009,atp.5;ExaminersInterview
of Kaushik Amin, Sept. 17, 2009, at p. 5; Examiners Interview of Mitchell King, Sept. 21, 2009, at p. 5;
ExaminersInterviewofMartinKelly,Oct.1,2009,atp.11;ExaminersInterviewofJosephGentile,Oct.
21,2009,atp.5.Balancesheettargetswereafunctionofthefirmwideleverageratiotarget,whichwas
reportedpublicly.See,e.g.,emailfromClementBernard,Lehman,toRogerNagioff,Lehman,etal.(Nov.
829

20,2007)[LBEXDOCID173748](ThenetBalanceSheetforecastforFIDforNovember30hasincreased
to$232.6Biofromapreviousforecastof$227Bio.Thisis$12.6Bioabovethelimitof$220Bio.Thelimit
of$220Bioequatestoaleverageratioof16whichisthecurrentfirmtarget.Basedonmyconversations
with Paolo [Tonucci] we need to get down to $225 Bio in order for the ratio to be back to target.);
Examiners Interview of Paolo R. Tonucci, Sept. 16, 2009, at p. 26 (stating that Lehmans balance sheet
targetsweredrivenbywhatanacceptablerangeofleverageforthefirmwouldbe);ExaminersInterview
of Martin Kelly, Oct. 1, 2009, at p. 11; Examiners Interview of Joseph Gentile, Oct. 21, 2009, at p. 5;
Examiners Interview of Ian T. Lowitt, Oct. 28, 2009, at pp. 3031 (stating that collaborative process
between Finance, Fixed Income, Markets, and Treasury used to set balance sheet targets for businesses
but that leverage ratio target was a firmwide target). After the leverage target was set, each Lehman
businessgroupordivisionwouldallocatebalancesheetusagetounitswithinthatbusinessbasedupon
how much balance sheet was needed to run a groups operations. For example, as part of his
management reporting duties, Joseph Gentile, the former Financial Officer of Lehmans FID, tracked
FIDs balance sheet on a daily basis and as part of Lehmans balance sheet management process.
ExaminersInterviewofJosephGentile,Oct.21,2009,atp.5.IfLehmansfirmwidenetleverageratio
wastoohigh,individualbusinessessuchasFIDwouldbeinformedoftheimpacttheirrespectivebalance
sheetbreacheshadonthefirmsleverageratio.Id.;seealsoemailfromGerardReilly,Lehman,toJoseph
Gentile, Lehman (Feb. 21, 2007) (stating the impact of $10 billion balance sheet breach by FID on
Lehmansnetleverageratioandstating:Theseguysaregoingtohavetotakeaccountabilityforunder
performance.Atleasttellguystocutb[alance]s[heet]iftheydontmakemoney.);emailfromJoseph
Gentile,Lehman,toGerardReilly,Lehman(Feb.21,2007)[LBEXDOCID4553347].MichaelMcGarvey
similarly said that beginning sometime in 2007 (as leverage became increasingly important to market
observers) and until September 2008, when Lehman filed for bankruptcy, he assumed a newlycreated
roleinwhichhebothworkedwithdifferentproductgroupswithinFIDtodevelopdailyestimatesofthe
groupsbalancesheetandhowmuchfundingeachdeskwasusing,andcommunicatedtoFIDproduct
controllersthebalancesheettargetssetbyLehmansTreasurygroup.ExaminersInterviewofMichael
McGarvey,Sept.11,2009,atp.6.McGarveyalsocommunicatedthesetargetstotheFinancialController.
See email from Michael McGarvey, Lehman, to Martin Kelly, Lehman (Jan. 30, 2008)
[LBHI_SEC07940_861472861474](reportingthatFIDsRatesbusinesshas$113.6billioninnetassets,that
thequarterendforecastismorethan$3billionovertarget,soLehmanshouldreducenetassetsby$68
billion). Lehman documents, including PowerPoint presentations and email communications, confirm
thesettingofbalancesheettargetsandleverageratiotargetsatthefirm.See,e.g.,Lehman,RatesBusiness
Projected Balance Sheet Spreadsheet (Aug. 21, 2006) [LBEXDOCID 2783441]; email from Kentaro
Umezaki,Lehman,toIanT.Lowitt,Lehman(Apr.16,2007)[LBEXDOCID288764](Givingouttargets
forQ2aswespeak.Numbersattached...allbizsareawareofitsimportancenow...Gerry[Reilly]has
usworkingwitha195netbalancesheettargetnow...togetusto15xnetleveragebyendofMay....);
Lehman, Lehman Asset Statement Balance Sheet January 10, 2007 Spreadsheet (Jan. 11, 2007) [LBEX
DOCID648081];emailfromMichaelMcGarvey,Lehman,toClementBernard,Lehman(Nov.29,2007)
[LBEXDOCID1852001](discussingwhetherRatesAsia,withinFID,willmakeitsbalancesheettarget);
Lehman,RatesProjectedBalanceSheetSpreadsheet(Jan.25,2007)[LBEXDOCID1447282];emailfrom
KentaroUmezaki,Lehman,toJosephGentile,Lehman(Feb.21,2007)[LBEXDOCID1808076](Whatis
ourlevratiotargetthisquarter?);Lehman,GlobalFIDBalanceSheetForecastasofNovember12,2007
(Nov. 13, 2007) [LBEXDOCID 3215542]; email from Sarah Paek, Lehman, to Balance Sheet Group,
Lehman(Nov.29,2007)[LBEXDOCID1851789](transmittingattachedFIDbalancesheetforecast[LBEX
DOCID1733969]reportingamountbywhichbusinesswithinFIDareover/undergrossandnetbalance
sheettargets);emailfromMichaelMcGarvey,Lehman,toMartinKelly,Lehman(Jan.30,2008)[LBEX
830

Although,asnotedabove,onlyhighlyliquidsecuritieswereeligibleforRepo105
treatment, Grieb, Reilly and others explored whether they could remove sticky
inventory from Lehmans balance sheet through the use of Repo 105 transactions.3196
DOCID1728898](Asofthe28th,Rateshad113.6bnofnetassets.Rightnowourquarterendforecastis
at~3bnovertargetsoweshouldreducenetassetsby68bn.);emailfromClementBernard,Lehman,to
RogerNagioff,Lehman,etal.(Nov.20,2007)[LBEXDOCID173748](ThenetBalanceSheetforecastfor
FIDforNovember30hasincreasedto$232.6[billion]fromapreviousforecastof$227[billion].Thisis
$12.6[billion]abovethelimitof$220[billion].Thelimitof$220[billion]equatestoaleverageratioof16
whichisthecurrentfirmtarget....BasedonmyconversationswithPaolo[Tonucci]weneedtogodown
to$225[billion]inorderfortheratiotobebacktotarget.);id.(notingalsothatmostoftheUnitedStates
AgencypositionswillbeoffbalancesheetthroughRepo105transactions).
2007)[LBEXDOCID2600714]);seealsoemailfromKaushikAmin,Lehman,toHerbertH.(Bart)McDade
III,Lehman(June3,2008)[LBEXDOCID574610](statingthatLiquidMarketsdivisionwithinFIDmade
Herculeaneffortstoreduceitsbalancesheet$25billionlowerthanitsactualbalancesheettargetnear
thequarterendinsecondquarter2008inordertocompensateforotherbusinesseswithinFIDthatwere
unable to meet their targets and transmitting report [LBEXDOCID 522198] showing Liquid Markets
conductedover$42billioninRepo105transactionsatcloseofsecondquarter2008andover$39billionin
Repo105transactionsatcloseoffirstquarter2008).
3196Forexample,GriebrecommendedtoLehmansAccountingPolicyGroupthatLehmanusetheRepo
105programtoremovefromthebalancesheetcertainresidualpositionsfrommortgagebackedandreal
estate backed securitizations. See email from Marie Stewart, Lehman, to Mark Cosaitis, Lehman, et al.
(Aug.17,2007)[LBEXDOCID3223799](Idiscussedtheissue...withEdGriebtomakesurehewould
beOKwithdoingthis....Youwillneedtorepo105everysinglepieceofthedealonb/sheet.Isthatthe
plan?); email from Mark Cosaitis, Lehman, to Marie Stewart, Lehman, et al. (Aug. 17, 2007) [LBEX
DOCID3223800](discussingwhether,ifLehmancantransferallWindermeresecuritiesusingRepo105,
Lehman caneliminate the gross up in addition to netting down the bonds?); email from Marie
Stewart,Lehman,toMarkCosaitis,Lehman,etal.(Aug.17,2007)[LBEXDOCID3223801](indicatingthat
Stewart planned to have a meeting that day with Grieb to discuss possibility of placing Windermere
bondsintoRepo105program);emailfromMarieStewart,Lehman,toBrettBeldner,Lehman,etal.(Aug.
17, 2007) [LBEXDOCID 3223803] (Ed told me yesterday that it was his idea that we use Repo 105 to
achievethisoutcome....Imnotwarmandfuzzyaboutusing[Repo105]togetentiredealsoffb/sheet
and [Ed Grieb] should discuss with E&Y.); email from Brett Beldner, Lehman, to Marie Stewart,
Lehman (Aug. 17, 2007) [LBEXDOCID 3223803] (I am also convinced that E&Y will say it doesnt
work.); email from Marie Stewart, Lehman, to Mark Cosaitis, Lehman, et al. (Aug. 17, 2007) [LBEX
DOCID 3223806] (I spoke to Ed [Grieb]. While a Repo 105 would work for saying the specific assets
undertheRepo105havebeensold,becausearepoinvolvesapromisetorepurchasethoseassets(andwe
actuallybookafwd)wedontthinkitwillworktogetfailedsalesdealsdeconsolidated.BrentBeldnerin
process of double checking with E&Y. . . .); see also Lehman, Repo 105/108 Benefit Summary (Nov. 9,
2007)[LBEXDOCID3219736](attachedtoemailfromAnurajBismal,Lehman,toDavidVasey,Lehman,
et al. (Nov. 9, 2007) [LBEXDOCID 3223369] and showing $744,212,553 in Repo 105 transactions using
831

Specifically, in the summer of 2007, Grieb and Reilly enlisted the help of John Feraca,
Kentaro Umezaki, and Michael McGarvey in an attempt to move mortgagebacked
securitiesintotheRepo105program.3197Thoughtheywereunsuccessfulintheirefforts
real estate held for sale in third quarter 2007 and calling this something odd); email from Anuraj
Bismal,Lehman,toMarieStewart,Lehman,etal.(Nov.12,2007)[LBEXDOCID3223374](Soundstome
thatwedidRepo105onRealEstateHeldforSale.Wehaveintroducedacontrolchecktotryanddetectif
this happens at Q4.); email from Marie Stewart, Lehman, to Anuraj Bismal, Lehman, et al. (Nov. 12,
2007)[LBEXDOCID3223375](replyingtonewsthatcommercialmortgagebackedsecuritieswereused
forRepo105bystating,Myheadwillexplodeifwehavetotalkthemaboutthisagain);emailfrom
Marie Stewart, Lehman, to Richard Holmes, Lehman, et al. (Nov. 12, 2007) [LBEXDOCID 3223373]
(statingthatbecausetheCMBSweholddonotexistforGAAPwecannotgetarepo105benefitfrom
them); email from Marie Stewart, Lehman, to Gary Bachman, Lehman, et al. (Nov. 21, 2007) [LBEX
DOCID 3223381] (FYI that weve had a few problems with people claiming Repo 105/108 benefit
recentlywhentheyshouldnothave.).
3197Email from Gerard Reilly, Lehman, to Steven Becker, Lehman, et al. (Aug. 16, 2007) [LBEXDOCID
251602] (Why cant we repo 105 some prime AAA stuff?); email from Steven Becker, Lehman, to
GerardReilly,Lehman,etal.(Aug.16,2007)[LBEXDOCID251603](IspokewithJohnwhoiscurrently
tryingtogetoffasmuchoftheEuropeandeals[apparentlyCMOsorcollateralizedmortgageobligations]
ashecanviaREPO105.);emailfromGerardReilly,Lehman,toStevenBecker,Lehman,etal.(Aug.16,
2007) [LBEXDOCID 251605] (Any mortgage should be our highest priority.); email from Kentaro
Umezaki,Lehman,toGerardReilly,Lehman(Aug.16,2007)[LBEXDOCID1905992](Whocangiveme
arepo105status/projection.Thisisaroundthemortgageinventoryandusingrepo105....Ineedsome
senseofwhatwearedoing,andwhetherwecanmovesomeofthehighratedmortgageproductsinto
that framework.); email from John Feraca, Lehman, to Gerard Reilly, Lehman (Aug. 18, 2007) [LBEX
DOCID 4553350] (Feraca and Reilly discuss putting either commercial mortgage backed securities or
residentialmortgagebackedsecuritiesintoRepo105);emailfromGerardReilly,Lehman,toJohnFeraca,
Lehman (Aug. 18, 2007) [LBEXDOCID 4553351] (Many benefits to us getting these assets [CMBS and
RMBS]intothe[Repo105]program.);emailfromJohnFeraca,Lehman,toDavidSherr,Lehman,etal.
(Aug.19,2007)[LBEXDOCID4553352]([W]earelookingatthepossibilityofRepo105forAAARMBS
andCMBSpositions...onlywanttofocusonnonagencyproductsforthisexerciseasbothagencypass
thrusandagencyCMOsrollupasgovernmentoragencyproductsinthebalancesheet,notmortgages.);
emailfromDavidSherr,Lehman,toJohnFeraca,Lehman,etal.(Aug.19,2007)[LBEXDOCID4553353]
(discussingplacementofCMBSandRMBSintoRepo105program);emailfromGerardReilly,Lehman,
toJohnFeraca,Lehman,etal.(Aug.19,2007)[LBEXDOCID4553356](same);emailfromGerardReilly,
Lehman, to Christopher M. OMeara, Lehman (Aug. 19, 2007) [LBEXDOCID 4553354] (forwarding
previousemailchaindiscussionsregardingmortgagebackedsecuritiesandRepo105toChrisOMeara).
832

toplacemortgagebackedsecuritiesintotheRepo105programin2007,3198byMay2008,
Reillyraisedtheideaagain.3199
Lehman was ultimately not able in 2007 to remove nonagency residential and
commercial mortgagebacked securities (RMBS and CMBS) from its balance sheet
throughRepo105transactions,butseniormanagementsoonrecognizedthatramping
up the useofRepo105transactions stillofferedLehman awayto relieve some ofthe
balance sheet pressure caused by the firms illiquid and sticky positions.3200 As Reilly
wroteinoneemail,Atleast...cutb[alance]s[heet]if[you]dontmakemoney.3201In
3198Email from John Feraca, Lehman, to David Sherr, Lehman, et al. (Aug. 20, 2007) [LBEXDOCID
4553357](Wespoketothe3ofthe4counterpartieswecurrentlyuseforRepo105onUSTandAgencies
via LBIE (the MTS equivalent) and all 3 declined our proposal to use AAA private label RMBS and
CMBS....[O]uronlyotherchoicewillbetolookifanyofourexistingcounterpartiesinLBIwouldbe
willing to transact through LBIE.); see also email from Gerard Reilly, Lehman, to Christopher M.
OMeara,Lehman,etal.(Aug.20,2007)(forwardingFeracaemaildiscussinguseofRMBSandCMBSin
Repo105program);emailfromKentaroUmezaki,Lehman,toJohnFeraca,Lehman,etal.(Aug.20,2007)
[LBEXDOCID 4553359] (Umezaki replies to Feraca, not sure that is worth the effortwe need Chris
[OMeara]toopine.);emailfromGerardReilly,Lehman,toKentaroUmezaki,Lehman,etal.(Aug.21,
2007) [LBEXDOCID 4553360] (What about agency cmos [collateralized mortgage obligations]? We
shouldpassonnonagencyatthispoint.);emailfromJohnFeraca,Lehman,toGerardReilly,Lehman,
etal.(Aug.21,2007)[LBEXDOCID4553361](Myunderstandingisagencycmosrolluptogovtproducts
forourbalancesheetdisclosuresandIdonotthinkitwillchangetheviewwegotfromthelenderswe
approachedyesterday.).
3199Email from Gerard Reilly, Lehman, to John Feraca, Lehman, et al. (May 1, 2008) [LBEXDOCID
4553429](Ifwecangetmortgageassetsinto105weneedtodothat.Iwouldthinkitishardtodobut
clearlytheywouldbeourpriority.).
3200Cf.EmailfromAnurajBismal,Lehman,toMartinKelly,Lehman,etal.(Feb.25,2008)[LBEXDOCID
3187495] (stating that FIDs overage in balance sheet is in real Estate and Securitized Products which
currentlyhavelessabilitytoreducebalancesheetandthatFIDwouldliketodomore[Repo105]but
itsaquestionofavailablecapacity).
3201EmailfromGerardReilly,LehmantoJosephGentile,Lehman(Feb.21,2007)[LBEXDOCID4553198].
By April 2007, FIDs balance sheet had grown 19% since 2005, while its revenue had grown only 3%.
Lehman,FIDBalanceSheetManagement(April2007),atp.2[LBEXDOCID1303268].Moreover,52%of
FIDsbalancesheetwasinbusinesseswithReturnonAssets(ROA)belowFIDsaverage.Id.Duringthis
sameperiodoftime,FIDsoffbalancesheetRepo105benefitgrewfrom$15billioninfirstquarter2006
to$22billioninfirstquarter2007.Id.
833

a November 2007 email from Reilly to Clement Bernard, Reilly wrote: Lets get our
bestthoughtsonfidb[alance]s[heet].Weareslippinginrealestate.Takealookatliquid
holdingslikecpanditemswecanputintotherepo105program.Weneedfidcloseto5bon
net.3202
Consistent with Gentiles recommendation to Grieb to increase the firms Repo
105 limits, Anuraj Bismal, a former Senior Vice President in Lehmans Balance Sheet
Group, said that the stickiness of mortgagebacked securities and other real estate
securitiesinventoryputpressureoneverythingelse.3203Thatis,totheextentLehman
couldnotremovestickyinventoryfromitsbalancesheetbysellingit,Lehmanhadto
removeevengreateramountsofothertypesofinventoryfromitsbalancesheeteither
viasalesorRepo105transactionstomeetthebalancesheetandleverageratiotargets
set by senior management. According to Bismal, this was a factor in Lehmans
increaseduseofRepo105transactionsstartinginmidtolate2007.3204MitchKing,the
former head of Lehmans United States Agencies Trading Desk, also believed that
Lehmans increased use of Repo 105 transactions beginning in midtolate 2007 was
linked to the balance sheet pressure Lehman faced caused by illiquid assets on its
balancesheetthatthefirmcouldnotsell.3205
3202Emailfrom Gerard Reilly, Lehman, to Clement Bernard, Lehman (Nov. 20, 2007) [LBEXDOCID
3203ExaminersInterviewofAnurajBismal,Sept.16,2009,atp.6.
3204Id.
3205ExaminersInterviewofMitchellKing,Sept.21,2009,atpp.47.
834

The reasons Gentile advanced for why Lehmans Repo 105 limit should be
increasedinFebruary2007namely,stickyinventoryLehmancouldnotsellorcould
only sell by incurring substantial losses only became more relevant in late 2007 and
early 2008, as even more of Lehmans real estate and mortgage assets became illiquid
anddifficulttosellwithoutsubstantiallosses.Indeed,asignificantportionofLehmans
realestatesecuritiesultimatelyprovedverydifficultforLehmantosell.3206Asaresult,
Lehmans illiquid holdings ballooned during 2007. At the same time during 2007,
LehmansFIDconsistentlybreacheditsbalancesheetlimits.3207
The origins of Lehmans balance sheet difficulties rest in Lehmans aggressive
countercyclicalgrowthstrategyspearheadedbyFuldin2006andearlytomid2007.3208
Thisstrategyincludedadecisiontospendcapitaltomakeacquisitions,which,inturn,
greatly increased the risk profile of the firm.3209 Within the Global Real Estate Group
(GREG), a business unit that fell mostly under the firms Fixed Income Division
umbrella,3210 the growth strategy involved deploying capital more aggressively,
increasing the bridge equity business, and acquiring and originating CMBS.3211 GREG
3206SeeSectionIII.A.1.b.4oftheReport.
3207Lehman,FIDBalanceSheetManagement(April2007),atp.2[LBEXDOCID1303268](attachedtoe
mailfromAnurajBismal,Lehman,toMatthewLee,Lehman(Apr.30,2007)[LBEXDOCID1334311]).
3208See Sections III.A.1.b.12 of the Report; see also Lehman Brothers, Executive Committee Offsite,
OpportunitiesforAdditionalRiskDeployment(Aug.3,2006)[LBEXDOCID2781866].
3209See Sections III.A.1.b.12 of the Report; see also Lehman Brothers, Executive Committee Offsite,
OpportunitiesforAdditionalRiskDeployment(Aug.3,2006)[LBEXDOCID2781866].
3210WiththeexceptionofRealEstatePrivateEquity,whichwascomanagedwithPrivateEquity,GREG
wasaunitwithinFID.
3211SeeSectionIII.A.1.doftheReport.
835

also oversaw the leveraged buyout of the ArchstoneSmith REIT by the joint venture
betweenLehmanandTishmanSpeyer.3212
As a result of these acquisitions, the size of Lehmans commercial real estate
(CRE)assetholdingssignificantlyescalatedin2006and2007.3213Asignificantpartof
the CRE inventory ultimately proved very difficult, if not impossible, for Lehman to
sell.3214ThetotalilliquidpositionsonLehmansbalancesheetincreasedfrom$41billion
in2006to$115billionin2007and$120billioninthefirstquarterof2008.3215
While deleveraging took on more urgency in 2008, it was not a new subject;
Lehmanhadbeenconcernedaboutbalancesheetandnetleverageforsometime.An
April2007internalLehmanFIDBalanceSheetManagementPresentationreportedthat
FID failed to meet its net balance sheet targets 11 out of the prior 15 months.3216 The
3212SeeSectionIII.A.1.doftheReport.
3213See Section III.A.1.d of the Report; see also Lehman, Global Real Estate Group, Global Real Estate
Update (Nov. 6, 2007) [LBEXDOCID 2504331]; Mark Walsh, Lehman, Commercial Real Estate Update,
PresentationtoLehmanBoardofDirectors(Mar.25,2008),atp.4[LBHI_SEC07940_127250](March2008
CREUpdate).
3214SeeSectionIII.A.1.b.4ofthisReport.InearlyFebruary2008,thenLehmanPresidentJosephGregory
warned GREG that it had to get its real estate balance sheet down quickly. Email from Mark Walsh,
Lehman,toAndrewJ.Morton,Lehman(Feb.26,2008)[LBHI_SEC07940_115814].Atthattime,firmCFO
ErinCallantoldGREGtoget$5billionofCREoffitsbalancesheetbythetimeofLehmansMarch18,
2008earningscall.EmailfromPaulHughson,Lehman,toMarkGabbay,etal.Lehman(Feb.27,2008)
[LBEXDOCID 1869265] (discussing the schedule for the $5 billion reduction target); email from Paul
Hughson, Lehman, to Mark Gabbay, Lehman, et al. (Mar. 7, 2008) [LBEXDOCID 1723168] (providing
update on sales progress and asking for updates regarding progress toward the $5 billion reduction
target).
3215AndrewJ.Morton,Lehman,FixedIncomeUpdate,PresentationtoLehmanBoardofDirectors,(May
7,2008),atp.4[LBHI_SEC07940_027994].
mail from Anuraj Bismal, Lehman, to Matthew Lee, Lehman, et al. (Apr. 30, 2007) [LBEXDOCID
1334311]; see also email from Joseph Gentile, Lehman, to Gerard Reilly, Lehman (Feb.20, 2007) [LBEX
836

presentationfurtherprovided,AccountingchangeshavegrownDeadBalanceSheet
to21.2bnandcontinuestoputpressureonthebalancesheetlimit.3217Asaresultofthe
stress on its balance sheet, Lehman proposed a policy of incentives and penalties for
meeting balance sheet targets.3218 The cover email to FIDs April 2007 balance sheet
presentationindicatedthatoneofthepurposesofthebalancesheetmanagementpolicy
changesdiscussedinthepresentationwastopositionLehmanforaratingsupgrade.3219
ThesamemonthastheFIDBalanceSheetManagementPresentation,April2007,
KentaroUmezakiinformedIanLowittthathehaddistributedbalancesheettargetsfor
secondquarter2007andthatrelevantLehmanpersonnelwereawareofitsimportance
now.3220ThenewtargetsweremeanttoallowLehmantoreacha15xnetleverageratio
DOCID 4553219] (complaining about FIDs serious balance sheet breaches and arguing that not only is
FIDunabletomeetthebalancesheettarget,itisntevenmakingmoney);emailfromSigridStabenow,
Lehman,toGerardReilly,Lehman,etal.(Apr.4,2007)[LBEXDOCID4553228](transmittingpresentation
[LBEXDOCID4553110]andsayingtalkingpointsandkeythemesfortheargumentthatFIDneedsto
addressbalancesheetefficiency);emailfromPaulMitrokostas,Lehman,toKentaroUmezaki,Lehman
(Nov. 14, 2007) [LBEXDOCID 1859142] (reporting that FID Core looks to be $7 to $15 billion over its
balancesheetlimit).
mail from Anuraj Bismal, Lehman, to Matthew Lee, Lehman, et al. (Apr. 30, 2007) [LBEXDOCID
1334311]).
3218Lehman,FIDBalanceSheetManagementPolicy(April2007),atp.3[LBEXDOCID1303268](Penalty
Chargeof5mmperbilliononnetbalancesheetoverages(Monthly)applicableataregionalPODlevel.);
seealsoemailfromAnurajBismal,Lehman,toMartinKelly,Lehman,etal.(Feb.25,2008)[LBEXDOCID
3187495](InthepasttheFixedIncomeDivisionhashadinplaceaspeedingticketchargeforbusinesses
thatexceedtheirnetbalancesheettarget);emailfromKaushikAmin,Lehman,toKentaroUmezaki,
Lehman,(May18,2007)[LBEXDOCID1811290]([T]henewbalancesheetlimitsaregoingtoreallyhurt
thebusiness.AtatimewhenIamtryingtogetthetraderstotakemorerisk,thisisinconsistent.).
3219Email from Kentaro Umezaki, Lehman, to Kaushik Amin, Lehman, et al. (Apr. 20, 2007) [LBEX
DOCID1334311].
3220Email from Kentaro Umezaki, Lehman, to Ian T. Lowitt, Lehman (Apr. 16, 2007) [LBEXDOCID
288764].
837

bytheendofsecondquarter2007.3221UmezakiadvisedLowittthatLehmansmortgage
assetsandrealestatesecuritiesweretheprimaryobstaclestoLehmanreachingitsnet
leverageratiotargetatthattime.3222
Another internal Lehman email from April 2007 illustrates the discourse and
dissensionamongseniorLehmanmanagementregardingthefirmsbalancesheet.3223In
the email chain, Chris OMeara, Umezaki, Lowitt, Gelband and others discussed the
balance sheet belt tightening effort in FID in light of a talk between Fuld and the
firms managing directors the night before.3224 Umezaki indicated that senior
management was sending conflicting messages: Fuld wanted to emphasize revenue
growth, while the message within FID was that meeting balance sheet targets was
necessary in order to achieve ratings upgrades.3225 OMeara noted that the firm had
allowed its leverage ratio to increase higher than planned, which further exacerbated
3221Id.(Gerryhasusworkingwitha195netbalancesheettarget...togetusto15xnetleveragebyend
ofMay....).
3222Id.
3223SeeemailfromKentaroUmezaki,Lehman,toChristopherM.OMeara,Lehman,etal.(Apr.18,2007)
[LBEXDOCID 187618]; see also email from Kentaro Umezaki, Lehman, to Paolo R. Tonucci, Lehman
(Apr.19,2007)[LBEXDOCID318475].
3224Email from Kentaro Umezaki, Lehman, to Christopher M. OMeara, Lehman, et al. (Apr. 18, 2007)
[LBEXDOCID187618].
3225Id.WhenaskedaboutarelatedemailfromthefollowingdayinwhichUmezakicomplainedabout
inconsistentmessagesaroundriskandgrowth,FuldexplainedthatasCEO,hetriedtomotivatepeople
but that he left it up to the Executive Committee to translate his remarks to the people in their ranks.
Examiners Interview of Richard S. Fuld, Jr., Sept. 25, 2009, at p. 17. Fuld did not specifically recall
hearing that there was confusion about balancing growth and risk and was not aware of Umezakis
concerns.Id.
838

the tension between the two messages (growth vs. balance sheet belttightening).3226
OMeara continued: I think we will have to make choices on how to best deploy the
balance sheet we have available. From my perspective, getting AA can be
accomplishedwithourplannedbalancesheetleverageratio.3227
InMay2007,JonathanCohen,aSeniorVicePresidentinGREG,askedUmezaki
whetherGREGcouldtradeitsbalancesheetallocationwithotherfirmbusinessgroups
toeasethepainofGREGsbalancesheetbreaches.3228Cohensuggestedthatiftrading
balance sheet was not an option, GREG would have no choice but to sell certain
positions at discount prices in order to meet balance sheet targets and stay under the
limit.3229
Significant effort was expended to remind FID, in particular, of its quarterend
balance sheet targets. Joseph Gentile, and after him, Clement Bernard, each of whom
reported directly to Gerard Reilly, Lehmans Global Product Controller, was tasked
withapplyingpressureontheheadofFIDtoensureFIDmetitsquarterlybalancesheet
targets.3230 Typically in this process, Gentile or Bernard would remind and cajole FID
3226Email from Kentaro Umezaki, Lehman, to Christopher M. OMeara, Lehman, et al. (Apr. 18, 2007)
[LBEXDOCID187618].
3227Id.
3228Email from Jonathan Cohen, Lehman, to Kentaro Umezaki, Lehman, et al. (Apr. 27, 2007) [LBEX
DOCID188165].
3229Id.;seealsoLehman,GlobalRealEstateGroup,GlobalRealEstateUpdate(Nov.6,2007),atp.1[LBEX
DOCID1419292](GREGbelievesthatunderanycircumstancesanestimated$15Bnreductioninglobal
balancesheetiswarranted.).
3230Examiners Interview of Joseph Gentile, Oct. 21, 2009, at p. 5; Examiners Interview of Clement
Bernard,Oct.23,2009,atp.11.
839

business leaders regarding their respective balance sheet targets as quarterend
approached.3231 Michael McGarvey (Finance) would apply the same pressure on
LehmansindividualtradingdesksandthenreportbacktoReillyandBernard.3232
In some instances, Gentile recalled having heated discussions with Umezaki in
early 2007 about using every effort to ensure that FID attempted to meet its balance
sheettargetsothatGentilecouldavoidfacingcriticismfromOMeara,Lehmansthen
3231See, e.g., Email from Joseph Gentile, Lehman, to Michael Gelband, Lehman, et al. (Feb. 21, 2007)
[LBEXDOCID 810934] ([W]e have a serious balance sheet issue for FID coming into the end of the
Quarter.Allbusinesseswiththeexceptionofcreditarerunninglargeexcessions....Ineedyoutostress
to [your business leaders]the need to manage down their excessions.); email from Kentaro Umezaki,
Lehman, to Joseph Gentile, Lehman (Feb. 20, 2007) [LBEXDOCID 1808077] (Umezaki: What is
serious?Gentileanswersa$10billionexcessionofthebalancesheetlimitandalsostatesthatleverage
ratio is too high.); email from Clement Bernard, Lehman, to Kieran Higgins, Lehman (Feb. 22, 2008)
[LBEXDOCID1854016](IamfollowingupontheconversationthatwehadontheBalancesheet.As
youmayknowwearestillstrugglingonourBalanceSheet.Wearecurrentlyat19bnaboveourtarget.
Within that number Rates Europe is 3.7 bn above target. . . . You mentioned that you would be doing
some reduction in gvt and maybe add repo 105.); email from Clement Bernard, Lehman, to Kaushik
Amin,Lehman(Feb.25,2008)[LBEXDOCID756417](TofollowuponourconversationforQ1.Weare
currentlyrunningat15.0bnaboveandweneedtogodownanextra$5.0bnforthefirmtomeetitsnet
leverage limit of 15.2. I need your help on this. . . . Let me know what you can do. . .); email from
ClementBernard,Lehman,toEricFelder,Lehman(Feb.25,2008)[LBEXDOCID2080410](Weneedto
reduceournetBalancesheettohitthefirmtargetnetleverageratioof15.2.CurrentlyFIDisprojectedto
be$15.0bnaboveitslimit....LetmeknowifthereisanythingyoucoulddotoreducetheBalanceSheet
andwhatwouldthepriceofdoingthat.);emailfromClementBernard,Lehman,toEricFelder,Lehman
(Feb.25,2008)[LBEXDOCID981497](Ihavecurrentlyaforecastof11.8vsalimitof10.4.Letmeknow
whatyoucandoandifthereisapricetomovesomeBSout.);emailfromClementBernard,Lehman,to
KaushikAmin,Lehman,etal.(Feb.28,2008)[LBEXDOCID1854189](FIDsnetbalancesheetoverage
hasincreasedto14.3bnfrom9.7bnasofyesterday....ThiswilldriveLehmannetleverageratioabove
target.Pleaseletmeknowwhatwecandotominimizetheimpact....Iknowitislateintheprocessbut
what ever we can do would help our ratio.); email from Clement Bernard, Lehman, to Martin Potts,
Lehman (Feb. 28, 2008) [LBEXDOCID 1854189] (We are looking at selling what ever we can and also
doingsomemorerepo105.);emailfromClementBernard,Lehman,toPaulMitrokostas,Lehman,etal.
(May 13, 2008) [LBEXDOCID 1697936] (discussing progress in reaching quarterend balance sheet
targets).
3232EmailfromMichaelMcGarvey,LehmantoMarkGavin,Lehman,etal.(Feb.28,2008)[LBEXDOCID
810932] (Given the critical balance sheet situation we are currently in Ive attached a list of corporate
bonds held in NY (all above BBB and 10mm in market value) available for any additional Repo 105
capacitywecanfind.Pleaseletusknowwhatissuesaresentoutsowecaninformthedesknottotrade
themforthetermoftherepo.).
840

CFO,andGrieb,thefirmsthenGlobalFinancialController,ifFIDbreacheditsquarter
endbalancesheettarget.3233Despitetheseeffortsofseniormanagement,FIDroutinely
failedtomeetitsbalancesheettargetsineveryquarterofLehmans2007fiscalyearand
in2008.3234
Even near the time of Lehmans bankruptcy, FID continued to perform poorly.
InresponsetoalateAugust2008emailfromReillyasking,Howmuchrepo105dowe
have now and how much will we have at 8/31, McGarvey replied, FID is the worst
rundivisioninthecompany.3235
In2008,FIDsbreachesofthebalancesheetlimitscontinuedtobeconcentrated
indifficulttosellsecuritizedproductsandrealestate.3236AFIDCoreGlobalBalance
SheetLiquiditydocumentdatedJanuary17,2008(reproducedbelow)indicatedthatFID
3233ExaminersInterviewofJosephGentile,Oct.21,2009,atpp.56.
3234Examiners Interview of Clement Bernard, Oct. 23, 2009, at p. 11; Lehman, FID Balance Sheet
Management(April2007),atp.2[LBEXDOCID1303268](FIDhasmisseditsnetbalancesheettarget11
outofthelast15months.);emailfromDominicGibb,Lehman,toMarkCosaitis,Lehman,etal.(Feb.28,
2009)[LBHI_SEC07940_1829372](Jockandhisteamareaggressivelyworkingtoobtainrepo105funding
foralleligiblegovviespositions.Iftheyaresuccessfulthenwewillhave$23bnofassetsonRepo105at
quarterend....ThiswouldleaveFIDwithanetbalancesheetof$51.7bn,$4.7bnabovetheFIDlimit...
);emailfromClementBernard,Lehman,toAndrewJ.Morton,Lehman(Mar.3,2008)[LBEXDOCID
1849880](Weendedupat15.6%onournetleverageratio....FIDwas$238bnvsalimitof223ie15bn
overlimit.).
3235Email from Michael McGarvey, Lehman, to Gerard Reilly, Lehman, (Aug. 29, 2008) [LBEXDOCID
4517471].
3236See Section III.A.1.b.4 of the Report; see also email from Gary Mandelblatt, Lehman, to Alex Kirk,
Lehman,etal.(Jan.15,2008)[LBEXDOCID1600235](statingthatthelackofsalesandsyndication[was]
a function of the tight credit markets); Notes from Lehman Monthly Risk Meeting with SEC (June 19,
2008), at p. 7 [LBEXSEC 007583] (Hughson stating that, in June 2008, buyers and sellers [were] just
staringateachother.);seealsoemailfromAnurajBismal,Lehman,toMartinKelly,Lehman,etal.(Feb.
25, 2008) [LBEXDOCID 3187495] (stating that a part of FID Cores [balance sheet] overage is in Real
EstateandSecuritizedProductswhichcurrentlyhavelessabilitytoreducebalancesheetanyways.).
841

held $115.857 billion in illiquid assets at that time.3237 Of that amount, $55.747 billion
wasinrealestate.3238
Similarly, an April 29, 2008 FID CORE balance sheet purporting to show first
quarter2008figures,listed$108.75billionintotalilliquidsecuritiesinventory,ofwhich
$52.12 billion was real estate securities.3239 So large was the amount of illiquid assets
that some within Lehman referred colloquially to these FID balance sheets as dead
assetschedules.3240
3237Lehman, Presentation regarding FID Global Balance Sheet (Jan. 17, 2008), at p. 4
[LBHI_SEC07940_1954891].
3238Id.
3239Lehman,FIDCoreQ1BalanceSheet(Apr.29,2008)[LBEXDOCID1741665](attachedtoemailfrom
NeerajChopra,Lehman,toAbeKebede,Lehman(May15,2008)[LBEXDOCID1953960]).
3240ExaminersInterviewofAnurajBismal,Sept.16,2009,atp.6;ExaminersInterviewofMatthewLee,
July1,2009,atpp.1011.
842

(5) DeleveragingResultedinIntensePressureatQuarterEndto
MeetBalanceSheetTargetsforReportingPurposes
The market focus on balance sheet and leverage in late 2007 and 2008 meant
increased pressure from Lehman senior management on its various business units to
meet their balance sheet targets to position the firm to meet its net leverage ratio
target.3241Inthetimeleadinguptoeachofthefirmsquarterends,businessunitsand
individualtradersscurriedtomeettheirbalancesheettargetsintimeforthereporting
period,inthecaseofFID,oftenthroughtheexpandinguseofRepo105transactions.3242
3241ExaminersInterviewofTejalJoshi,Sept.15,2009,atpp.56;ExaminersInterviewofKaushikAmin,
Sept.17,2009,atp.5;ExaminersInterviewofMitchellKing,Sept.21,2009,atpp.46.
3242ExaminersInterviewofTejalJoshi,Sept.15,2009,atpp.56;ExaminersInterviewofKaushikAmin,
Sept. 17, 2009, at p. 5; Examiners Interview of Mitchell King, Sept. 21, 2009, at pp. 46. Numerous
documentsdemonstratetheintensebalancesheetpressure,especiallynearoratquarterend.See,e.g.,e
mailfromMitchellKing,Lehman,toMarkGavin,Lehman,etal.(Dec.3,2007)[LBEXDOCID3232555]
(statingwithrespecttoUSAgencyDeskuseofRepo105,Asweapproachourquarterend,westartto
raise the balances so that we reserve size with our counterparties the week we really need it (over
quarterend).Atthisfiscalyearendwetooktheamountsashighaswecould,asweknewtherewould
beintensebalancesheetpressure.);emailfromJerryRizzieri,Lehman,toMitchellKing,Lehman(Feb.
19,2008)[LBEXDOCID3233177](statingtendaysbeforecloseofquarter,BalanceSheetstillabigpush.
Agencybusiness,evenwith105,stilloverbyalmost$4billion....);emailfromMarkGavin,Lehman,to
John Feraca, Lehman, et al. (Feb. 28, 2008) [LBEXDOCID 098492] (Just took a call from FID mgmt
seemstheyreuponnetb/sby3blnunanticipated&arealittleexcitedwQend.Iamlookingtodoan
additional repo 105 with Mizuho using this additional limit . . . if they have appetite.); email from
Alvaro Mucida, Lehman, to Gabriel Buteler, Lehman, et al. (May 2, 2008) [LBEXDOCID 601783]
([P]ressureforbalancesheethereisenormousandIwastoldthateven105wasscarce);emailfrom
Mitchell King, Lehman, to Ryan Murphy, Lehman (May 19, 2008) [LBEXDOCID 3233040] (stating 12
daysbeforecloseofquarter,Gettingclose,managementwalkingaroundtalkingbalancesheet);email
fromMarkGavin,Lehman,toMichaelMcGarvey,Lehman,etal.(May22,2008)[LBEXDOCID3232907]
(statingninedaysbeforecloseofquarter,thereisadrivetogetmoreRepo105inplace);emailfrom
Kevin Croutier, Lehman, to Mitchell King, Lehman (May 22, 2008) [LBEXDOCID 3233057] (nine days
before close of quarter, Croutier: How much more repo 105 trades are you trying to do before month
end?King:Wearetryingtogeteverythingoutthatwecan.);emailfromMitchellKing,Lehman,to
Marc Silverberg, Lehman (May 28, 2008) [LBEXDOCID 3233083] (stating three days before close of
quarter, I just want tosee if there isany possibility to add to105... . Im pretty sure wehavealmost
everythingout,butwanttocheck).
843

In November 2007, Lehmans Treasurer Paolo Tonucci informed Clement
Bernard,FIDsChiefFinancialOfficer,thatFIDsbalancesheetlimithadtobereduced,
despite FIDs repeated breaches of the balance sheet limit, in order to meet the firms
leverage ratio targets.3243 Bernard typically communicated balance sheet limits and
relatednetleverageratiotargetstoFIDpersonnelandpressuredtheFIDbusinessheads
toreducebalancesheetbyanymeansnecessary,whichusuallyentailedincreasedRepo
105transactionsatornearquarterends.3244
In a January 2008 email, Michael McGarvey informed Bernard about a
discussionwithAlexKirkandAndrewMortonregardingFIDs$13billionbreachofthe
balance sheet limit. McGarvey wrote: Alex was going to have a conversation with
Kaushik[Amin]aboutpotentiallycominginundertheirtargetforbalancesheetifneed
beandthat[a]meetinghasbeensetup...toreviewthenextstepsforRepo105for
theQ1(ItwouldbehelpfultoknowifGerry[Reilly]hasaviewonwhatthemaximum
tolerablelevelofrepo105isforthefirm).3245
Mitch King, the former Head of FIDs United States Agencies Trading Desk,
recalledtherewasalwaysbalancesheetpressureatquarterends,butthatsometime
in mid2007 there was a definite change and the firm began trying desperately to
3243Email from Clement Bernard, Lehman, to Roger Nagioff, Lehman, et al. (Nov. 20, 2007) [LBEX
DOCID272199].
3244ExaminersInterviewofClementBernard,Oct.23,2009,atpp.911.
3245EmailfromMichaelMcGarvey,Lehman,toClementBernard,Lehman(Jan.28,2008)[LBEXDOCID
3384755].
844

reduce its balance sheet, thereby further intensifying the quarterend alarm.3246 The
message from senior Lehman management was to keep making P&L but . . . get
balance sheet down.3247 King continued: There was a way to . . . to reduce balance
sheet at quarter end . . . . To the powers that be, Repo 105 counted as balance sheet
reduction.3248
Thus, Repo 105 transactions were used as a shortcut for meeting quarterend
balancesheettargets(i.e.,avoidingbalancesheetlimitbreaches)andreachingthefirm
widenetleverageratiotarget:
Is there a formal limit on Repo 105? We are trying to do more of these in

ordertoreducethebs[balancesheet].3249
AsB/S[balancesheet]willbesupertight,Ineedtomakesurewemakebest
useof[Repo]105.3250
(6) LehmansEarningsCallsandPressReleaseStatements
RegardingLeverage
Initsearningscallsandpressreleasesin2008,Lehmanspokeextensivelyabout
the size of the firmwide balance sheet, FIDs performance, and firmwide aggressive
effortstodeleverage.Notably,Lehmanneverdisclosedthatitrelieduponanexpanded
3246Examiners Interview of Mitchell King, Sept. 21, 2009, at p. 4. When he held the position of Global
Financial Controller, Edward Grieb would hold monthly issues meetings with his staff. Examiners
InterviewofMatthewLee,July1,2009,atp.16.Atleastoneattendee,MatthewLee,recalledthatwhen
the issue of the volume of Lehmans Repo 105 transactions was raised, the response was usually that
thenChiefFinancialOfficerChrisOMearawasquitekeenonreducingthebalancesheet.Id.
3247ExaminersInterviewofMitchellKing,Sept.21,2009,atp.5.
3248Id.
3249Email from Clement Bernard, Lehman, to Gerard Reilly, Lehman (Jan. 27, 2008) [LBEXDOCID
2793484].
3250Email from Thomas Siegmund, Lehman, to Kaushik Amin, Lehman (Apr. 17, 2008) [LBEXDOCID
739685].
845

use of Repo 105 transactions at quarterend to manage its balance sheet when market
conditions declined. Similarly, Lehman never disclosed that its net leverage ratio
which Lehman publicly touted as evidence of its discipline and financial health
dependeduponLehmansRepo105practice.
During the first quarter 2008 earnings conference call, thenChief Financial
OfficerErinCallanremarkedthatsincethepreviousquarter,Lehmanhadbeentrying
to give the group [i.e., the analysts] a great amount of transparency on the balance
sheet.3251 At no time, however, did Callan or anyone else from Lehman disclose the
firms use of Repo 105 transactions to manage the balance sheet. Callan told the
analysts that Lehman did, very deliberately, take leverage down for the quarter. We
endedwithanetleverageratioof15.4timesdownfrom16.1atyearend.Andwewill
continuetoallocatecapitalonthebalancesheetinthemarketinawaythatweconsider
prudent,andthatreflectstheliquidityprofileofthebalancesheet.3252
WhenCallanbrieflyaddressedLehmansordinaryrepotransactionsduringthe
firstquarter2008earningscall,shemadenomentionofLehmansRepo105program.3253
3251FinalTranscriptofLehmanBrothersHoldingsInc.,FirstQuarter2008EarningsCall(Mar.18,2008),at
p.7[LBHI_SEC07940_7579849].
3252Id.atp.8.Thisdeliberatedeleveragingstrategyisconsistentwithdocumentaryevidenceinwhich
Clement Bernard, Kaushik Amin and others pressured FID business leaders to reduce their respective
balancesheetsatquarterend,througheithersalesorRepo105transactions,sothefirmcouldmakeits
net leverage ratio target. Callans statement also indicates that senior management gave orders to
aggressivelydeleverage.
3253Id.atp.9(Totalrepo,exclusiveofthematch[ed]book,was215billionofwhichasubstantialmajority
of this collateral is eligible to be pledged under the new fed facility. We have 115 billion of triparty
846

Duringthequestionandanswerportionofthefirstquarter2008earningscall,an
OppenheimeranalystaskedCallantocommentonthelackofapermanentbuyerfor
so many of these securities and the time horizon and pace at which Lehman
anticipatedbringingdownitsleverageratios.3254Callansresponselinkedtheincreased
illiquidityofLehmansbalancesheetwithLehmansdeliberateplantodeleverage,but
sheindicatedthatLehmanachievedthereductioninleveragethroughthesaleofassets:
We did have a deliberate decision this quarter to take leverage down,

which I think is more appropriate for the increased illiquidity of the
balance sheet, and if the environment continues to stay this way well
continuetobefocusedonthatdiscipline.TherealbalancingactthatIm
sureyoucanappreciate,thatwethinkhardaboutisthebalancingactof
our fundamental view of the assets themselves, what we consider to be
the loss of P&L associated with selling an asset at a given price today,
givenwhatwethinkitsMPVis.Andthetradeoffwiththatwithprudent
balancesheetmanagement.3255
When a Bank of America analyst again raised the topic of leverage during the
first quarter 2008 earnings call, Callan explained that Lehman would continue to sell
assetsinordertoreduceitsleverage.3256CallantoldanalyststhatLehmansgoalisto
continue to take that leverage down . . . . In order to do so . . . we will sell assets as
appropriateandwithintherightpricingcontext,togettothatoutcome....Idontsee
whytheresanyreasonatthispointtochangeoffthatcourseandwellstayonthatpath
secured financing, which is really just the total repo amount less treasuries and agencies which go
throughtheFICCsystemanonymously.).
3254Id.atp.13.
3255Id.
p.23[LBHI_SEC07940_7579849].
847

until...somethingabouttheenvironment...tellsusweshouldbehavedifferently.3257
Noanalystcouldhavebeenaware,onthebasisofLehmansstatementsduringthefirst
quarter2008earningscall,thatLehmanemployedover$49billionofquarterendRepo
105transactionstomanageitspubliclyreportednetleverageforfirstquarter2008.
Initssecondquarter2008,whichendedonMay31,2008,Lehmancontinuedto
highlight its deleveragingefforts.3258EarlyinaJune9 analysts call,Callan focused on
Lehmanssuccessinreducingitsnetleverageandbalancesheet:
The net loss of $2.8 billion compares to net income of $489 million last
quarterand$1.3billioninthesecondquarterof2007.Importantlyand
you will hear this throughout the call during the quarter we executed
on a number of the capital and liquidity goals that we set out for
ourselves,whichincludesasfollowsloweringgrowthandnetleverage
tolessthan25timesandlessthan12.5times,respectively.Bothofthose
numbers are prior to todays capital raise. Reducing our gross assets by
approximately$130billionandournetassetsbyapproximately$60billion
with a large part of the reduction, as I will talk about in detail, coming
from less liquid asset categories and also providing significant price
visibilityformarkingtheremainderofourinventory.3259
Callan said that, taking into account the early June 2008 capital raise, Lehman
reduced its net leverage to 10x.3260 Callan described the firms deleveraging effort as
aggressive but said we do not expect to use the proceeds of this equity raise to
3257Id.
3258Inadditiontoloweringitsleverageratiosinsecondquarter2008,Lehmanalsogrewitscashcapital
surplus to $15 billionfrom $7 billionin firstquarter 2008,andits liquidity pool to$45 billion from$34
billioninthepreviousquarter.FinalTranscriptofLehmanBrothersHoldingsInc.SecondQuarter2008
PreliminaryEarningsCall(June9,2008),atp.3.Duringthistime,theperformanceofLehmansFixed
IncomeDivisionwasweak,withrevenuesofnegative$3billion.Id.atp.4.
3259Id.atpp.34.
3260Id.atp.7.
848

further decrease leverage but rather to take advantage of future market
opportunities.3261 A Goldman Sachs analyst questioned Callan about Lehmans
defensive deleveraging process during the second quarter preliminary earnings
call.3262 Callans reply confirmed that senior Lehman management imposed strict
balancesheettargetsthatquarter:
I think part of the rationale for us this quarter of why we were so

aggressive,whyweputoutexplicittargets,andwhywehadsuchatight
schedulewasexactlythat....[T]hebusinessoperators...knewwhatthe
targetswere.Wewereexplicitfromthebeginningofthequarter....SoI
think the discipline of getting it done primarily in a single quarter was
importanttokeepthemindsetsfocused.3263
One Merrill Lynch analyst asked Callan during the June 9 call to respond to
critics who are going to say that the $130 billion of assets sales [by which Lehman
deleveraged]mustbetheabsoluteeasiestassetstosell.3264Callanprovidedanecdotal
evidence that Lehman sold whole loan positions from its commercial real estate and
residential real estate books.3265 Callan said nothing about Lehmans use of Repo 105
transactions, which as noted above involved only the firms most liquid securities, to
effectuate temporary sales at quarterend to remove assets from the firms balance
sheet.
3261Final Transcript of Lehman Brothers Holdings Inc. Second Quarter 2008 Preliminary Earnings Call
(June9,2008),atp.7.
3262Id.atp.9.
3263Id.atp.9.
3264Id.atp.12.
3265Id.
849

Lehmanheldanothersecondquarter2008earningscallonJune16,2008.Bythat
time,IanLowitthadreplacedCallanasLehmansCFOandBartMcDadehadreplaced
JoeGregoryasLehmansPresidentandChiefOperatingOfficer.McDadestatedonthe
call that Lehman made substantial improvements in its balance sheet and that
Lehmansbalancesheetimprovementsgiveustheadditionalresourcesandadditional
capacity to drive our client model.3266 Asked whether the sales by which Lehman
achieved the balance sheet improvements were pretty much ratably spread over the
quarterorweretheymoreskewedtowardeithertheearlyorlatterpartofthequarter,
Lowittrepliedthatthesaleswerespreadoverthewholequarter.3267Lehmansuseof
Repo105transactions,however,spikedatquarterend,includingtheendofthesecond
quarter2008.Forexample,thetotalamountofassetsinvolvedinRepo105transactions
onApril30,2008was$24.74billion,butincreasedto$50.38billiononMay30,2008,at
Lehmansquarterend.3268
(a) AnalystsStatementsRegardingLehmansLeverage
In addition to documents demonstrating that Lehman, internally, continued to
focus in 2008 on reducing its firmwide leverage, analysts and the market similarly
3266FinalTranscriptofLehmanBrothersHoldingsInc.SecondQuarter2008EarningsCall(June16,2008),
atp.10[LBHI_SEC07940_1139550].
3267Id.atp.14.
3268Lehman,TotalRepo105&Repo108Report(June11,2008),atp.1[LBEXDOCID2078195](attached
toemailfromKristieWong,Lehman,toMartinKelly,Lehman(June11,2008)[LBEXDOCID2325872].
(May31,2008,Lehmansquarterend,wasaSaturday).
850

continued their focus on the firms leverage. A few illustrative examples of analyst
commentsfollow:
The modest silver lining is that LEH was able to reduce gross assets by
$130 billion, including large reductions in mortgage related (15%20%) and
leveragedloan(35%)exposures.3269
Leverage is down a lot (and even more post capital raise) . . . illiquid
positionsaredown15%20%....3270
WhileLEHreducedgrossleveragefrom32xto25x,increasedtheirliquidity
pool from $34B to $45B, and drove reductions across most troubled asset
classes(andreducedtotalassetsby$130Bor17%),weawaitmoredetailson
totalremainingtroubledassetsinaggregateaswellasaLIIIorilliquidasset
update to help answer the question of whether $6B in incremental capital
raiseissufficient.3271
[T]he firm aggressively deleveraged in the quarter as total balance sheet

assetsdeclinedby$130bnandnetassetsdeclinedbyabout$60bn,bringing
grossleverageto25.0xfrom31.7xandnetleverageto12.5xfrom15.4x.This
broad based selling likely exacerbated the writedowns the firm took this
quarter. As part of its deleveraging, Lehman reduced RMBS and CMBS
exposure by1520%,leveragedloansby35%andhigh yieldby 20%. While
Lehman is clearly not out of the woods just yet, we believe todays
announced capital raise will reduce investors fears and help promote a
better liquidation of assets should LEH want to continue to reduce its
leverage.3272
3269SandlerONeill & Partners Report, Lehman Brothers Holdings Inc. (June 9, 2008), at p. 1 [LBEX
DOCID 015863] (attached to email from Roopali Hall, Lehman, to Lehman Brothers Executive
CommitteeMembers,Lehman(June9,2008)[LBEXDOCID15861]).
3270UBSInvestmentResearch,FirstRead:LehmanBrothers(June9,2008),atp.1[LBEXDOCID015863]
(attached to email from Roopali Hall, Lehman, to Lehman Brothers Executive Committee Members,
Lehman,etal.(June9,2008)[LBEXDOCID15861]).
3271BankofAmericaEquityResearchReport,LehmanBrothersHoldingsInc.(June9,2008),atp.1[LBEX
DOCID 015863] (attached to email from Roopali Hall, Lehman, to Lehman Brothers Executive
CommitteeMembers,Lehman,etal.(June9,2008)[LBEXDOCID15861]).
3272GoldmanSachsReport,LehmanBrothersHoldingsInc.(June9,2008),atp.1[LBEXDOCID015863]
Lehman,etal.(June9,2008)[LBEXDOCID15861])
851

Despite the negative results this quarter, there were some positive
takeaways: Balance sheet and leverage reduced . . . . Riskier assets cut . . .
.3273
Overall, we believe the companys moves to deleverage the balance sheet

arepositivefactorsfromaratingsperspective.3274
LEHreduceditsbalancesheetby$130bn(or17%)andreducednetassetsby
$60bn.Evendespitethelargeloss,thisdrovenetleveragedownto12.5xand
gross leverage below 25x. After the announced capital raise of $4bn in
common equity and $2bn in mandatory convertible preferred, we expect
grossleverageonaproformabasistofalltocloseto20xandnetleverageto
fallto10xbyfarthelowestintheindustry(25%35%lowerthanpeers)..
..[M]anagementnotedthatmuchoftheselldownwasfocusedontheriskier
and less liquid assets, rather than the high grade and more liquid
securities.3275
Lehman is the most levered large investment bank to the fixed income
market, and hence a more challenging fixed income market (with higher
longterminterestrates,lowervolatilityandwidercreditspreads)couldhurt
themthemost....WhileLehmanreducedgrossleveragefrom32xto25x,
increasedtheirliquiditypoolfrom$34Bto$45B,&drovereductionsacross
most troubled asset classes (& reduced total assets by $130B, or 17%), we
awaitmoredetailsontotalremainingtroubledassetsinaggregateaswellas
aLIIIorilliquidassetupdatetohelpanswerthequestionofwhether$6Bin
incrementalcapitalraiseissufficient.3276
The companys gross leverage ratio improved to 24.3x (vs. 31.7x in 1Q08)
and its net leverage ratio decreased to 12.0x, down from 15.4x in the prior
3273Buckingham Research Report, Lehman Brothers Holdings Inc. (June 9, 2008), at p. 2 [LBEXDOCID
245428] (attached to email from Roopali Hall, Lehman, to Lehman Brothers Executive Committee
Members,Lehman,etal.(June9,2008)[LBEXDOCID244039]).
3274CreditSights Report, Lehman Brothers Holdings Inc. (June 9, 2008), at p. 4 [LBEXDOCID 245428]
Lehman,etal.(June9,2008)[LBEXDOCID244039]).
3275Buckingham Research Report, Lehman Brothers Holdings Inc. (June 9, 2008), at p. 2 [LBEXDOCID
245428] (attached to email from Roopali Hall, Lehman, to Lehman Brothers Executive Committee
Members,Lehman,etal.(June9,2008)[LBEXDOCID244039]).
3276Bank of America Equity Research Report, Lehman Brothers Holdings Inc. (June 9, 2008), at pp. 1, 3
[LBEXDOCID 245428] (attached to email from Roopali Hall, Lehman, to Lehman Brothers Executive
CommitteeMembers,Lehman,etal.(June9,2008)[LBEXDOCID244039]).
852

quarter.Theimprovementintheleverageratiosweredrivenbylowerasset
levels, partially offset by a drop in equity as the firm delevered its balance
sheet.Lehmannotedthatithadfinishedthebalancesheetdeleveragingit
wanted to achieve, but it had not achieved the balance sheet mix that it
wanted. So, we sense the company will continue to opportunistically
disposeofmortgagerelatedexposuresandleveragedlending.3277
EngineerPubliclyReportedFinancialResults
Whenseniormanagementgavebalancesheettargetstobusinessdivisionswithin
Lehman, the orders were given so that the firm could manage its business towards a
target net leverage ratio with an eye toward rating agencies and the firms public
disclosures.3278 Lehman used SFAS 140s true sale accounting treatment for Repo 105
transactions and Repo 105 cash borrowings to make its balance sheet appear stronger
than it actually was. In order for this offbalance sheet device to benefit Lehman, the
firmhadtoconcealinformationregardingitsRepo105practicefromthepublic.
(1) LehmanDidNotDiscloseItsAccountingTreatmentFororUse
ofRepo105TransactionsinItsForms10Kand10Q
Lehman reported a lower net leverage ratio in its publicly filed financial
statementswithoutrevealingthatitemployedRepo105transactionstomanageitsnet
leverage ratio. Several Lehman witnesses with financial reporting responsibilities
3277CreditSightsReport,LehmanBrothersHoldingsInc.(June16,2008),atp.2[LBEXDOCID015911].
3278ExaminersInterviewofJosephGentile,Oct.21,2009,atp.5(statingthatLehmanasafirmmanaged
its entire business towards a target net leverage ratio); Examiners Interview of Ian T. Lowitt, Oct. 28,
2009,atp.10(statingthatbusinesseswithinLehmanmanagedtheirrespectivebusinessestowardbalance
sheettargets).
853

confirmed the Examiners conclusion that Lehman did not disclose its accounting
treatmentoruseofRepo105transactionsinitsForms10Kand10Q.3279
EdGrieb,formerLehmanFinancialControllerwhopreparedLehmansForm10
QandForm10Kstatements,recalledthatLehmandidnotdiscloseitsuseofRepo105
transactionsortheaccountingtreatmenttheyreceived.3280MarieStewart,formerGlobal
Head of Accounting Policy, also said that Lehman made no disclosures relating to its
Repo105program.3281
Lehmans increasing reliance on Repo 105 transactions and the absence of any
disclosure of that fact in Lehmans Forms 10Q and 10K disquieted Martin Kelly
(whose department was responsible for the preparation of Lehmans periodic
reports).3282Kelly,Griebssuccessor,toldtheExaminerthatifananalystoramemberof
theinvestingpublicweretoreadLehmansForms10Qand10Kfromcovertocover,
taking as much time as she or he needed, they would have no transparency into
[Lehmans]Repo105program.3283
Similarly, Matthew Lee, who reported to Kelly, recalled that Lehman did not
disclose its Repo 105 practice in its publicly filed statements. If you dont say
anything,isthatdisclosure?[Lehman]wastellingthepublictheyreducedthebalance
3279AdetailedanalysisofLehmansForm10Kand10QmisstatementsandomissionsappearsinSection
III.A.4.j.2.c.iiofthisReport.
3283Id.
854

sheet,butnottellingthemtheyweredoingsobyunartfulmeans.3284Leerecalledthat
Lehmanhadwaymoreleveragethanpeoplethought;itwasjustoutof[thepublics]
sight.3285
(a) LehmansOutsideDisclosureCounselWasUnawareof
LehmansRepo105Program
SimpsonThacher&BartlettservedasLehmansdisclosurecounselinconnection
withLehmanspreparationandfilingofitsForms10Qand10Kstatementsduringthe
time periods relevant to the Examiners investigation. Andrew Keller, a Simpson
Thacher partner involved in the preparation of Lehmans publicly filed financial
statements,wasnotawareofLehmansuseofRepo105transactions,eitherbynameor
description.NorwasKellerawareoftheimpactLehmansuseofRepo105transactions
hadonLehmansreportednetleverage.3286
In his role as Lehmans disclosure counsel, Keller always assumed that repos
were treated as secured financings because that was the general rule and was
Lehmansstatedpolicyinthenotestoitsfinancialstatements.3287
ThoughheneverhadsuchadiscussionwithLehmanpersonnelregardingRepo
105,KelleradvisedtheExaminerthatifhehadneededtodiscussanoffbalancesheet
3284ExaminersInterviewofMatthewLee,July1,2009,atp.16.
3285Id.
3286Examiners Interview of Andrew Keller, Nov. 20, 2009, at p. 3. Keller explained that he generally
spoke directly to Lehmans inhouse counsel and Ryan Traversari, Senior Vice President of External
Reporting,whoreportedtoLehmansGlobalFinancialController.Id.
3287Id.;cf.SectionIII.A.4.j.2.cofthisReport,discussingLehmansactualForm10Kand10Qdisclosures
regarding its repo transactions, including its statement that it treated repo transactions as financing
transactionsforreportingpurposes.
855

itemwithLehmanasageneralmatter,hewouldhavelikelyspokentoRyanTraversari,
Lehmans Senior Vice President of External Reporting, who reported to the Financial
Controller.3288 Traversari, whom Keller relied upon, knew about but did not disclose
LehmansRepo105practiceinhisdiscussionswithKeller.3289Inaninterviewwiththe
Examiner,TraversarisaidhewasfamiliarwithLehmansuseofRepo105transactions
andrecalledthatLehmanundertookthesetransactionsonthebasisofanopinionletter
thataLehmanUnitedKingdomsubsidiaryhadacquired.3290Traversariunderstoodthat
Repo 105 transactions effectively reduced Lehmans net balance sheet and he did not
recallanybusinesspurposetothetransactions.3291
(2) LehmansRepo105PracticeImprovedtheFirmsPublic
BalanceSheetProfileatQuarterEnd
Kaushik Amin, the former head of the Liquid Markets group within Lehmans
FID (a large user of Repo 105 transactions), pressured those who reported to him to
meet the balance sheet targets that senior management imposed on Amin.3292 Amin
3288ExaminersInterviewofAndrewKeller,Nov.20,2009,atp.3.
3289Id.(statingthatRyanTraversariwouldhavebeentheLehmanemployeetoinformhimofoffbalance
sheet arrangements and that Keller was never informed of Repo 105 transactions or their accounting
treatment);ExaminersInterviewofRyanTraversari,Sept.24,2009,atpp.45(statingthathewasaware
ofLehmansRepo105programandtheimpactofthesetransactionsonLehmansbalancesheet).
3290ExaminersInterviewofRyanTraversari,Sept.24,2009,atpp.45.
3291Id.
3292See,e.g.,EmailfromGaryLynn,Lehman,toKaushikAmin,Lehman(Aug.22,2006)[LBEXDOCID
2786867](informing Amin, nine days beforequarterend, that hemay use $20billion, rather than $17.5
billion,ofRepo105transactionsinordertomeetbalancesheettarget,butthatwiththeadditional$2.5
billionofRepo105,heisstill$7.9billionoverhisnetbalancesheettarget);emailfromKaushikAmin,
Lehman, to Thomas Siegmund, Lehman (Aug. 23, 2006) [LBEXDOCID 2786869] (We have additional
$2.5BlninRepo105thatthefirmhassignedoffon....So,letsmaxoutthecapacity.Weshouldbeable
tousesomeofthecollateralfromtheAgencybusinessintheUS.);emailfromGaryLynn,Lehman,to
856

explained that the quarterend rush to meet balance sheet targets put discipline on
traders to liquidate securities inventory as quickly as possible.3293 Indeed, the
investigationandreviewofinternalLehmandocumentsrevealedthatAminoftensent
forcefulbalance sheettarget emailstothose whoreportedto him,oronbehalf of his
peers,oftenatornearthecloseofthequarter.3294
Lehman management cared more about meeting quarterend balance sheet
targets, as opposed to monthly balance sheet targets, because Lehmans quarterend
balancesheetfigureswerepublishedinthefirmsquarterlyfinancialreportsand10Q
Sharan Mirchandani, Lehman, et al. (Feb. 21, 2007) [LBEXDOCID 1431154] (writing one week before
quarterend,[W]earesignificantlyovertheQ1balancesheetlimitsforIRPandLMPwithoneweekto
go,andKaushikhasdeliveredthatmessagetothebusinessheadsthatweneedtocomedownfurtheras
thereisnoroomforustobeoverourlimits);emailfromClementBernard,Lehman,toKaushikAmin,
Lehman(Feb.25,2008)[LBEXDOCID1849835](Bernard:TofollowuponourconversationonFriday
onthenetbalancesheetforQ1.Wearecurrentlyrunningat15.0bnaboveandweneedtogodownan
extra$5.0bnforthefirmtomeetitsnetleveragelimitof15.2.Amin:Theentireteamisfocusedonthis
and I am pushing everybody pretty hard. We should make the target.); email from Kaushik Amin,
Lehman,toMartinKelly,Lehman(Apr.17,2008)[LBEXDOCID3223698](followingFIDAsiasattempt
toapplytheRepo105mechanismtoAustraliansecurities,whichMarieStewartinLehmansAccounting
Policyforbade,AminimploredKelly:Thisisimportantforus.Wouldappreciateyourhelphere).
3293ExaminersInterviewofKaushikAmin,Sept.17,2009,atpp.56.
3294EmailfromGaryLynn,Lehman,toSharanMirchandani,Lehman,etal.(Feb.21,2007)[LBEXDOCID
1431154](AsyouareawarewearesignificantlyovertheQ1balancesheetlimitswithoneweektogo,
and Kaushik has delivered that message to the business heads that we need to come down further as
thereisnoroomforustobeoverourlimits.);emailfromKaushikAmin,Lehman,toKieranHiggins,
Lehman (Feb. 28. 2008) [LBEXDOCID 3234351] (We have a desperate situation and I need another 2
billionfromyou,eitherthroughRepo105oroutrightsales.Costisirrelevant,weneedtodoit.);email
fromKaushikAmin,Lehman,toBorutMiklavcic,Lehman(May13,2008)[LBEXDOCID2103909]([M]y
targetforGlobalRatesisonly$75Billion.ThereisnowayIcanhitmyglobaltargetwithyouanywhere
close to your current number.); email from Kaushik Amin, Lehman, to Thomas Siegmund, Lehman
(May 21, 2008) [LBEXDOCID 756545] (Do as much as you can in Repo 105. Can you find Repo 105
capacityamongJapanesecounterpartiestotakeUSAgencies?);emailfromKaushikAmin,Lehman,to
KieranHiggins,Lehman(May21,2008)[LBEXDOCID3234382](LetsmaxoutontheRepo105foryour
stuffandseewhereweendup.).
857

statements.3295 As one email put it, The recent increase in [Repo] 105 business was
urgentlytransactedtoimprovetheFirmsbalancesheetprofileover...quarterend.3296
InanotheremaildiscussingRepo105usageatquarterend,MichaelMcGarveywrote:
We only focus on meeting our quarter end balance sheet targets. The intra month
targets historically havent been actively managed.3297 Later in the same email,
McGarvey continued: Being the nonquarter month end balance sheets arent
3296See email from Stephen Allery, Lehman, to Miyuki Suzuki, Lehman (Aug. 31, 2007) [LBEXDOCID
98492].ThisemailchainregardingAllerysongoingattempttogetincreasedcapacitytoundertakeRepo
105transactionswithMizuhocontainsinterestingdialoguethatprovidestransparencyintothelevelsto
which Lehman personnel went to utilize Repo 105 transactions for balance sheet relief during the late
2007early 2008 time period. In November 2007, Allery implored Suzuki, Given the very sensitive
business environment faced by Lehman at presentand ourongoing desire tomanage balance sheet to
bolsterourimageandfinancialstrengthobjectives,IamratherdisappointedthatCreditisimposingthis
rigidapproach[i.e.,alimittoRepo105capacity].Isthereanylatitudetotradeathigherlevelsacrosskey
reporting dates such as Nov 30th? Email from Stephen Allery, Lehman, to Miyuki Suzuki, Lehman
(Nov. 8, 2007) [LBEXDOCID 98492] (emphasis added). November 30 was the end of Lehmans fiscal
year. Allery continued to press for Repo 105 capacity with Mizuho. On February 19, 2008, he wrote,
Quarterend is approaching and we would like to maximize balance sheet efficiency via Mizuho. E
mailfromStephenAllery,Lehman,toMiyukiSuzuki,Lehman(Feb.19,2008)[LBEXDOCID98492].The
nextday,hewroteagaintoSuzuki,Sorrytochase,butwearebeingaskedaboutourcapacitytohelp
FID reduce B/S at qtrend. Email from Stephen Allery, Lehman, to Miyuki Suzuki, Lehman (Feb. 20,
2008) [LBEXDOCID 98492]. Suzuki replied, Could you advise how much you need for the balance
sheetreliefforthequarterend?EmailfromMiyukiSuzuki,Lehman,toStephenAllery,Lehman(Feb.
21,2008)[LBEXDOCID98492].OnFebruary28,2008,onedaybeforethecloseofthequarter,Lehmans
creditlineforRepo105transactionswithMizuhowasfinallydoubledto$5billion.EmailfromMiyuki
Suzuki, Lehman, to Stephen Allery, Lehman (Feb. 28, 2008) [LBEXDOCID 98492]; see also Lehman
Brothers,CreditRiskManagement,CreditReview,MizuhoFinancialGroup,Inc.(Nov.27,2007)[LBEX
DOCID 2513180] (containing review and proposal for Repo 105 line increase with Mizuho, stating that
limitincreaseistoaccommodate...increasingbusinessrequestsforrepo105activitiesatLBIEforour
balancesheetrelief,especiallytowardourfiscalyearendandattachedtoemailfromFumiyoshiOoka,
Lehman,toPatrickMcGarry,Lehman(Nov.27,2007)[LBEXDOCID2552287]).
3297Email from Michael McGarvey, Lehman, to Dominic Gibb, Lehman, et al. (Dec. 20, 2007) [LBEX
DOCID3223846].
858

published in the financials we dont focus on them. We dont want traders spending
moneytocomedowninbalancesheetunlessitsreallynecessary.3298
(a) ContemporaneousDocumentsConfirmThatLehman
SheetandReverseEngineerItsLeverage
Lehmans Repo 105 practice engendered a certain level of cynicism within the
firm.3299Notably,inresponsetoanemailstating[n]otsureyouarefamiliarwithRepo
105butitisusedtoreducenetbalancesheetinourgovernmentsbusinessesaroundthe
3298Email from Michael McGarvey, Lehman, to Dominic Gibb, Lehman (Dec. 20, 2007) [LBEXDOCID
3223846]. Dominic Gibb, a Lehman Managing Director based in London, became nervous about
McGarveys statements regarding quarterend focus, writing: We historically havent liked to see
massiveswingsinourutilisationofrepo105justatquarterend.EmailfromDominicGibb,Lehman,to
Michael McGarvey, Lehman (Dec. 20, 2007) [LBEXDOCID 3223846]. This sentiment was echoed by
Gerard Reilly, who replied to a request by Clement Bernard for expanded capacity for Repo 105
transactionstoreducethefirmsbalancesheetasfollows:Ifwefundourpositionsinthismannerallthe
timethenwecandoit.Cantjustbeatquarterend.EmailfromGerardReilly,Lehman,toClement
Bernard,Lehman(Jan.29,2008)[LBEXDOCID2796630].SeeSectionIII.A.4.f.3(discussingcontinualuse
and120%rules).
3299OneemailappearstoreflectacertainlevelofnervousnessbyoneLehmanemployeewithrespectto
howcounterpartieswouldreacttothetruthaboutRepo105transactions.Intheemail,LBIEsJawad
wrote to Higgins about his quest for more counterparties for 105. See email from Anthony Jawad,
Lehman, to Kieran Higgins, Lehman (May 22, 2008) [LBEXDOCID 3234386]. Jawad reported that the
ReserveBankofAustraliaaskedLehmanwhyLehmanwantedtoengageinRepo105transactions.Id.
Jawadthenstated,IspoketoMarkCosaitisaboutthisandheobviouslywouldlikeustogiveavague
reason about getting better net down treatment, which isnt a lie. However, if they want a deeper
explanationthenwemayhavetogetdowntothenittygrittyofthetruth.Doyouwantustogodown
thislineorwantustojustgiveitamiss....[T]hemorepeoplethatknowthetruth,themoredodgyit
canbe.Id.Assiwroteback,Fortherecordthetruthisthatwhatwearedoingisperfectlylegal.Id.
Aminreplied,MyviewisthesameasGeorges.AccountingrulesareverycleararoundRepo105....
Id. The statement by Jawadabout better net down treatmentrefers to Lehmans terminologyfor the
reductionofnetassetsbymeansofRepo105.SeeDuff&Phelps,ExplanationofRepo105Accounting
Ledger Entries and Trading System Output (Jan. 5, 2010), at pp. 34 (stating that net down was the
methodofremovalofthesecurityfromLehmansconsolidatedbalancesheet,i.e.,theamountbywhich
the securities inventory would be reduced (sold) in a Repo 105 transaction pursuant to Lehmans
Accounting Policy). Though Assi referred to the legality of repo transactions, the issue from the
Examiners perspective is whether proper disclosure has been made by Lehman in its securities filings
andotherpublicstatements.
859

world,BartMcDade,LehmansformerPresidentandChiefOperatingOfficer,replied:
Iamveryaware...itisanotherdrugweron.3300
Numerous internal Lehman emails referred to Repo 105 transactions in
pejorativeterms,suchasbalancesheetwindowdressing.Anillustrativeexampleis
foundinthefollowingJuly2008emailexchange:
Vallecillo: So whats up with repo 105? Why are we doing less next
quarterend?3301
McGarvey: Its basically windowdressing. We are calling repos true sales

basedonlegaltechnicalities.Theexeccommitteewantedthenumbercutin
half.3302
Vallecillo:Isee...soitslegallydoablebutdoesntlookgoodwhenwe
actuallydoit?Doestherestofthestreetdoit?Alsoisthatwhywehave
somuchBS[balancesheet]toRatesEurope?3303
McGarvey:Yes,Noandyes.:)3304
3300Email from Herbert H. (Bart) McDade III, Lehman, to Hyung Lee, Lehman (Apr. 3, 2008) [LBEX
DOCID1570783].DuringhisfirstinterviewwiththeExaminer,McDadeattemptedtoexplainhisdrug
commentassimplythethoughtthatRepo105mightbeaneasierwayofmanagingthebalancesheetthan
amoredisciplinedapproach.ExaminersInterviewofHerbertH.BartMcDadeIII,Sept.16,2009,atp.
4.Inarelatedemail,McDadecontinuedwithhisdruganalogy.Inresponsetoanemailstatingthata
Repo 105 counterpartys refusal to roll Lehmans Repo 105 transactions would lead to an increase in
LehmansquarterendnetbalancesheetunlessLehmancouldfindanadditionalRepo105counterparty,
McDadestatedthatthiswasexactlywhythedrugisaproblem.EmailfromHerbertH.(Bart)McDade
III,Lehman,toAndrewJ.Morton,Lehman(Apr.3,2008)[LBEXDOCID2984871].
3301EmailfromJormenVallecillo,Lehman,toMichaelMcGarvey,Lehman(July2,2008)[LBEXDOCID
3379145].
3303EmailfromJormenVallecillo,Lehman,toMichaelMcGarvey,Lehman(July2,2008)[LBEXDOCID
3379145].
3379145].
860

Numerous other internal Lehman emails confirm that Lehmans true purpose
for undertaking Repo 105 transactions at quarterend was balance sheet and leverage
manipulation.Bywayofexampleonly:
InreferencetotheAgenciesbusinesssuseofRepo105transactions:Aswe
approachquarterend,westarttoraisethebalancessothatwereservesize
withourcounterpartiestheweekwereallyneedit(overquarterend).Atthis
fiscal year end we took the amounts up as high as we could, as we knew
therewouldbeintensebalancesheetpressure.3305
[T]hefirmhasafunctioncalledrepo105wherebyyoucanrepoaposition
foraweekanditisregardedasatruesaletogetridofnetbalancesheet.3306
WehavebeenusingRepo105inthepasttoreducebalancesheetatquarter
end....3307
When Lehmans repo trading desk in London informed personnel in

Lehmans New York Fixed Income Division that certain Repo 105
counterparties were no longer interested in participating in Repo 105
transactions,KentaroUmezakiwrotetoClementBernardandGerardReilly,
copying Kaushik Amin and Andrew Morton, stating Looks like we may
need to rethink how much of [Repo 105] we can rely on for balance sheet
relief. Could someone in Finance coordinate how much of this we should
expecttohaveavailableforbalancesheetreliefatmonth/quarterendgoing
forward?3308
3305Email from Mitchell King, Lehman, to Mark Gavin, Lehman, et al. (Dec. 3, 2007) [LBEXDOCID
3232555].
3306Email from Anthony Jawad, Lehman, to Andrea Lenardelli, Lehman (Mar. 3, 2008) [LBEXDOCID
235036].
3307Email from Raymond Chan, Lehman, to Paul Mitrokostas, Lehman (July 15, 2008) [LBEXDOCID
3384937].
3308Email from Kentaro Umezaki, Lehman, to Clement Bernard, Lehman, et al. (Sept. 4, 2007) [LBEX
DOCID3232534].NumerousotherdocumentssupporttheconclusionthatLehmansRepo105program
was a mechanism for managing the balance sheet at quarterend. See, e.g., email from Anuraj Bismal,
Lehman, to Marie Stewart, Lehman, et al. (Jan. 29, 2008) [LBHISEC07940_861461] (consisting of email
chaindiscussionregardingbalancesheetprojectionsandriseinnetleverageinwhichMichaelMcGarvey
statesthatadditionalRepo105willcleanupthebalancesheetandAnurajBismalcallsRepo105/108an
importantfeature.);emailfromSigridStabenow,Lehman,toGerardReilly,Lehman,etal.(Jan.30,2008)
[LBEXDOCID 4292184] (reporting to Reilly and Clement Bernard regarding the gap to quarter end
861

Bernard wrote to Amin and Higgins on February 28, 2008, regarding FIDs
net balance sheet overage; in particular, Bernard indicated that FIDs Rates
business was $4.5 billion over target.3309 Bernard warned: This will drive
Lehmannetleverageratioabovetarget.Pleaseletmeknowwhatwecando
tominimizethisimpact....Iknowitislateintheprocessbutwhateverwe
can do would help our ratio.3310 Later that day, Bernard forwarded that
message to Martin Potts, adding the message: We are looking at selling
whateverwecanandalsodoingsomemorerepo105.3311
AftersuccessfullylobbyingforadditionalRepo105capacityatquarterend,
JeffMichaelswrotetoAmin:Thegoodnewsis...assoonaslehmangives
thegreenlight,wecanreducethenet/grossbyanother2.53bn.3312
Indeed,Repo105transactionsbecamesuchadeeplyingrainedfeatureofbalance
sheet management that balance sheet targets and Repo 105 often were discussed
together,aswhenMichaelsemailedAminaspreadsheetTejal[Joshi]helpedmeput
together with my suggested allocations for the global balance sheet/repo 105 for this
quarter.3313 When Michaels explained in an email that he was working on balance
targetandstatingthatFIDisforecastingtobe$15bnoverquarterendlimitandFIDleadersmadea
[r]ecommendationthatRepo105programisexpanded.);emailfromJerryRizzieri,Lehman,toKieran
Higgins, Lehman, et al. (Apr. 22, 2008) [LBEXDOCID 756532] (following the announcement of new
balance sheet targets for quarter end, Rizzieri wrote: We will need to be focused very early in the
processinordertomeetthesetargets,thatthereisnoroomforerrorthisquarterandthataccordingly
wealsoneedtohaveacoordinatedapproachtorepo105allocation).
3309EmailfromClementBernard,Lehman,toKaushikAmin,Lehman,etal.(Feb.28,2008)[LBEXDOCID
1854189].
3310Id.
3311Email from Clement Bernard, Lehman, to Martin Potts, Lehman (Feb. 28, 2008) [LBEXDOCID
1854189].
3312EmailfromJeffMichaels,Lehman,toKaushikAmin,Lehman(May21,2008)[LBEXDOCID736186].
3313Email from Jeff Michaels, Lehman, to Kaushik Amin, Lehman, et al. (July 31, 2008) [LBEXDOCID
756327] (transmitting attached spreadsheet of balance sheet targets and Repo 105 allocations [LBEX
DOCID633334]).
862

sheet allocations, he wrote: It is really a bottomup process about who has sticky
inventory.ObviouslyintheUSitisAgencies,andinLondonitisInflation.3314
Lehmans internal balance sheets tracked the firms Repo 105 usage and its
resultingbenefittothefirmwidebalancesheet.3315Thesebalancesheetswereusedby
3314EmailfromJeffMichaels,Lehman,toKaushikAmin,Lehman(July30,2008)[LBEXDOCID613324].
Because Michaels worked for the Liquid Markets division, sticky in this context does not refer to
actually illiquid assets, but rather, is used relative to the most liquid inventory. Sticky agencies, for
example, would likely refer to offtherun securities all government and treasury securities issued
beforethemostrecentlyissuedsecurityofaparticularmaturityisofftherun.Offtherunsecurities
arelessfrequentlytradedandarethereforeilliquidcomparedtothemostrecentlyissuedsecurity.
3315See,e.g.,Lehman,GlobalConsolidatedBalanceSheet,GlobalConsolidatedSummary[Draft](Aug.31,
2007) [LBEXDOCID 3215510] (stating Repo 105 usage on Aug. 31, 2007 was $36.627 billion); Lehman,
GlobalConsolidatedBalanceSheet,GlobalConsolidatedSummary[Draft](Sept.28,2007)[LBEXDOCID
2705059] (stating Repo 105 usage on Sept. 28, 2007 was $24.406 billion); Lehman, Global Consolidated
Balance Sheet, Global Consolidated Summary [Draft] (Oct. 31, 2007) [LBEXDOCID 2705943] (stating
Repo105usageonOct.31,2007was$29.623billion);Lehman,GlobalConsolidatedBalanceSheet,Global
ConsolidatedSummary(Nov.30,2007)[LBEXDOCID3439086](statingRepo105usageonNov.30,2007
(quarterend) was $38.634 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated
Summary (Jan. 29, 2008) [LBEXDOCID 3363236] (stating Repo 105 usage on Jan. 29, 2008 was $28.883
billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary (Feb. 13, 2008)
[LBEXDOCID 1697794] (stating Repo 105 usage on Feb. 13, 2008 was $23.602 billion); Lehman, Global
Consolidated Balance Sheet, Global Consolidated Summary (Feb. 22, 2008) [LBEXDOCID 3363289]
(stating Repo 105 usage on Feb. 22, 2008 was $31.029 billion); Lehman, Global Consolidated Balance
Sheet,GlobalConsolidatedSummary(Feb.29,2008)[LBEXDOCID579841](statingRepo105usageon
Feb. 29, 2008 (quarterend) was $49.102 billion); Lehman, Global Consolidated Balance Sheet, Global
ConsolidatedSummary(Mar.13,2008)[LBEXDOCID765323](statingRepo105usageonMar.,13,2008
was $26.212 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary (Apr.
14,2008)[LBEXDOCID766086](statingRepo105usageonApr.14,2008was$19.546billion);Lehman,
GlobalConsolidatedBalanceSheet,GlobalConsolidatedSummary(Apr.21,2008)[LBEXDOCID766088]
(stating Repo 105 usage on Apr. 21, 2008 was $21.907 billion); Lehman, Global Consolidated Balance
Sheet,GlobalConsolidatedSummary(Apr.28,2008)[LBEXDOCID766092](statingRepo105usageon
Apr. 28, 2008 was $24.077 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated
Summary (Draft) (Apr. 30, 2008) [LBEXDOCID 394333] (stating Repo 105 usage on Apr. 30, 2008 was
$24.709 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary (May 6,
2008) [LBEXDOCID 766102] (stating Repo 105 usage on May 6, 2008 was $24.388 billion); Lehman,
GlobalConsolidatedBalanceSheet,GlobalConsolidatedSummary(May13,2008)[LBEXDOCID766107]
(stating Repo 105 usage on May 13, 2008 was $25.282 billion); Lehman, Global Consolidated Balance
Sheet,GlobalConsolidatedSummary(May28,2008)[LBEXDOCID766924](statingRepo105usageon
May 28, 2008 was $43.112 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated
Summary(May29,2008)(statingRepo105usageonMay29,2008was$46.820billion);Lehman,Global
ConsolidatedBalanceSheet,GlobalConsolidatedSummary(Aug.14,2008)[LBEXDOCID84891](stating
863

managementandwerenotreportedexternally.3316LBHIsGlobalConsolidatedBalance
Sheet, for example, showed securities inventory levels preRepo 105 usage and with
Repo 105, and contained columns for Repo 105/108 added back as well as balance
sheet targets.3317 The Fixed Income Divisions Global Rates businesss balance sheet
projections spreadsheets recorded the balance sheet target and projected net balance
sheet, and populated with data individual columns for actual preRepo 105, Repo
105, actual postRepo 105, and Repo 105 target.3318 The Global Rates businesss
balance sheet management reports included sidebyside columns for gross balance
sheet, net balance sheet, and Repo 105.3319 Other balance sheet spreadsheets from the
Repo 105 usage on Aug. 14, 2008 was $18.274 billion); see also email from Mark Neller, Lehman, to
AnthonyKush,Lehman,etal.(Dec.5,2007)[LBEXDOCID3223384](PleasebeawarethatallRepo105
benefit taken to Management Balance Sheet at November month end needs to be replicated within
respectiveentitiesDBSaccounting.).
3316See email from Jody Li, Lehman, to Paolo R. Tonucci, Lehman, et al. (Mar. 15, 2008) [LBEXDOCID
117307] (transmitting to Lehmans Treasurer the Global Consolidated Balance Sheet [LBEXDOCID
120158] showing Repo 105 balance on Mar. 13, 2008); email from Gerard Reilly to Herbert H. (Bart)
McDade III (Mar. 27, 2008) [LBEXDOCID 560109] (transmitting Global Consolidated Balance Sheet for
Feb. 29, 2008 (Mar. 27, 2008) [LBEXDOCID 579841] and stating Bart this is the firm bs); email from
Atiba Rodriguez, Lehman, to Clement Bernard, Lehman, et al. (May 29, 2008) [LBEXDOCID 3221577]
(transmitting Global Consolidated Balance Sheet [LBEXDOCID 3237577] to Chief Financial Officer for
FID).
3317Email from Gerard Reilly to Herbert H. (Bart) McDade III (Mar. 27, 2008) [LBEXDOCID 560109]
(transmittingGlobalConsolidatedBalanceSheetforFeb.29,2008(Mar.27,2008)[LBEXDOCID579841]
toPresidentandCOOandstatingBartthisisthefirmbs).
3318Lehman, GlobalRates Net BalanceSheet (Dec.20, 2007) [LBEXDOCID 3215591](attached to email
fromMarkNeller,Lehman,toDivyeshChokshi,Lehman(Dec.21,2007)[LBEXDOCID3234333]).
3319Lehman,GlobalRatesQ3BalanceSheetManagement(Aug.18,2008)[LBEXDOCID637339](attached
to email from Tejal Joshi, Lehman, to Kaushik Amin, Lehman, et al. (Aug. 19, 2008) [LBEXDOCID
736504]); Lehman, Global Rates Q3 Balance Sheet Management (Aug. 19, 2008) [LBEXDOCID 637341]
(attached to email from Tejal Joshi, Lehman, to Kaushik Amin, Lehman, et al. (Aug. 20, 2008) [LBEX
DOCID 736507]); Lehman, Global Rates Q3 Balance Sheet Management (Aug. 21, 2008) [LBEXDOCID
637338] (attached to email from Tejal Joshi, Lehman, to Kaushik Amin, Lehman, et al. (Aug. 22, 2008)
[LBEXDOCID736506]).
864

Rates business tracked net balance sheet, [a]dditional Repo 105, reduction of
governmentinventory,andtotalbalancesheetreductionbytradingdesk.3320Similarly,
theLiquidMarketsgroupwithinFIDreportedinternalbalancesheetprojectionfigures
forbothgrossandnetbalancesheettargetsalongwithRepo105.3321
Senior management exerted pressure, particularly at or near quarterend, to
utilizetheRepo105mechanismtomeetthefirmimposedbalancesheettargets:
FourdaysbeforethecloseofLehmansfiscalyearinNovember2007,Mitch
KingwrotetoMarcSilverberg:Letmeknowifwehaveroomforanymore
repo105.IhavesomemoreIcanputinovermonthend.3322JerryRizzieri,
whoreporteddirectlytoKaushikAmin,repliedtoKing:Canyouimagine
whatthiswouldbelikewithout105?3323
On February 28, 2008, one day before the close of Lehmans first quarter
2008, Amin, thenHead of Liquid Markets, wrote to Kieran Higgins: We
have a desperate situation and I need another 2 billion from you, either
throughRepo105oroutrightsales.Costisirrelevant,weneedtodoit.3324
AlsoonFebruary28,2008,MarkGavinwrotetoJohnFeraca:Justtookacall
fromFIDmgmtseemstheyreuponnetb/sby3blnunanticipated&area
little excited w Q end. I am looking to do an additional repo 105 with
Mizuho....3325
3320Lehman, Rates Americas Balance Sheet (Feb. 26, 2008) [LBEXDOCID 3218412] (attached to email
fromMichaelMcGarvey,Lehman,toJerryRizzieri,Lehman(Feb.28,2008)[3233807].
3321Lehman, Liquid Markets Balance Sheet (May 15, 2008) [LBEXDOCID 3439007] (attached to email
fromMichaelMcGarvey,Lehman,toTalLitvin,Lehman(May19,2008)[LBEXDOCID3383917].
3322Email from Mitchell King, Lehman, to Marc Silverberg, Lehman (Nov. 26, 2007) [LBEXDOCID
3232804].
3323Email from Jerry Rizzieri, Lehman, to Mitchell King, Lehman (Nov. 26, 2007) [LBEXDOCID
3232804].
3324Email from Kaushik Amin, Lehman, to Kieran Higgins, Lehman (Feb. 28, 2008) [LBEXDOCID
3234351].
3325EmailfromMarkGavin,Lehman,toJohnFeraca,Lehman,etal.(Feb.28,2008)[LBEXDOCID98492].
865

HigginswrotetoJeffMichaels,onMay2,2008:Inlightofthefirmsmax
ratio at q end to month avg [] we started to [Repo] 105 irp balance sheet
severalweeksagoforqend(thishasarealcostthough).3326
OnMay21,2008,AminwrotetoHiggins:LetsmaxoutontheRepo105for
your stuff and see where end up.3327 When Amin asked Higgins for an
update on the balance sheet management, Higgins replied: [A]nything that
movesisgetting105d.3328
In an email from McGarvey to Reilly written ten days before the close of
Lehmans second quarter 2008, McGarvey wrote: Kaushik [Amin] has just
requestedthattheydoasmuchRepo105aspossible.3329
InanemailtoThomasSiegmund,alsotendaysfromthecloseofLehmans
secondquarter,Aminwrote:DoasmuchasyoucaninRepo105.Canyou
find Repo 105 capacity among Japanese counterparties to take US
Agencies?3330
As the close of Lehmans third quarter 2008 was approaching, Amin asked
Andrew Morton, thenhead of Lehmans Fixed Income Division, for
additionalRepo105authorityinordertomakebalancesheettargets.3331
3326EmailfromKieranHiggins,Lehman,toJeffMichaels,Lehman(May2,2008)[LBEXDOCID601783].
3327Email from Kaushik Amin, Lehman, to Kieran Higgins, Lehman (May 21, 2008) [LBEXDOCID
3234382].
3328Email from Kieran Higgins, Lehman, to Kaushik Amin, Lehman (May 21, 2008) [LBEXDOCID
3329Email from Michael McGarvey, Lehman, to Gerard Reilly, Lehman, et al. (May 21, 2008) [LBEX
DOCID3221744].
3330Email from Kaushik Amin, Lehman, to Thomas Siegmund, Lehman (May 21, 2008) [LBEXDOCID
756545]; see also email from Jeff Michaels, Lehman, to Kaushik Amin, Lehman (May 27, 2008) [LBEX
DOCID723365](respondingtoAminsmessageImportanttogetasmuchoftheAgencyinventoryout
aspossible,bystating:Theycontinuetodoso,andhaverepo105deverythingtheycan....).
3331SeeemailfromKaushikAmin,Lehman,toAndrewJ.Morton,Lehman(Aug.20,2008)[LBEXDOCID
3234406] (responding to Mortons question Can you keep going on bal sheet[?] by stating: I am
squeezing hard. But, the challenge is that liquidity is poor given the European holidays. Most of our
tough balance sheet is inflation and Agencies, which is extremely illiquid. I think we should relax the
Repo105constraintsabit.Insteadof$20Bln,weshouldtakeituptosay$25Bln.).
866

(b) WitnessStatementstotheExaminerRegardingtheTrue
PurposeofLehmansRepo105Practice
Virtuallyeverywitness theExaminerquestionedregarding LehmansRepo 105
practice, including some in the top echelon of Lehmans management, agreed that
Lehman relied upon Repo 105 transactions to reduce its net balance sheet at quarter
end.AmongthestatementsmadeduringtheinvestigationoftheRepo105issueare:
Paolo Tonucci, former Treasurer, recalled that near the end of reporting
periods, Lehman would deploy Repo 105 transactions to reduce its balance
sheet.3332HealsoacknowledgedthatLehmansuseofRepo105transactions
impactedLehmansnetleverageratio.3333
IanLowitt,formerChiefFinancialOfficer,recalledthatLehmanestablisheda
regime of limits, meaning balance sheet targets, for each business unit to
managetoandthatRepo105wasonewaytoselldownassetstomeetthe
targets.3334
Ed Grieb, former Global Financial Controller, stated thatLehmans total

assets were reduced by Repo 105transactions because the securities
inventorycameoffLehmansbooksand,importantly,thecashthatLehman
receivedinaRepo105transactionwasusedtopaydownotherliabilitiesor
topayforsecuritiesitrepoed.3335GriebmadeclearthatLehmanwouldnot
have simply sat on the cash it received in Repo 105 transactions, which
would have resulted in a net zero impact on Lehmans assets.3336
Accordingly, Grieb agreed that one consequence of Lehmans Repo 105
transactionswasareductioninLehmansnetleverageratio.3337
3335ExaminersInterviewofEdwardGrieb,Oct.2,2009,atpp.9,11.
3336Id.
3337Id.atp.11.
867

MartinKelly,formerGlobalFinancialController,saidthattheonlypurpose
or motive for [Repo 105] transactions was reduction in the balance sheet
andthattherewasnosubstancetothetransactions.3338
ClementBernard,formerChiefFinancialOfficerforFID,saidthatastheend
ofaquarterdrewnear,LehmanpersonnelrelieduponRepo105transactions
forbalancesheetreliefandtoreachfirmimposedbalancesheettargets.3339
JohnFeraca,whorantheSecuredFundingDeskinLehmansPrimeServices
Group,stated:Seniorpeoplefelturgencyonlyinthesenseoftryingtoget
to their targets because the Finance Division wanted to report as healthy a
balance sheet and leverage ratio as possible for investors, creditors, rating
agencies and analysts.3340 He added: It was universally accepted
throughout the entire institution that Repo 105 was used for balance sheet
reliefatquarterend.3341
Kaushik Amin, former Head of Liquid Markets, said that Lehman reduced
itsnetbalancesheetatquarterendbyengagingintensofbillionsofdollars
ofRepo105transactionsandthatanumberofdaysaftertheopeningofthe
new quarter, the Repo 105 inventory would return to Lehmans balance
sheet.3342
Matthew Lee, former Senior Vice President, Finance Division, in charge of

Global Balance Sheet and Legal Entity Accounting, recalled that Lehman
wouldsellassetsthroughRepo105transactionsapproximatelyfourorfive
daysbeforethecloseofaquarterandthen repurchasethemapproximately
fourorfivedaysafterthebeginningofthenextquarterinordertoreverse
engineeritsnetleverageratioforitspubliclyfiledfinancialstatements.3343
3338ExaminersInterviewofMartinKelly,Oct.1,2009,atp.7.SeeSectionsIII.A.4.g.1andIII.A.4.h.3.bcof
the Report for discussion of Kellys discomfort with Repo 105 transactions; see also email from Martin
Kelly,Lehman,toMarieStewart,Lehman(Feb.14,2008)[LBEXDOCID3223647](Whatisourcurrent
BS advantage resulting from Repo 105/108 approx?). When asked about this email, Kelly told the
ExaminerthatbalancesheetadvantagereferredtoareductionofnetbalancesheetthroughRepo105.
ExaminersInterviewofMartinKelly,Oct.1,2009,atp.6.
3339ExaminersInterviewofClementBernard,Oct.23,2009,atp.7.
3341Id.
3342ExaminersInterviewofKaushikAmin,Sept.17,2009atp.6.
868

Marie Stewart, the former Global Head of Lehmans Accounting Policy

Group, described Repo 105 transactions as a lazy way of managing the
balance sheet as opposed to legitimately meeting balance sheet targets at
quarterend.3344
Anuraj Bismal, former Senior Vice President in Lehmans Balance Sheet

group,agreedwithotherwitnessstatementsdescribingthefirmsRepo105
program in pejorative terms, such as windowdressing and a drug.3345
Bismal explained that although Lehman had acquired a legal opinion and
developed an accounting policy justifying Repo 105 transactions, there
remained discomfort within Lehman regarding the use of Repo 105
transactionsforremovingsecuritiesinventoryfromthebalancesheet.3346
MurtazaBhallo,theformerBusiness/RiskManagerforPTGLiquidMarkets,
saidthatRepo105wasanaccountinggimmick.3347
MitchKingwastheformerheadofLehmansUnitedStatesAgenciestrading
desk who was required on a weekly basis to compile lists of collateral
available for inclusion in Repo 105 transactions and send the lists to LBIE
personnel.3348 King stated that no business purpose existed for Repo 105
transactions other than to reduce Lehmans net balance sheet.3349 King
referredtoLehmansRepo105programasanuisance.3350Accordingly,he
said,[t]herewasnoreasonformetogooutandRepo105.3351Kingfurther
stated that [f]rom a traders perspective, I would have rather never seen
anythingRepo105related.ItwasjustanotherthingIhadtodothatwasnot
atradeandthatwasnotapartofmybusiness.Iwouldnotgooutandseek
toRepo105[i.e.,ifhewasntrequiredtobysuperiors].3352
3345ExaminersInterviewofAnurajBismal,Sept.16,2009,atpp.78.
3346Id.
3347ExaminersInterviewofMurtazaBhallo,Sept.14,2009).
3348ExaminersInterviewofMitchellKing,Sept.21,2009,atp.6.
3349Id.
3350Id.
3351Id.
3352Id.
869

(3) QuarterEndSpikesinLehmansRepo105UsageAlsoSuggest
theTruePurposeofLehmansRepo105PracticeWasBalance
SheetManipulation
The documentary evidence and witness statements establish that Lehman
employed Repo 105 transactions for quarterend balance sheet reduction. This
conclusion is further confirmed by the fact that that Lehmans use of Repo 105
transactionsregularlyspikedupatquarterend.3353
Notably, this quarterend spike in Repo 105 usage occurred notwithstanding
evidence that certain Lehman personnel expressed concern about the concentration of
transactions at quarterend. For example, Martin Kelly, Lehmans Global Financial
Controller from December 1, 2007 through September 2008, said that he had
discomfort with the skewing of Repo 105 transactions at quarterend.3354 Kelly
further explained that he had expressed that concern about the quarterend
concentrationtobothCFOstowhomhereported,ErinCallanandIanLowitt.3355
TotheextentseniorLehmanpersonnelhaddiscomfortregardingthequarter
end spikes in Repo 105 usage, or concern about the risk of growing dependant upon
large volumes of Repo 105 transactions at quarterend given that the FASB could
potentiallychangeSFAS140,ChrisOMeara,EdGrieb,andGerardReillymandateda
set of two related guidelines loosely known within Lehman as (1) the 80/20 or
3353SeeDuff&Phelps,Repo105/108Usagevs.LimitComment(Oct.16,2009),atpp.79.
3355Id. See Sections III.A.4.h.3.bc of this Report (describing the conversations between Kelly and each
ChiefFinancialOfficerindetail).
870

continual use rule and (2) the 120% rule.3356 Those guidelines provided,
respectively, that (1) Repo 105 transactions outstanding at any time should be
maintained at a level throughout an entire month that was approximately 80% of the
amountatthatmonthend;and(2)themonthorquarterendspikeinRepo105activity
couldnotresultinabalancethatexceeded120%ofthedailyaverageusagethroughout
thatmonth.3357
3356Examiners Interview of Edward Grieb, Oct. 2, 2009, at p. 13. Paolo Tonucci, former Treasurer,
attributed the setting of a cap on Repo 105 usage to concern regarding overdependence on Repo 105
transactionstomanagebalancesheet.ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atp.26.
[LBEXWGM748489](Repo105transactionsmustbeexecutedonacontinualbasisandremaininforce
throughout the month. To meet this requirement, the amount outstanding at any time should be
maintainedatapproximately80%oftheamountatmonthend.[perChrisOMearaandEdGrieb.);e
mail from Michael McGarvey, Lehman, to Kentaro Umezaki, Lehman, et al. (Aug. 17, 2007) [LBEX
DOCID1635769](Theguidelineformonthendusageofrepo105isthatitshouldnotexceed120%of
yourdailyaverage.).Inanotheremail,McGarveyexplainedtheruletoClementBernard(formerFID
CFO):Wehaverepo105fundingbenefittradesonconstantlyinthenormalcourseofbusinessbecause
accountingpolicystipulatesitmustbearegularway[to]fundourpositions.Weincreasethebalancesfor
month end but try to keep it within 120 percent of the average daily usage (we are decent at this, not
great).SeeemailfromMichaelMcGarvey,Lehman,toClementBernard,Lehman(Jan.31,2008)[LBEX
DOCID2796633].McGarveywasmistaken,however,thatthecontinualuserulewaspartofLehmans
Repo105AccountingPolicy,whichdoesnotmentiontheguideline.Griebstatedthatthecontinualuse
rulewasnotanaccountingbasedrule.ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.13.See
alsoEmailfromClareChristofi,Lehman,toJosephGentile,Lehman,etal.(Dec.1,2006)[LBEXDOCID
3234175](forwardingearliermessagestatingWehaveaprovisionforRepo105/108whichis$24.6bn.
ThedailyaverageforNovemberis$18.1bngiving$21.8bntotalthatcanbetakenat120%,soweareover
by$2.9bn.);emailfromAnurajBismal,Lehman,toClareChristofi,Lehman,etal.(May8,2007)[LBEX
DOCID3234167]([I]tsmoreaboutconsistentusageofRepo105and108weshouldnothavethedeep
troughsofusagethatweusedtohave[inFIDworld].The80%rulethatClaretalksaboutaddressesthat
head on.); email from Anuraj Bismal, Lehman, to Michael McGarvey, Lehman, et al. (May 9, 2007)
[LBEXDOCID3223356](Asthebscontinuestogrowthenmaybeahigherlimitwouldbesupportedby
the80%math.);emailfromDivyeshChokshi,Lehman,toAnurajBismal,Lehman,etal.(Aug.14,2007)
[LBEXDOCID 3234164] (I thought that we had moved away from the Limit definitions as the desk
needs to demonstrate a consistent application during the month of Repo [105] benefit taken.); email
fromDivyeshChokshi,Lehman,toAnurajBismal,Lehman,etal.(Aug.14,2007)[LBEXDOCID3234166]
(disputingwithBismalwhetherBismalknewthatLehmanhadmovedawayfromlimitsandstatingwe
neededtoensurethattherewasaconsistentapplicationofRepo105Benefit.Ifhardlimitshavebeenset
thenletmeknow;emailfromClareChristofi,Lehman,toAnurajBismal,Lehman,etal.(Aug.14,2007)
871

Griebstatedthattheguidelineswereputinplacetomakesurethetransactions
had a legitimate business purpose.3358 Grieb, OMeara, and Reilly put together the
guidelines because they wanted to see there was a business purpose, that
counterpartiesweredoingthisonanongoingbasis,and...thattherewerenospikes
justattheendofthemonthorquarterend.3359
AnurajBismalsimilarlyrecalledthatLehmanmanagementmandatedRepo105
usagethroughoutaquartertodemonstratethatLehmansuseofRepo105transactions
was not solely windowdressing aimed at improving the firms quarterend financial
number.3360Bismalstatedthatthesocalled80/20rulewasaimedataddressingfirm
widediscomfortthatnovalidbusinessreasonexistedforRepo105transactions.3361In
Bismals words, the continual use rule was for mitigating the dips between the
peaks.3362
[LBEXDOCID 3234180] (Ed [Grieb] and Gerry [Reilly] were interested in the 80/120% of av daily
balance.); Lehman, Global Repo 105/108 vs. 120% of Daily Average Graph (July 31 Aug. 15, 2007)
[LBEXDOCID3219672](attachedtoemailfromMichaelMcGarvey,Lehman,toStevenBecker,Lehman,
etal.(Aug.17,2007)[LBEXDOCID3221344]);emailfromMichaelAnthony,Lehman,toKieranHiggins,
Lehman (Oct. 12, 2007) [LBEXDOCID 738606] ([I]t looks like the only limitation we have on size [for
Repo105]isthemonthendbalancecantbemorethan120%ofourdailyaveragethroughoutthemonth.
More specifically for the index business, if all positions are term repod for at least one month than
effectivelythereisnocaponsizeasourpositionswillbeincludedaspartofthedailyaverage.).
3359Id.
3360ExaminersInterviewofAnurajBismal,Sept.16,2009,atp.8.AccordingtoBismal,inapproximately
2005, thenChief Financial Officer Chris OMeara requested that John Feraca prepare a business case
justificationdocument.Id.BismalbelievedthatthedocumentsetforththepropositionthatifRepo105
transactionswereanormal(i.e.,constant)sourceoffundingforLehman,avalidbusinessreasonexisted
toundertakethetransactions.Id.
3361Id.
3362Id.
872

Lehmandidnotactuallyfollowtheseselfimposedrules.Thatisnotsurprising,
sincenowitnesswasabletoexplainabusinessrationaleforthearbitrary1xleverage,
continualuse,and120%rules.3363IfRepo105transactionsmadegoodbusinesssenseon
theirown,therewouldbenoapparentreasontoarbitrarilyrestricttheamountofsuch
transactionsto1xleverageortoimposeintramonthlimitstoensurethattheamountof
thetransactionsatreportingperiodsdidnotspiketomorethan120%ofaverageusage.
Noreason,thatis,excepttokeepthetransactionsundertheradar,bylimitingtheirtotal
andtheamountofaquarterendspike.
These dips were nevertheless pronounced. For instance, the total amount of
Repo105transactionsattheendoffirstquarter(February)2008wasapproximately$49
billion,theintraquarterdipasofApril30,2008wasapproximately$24.7billionandthe
quarterendamountforsecondquarter(May)2008wasapproximately$50.38billion.3364
Numerous balance sheet documents from Lehmans archives establish that Lehmans
3363 Note that Lehmans former Global Treasurer, Paolo Tonucci, cited two reasons why Lehman
management set limits on Repo 105 usage: (1) if there were a change to SFAS 140, such that true sale
treatment for repo transactions was no longer available, Lehman did not want to experience a seismic
shiftinitsbalancesheet;and(2)withoutlimits,therewasariskthatLehmansbusinesseswouldbecome
too dependent on the amount of flexibility the Repo [105] arrangement provided. Examiners
InterviewofPaoloR.Tonucci,Sept.16,2009,atp.27.
3364SeeLehman,TotalRepo105&Repo105Report(June11,2008)[LBEXDOCID2078195](showingthat
totalRepo105usageatcloseoffirstquarter2008was$49.1024billion,April30,2008totalRepo105usage
was$24.7439billion,andtotalRepo105usageatcloseofsecondquarter2008was$50.3834).
873

intraquarter use of Repo 105 transactions dipped significantly, as low as $12.75
billion.3365
3365See,e.g.,Lehman,GlobalConsolidatedBalanceSheet,GlobalConsolidatedSummary(Aug.31,2007)
[LBEXDOCID 3237230] (stating Repo 105 usage on Aug. 31, 2007, a quarterend, was $36.407 billion);
Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary [Draft] (Sept. 28, 2007)
[LBEXDOCID2705059](statingRepo105usageonSept.28,2007was$24.406billion);Lehman,Global
Consolidated Balance Sheet, Global Consolidated Summary (Draft) (Oct. 31, 2007) [LBEXDOCID
2705943] (stating Repo 105 usage on Oct. 31, 2007 was $29.936 billion); Lehman, Global Consolidated
BalanceSheet,GlobalConsolidatedSummary(Nov.30,2007)[LBEXDOCID3439086](statingRepo105
usageonNov.30,2007,aquarterend,was$38.634billion);Lehman,GlobalConsolidatedBalanceSheet,
GlobalConsolidatedSummary(Jan.29,2008)[LBEXDOCID3363236](statingRepo105usageonJan.29,
2008 was $28.883 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary
(Feb. 13, 2008) [LBEXDOCID 1697794] (stating Repo 105 usage on Feb. 13, 2008 was $23.602 billion);
Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary (Feb. 15, 2008) [LBEX
DOCID 3215625] (stating Repo 105 usage on Feb 15, 2008 was $24.217 billion); Lehman, Global
Consolidated Balance Sheet, Global Consolidated Summary (Feb. 22, 2008) [LBEXDOCID 3363289]
(stating Repo 105 usage on Feb. 22, 2008 was $31.029 billion); Lehman, Global Consolidated Balance
Sheet,GlobalConsolidatedSummary(Feb.28,2008)[LBEXDOCID4517138](statingRepo105usageon
Feb. 28, 2008 was $40.003 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated
Summary(Feb.29,2008)[LBEXDOCID579841](statingRepo105usageonFeb.29,2008,aquarterend,
was $49.102 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary (Mar.
12,2008)[LBEXDOCID022302](statingRepo105usageonMar.12,2008was$26.685billion);Lehman,
GlobalConsolidatedBalanceSheet,GlobalConsolidatedSummary(Mar.13,2008)[LBEXDOCID765323]
(stating Repo 105 usage on Mar., 13, 2008 was $26.212 billion); Lehman, Global Consolidated Balance
Sheet,GlobalConsolidatedSummary(Mar.14,2008)[LBEXDOCID3438624](statingRepo105usageon
Mar. 14, 2008 was $12.750 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated
Summary(Mar.27,2008)[LBEXDOCID3363367](statingRepo105usageonMar.27,2008was$22.104
billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary (Mar. 28, 2008)
[LBEXDOCID 3363367] (stating Repo 105 usage on Mar. 28, 2008 was $24.597 billion); Lehman, Global
Consolidated Balance Sheet, Global Consolidated Summary (Apr. 3, 2008) [LBEXDOCID 3438756]
(statingRepo105usageonApr.3,2008was$21.835billion);Lehman,GlobalConsolidatedBalanceSheet,
GlobalConsolidatedSummary(Apr.4,2008)[LBEXDOCID3438756](statingRepo105usageonApr.4,
(Apr. 11, 2008) [LBEXDOCID 766086] (stating Repo 105 usage on Apr. 11, 2008 was $20.260 billion);
Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary (Apr. 14, 2008) [LBEX
DOCID 766086] (stating Repo 105 usage on Apr. 14, 2008 was $19.546 billion); Lehman, Global
Consolidated Balance Sheet, Global Consolidated Summary (Apr. 18, 2008) [LBEXDOCID 1961054]
(stating Repo 105 usage on Apr. 18, 2008 was $19.785 billion); Lehman, Global Consolidated Balance
Sheet,GlobalConsolidatedSummary(Apr.21,2008)[LBEXDOCID766088](statingRepo105usageon
Apr. 21, 2008 was $21.907 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated
Summary (Apr. 28, 2008) [LBEXDOCID 766092] (stating Repo 105 usage on Apr. 28, 2008 was $24.077
billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary (Draft) (Apr. 30,
2008) [LBEXDOCID 394333] (stating Repo 105 usage on Apr. 30, 2008 was $24.709 billion); Lehman,
874

GlobalConsolidatedBalanceSheet,GlobalConsolidatedSummary(May6,2008)[LBEXDOCID766102]
(statingRepo105usageonMay6,2008was$24.388billion);Lehman,GlobalConsolidatedBalanceSheet,
GlobalConsolidatedSummary(May12,2008)[LBEXDOCID766107](statingRepo105usageonMay12,
(May 13, 2008) [LBEXDOCID 766107] (stating Repo 105 usage on May 13, 2008 was $25.282 billion);
Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary (May 27, 2008) [LBEX
DOCID 3237577] (stating Repo 105 usage on May 27, 2008 was $39.237 billion); Lehman, Global
Consolidated Balance Sheet, Global Consolidated Summary (May 28, 2008) [LBEXDOCID 766924]
(stating Repo 105 usage on May 28, 2008 was $43.112 billion); Lehman, Global Consolidated Balance
Sheet, Global Consolidated Summary (May 29, 2008) (stating Repo 105 usage on May 29, 2008 was
$46.820 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary (May 30,
2008) [LBEXDOCID 1427836] (stating Repo 105 usage on May 30, 2008, a quarter end, was $50.383
billion);Lehman,TotalRepo105&Repo108Report(July14,2008)[LBEXDOCID3363529](statingRepo
105 usage on July 14, 2008 was $17.315 billion); Lehman, Global Consolidated Balance Sheet, Global
ConsolidatedSummary(July15,2008)[LBEXDOCID3363529](statingRepo105usageonJuly15,2008
was $16.828 billion); Lehman, Global Consolidated Balance Sheet, Global Consolidated Summary (July
21,2008)[LBEXDOCID3363538](statingRepo105usageonJuly21,2008was$15.528billion);Lehman,
Global Consolidated Balance Sheet, Global Consolidated Summary (July 23, 2008) [LBEXDOCID
3363541] (stating Repo 105 usage on July 23, 2008 was $14.786 billion); Lehman, Global Consolidated
Balance Sheet, Global Consolidated Summary (July 29, 2008) [LBEXDOCID 3363542] (stating Repo 105
usage on July 29, 2008 was $14.548 billion); Lehman, Global Consolidated Balance Sheet, Global
ConsolidatedSummary(Aug.14,2008)[LBEXDOCID84891](statingRepo105usageonAug.14,2008
was$18.274billion).
875

The chart above, for illustrative purposes only, uses confirmed Repo 105 data
reported in Lehmans Global Consolidated Balance Sheet, a comprehensive report
Lehman produced for purposes of tracking its success in achieving its gross and net
balance sheet targets.3366 The data from the Global Consolidated Balance Sheets
demonstrate that Lehmans Repo 105 usage spiked at quarterends and fell off on an
intraquarterbasis.3367
Lehman consistently failed to comply with the 80/20 rule.3368 For most months
(and all quarterend months) Lehman failed to maintain an average daily balance
throughout the month that equaled or exceeded 80% of the monthend balance.3369
Similarly, at every quarterend (and most month ends) after the first quarter 2006,
3366 See note 3365, supra (providing more data from Lehmans Global Consolidated Balance Sheet
regardingRepo105usageonparticulardates)andAppendix17,Repo105Appendix(providingdatain
table form). Lehmans Global Consolidated Balance Sheet generally summarized, by division and
business unit, Lehmans consolidated financial position e.g., its balance sheet size, dayoverday
changes, net and gross balance sheet targets, amounts by which it was over/under targets and the
impact of Repo 105 on the net balance sheet was summarized as well. The impact of Repo 105 on
Lehmans grossand net balancesheetas presentedin the Global Consolidated Balance Sheet reports is
consistent with the impact of Repo 105 usage on Lehmans net balance sheet that Duff & Phelps
independently ascertained in its analyses. See Duff & Phelps, Assumed Hierarchy of Repo 105 Usage
Data(Jan.26,2010),atp.2(alsostatingthatLehmansGlobalConsolidatedBalanceSheetdataonRepo
105isveryauthoritative).
3367Seenote3365,supra;Appendix17,Repo105Appendix.
3368Duff & Phelps, Repo 105/108 Usage vs. Limit Comment (Oct. 16, 2009), at p. 7; see also email from
MichaelMcGarvey,Lehman,toClementBernard,Lehman(Jan.30,2008)[LBEXDOCID2796630](We
increasethebalancesformonthendbuttrytokeepitwithin120percentoftheaveragedailyusage(we
aredecentatthis,notgreat.)).
3369SeeDuff&Phelps,Repo105/108Usagevs.LimitComment(Oct.16,2009),atp.7.
876

Lehmans Repo 105 usage exceeded 120% of the preceding months daily average
usage.3370
(4) Repo105TransactionsServedNoBusinessPurposeOther
ThanBalanceSheetReduction
When pressed to identify any legitimate business purpose for Lehmans use of
Repo105transactions,severalwitnessesnotedthesecuredshorttermfinancingforthe
transactions in addition to the balance sheet reduction purpose.3371 While one
consequenceofRepo105transactionswasthatLehmanreceivedfinancinginexchange
for collateral (which, as noted above, it did not record as a borrowing), a Repo 105
transaction was a more expensive way for Lehman to secure shortterm financing as
comparedtoanordinaryrepo.3372
(a) Repo105TransactionsCameataHigherCostThan
OrdinaryRepoTransactions
Nothing prevented Lehman from engaging in a traditional overnight repo
transactionusingthesameassets,withthesamecounterparty,butatalowerhaircut
(e.g., 102 assets/$100 versus 105 or 108 assets/$100) and lower cost on any particular
3370Seeid.
3371ExaminersInterviewofMarkGavin,Sept.24,2009,atpp.45(statingthatprimarypurposeofRepo
105transactionswasbalancesheetmanagement,butstatingthattheyalsohadafundingpurpose,though
repeatedlyacknowledgingthataregularrepowouldhavebeencheaper);ExaminersInterviewofJohn
Coghlan,Nov.11,2009,atp.7(statingthatthepurposewasbalancesheetreductionandfinancing,and
acknowledgingthatRepo105transactionsweremoreexpensivethanordinaryrepotransactions).
3372Examiners Interview of Mitchell King, Sept. 21, 2009, at p. 7; Examiners Interview of Mark Gavin,
Sept.24,2009,atpp.45;ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.6;ExaminersInterviewof
MatthewLee,July1,2009,atp.14.
877

date when Lehman engaged in a Repo 105 transaction.3373 The more expensive route
was taken because the traditional repo transaction would not have provided Lehman
the balance sheet benefit that Repo 105 transactions provided to the firm namely,
Repo 105 transactions enabled Lehman to reverse engineer its externally reported net
balancesheetandnetleverageratioforpublicconsumption.3374
A Repo 105 transaction was more expensive to Lehman than an ordinary repo
transactionforseveralreasons:3375
Repo 105 transactions generally carried a higher yield, that is, the interest
rate the counterparty charged Lehman for the borrowing.3376 [C]ertain of
3373ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.6(statingthatthesameassetscouldbeusedin
either an ordinary repo or a Repo 105 transaction, that with most counterparties, Lehman had the
capacity to do either type of transaction). This is not to suggest that any counterparty with which
Lehman engaged in ordinary repos would have also agreed to enter into a Repo 105 agreement with
Lehman. Rather, Repo 105 counterparties would have been willing to enter into ordinary repo
transactions.
3374ExaminersInterviewofMarkGavin,Sept.24,2009,atpp.45(statingthataregularrepotransaction
would have been cheaper than a Repo 105 transaction and that the latter was chosen for balance sheet
management); Examiners Interview of John Feraca, Oct. 9, 2009, at p. 6 (stating that Repo 105
transactionsweremoreexpensiveandthatLehmanengagedinthembecause[c]learly,thiswasaneffort
toreducebalancesheet.);ExaminersInterviewofMatthewLee,July1,2009,atp.14.
3375Andrew J. Morton Interview, Sept. 21, 2009, at p. 22 (Repo 105 transaction more expensive than
ordinary repo transaction); Examiners Interview of John Coghlan, Nov. 11, 2009, at p. 7 (same); email
fromMarkGavin,Lehman,toMarkNeller,Lehman,etal.(Aug.26,2008)[LBEXDOCID3232989](FYI
amnowrunningintoprettyunpalatablelevelsonthesetrades....)
3376ExaminersInterviewofMitchellKing,Sept.21,2009,atp.7(statingthatRepo105wasmorecostly
and expensive way to finance, that he believed the charges were unfair, and that there were
sometimesdiscrepanciesof5bpsintheamountdifferentRepo105counterpartieschargedforthesame
securities); Examiners Interview of Mark Gavin,Sept. 24,2009,at p.7(explaining that haircut,interest
rate,andoffshoretradingmadeRepo105moreexpensivethanordinaryrepo);ExaminersInterviewof
JohnFeraca,Oct.9,2009,atp.5(explainingwhyRepo105moreexpensivethanordinaryrepo).Butnote
thatKaushikAminsaideventhoughRepo105transactionswerecostlierthanregularrepotransactions,
theadditionalcostwasnegligibleandimmaterial.ExaminersInterviewofKaushikAmin,Sept.17,2009,
at p. 7. Unlike ordinary repos, the most common of whose term was overnight, Repo 105 transactions
typically had a seven or ten day term. The longer term could carry a costlier interest rate than the
overnight rate. However, during the relevant period (late 2007 to 2008), the interest rate on overnight
reposwasjustaslikelytobemoreexpensivethantheinterestrateonaweeklongrepousingthesame
878

ourcounterpartieschargeveryexpensivelevels[forRepo105],sowecannot
retainthosetypesoftradesforanylongerthannecessary.3377
As set forth above, Repo 105 transactions were required to carry a higher
margin or haircut (e.g., the minimum five percent haircut for Repo 105
transactions, as opposed to a two percent haircut for an ordinary repo
transaction using highly liquid collateral), which Lehman itself had to
fund.3378Thatis,Lehmanwouldhavehadtofundtheadditionalhaircutby
either dipping into its equity or through long term borrowings.3379 John
treasurycollateral.SeeBloombergFinanceL.P.RPGT01DRepoFinancingOVERNIGHTandRPGT
01WRepoFinancing1Week.Consequently,thehigherinterestrateinaRepo105couldnothavebeena
functionofthetermoftherepo.
3377Email from Mitchell King, Lehman, to Mark Gavin, Lehman, et al. (Dec. 3, 2007) [LBEXDOCID
3232555].
3378ExaminersInterviewofMitchellKing,Sept.21,2009,atp.7(statingthatRepo105wasmorecostly
and expensive way to finance, that he believed the charges were unfair, and that there were
sometimes discrepancies in the amount different Repo 105 counterparties charged for the same
securities); Examiners Interview of Mark Gavin,Sept. 24,2009,at p.7(explaining that haircut,interest
rate,andoffshoretradingmadeRepo105moreexpensivethanordinaryrepo);ExaminersInterviewof
JohnFeraca,Oct.9,2009,atp.5(explainingwhyRepo105moreexpensivethanordinaryrepo).
Inlate2007and2008,Lehmanoftenfaceda6.5%orhigherhaircutonRepo105transactionsand
aninepercenthaircutonRepo108transactions.LehmanhadbeenlosingliquiditysinceJuly2007,as
repo lenders across the board gradually increased collateral requirements in their transactions with
Lehman.ExaminersInterviewofRichardPolicke,May28,2009,atp.4;seealsoPeterHordahl&Michael
R.King,DevelopmentsinRepoMarketsDuringtheFinancialTurmoil,BankingIntlSettlementsQ.Rev.,
Dec.2008,at37(focusingontheperiodsincethestartofthefinancialturmoilinmid2007andnotingthat
[a]s financing inunsecured markets became moreexpensive orunavailable,financialinstitutions with
funding requirements bid more aggressively in repo markets to secure financing); Gary Gorton,
NationalBureauofEconomicResearch,SecuritizedBankingandtheRunonRepo,YaleICFWorkingPaper
No.0914(Nov.13,2009),at1,availableat:http://ssrn.com/abstract=1440752(Wearguethatthefinancial
crisisthatbeganinAugust2007isasystemicevent....Wearguethatthecurrentcrisisissimilar[tothe
bankingpanicsofthe19thcentury]inthatcontagionledto...unprecedentedrepohaircutsandeventhe
cessation of repo lending on many forms of collateral.). Consequently, it appears that haircuts for all
repos not just Repo 105 transactions could have increased in mid2007 and 2008. See email from
Michael McGarvey, Lehman, to Divyesh Chokshi, Lehman (Aug. 21, 2007) [LBEXDOCID 3234192] (I
wasonacallwiththefundingdeskonFridayandwastoldtheywerehavingdifficultymaintainingRepo
105 term liquidity on even the best collateral.); email from Michael McGarvey, Lehman, to Anuraj
Bismal, Lehman (Aug. 23, 2007) [LBEXDOCID 3232709] (stating that Mizuho rejected Freddie Mac
subdebt for Repo 105 transactions and that [t]his is just indicative of the liquidity situation in the
market.); email from Michael McGarvey, Lehman, to Anuraj Bismal, Lehman, et al. (Jan. 31, 2008)
[LBEXDOCID3223415](referringtodisruptionsintherepomarketwhichJawaddescribedastheworst
hesseenin7years).
3379The contribution to the cost of a Repo 105 transaction of 3% additional collateral, relative to an
ordinaryrepo,issignificant.Ultimately,ifallotherfeaturesofaRepo105andordinaryrepotransaction
(includingstatedinterestrate)wereidentical,theRepo105transactionwouldbemoreexpensive.Thisis
879

Feraca,whowasresponsibleforLehmansSecuredFundingDesk,saidthat
unlike ordinary repo haircuts, the haircut on a Repo 105 was funded with
moreexpensiveformsoffinancing,suchaslongtermdebt.3380
Offshore trading of United States agency securities, treasuries, and

governmentsecuritieswaspotentiallymoreexpensivethandomestictrading
within the United States.3381 (Recall that a substantial volume of Lehmans
Repo 105 transactions, conducted in Europe, involved these types of
securities).
Asonewitnessrecalled,Wewereinabitofapricetakingsituationbecause
therangeof[Repo105]counterpartieswaslimited.3382
duetothefactthattheadditionalovercollateralizationofRepo105borrowingswasnotfinanceableinthe
transactionandhadtobefundedbyLehmanitselfwithequityorotherlongterm,morepermanentforms
of funding that carried higher costs. Further, the haircut determined the amount of leverage an
institution undertook in a transaction. Such increases in haircuts from very low levels can have a
particularlyharmfulimpactonaninstitutionsabilitytomaintainitslevelofearningsanditsreturnon
equity. This places a significant burden, potentially including the need to raise equity capital, on
institutionsthatexperienceincreasinghaircuts.SeeTobiasAdrian,etal.FinancialIntermediaries,Financial
StabilityandMonetaryPolicy,FederalReserveBankofNewYorkStaffReportNo.346(Sept.2008),atpp.
1113,availableat:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1266714.
3381ExaminersInterviewofMarkGavin,Sept.24,2009,atp.7.
3382ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.5;seealsoemailfromStephenGerber,Lehman,
to Gary Lynn, Lehman (Aug. 22, 2007) [LBEXDOCID 3234616] (responding to Gerbers statement that
Aswediscussedyesterday,counterpartiesaregettingalittlepickierwithRepo,bystating,Uhohis
thisforrepo105?towhichGerberresponded:Yes.).Inthe2007to2008period,LehmansRepo105
counterpartieswereprimarilyrestrictedtoMizuho,Barclays,UBS,Mitsubishi,andKBC,thoughsomeof
these also tapered off their Repo 105 trading in 2008. Email from Chaz Gothard, Lehman, to Mark
Gavin,Lehman,etal.(Sept.4,2007)[LBEXDOCID4553246](KBCarenolongerabletofinanceour105
agencytrades....Thiseffectivelymeansweonlyhave3counterpartswithwhichtotransactthisbusiness
Mizuho, Barclays & UBS. Whilst they have taken all the paper weve thrown at them to date this
situationshouldnotbereliedupon.);emailfromJohnFeraca,Lehman,toIanT.Lowitt,Lehman,etal.
(Feb.28,2008)[LBEXDOCID3207903](reportingRepo105tradeswithBarclays$3billion,UBS$6
billion,Mizuho$2billion);emailfromMarkGavin,Lehman,toDanielMalone,Lehman,etal.(May
20,2008)[LBEXDOCID736184](notinginemailwithsubjectlineRE:Repo105CPSthatMizuho
$5bln,[n]olongeratthetable:Barclaysupto$15bln,UBSupto$10bln,Mitsubishiupto$1bln,
andKBCupto$2bln);seealsoLehman,USAgencyDesk,Repo10512Mar19MarMizuho@2.73%
(Mar. 12, 2008) [LBEXDOCID 4523953] (listing 6.5% haircut on Repo 105 transactions); Lehman, US
Agency Desk, Repo 105 12 Mar19 Mar. UBS @ 3.10% (Mar. 12, 2008) [LBEXDOCID 4523950] (listing
sevenpercenthaircutonRepo105transactions);Lehman,USAgencyDeskRepo10512Mar19MarUBS
@2.75%(Mar.12,2008)[LBEXDOCID4523955](listing6.5%haircutonRepo105transactions);Lehman,
US Agency Desk, Repo 105 28 May4 Jun Mizuho @ 2.24 (May 27, 2008) [LBEXDOCID 4523968]
880

Manyvariablesimpactedtheinterestrateforbothanordinaryrepotransaction
and a Repo 105 transaction, so it is difficult to precisely measure the magnitude by
whichtheinterestrateonaRepo105wasgreaterthananordinaryrepo.3383However,
witnesses who have knowledge on the subject uniformly advised the Examiner that
Repo105tradesgenerallyweremoreexpensivetoLehmanthanordinaryrepos.3384
As one email succinctly states: Everyone knows 105 is an off balance sheet
mechanismsocounterpartiesarelookingforridiculouslevelstotakethem.3385Asked
(reflecting haircuts on Repo 105 transactions ranging from 6.5% to 210%); Lehman, US Agency Desk,
Repo105Mizuho28May4June(May27,2008)(showing2.6%and2.42%interestrateand6.5%haircut
onRepo105transaction).LehmanfrequentlypetitionedtoexpanditsRepo105linewithMizuho.See,
e.g.,EmailfromPaoloR.Tonucci,Lehman,toMatthewPinnock,Lehman(May22,2008)[LBEXDOCID
1548434] (Think I can get Chris [OMeara] to agree [to] another $2 bill, but it is critical to get some
contextaroundwhatischanging.).InMay2008,onlytendaysbeforequarterend,MatthewPinnock,on
behalf of Jeff Michaels and Kaushik Amin of FID, attempted to increase its Repo 105 line with
counterparty Mizuho. Id. Tonucci and OMeara were involved in this process of authorizing a
temporary increase in Lehmans Repo 105 capacity limits for the close of second quarter 2008. Id. In
February2008,LehmanfoundanewRepo105counterpartyinABNAmroBankNV(LondonBranch).
See email from Nirav Patel, Lehman, to Kandy Hosea, Lehman, et al. (Feb. 29, 2008) [LBEXDOCID
3383394]. Deutsche Bank was also a Repo 105 counterparty to Lehman in 2008. When a Repo 105
transaction with Deutsche Bank failed, Tonucci assigned Carlo Pellerani (International Treasurer) to
ensuretheproblemwasresolved.SeeemailfromPaoloR.Tonucci,Lehman,toJohnCoghlan,Lehman
(Mar.25,2008)[LBEXDOCID117336].
3383LehmansRepoManual,areferenceguidethefirmpublishedforinternalusebyitsownsalespeople,
providedthat[T]herateusedtocalculatetheinterestisafunctionofmanyfactors,including,butnot
limitedto:thesupplyanddemandforthesecuritiesusedascollateral,thesupplyanddemandforcash,
thematurityoftheRepo,andthemethodusedtotransferthesecuritiesusedascollateralfromthedealer
to the investor. Lehman, Repo Manual (Nov. 8, 2005), at p. 10 [LBEXLL 1175483]. The Manual also
statedthattherepointerestratebearsnorelationtotheinterestrateonthesecuritiesusedascollateral.
Id.Thecalculationoftherepointerestratepaymentisasfollows:(cashinvestment)x(repointerestrate)
x(numberofdaysrepooutstanding)dividedby360=repointerest.Id.
3384ExaminersInterviewofAnurajBismal,Sept.16,2009,atp.10;ExaminersInterviewofMitchellKing,
Sept.21,2009,atp.7;ExaminersInterviewofMarkGavin,Sept.24,2009,atp.7;ExaminersInterviewof
JohnFeraca,Oct.9,2009,atp.5;ExaminersInterviewofJohnCoghlan,Nov.11,2009,atp.7.
3385Email from Michael McGarvey, Lehman, to Anuraj Bismal, Lehman (Jan. 31, 2008) [LBEXDOCID
3384033].GiventhatinaRepo105transaction,Lehmanprovideditscounterpartywithmorecollateralfor
the same amount of cash as in an ordinary repo, one might expect the interest rate to be lower, as the
881

by the Examiner to explain this statement, McGarvey, the author of the email, stated
that counterparties such as Mizuho knew that Repo 105 transactions received off
balancesheettreatmentandasaresultmighttrytosqueezeLehman.3386
(b) WitnessesAlsoStatedThatFinancingWasNottheReal
MotiveforUndertakingRepo105Transactions
When asked directly, Joseph Gentile, a former FID Finance executive who
reportedtoGerardReilly,didnotbelievethatLehmansmotiveforundertakingRepo
105 transactions was financing.3387 Gentile stated unequivocally that no business
purposeforLehmansRepo105transactionsexistedotherthanobtainingbalancesheet
relief.3388GentilesaidthathereceivedhisRepo105educationsometimeneartheend
ofLehmans2006fiscalyearfromEdGrieb,LehmansGlobalFinancialControllerwho
terms were better for the lender, i.e., had greater protection in the form of more collateral in the case
Lehmandidnotrepayitsborrowing.TheExaminersanalysisshowsthat,onthecontrary,theinterest
rate in a Repo 105 transaction was higher than in an ordinary weeklong repo despite the
overcollateralization. Based on witness statements that Lehman was in a price taking situation, and
documentssuchastheemailinwhichLehmanstaffersbeggedtoincreasetheRepo105creditlinewith
Mizuho to improve the balance sheet profile at quarter end, the higher interest rate in a Repo 105
transaction was likelya consequence of Repo 105 counterpartiesbeing awareof Lehmansdesperation.
Examiners Interview of John Feraca (Oct. 9, 2009), at p. 5; see email from Stephen Allery, Lehman, to
MiyukiSuzuki,Lehman(Feb.19,2008)[LBEXDOCID098492].
3387ExaminersInterviewofJosephGentile,Oct.21,2009,atpp.67.Similarly,IrinaVekslerbelievedthat
Repo105transactionswerenotusedtogenerateliquidity.ExaminersInterviewofIrinaVeksler,Sept.
11,2009,atp.8.WhatthesewitnessesmeantisthatLehmansmotiveorpurposeforenteringintoRepo
105transactionswasnotfinancing.Inotherwords,althoughLehmanreceivedcashjustasitdidinan
ordinary repo transaction, this was just an outcome of the transaction but not Lehmans motive for
undertakingRepo105transactions.AsdescribedindetailinthisReport,LehmanconceiveditsRepo105
program for purposes of managing its balance sheet, particularly at quarterend reporting periods. If
Lehman had actually wanted to use its assets for purely financing arrangements to raise needed cash,
Repo105transactionswereacostlierandlesseffectivemeansofgeneratingliquiditythanordinaryrepo
transactions.
3388ExaminersInterviewofJosephGentile,Oct.21,2009,atp.6.
882

reporteddirectlytothenCFOChrisOMeara.3389AccordingtoGentile,Griebexplained
that Repo 105 transactions were a balance sheet management mechanism: a tool that
couldbeusedtoreduceLehmansnetbalancesheet.3390
Though Gentile did not understand the specific mechanics of Repo 105
transactions, he recalled that Repo 105 was a vehicle that Grieb owned and he was
using it to take my balance sheet away.3391 When the Examiner asked for further
explanation of that statement, Gentile said that if FID had excessions in its balance
sheet, Grieb would authorize additional Repo 105 capacity to alleviate potential
breachesofthebalancesheetlimit.3392GentileexplainedthattwowaysexistedforFID
to make its balance sheet targets where excessions existed: by selling assets or by
engaging in Repo 105 transactions.3393 Repo 105 transactions filled the gap between
whatLehmancouldsellthroughnormalbusinesspracticesandtheassetsthatLehman
neededtomoveoffitsbalancesheetinordertomeetbalancesheettargets.3394
3389Id.BeforearrivingatLehmaninJune2006,GentilehadneverheardofRepo105transactions,eitherby
nameordescription.Id.Withoutanyprompting,Gentilesaidthatitwashisunderstandingthatneither
JPMorgan,whereGentilehehadworkedfor11years,norBankofAmerica,wherehehadworkedfor5
years,usedsuchamechanism.Id.
3390Id. John Feraca similarly told the Examiner that the purpose of Repo 105 transactions was to take
advantageofSFAS140forpurposesofmanagingitsbalancesheet.ExaminersInterviewofJohnFeraca,
Oct.9,2009,atpp.67,1213.
3392Id. As Lehmans quarterend approached, OMeara, Grieb and Reilly would pressure Gentile to
ensurethatFIDmetitsbalancesheettargets.Id.Grieb,ontheotherhand,deniedhavinganyrecollection
ofLehmanfacingbalancesheetpressuresinitsFixedIncomeDivisionin2007.ExaminersInterviewof
EdwardGrieb,Oct.2,2009,atp.11.
3394See,e.g.,EmailfromKaushikAmin,Lehman,toHerbertH.(Bart)McDadeIII,Lehman(June3,2008)
[LBEXDOCID 574610] (stating that the Liquid Markets business within FID targeted lower numbers
883

Similarly,MatthewLeesaidtherewasnolegitimatebusinesspurposeforRepo
105transactions.3395Inhisview,LehmansRepo105practicewasforwindowdressing
thebalancesheettomakethecreditratinghigher.3396
g) TheMaterialityofLehmansRepo105Practice
(1) TheRepo105ProgramExposedLehmantoPotential
ReputationalRisk
Martin Kelly, who CFO Erin Callan handpicked to assume the role of Global
Financial Controller on December 1, 2007 (replacing Ed Grieb) and who retained that
position until Lehmans bankruptcy petition date in September 2008, first became
familiar withLehmans use of Repo 105transactions soon after he became Financial
Controller.3397 Lehmans reliance on Repo 105 transactions for balance sheet relief
sincetherestofFIDwashavingdifficultymeetingitstarget,transmittingLiquidMarketsBalanceSheet
ReportforMay30,2008[LBEXDOCID522198]showingthatLiquidMarketsused$42.221billioninRepo
105 transactions to come in $9.2 billion below its quarterend net balance sheet target, and stating we
spentalotofmoneytoachievethesetargets.Now,wehavetomakemoney).
3396Id.
3397ExaminersInterviewofMartinKelly,Oct.1,2009,atp.6.Kellydescribedatransitionperiodatthe
end of 2007, when Grieb was transitioning out of the role of Financial Controller and Kelly was
transitioning in. Id. In a November 6, 2007 email, Marie Stewart (Global Head of Accounting Policy)
sent Kelly a copy of the August 2007 version of the Balance Sheet Netting Grid, an accounting policy
documentthatoutlinedthevariousmechanismsbywhichLehmanmadeadjustmentstoitsbalancesheet.
Email from Marie Stewart, Lehman to Martin Kelly, Lehman (Nov. 6, 2007) [LBEXDOCID 2736621]
(statingthisisthedocthatsummarizeseveryreasonwenetdowntheb/sheet.Asdiscussed,E&Yarein
theprocessofreviewingitandtransmittingAccountingPolicyReviewBalanceSheetNettingandOther
Adjustments (Aug. 2007) [LBEXDOCID 2720761] (The Netting Grid)). The Netting Grid includes a
brief discussion of the Repo 105 program. See Accounting Policy Review Balance Sheet Netting and
OtherAdjustments(Aug.2007),atp.26[LBEXDOCID2720761](Undercertainconditionsthatmeetthe
criteriaasdescribedinparagraphs9and218ofFAS140,Lehmanpolicypermitsrepoagreementstobe
recharacterizedaspurchasesandsalesofinventory.).AnemailfromDecember2007revealsthatKelly
andStewartintendedtodiscusstheRepo105programsometimeafterLehmanfiledits2007Form10K.
SeeemailfromMarieStewart,Lehman,toMartinKelly,Lehman(Dec.18,2007)[LBEXDOCID3221244].
884

causedKellydiscomfort,3398becauseofthemagnitudeofLehmansusageand,inpart,
because he believed Lehman was the last of its peer CSE firms to employ similar
accountingforthesetypesoftransactions.3399
Kelly further attributed his discomfort with Lehmans use of Repo 105
transactionstothefactthattheonlypurposeormotiveforthetransactionswasreductionin
balance sheet and that there was no substance to the transactions.3400 Kelly thought
thatthelackofbusinesspurposeforthesetransactions,combinedwiththemagnitude
3399Id.The Balance Sheet Group regularly apprised Kelly of the volume of Lehmans Repo 105
transactions.See,e.g.,EmailfromAnurajBismal,Lehman,toMartinKelly,Lehman,etal.(Dec.5,2007)
[LBEXDOCID3223388](Weendedtheyearwith$38billionofrepo105/8nettings);Lehman,Current
Day November 30, 2007 Total Repo 105 and Repo 108 Graph (Dec. 5, 2007) [LBEXDOCID 3238265]
(attached to email from Anuraj Bismal, Lehman, to Martin Kelly, Lehman, et al. (Dec. 5, 2007) [LBEX
DOCID3223388]andstatingthattotalRepo105usageonNovember30,2007was$38.634billion);email
fromAnurajBismal,Lehman,toMartinKelly,Lehman,etal.(Feb.28,2008)[LBEXDOCID3223439](Per
PClooklikeRepo105/108maylandat$40Borslightlyhigher);emailfromAnurajBismal,Lehman,to
MartinKelly,Lehman,etal.(Mar.6,2008)[LBEXDOCID3223441](OurinitialestimatesarethatforQ1
2008 we used $48 Billion of repo 105/8nettings.). Numerous witnesses and internal emails state that
Lehman wasthe last ofits peer investment banks to be using Repo 105type transactionsby December
2007. The Examiner has not verified whether other CSE firms had at one time used these kinds of
transactions but later ceased using them. Bismal, Stewart, and McGarvey said that they believed that
LehmanwastheonlyCSEfirmengaginginRepo105transactionsbylate2007.MurtazaBhallosaidthat
BarclaysdidnotuseRepo105transactions.JosephGentilesaidthathehadpersonalknowledgethatJP
MorganandBankofAmericadidnotengageinRepo105typetransactionsformanagingtheirrespective
balancesheets.InDecember2007,Bismalwrote:Waschattingwithexlehmanemployee[CarlosLo]at
Merrillyesterdayheisintheirbalancesheetgrouphetold methatthey donotuserepo105/8,to
whichMarieStewartreplied,Thenthatmeanswearetheonlyoneleftwhodoes.EmailfromAnuraj
Bismal,Lehman,toMarieStewart,Lehman(Dec.5,2007)[LBEXDOCID3223386].InaJanuary2008e
mail,McGarveywrote:BythewaywearenowtheonlylargefirmonthestreetthatusesRepo105.E
mail from Michael McGarvey, Lehman, to Clement Bernard, Lehman (Jan. 30, 2008) [LBEXDOCID
2796630].InaMay2008emailfromRyanTraversaritoOMeara,TraversarireportedthatCitigroupand
JP Morgan likely do not do Repo 105 and Repo 108 which are UKbased specific transactions on
opinionsreceivedbyLEHfromLinklaters.ThiswouldbeanotherreasonwhyLEHsdailybalancesheet
is larger intramonth then at monthend. Email from Ryan Traversari, Lehman, to Christopher M.
885

ofLehmans Repo 105 usage at quarterend (at $38.6 billion at fiscal year end 2007,
when Kelly became Global Financial Controller) carried a potential for reputational
risktoLehmanandthat,shoulditbecomepublicknowledge,itmayreflect[]poorly
onthefirm.3401
Kellyfurtherexplainedthatthesizeoftheprograminanabsolutesensewasof
asizethatpresentedheadlinerisk,particularlyastheprogramwasskewedtoquarter
ends.3402WhenaskedbytheExaminerwhathemeantbyheadlinerisk,Kellystated
that if there were more transparency to people outside the firm around the
transactions,itwouldpresentadimpictureofLehman.3403
Lehmans increasing reliance on the Repo 105 transactions and the absence of
any disclosure of that fact in Lehmans Forms 10Q and 10K disquieted Kelly; he
remarkedthatifananalystoramemberoftheinvestingpublicweretoreadLehmans
Forms 10Q and 10K from cover to cover, taking as much time as she or he needed,
theywouldhavenotransparencyinto[Lehmans]Repo105program3404
KellysconcernsaboutLehmansuseofRepo105transactionspromptedhimto
raise them toboth of the Chief Financial Officers in place during Kellys tenure as
3401Id.; cf. email from Martin Kelly, Lehman, to Kaushik Amin, Lehman (Apr. 17, 2008) [LBEXDOCID
488108]([Repo105]Programhassomerisktoit.Reluctancetoexpandtonewregions/geographies.).
3403Id.
3404Id.
886

Global Financial Controller: Erin Callan and, later, Ian Lowitt.3405 According to Kelly,
the purpose of the conversations being to make sure they understood the size of the
programandthattherewasriskintheprogram.3406
Kelly spoke first to Callan and then to Lowitt, Callans successor, regarding
LehmansuseofRepo105transactionsonseparateoccasionswheneachwasservingas
Lehmans CFO.3407 Kelly recalled raising the following topics in his Repo 105
conversations with both Callan and Lowitt: (1) Kellys discomfort with the possible
reputationalriskLehmanwouldsufferiftheinvestingpublicandanalystslearnedthat
Lehman used Repo 105 transactions solely to reduce its balance sheet; (2) the size of
LehmansRepo105program,thatis,thevolumeofRepo105transactionsthatLehman
undertookatquarterendtoreduceitsbalancesheet;(3)thetechnicalbasis,froman
accounting perspective, by which Lehman was authorized to engage in Repo 105
transactions;(4)KellysbeliefthatnoneofLehmanspeerinvestmentbanksusedRepo
105 transactions; and (5) the fact that Lehmans Repo 105 activity was skewed at
quarterend, in other words, that the firms Repo 105 usage spiked at quarterend,
duringLehmansreportingperiods.3408
3405Id.; see also email from Marie Stewart, Lehman, to Dominic Gibb, Lehman (Dec. 21, 2007) [LBEX
DOCID3223846](FYIthatouruseofRepo105isaconversationattheCFOlevelatthispoint.).
3407Id.
3408Id.KellysdiscussionwiththeCFOsisdiscussedfurtheratSectionsIII.A.4.h.2.bcofthisReport.
887

(2) LehmansRepo105PracticeHadaMaterialImpacton
LehmansNetLeverageRatio
Lehmans Repo 105 practice at quarterend in late 2007 and for the first two
quarters2008hadamaterialimpactonLehmanspubliclyreportednetleverageratio
andLehmanmanagementknewit.Forexample,inaDecember5,2007email,Bismal
reported that Lehman would be at net leverage of 18.0x [vs say 16.3x] without repo
105/8.3409 Consistent with Bismals email, Lehman publicly reported a firmwide net
leverageratioof16.1xinitsForm10Kforthe2007fiscalyear.3410
Using Lehmans firmwide Repo 105 usage at the end of each quarter from
November 2006 through May 2008, the Examiner analyzed the impact that Lehmans
removalofassetsfromitsbalancesheetusingRepo105transactionshadonthefirms
publiclyreportednetleverageratio.Asthechartbelowdemonstrates,foreachofthose
seven reporting periods fourth quarter 2006 through second quarter 2008 by
employing Repo 105transactions rather than ordinary repo transactions, Lehman was
abletoreduceitspublishednetleverageratiobyaminimumof9%,withthatreduction
increasingto12%and15%infirstquarter2008andsecondquarter2008,respectively:
3409Email from Anuraj Bismal, Lehman, to Marie Stewart, Lehman, et al. (Dec. 5, 2007) [LBEXDOCID
3223384].
3410LBHI200710K,atpp.29,64.
888

GrossandNetBalanceSheetRatios
AttheQuarterEnded
May31 Feb29, Nov30, Aug31, May31, Feb28, Nov30,
$inMillions 2008 2008 2007 2007 2007 2007 2006
(a) TotalAssets 639,432 786,035 691,063 659,216 605,861 562,283 503,545
Less:
Cashandsecuritiessegregatedandondepositforregulatoryandotherpurposes (13,031) (16,569) (12,743) (10,579) (7,154) (6,293) (6,091)
Collateralizedlendingagreements* (294,526) (368,681) (301,234) (287,427) (257,388) (251,662) (225,156)
Identifiableintangibleassetsandgoodwill (4,101) (4,112) (4,127) (4,108) (3,652) (3,531) (3,362)
(b) NetAssets 327,774 396,673 372,959 357,102 337,667 300,797 268,936
(c) TotalStockholder'sEquity 26,276 24,832 22,490 21,733 21,129 20,005 19,191
(d) TangibleEquityCapital** 27,179 25,696 23,103 22,164 21,881 19,487 18,567
LeverageRatio(a)/(c) 24.3x 31.7x 30.7x 30.3x 28.7x 28.1x 26.2x
NetLeverageRatio(b)/(d) 12.1x 15.4x 16.1x 16.1x 15.4x 15.4x 14.5x
(e) Repo105/108Usage 50,383 49,102 38,634 36,407 31,943 27,284 24,519
Ifreposwereusedinplaceofrepo105s:
LeverageRatio((a)+(e))/(c) 26.3x 33.6x 32.4x 32.0x 30.2x 29.5x 27.5x
%increaseoveractualLeverageRatio 8% 6% 6% 6% 5% 5% 5%
NetLeverageRatio((b)+(e))/(d) 13.9x 17.3x 17.8x 17.8x 16.9x 16.8x 15.8x
%increaseoveractualNetLeverageRatio 15% 12% 10% 10% 9% 9% 9%
Notes:
*Collateralizedlendingagreementsaresecuritiesreceivedascollateral,securitiespurchasedunderagreementstoresell,andsecuritiesborrowed
**TangibleEquityCapitalisTotalStockholdersEquityplusjuniorsubordinatednoteslessidentifiableintangibleassetsandgoodwill.
Sources:
AssetandEquitydata:LehmanBrothersSEC10Kand10Qfilings.
Repo105/108Usage:Q42006,Q1,Q2andQ32007:LBEXDOCID3363434;Q42007:LBEXDOCID3219746;Q1andQ22008:LBEXDOCID2078195
AwalkthroughdocumentrelatedtoErnst&Youngs2007fiscalyearendaudit
ofLehmandefinesmateriality,withrespecttotheprocessforreopeningoradjusting
aclosedbalancesheet,asanyitemindividually,orintheaggregate,thatmovesnetleverage
by0.1ormore(typically$1.8billion).3411WilliamSchlich,formerleadpartneronErnst&
Youngs Lehman team, stated that this was Lehmans, rather than Ernst & Youngs,
definition of materiality and that it represented Lehmans determination of a
p.14[EYLELBHICORPGAMX07033384](Materialityisusuallydefinedasanyitemindividually,or
intheaggregate,thatmovesnetleverageby0.1ormore(typically$1.8billion).).Accordingly,anitem
thatimpactednetleverageby0.1pointwasdeemedmaterialenoughtoreopenbooks.Thewalkthrough
paper also states, Net leverage is an important ratio analyzed by the rating agencies and included in
Lehmansearningsreleases.Id.
889

materialitythresholdinconnectionwithLehmansowncriteriaforwhentoconsider
reopeningandadjustingtheclosedbalancesheet.3412
AsaresultofitsquarterendRepo105practicefromlate2007throughthesecond
quarter 2008, Lehman publicly reported a net leverage ratio that was 1.7 to 1.9 points
lower than what its net leverage ratio would have been if Lehman had used ordinary
repotransactionsinsteadofRepo105transactions.
(a) LehmanSignificantlyExpandedItsRepo105Practicein
Late2007andEarly2008
AlthoughLehmanhadusedRepo105transactionssince2001,beginninginmid
2007,LehmanrequiredgreateramountsofRepo105relieftoimproveitsreportednet
leverage ratio.3413 As a result, Lehmans quarterend use of Repo 105 transactions
significantlyincreasedbeginninginmid2007withthecloseofLehmansthirdquarter
2007 in August 2007, at which time Lehmans combined Repo 105 usage was $36.4
3412ExaminersInterviewofErnst&Young,Repo105Session,Oct.16,2009,atp.7(statementofWilliam
Schlich). Asked if he could describe what level of impact to Lehmans firmwide net assets Ernst &
Youngwouldhaveconsideredmaterial,SchlichsaidthatErnst&Youngdidnothaveahardandfast
rule defining materiality in the balance sheet context. Id. He said that with respect to balance sheet
issues,materialitydependsuponthefactsandcircumstances.Id.
3413Andrew Morton, the former Global Head of Lehmans Fixed Income Division, stated that Lehman
established limits on Repo 105 usage at the inception of the program in 2001. Examiners Interview of
AndrewJ.Morton,Sept.21,2009,atp.4.JohnFeracaalsorecalledthatLehmanplacedlimitsonRepo
105 usage at the programs inception: There were limits to Repo 105 going back to the beginning.
Sometimestheseweremoreemphaticandsometimesrelaxed.ExaminersInterviewofJohnFeraca,Oct.
9,2009,atp.8.Feracarecalledafirmwidelimitofbetween$10billionand$20billionwhenLehmanfirst
conceiveditsRepo105programin2001.Id.Feracasaidthatacertainlevelofsenioritywasrequiredto
setthecapsonRepo105andthatthesecaps/limitswerecommunicatedtothetradingdesksaswellasto
himatthefundingdesk.Id.
890

billion.3414AtthecloseofLehmansfiscalyearinNovember2007,LehmanstotalRepo
105was$38.63billion,incontrasttothe$25billioninternallimitsupposedlyineffectat
thattime.3415
TotalRepo105/108atQuarterEnd 3416
Q32006 Q42006 Q12007 Q22007 Q32007 Q42007 Q12008 Q22008

Repo105 n/a $19.213 $20.578 $23.054 $29.054 $29.727 $42.200 $44.536
Repo108 n/a $5.091 $6.4 $8.575 $6.863 $8.854 $6.902 $5.847
Total $27.153 $24.519 $27.284 $31.943 $36.407 $38.634 $49.102 $50.383
Key:
Dollar amounts are given in billions.
For purposes of this chart, Repo 105 amount refers to the total volume of Repo 105 transactions
undertaken by the Fixed Income Division.
For purposes of this chart, Repo 108 amount refers to the total volume of Repo 108 transactions
undertaken by the Equities Division.
Total Repo 105/108 amount may be greater than the sum of Repo 105 and Repo 108 volumes
reported in this chart due to intermittent and de minimis amount of Repo 105 transactions undertaken
by other Lehman divisions or groups.
3414Lehman,TotalRepo105/108Trend(Feb.20,2008)[LBHI_SEC07940_1957956].
3415Id.;Lehman,TotalRepo105&Repo108Report[LBEXDOCID3219746](Dec.5,2007)(attachedtoe
3223384]); email from Michael McGarvey, Lehman, to Kentaro Umezaki, Lehman, et al. (May 8, 2007)
[LBEXDOCID 1811432](25 bn is the total Lehman Repo 105/108limit. FIDs share is20bn. Rates has
been generally using 1618bn out of the 20bn with the remainder in credit.); email from Sigrid
Stabenow, Lehman, to Clement Bernard, Lehman, et al. (Jan. 25, 2008) [LBEXDOCID 1853428]
(recommendingthatRepo105programbeexpandedfrom$20billionto$23billion).
3416EmailfromMarkCiolli,Lehman,toMichelleNg,Lehman,etal.(Sept.6,2006)[LBEXWGM748487]
(statingthattotalRepo105usageonAugust31,2006,closeofthirdquarter2006,was$27.1533billion);
Lehman,TotalRepo105&Repo108Report(Jan.2,2007)[LBEXDOCID2715058](statingtotalRepo105
usage on November 30, 2006, close of fourth quarter 2006, was $24.5192 billion); Lehman, Total Repo
105/108Trend(Feb.20,2008)[LBHI_SEC07940_1957956](statingtotalRepo105usageonAugust30,2007,
closeofthirdquarter2007,was$36.4billion);Lehman,TotalRepo105&Repo108Report(Dec.5,2007)
[LBEXDOCID3219746](statingtotalRepo105usageonNovember30,2007,closeoffourthquarter2007,
was$38.634billion);Lehman,TotalRepo105&Repo108Report(June11,2008)[LBEXDOCID2078195]
(statingtotalRepo105usageonFebruary29,2008,closeoffirstquarter2008,was$49.102billionandfor
May 30, 2008, close of second quarter 2008, was $50.3834 billion); see also Lehman, Total Repo 105/108
TrendReport(June20,2008)[LBEXDOCID3363434](statingtotalquarterendRepo105usageforfourth
quarter2006throughsecondquarter2008).
891

Lehman Treasurer Paolo Tonucci recalled that Lehman placed a cap on total
Repo105usagebecauseaccountingrulescouldpotentiallychangeandwithoutalimit
inplace,therewasariskthatLehmansbusinesswouldbecometoodependentonthe
Repo105offbalancesheetarrangement.3417AJuly2006documentrevealsthat,atthat
time,thelimitswere:$17billionforRepo105transactionsand$5billionforRepo108
transactions.3418 The $17 billion limit on Repo 105 transactions was keyed to tangible
equity.3419 Other documents demonstrate that throughout 2007and into January2008,
theofficialinternallimitsonLehmansuseofRepo105/108transactionsremainedinthe
mid$20 billion range, generally $17 to $20 billion for Repo 105 transactions and $5
billionforRepo108transactions.3420
3417ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009atp.26.
WGM748489](GlobalBalanceSheetOverview);seealsoemailfromGaryLynn,Lehman,toKaushik
Amin,Lehman,etal.(Aug.22,2006)[LBEXDOCID2786867](discussingtemporaryincreaseofRepo105
limitto$20billionfrom$17.5billion).
3419SeeDuff&Phelps,Repo105/108Usagevs.LimitComment(Oct.16,2009),atpp.12(explainingthat
theRepo105limitwassetat1xTangibleEquity).TheGlobalBalanceSheetOverviewsaidthatRepo
105iscappedat$15B(1xleverage).Lehman,GlobalBalanceSheet,OverviewofRepo105(FID)/108
(Equities)(July2006),atp.2[LBEXWGM748489].TheOverviewalsoimpliedthat1xleveragemeant
thatRepo105usageshouldnotexceedTangibleEquity.Id.atp.5.
3420Email from Gary Lynn, Lehman, to Kaushik Amin, Lehman, et al. (Aug. 22, 2006) [LBEXDOCID
2786868]; email from Clare Christofi, Lehman, to Anuraj Bismal, Lehman, et al. (May 8, 2007) [LBEX
DOCID3234172](Limitswere$5bnforEq[uities]and$17bnforFID.);emailfromMichaelMcGarvey,
Lehman, to Kentaro Umezaki, Lehman, et al. (May 8, 2007) [LBEXDOCID 1811432] (25 bn is the total
LehmanRepo105/108limit.FIDsshareis20bn.Rateshasbeengenerallyusing1618bnoutofthe20bn
withtheremainderincredit.);emailfromMichaelMcGarvey,Lehman,toGerardReilly,Lehman(May
23,2007)[LBEXDOCID4553348](Wereprojectingtolandat24.5bninRepo105/108.18.5bnFID/6.5bn
Equities.); email from Sigrid Stabenow, Lehman, to Clement Bernard, Lehman, et al. (Jan. 25, 2008)
[LBEXDOCID 1853428] (recommending that Repo 105 program be expanded from $20 billion to $23
billion).
892

As market conditions worsened and the pressures on Lehman to reduce its net
leverage ratio increased, pressure mounted inside Lehman to adjust upward these
limits on Repo 105 transactions.3421 As discussed above, in February 2007, Joseph
Gentile(FIDChief Financial Officer) recommendedto Grieb thatLehmanincrease the
$22billioncombinedRepo105/108limit($17billioninRepo105and$5billioninRepo
108) by $3 billion to mitigate problems caused by: [e]xiting large CMBS positions in
Real Estate and sub prime loans in Mortgages [that] before quarter would [result in]
largelosses.3422
When interviewed by the Examiner, Grieb hadno recollection of receiving this
recommendationfromGentile.3423Griebalsodidnotrecallwhathappenedasaresultof
Gentilesrequest to increase the Repo 105 limit by $3 billion and further disclaimed
3421SeeSectionsIII.A.4.e.1andIII.A.4.e.45ofthisReport.
3422Lehman, Proposed Repo 105/108 Target Increase for 2007 (Feb. 9, 2007) [LBEXDOCID 2489498]
(attached to email from Joseph Gentile, Lehman, to Edward Grieb, Lehman (Feb. 10, 2007) [LBEX
DOCID 2600714]; see alsoemailfrom Joseph Gentile, Lehman, to Edward Grieb, Lehman(Feb.8,2007)
[LBEXDOCID2604414](Whatisyourappetiteforusexceedingourrepo105limitby$1.6bnatmonth
end?From17.0to18.6?).Gentilesproposalisdiscussedatlength,supra,atSectionIII.A.4.e.4.Whenthe
Examiner interviewed Gentile, he did not recall preparing the February 2007 analysis and
recommendationhesenttoGriebinwhichherequestedthe$3billionincreaseinthefirmwideRepo105
limit for first quarter 2007 (from $22 billion to $25 billion), though he recalled that authorization was
requiredtoexceedthefirmwideRepo105limit.ExaminersInterviewofJosephGentile,Oct.21,2009,at
p.8.GentilespeculatedthatsomeonefromLehmansBalanceSheetgroupmayhavepreparedportions
of the report for him, but Gentile was absolutely certain that he would have shown the analysis and
recommendationtoReilly,towhomhereported,beforesubmittingittoGrieb.Id.
3423ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.12.Similarly,Griebclaimedtohavenever
beforeheardthephrasestickyassetsandclaimedtohavenorecollectionofmarketconditionsin2007.
Grieb said that he did not even recollect that the $22 billion combined Repo 105 limit was in place in
February 2007, though he said he had no reason to dispute this fact. Id. Likewise (and contrary to
numerous documents and other witness statements), Grieb said that he had no recollection of balance
sheetpressureswithinLehmansFIDin2007.Id.
893

knowledge of whether Chris OMeara and Gerard Reilly received similar
petitions.3424ThoughGriebhadnorecollectionspecificallyofa$3billionincreasein
the Repo 105 cap (even when shown later emails which confirm that Grieb granted
Gentilesrequestforthe$3billionincrease),herecalledgenerallythatatsomepoint
intime,asaresultofdiscussionswithOMearaandReilly,weraisedthelimit.3425
Gentile also did not recall specifically whether Grieb approved the $3 billion
increase, which would have pushed Lehmans firmwide Repo 105 limit to $25
billion.3426 But when shown an email he sent to Michael Gelband (thenHead of FID)
indicatingthatGriebhadapprovedtherequestedincrease,Gentilesaidthathewould
neverhavewrittensuchanemailunlessGriebhadinfactauthorizedtheincrease.3427
Consistent with statements in his email to Gelband, Gentile stated that the$3 billion
3424Id.
3425Id.;seeemailfromJosephGentile,Lehman,toGerardReilly,Lehman(Feb.21,2007)[LBEXDOCID
4553220](Wespokewithgrieband...hewasokwithatemporaryexcessionof$3....);emailfrom
GaryLynn,Lehman,toSharanMirchandani,Lehman,etal.(Feb.21,2007)[LBEXDOCID1431154](As
youareawarewearesignificantlyovertheQ1balancesheetlimitswithoneweektogo,andKaushik
hasdeliveredthatmessagetothebusinessheadsthatweneedtocomedownfurtherasthereisnoroom
for us to be over our limits. Please note that the current projected overagealready includes an
additional$3bnofRepo105thatwehavebeengrantedabovethenormalRepo105limits,butithasbeen
communicated to me that this additional Repo 105 is to satisfy overages we currently have in other
business lines.). Marie Stewart (former Global Head of Accounting Policy) recalled that Repo 105
transactions became more prevalent in late 2007 and 2008, but she did not specifically recall an official
rampinguppolicy.ExaminersInterviewofMarieStewart,Sept.2,2009,atp.10.
3427ExaminersInterviewofJosephGentile,Oct.21,2009,atp.8;emailfromJosephGentile,Lehman,to
MichaelGelband,Lehman,etal.(Feb.20,2007)[LBEXDOCID1808077](Ihavebeenabletogetatemp
limitof3bnforrepo105activity,whichcoversknownrealestateissues.Wehaveissuesinmortgages
andliquidmarkets.).Inthesameemail,GentilealsonotedthatFIDwasmorethan$10billionoverits
balance sheet target for the quarter and that consequently, Lehmans firmwide net leverage ratio was
15.6ratherthanthetarget,14.8.Id.
894

increase was temporary and intended to apply to Lehmans first quarter 2007 only.3428
Other emails confirm that the $3 billion increase was granted.3429 As noted in this
Report,however,withinmonthsofFebruary2007,LehmansfirmwideRepo105usage
wasexceedingeventhatincreasedlimit.3430
3428Email from Joseph Gentile, Lehman, to Kentaro Umezaki, Lehman (Feb. 21, 2007) [LBEXDOCID
1808077].
3429EmailfromGerardReilly,Lehman,toJosephGentile,Lehman(Feb.21,2007)[LBEXDOCID4553218]
(asking after Gentile informed Reilly of a $3 billion increase to the Repo 105 limit, Where did the 3b
comefrom?Howfaroverisfid?);emailfromJosephGentile,Lehman,toGerardReilly,Lehman(Feb.
21,2008)[LBEXDOCID4553220](Wespokewithgriebanddidananalysiswhichshowedwedidnot
spikeandhewasokwithatemporaryexcession[intheRepo105limit]of$3[billion].).
3430No witness was able to explain to the Examiner why Lehman exceeded, by a significant margin,
LehmansselfimposedRepo105limits.MartinKellywasnotinvolvedwiththesettingorincreasingof
LehmansRepo105limitsatanytimewhilehewasFinancialController.ExaminersInterviewofMartin
Kelly,Oct.1,2009,atp.6.Infact,KellysaidhewouldhavehadnoauthoritytosetafirmwideRepo105
limitandthatabroaderandmoreseniorgroupthan[him]wouldhavehadauthorityoverthoselimits.
Id. Gentile stated unequivocally that authorization from senior Lehman personnel was required to
exceed Lehmansfirmwide Repo 105 limit during Gentiles tenure at Lehman(June2006 throughMay
2007).ExaminersInterviewofJosephGentile,Oct.21,2009,atp.7.GentileexplainedthatYouhadto
gothroughthechainofcommandthroughthelegalentitysideofthebusinesstogetmoreRepo105and
thatFIDcouldneverblowbythe[Repo105]limits...someonehadtoapproveit.Id.Ifanindividual
or group at Lehman sought to exceed the Repo 105 limit, according to Gentile, they needed to obtain
approvalfromGriebfortheexcession.Id.AccordingtoGrieb,thelimitsonLehmansRepo105usage
werenotexclusivelyforquarterend;rather,theyrepresentedthelimitforanygivenmomentthroughout
thequarter.ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.9.Accountingrulesapplicableto
Repo105transactionsdidnotprescribeafirmwidelimitonRepo105usage.Id.Rather,Grieb,OMeara,
and Reilly set Repo 105 limits as a prophylactic measure to prevent firm personnel from becoming too
reliant upon Repo 105 transactions as a tool for balance sheet relief just in case that funding source
drie[d]upandcounterpartieslos[t]interest.Id.DuringhisinterviewwiththeExaminer,Griebhadno
recollection of the quarterend amounts of assets moved off Lehmans balance sheet via Repo 105
transactions. Id. Grieb recalled, however, that at the time he wasLehmans Financial Controller, he
wouldhaveread,atleastseveraltimesamonth,reportsthatlistedLehmansfirmwideRepo105usage,
but that hesimply did not recall the volumes at present. Id. When the Examiner showed Grieb a
Lehmanprepared chart that indicated the total firmwide Repo 105usage at the end of fourth quarter
2007 was $38.634 billion when Grieb was still Lehmans Controller Grieb stated that he had no
recollection of this number but did not dispute its accuracy and saidthe figure did not shock him.
ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.12.WhenaskedtoexplainhowLehmansfirm
wide Repo 105 usage got as high as $39 billion in November 2007, approximately six months after
Lehman increased its firmwide Repo 105 limit to $25 billion, Grieb recalled having discussions with
OMearaandReillyaboutpossiblyincreasingLehmansfirmwiderepolimitinmidtolate2007.Id.
895

By the close of Lehmans first quarter 2008, February 29, 2008, Lehmans total
Repo105quarterendusagewas$49.1billion.3431AndatthecloseofLehmanssecond
quarter2008,May30,2008,LehmanstotalRepo105usagewas$50.38billion.3432Thus,
LehmansuseofRepo105transactionsmorethandoubledinthespanoffivereporting
periods,fromapproximately$24billionatfourthquarter2006(November2006)to$49.1
billionand$50.38billionatfirstquarter2008(February2008)andsecondquarter2008
(May2008),respectively.3433TheExaminertrackedLehmansactualRepo105usageand
comparedittothelimitasaratiooftangibleequity,asseeninthechartbelow:
3431See Lehman, Total Repo 105 & Repo 108 Report (June 11, 2008) [LBEXDOCID 2078195] (showing
February29andMay30,2008totalRepo105usage).NotethatMay31,2008wasaSaturday.
3432Id.
3433Lehman,TotalRepo105&108Report(Dec.13,2006)[LBEXDOCID2521357](statingNovember30,
2006totalRepo105usagewas$24.519billion);emailfromMichaelMcGarvey,Lehman,toGerardReilly,
Lehman, et al. (May 23, 2007) [LBEXDOCID 4553348] (stating firmwide Repo 105 usage projected at
$24.5 billion); Lehman, Balance Sheet and Cash Capital (Mar. 27, 2008), at p. 1 [LBEXDOCID 1698667]
(attachedtoemailfromClementBernard,LehmantoLisaRivera,Lehman(Mar.28,2008)[LBEXDOCID
1854835]andshowingfirmwidequarterendRepo105usageof$49.1billionforfirstquarter2008);email
from Michael McGarvey, Lehman, to Clement Bernard, Lehman, et al. (Apr. 15, 2008) [LBEXDOCID
3221734](FIDused42bninRepo105inQ1andEquitiesused7.0bso49bnwasthetotalfirmnumber.
Thiswasanincreaseof24bnfromQ406.).
896

Repo1051Usagevs.1XTangibleEquity
(Repo105UsageasaMultipleofTangibleEquity)
50,000
1.6X
45,000
1.6X
40,000

35,000

1.3X
1.3X
30,000
$inMillions

25,000 1.1X
1.1X
1.0X
20,000

15,000

10,000

5,000

0
Q42006 Q12007 Q22007 Q32007 Q42007 Q12008 Q22008

AtQuarterEnd Repo105 Usage 1XTangibleEquity

Q42006 Q12007 Q22007 Q32007 Q42007 Q12008 Q22008
Repo105Usage 19,213 20,578 23,054 29,075 29,916 41,844 44,536
1XTangibleEquity 18,567 19,487 21,881 22,164 23,103 25,696 27,179
UsageXTangibleEquity 1.0X 1.1X 1.1X 1.3X 1.3X 1.6X 1.6X

1.PleasenotetheseamountsreferonlytoRepo105,nottocombinedRepo105andRepo108amounts.
Sources:
ActualRepo105/108Usage:
Q42006,Q1,Q2andQ32007:LBEXDOCID3363434.Repo105UsageisassumedtobetheFixedIncomeDivision'stotalusage.
Q42007:LBEXDOCID3219746
TangibleEquity:
LehmanBrothersSEC10Kand10Qfilings.
Repo105Limitas1XTangibleEquity:
1
LBEXWGM748489:Seepage2forOperatingRules.Seepage5forsuggestionthatTangibleEquityistheappropriatemeasureofleverage.

Clement Bernard, who replaced Gentile in approximately August 2007, did not
recallhow LehmansfirmwideRepo105usagereached$50billioninearly2008,even
thoughaseriesofemailsshowntohimrevealedthat:(1)hewasinformedofthetotal
Repo105usagein2008;(2)hewasinformedthattheusagehaddoubledsince2006;and
897

(3) he pressured FID leaders to meet quarterend balance sheet targets by means of
either salesof assets or Repo 105 transactions.3434 When asked by the Examiner if the
significantincreaseinLehmansfirmwideRepo105usageinlate2007and2008caused
himanyalarm,Bernardanswered:no.3435
LehmansRepo105usageasofNovember30,2007,February29,2008,andMay
31,2008wasinlinewithwhatJohnFeraca,theformerheadoftheSecuredFunding
Desk for Lehmans Prime Services Group, would have expected even though it far
3434Email from Clement Bernard, Lehman, to Kieran Higgins, Lehman (Feb. 22, 2008) [LBEXDOCID
1854016] (informing Higgins that [w]e are currently at 19 bn above our target and asking him how
manyRepo105transactionshecanundertake);emailfromClementBernard,Lehman,toKaushikAmin,
Lehman(Feb.25,2008)[LBEXDOCID756417](informingAminthat[w]earecurrentlyrunningat15.0
bnabove[netbalancesheettarget]andweneedtogodownanextra$5.0bnforthefirmtomeetitsnet
leveragelimitof15.2.Ineedyourhelponthis);emailfromClementBernard,Lehman,toEricFelder,
Lehman(Feb.25,2008)[LBEXDOCID2080410](WeneedtoreduceournetBalancesheettohitthefirm
targetnetleverageratioof15.2.CurrentlyFIDisprojectedtobe$15.0bnaboveitslimitLetmeknowif
thereisanythingyoucoulddotoreducetheBalanceSheetandwhatwould[be]thepriceofdoingthat.);
email from Clement Bernard, Lehman, to Martin Potts, Lehman, et al. (Feb. 28, 2008) [LBEXDOCID
1854189](Wearelookingatsellingwhateverwecanandalsodoingsomemorerepo105[becauseover
balance sheet target by $ 14.3 billion].); email from Clement Bernard, Lehman, to Mark Cosaitis,
Lehman(Feb.29,2008)[LBEXDOCID2803733](thankingCosaitisforhiseffortsinundertakingRepo105
transactionsusingcorporatepositionsduringlastdayofquarterandstatingheexpectsthefirmtomake
the15.2netleverageratiotarget);Lehman,BalanceSheetandCashCapital(Mar.27,2008),atp.1[LBEX
DOCID 1698667] (attached to email from Clement Bernard, Lehman to Lisa Rivera, Lehman (Mar. 28,
2008) [LBEXDOCID 1854835] and showing $49.1 billion in Repo 105 quarterend usage first quarter
2008); email from Michael McGarvey, Lehman, to Clement Bernard, Lehman, et al. (Apr. 15, 2008)
[LBEXDOCID3221734](FIDused42bninRepo105inQ1andEquitiesused7.0bso49bnwasthetotal
firmnumber.Thiswasanincreaseof24bnfromQ406.).
3435ExaminersInterviewofClementBernard,Oct.23,2009,atp.9.Bernardexplainedthathehadbeen
focused at that time on Lehmans sticky assets like commercial real estate and leveraged loans and
thathedidnotpayparticularattentiontoLehmansuseofRepo105transactions.Id.Bernarddidnot
recalldiscussionswithReilly,Bernardssupervisor,oranyoneelseaboutthevolumesofLehmansRepo
105usageordiscomfortwithLehmansrelianceuponRepo105transactions.Id.Bernarddid,however,
recall that Reilly wanted Lehman to curtail its use of Repo 105 in 2008, though Bernard could only
speculatewhy.Id.BernardrecalledthatitwouldnothavebeenuncommonforLehmantraderstohave
theabilitytomoveupwardsof$2billionofassets,throughRepo105transactions,inasinglehourasa
quarterwasending.Id.
898

exceededthelastknownlimitof$25billion,whichwasinplaceinearly2007.3436The
rampup in Lehmans firmwide Repo 105 usage was probably a combination of an
increaseinlimitsandalackofpolicing,thoughprobablymoreofthelatter.3437Feraca
continued: The fact that we were going to breach the[Repo 105] limit at quarterend
was not an issue for management.3438 Feraca had no recollection of anyone saying
youre over limit, nor did he have any recollection of a formal increase of the Repo
105 limit.3439 I know why it happened. The business wanted more, needed more, to
maketargets.Thenumberswerereportedinternally,daily,sotherewastransparency,
buttherewasnostoppage.3440
(3) BalanceSheetTargetsforFIDBusinessesWereUnsustainable
WithouttheUseofRepo105Transactions
Bart McDades description of the Repo 105 mechanism for quarterend balance
sheet relief as a drug was apt: Repo 105 enhanced Lehmans reported net leverage
ratio and without the artificial floor Repo 105 created, balance sheet and net leverage
ratio targets were beyond reach. In a March 19, 2008 email to McDade, Andrew
Morton, Mark Walsh, and other Lehman personnel, Munir Dauhajire warned that
3436ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.11;seealsoLehman,TotalRepo105&Repo108
Report(Dec.5,2007)[LBEXDOCID3219746](showingRepo105usageatcloseoffourthquarter2007);
Lehman,TotalRepo105&Repo108Report(June11,2008)[LBEXDOCID2078195](showingRepo105
usageatcloseoffirstquarterandsecondquarter2008).
3438Id.
3439Id.
3440Id.
899

RUNNINGAFIRMWIDEBALANCESHEETOF15.3XLEVGISNOTGOINGTOBE
ASUSTAINABLEBUSINESSMODELFORTHEFIRM.3441
Afterengaginginover$49.1billionand$50.38billionofRepo105transactionsat
the end of the first and second quarters 2008, respectively, by June 2008, when Bart
McDadehadbecomePresidentandCOO,McDadesetaquarterendRepo105targetfor
third quarter 2008 of $25 billion.3442 The evidence also shows that senior Lehman
management sought to completely abolish the firms use of Repo 105 transactions by
thebeginningofthefourthquarter2008.3443
The reduction in Repo 105 usage for third became well known throughout the
firm.3444 A July 2008 email noted that [t]he exec committee wanted the number [of
Repo105]cutinhalf.3445Theresultoftheannouncedreductioninapprovedfirmwide
3441EmailfromMunirDauhajre,Lehman,toHerbertH.(Bart)McDadeIII,Lehman,etal.(Mar.19,2008)
[LBEXDOCID119728](allcapitalsinoriginal).
3442OneweekbeforecloseofLehmansthirdquarter2008,ReillywrotetoMcGarvey:Howmuchrepo
105 do we have now and how much will we have at 8/31? Email from Gerard Reilly, Lehman, to
Michael McGarvey, et al. Lehman (Aug. 26, 2008) [LBEXDOCID 4297834]. McGarvey replied that the
forecast at quarterend was $21 billion in Repo 105 and $3.8 billion in Repo 108. Id.; see also Lehman,
Balance Sheet and Key Disclosures 2008 3Q Targets [Draft] (June 16, 2008) [LBEXDOCID 012458]
(attachedtoemailfromGerardReilly,Lehman,toHerbertH.(Bart)McDadeIII,Lehman,etal.(June17,
2008)[LBEXDOCID011380]andcontainingbalancesheettargetandproposingaRepo105targetof$25
billionforQ32008).
3443See email from Jeff Michaels, Lehman, to Kaushik Amin, Lehman (July 30, 2008) [LBEXDOCID
613324] (Repo 105 is going away by Q4.); email from Jeff Michaels, Lehman, to Kaushik Amin,
Lehman,etal.(July31,2008)[LBEXDOCID756327](Repo105isgoingtozeroinQ4.).
3444SeeSectionIII.A.4.e.2.aofthisReport(discussingroleofBartMcDadeinproposingreductioninRepo
105usage).
3379145].Whenquestionedaboutthisemail,McGarveycouldnotexplainwhytheExecutiveCommittee
had decided to reduce Lehmans Repo 105 usage by half. Examiners Interview of Michael McGarvey,
Sept.11,2009,atp.11.
900

Repo 105 usage was disquiet. As one internal Lehman presentation put succinctly:
WeanourselvesoffRepo105ASAP!3446
WheninJune2008Reillycommunicatedtheproposed$25billionRepo105cap
for third quarter 2008, Andrew Morton, thenHead of FID, replied: rates business
cannotsurviveattheselevels,iereducingr105by20.3447WhenalsoinJune2008,Paul
Mitrokostas, the ChiefOperatingOfficerofFID,communicatedthe thirdquarter2008
balance sheet target and the fact that FIDs Repo 105 limit for that quarter was being
reducedto$25billion,Aminprotestedthata$55billionnetbalancesheetlimitforthe
firmsRatesbusiness,with$22billionlessofRepo105capacityavailableatquarterend,
wasunsustainable:Wecantrunthebusinessunderthoseparameters.3448
Similarly,JeffMichaelscomplainedtoAmininJuly2008thatgiventhereduction
inFIDsRepo105capacityforthirdquarter2008,andthecompletecurtailmentofRepo
105usageinfourthquarter2008,therearenotmanyplaceswecanreallocatebalance
sheet from if Repo 105 is gone for the inflation book.3449 In another email, Michaels
wrote: [Repo] 105 is going to zero in Q4, which means we either need more balance
3446Lehman,GlobalRatesMidYearReview2008(Sept.12,2008)[LBEXDOCID659022],atp.5(attached
toemailfromJeffMichaels,Lehman,toKaushikAmin,Lehman(Sept.12,2008)[LBEXDOCID679130]).
A hard copy of this presentation was also found among Clement Bernards documents. See Lehman,
GlobalRatesMidYearReview2008(nodate)[LBEXWGM756153].
3447Email from Andrew J. Morton, Lehman, to Gerard Reilly, Lehman (June 17, 2008) [LBEXDOCID
4553446].
3448Email from Kaushik Amin, Lehman, to Paul Mitrokostas, Lehman, et al. (June 20, 2008) [LBEX
DOCID2319659].
3449EmailfromJeffMichaels,Lehman,toKaushikAmin,Lehman(July30,2008)[LBEXDOCID613324].
Inflation book or inventory likely refers to Treasury Inflation Protected Securities (TIPS), which are
inflationindexedbondsissuedbytheUnitedStatesTreasury.
901

sheet from FID or we need to make significant reductions in Europe, which has not
happeneduntilnow.ThereisnowaywecanmakeQ4balancesheetwithoutRepo105
unlessourinflationinventoryiscutby6075%fromcurrentlevels.3450
(4) RatingAgenciesAdvisedtheExaminerthatLehmans
Information
Just as it did in its Forms 10Q and 10K, Lehman emphasized its net leverage
ratiototheratingsagenciesthroughout2008asLehmanattemptedtoforestallaratings
downgrade. The concerted effort by Lehmans senior management to cut the balance
sheetbyhalf,achievedbyreducingthefirmsnetleverageratio,andLehmanspublic
statements about this achievement, improved the firms standing with at least two of
thethreeratingagencies,FitchRating(Fitch),andStandard&Poors(S&P).3451
InMay2008,LehmangaveapresentationtoMoodysInvestorServiceinwhich
oneofthekeymessagesinthepresentationwasthatbecauseLehmanhadstrengthened
itscapitalpositionthroughactivedeleveragingincludingapproximately$50billion
reduction in net assets, no negative rating action for the firm was justified.3452 The
3450Email from Jeff Michaels, Lehman, to Kaushik Amin, Lehman, et al. (July 31, 2008) [LBEXDOCID
756327] (transmitting Lehman, Balance SheetGlobal Rates [LBEXDOCID 633334], and showing Global
RatesbusinessRepo105usage).
3451Fitchs and S&Ps analysis of Lehman took into account the firms net leverage ratio. Examiners
atp.5.Moodys,ontheotherhand,lookedprimarilytootherindicators,particularlyrisk.Examiners
InterviewofPeterE.Nerby,Oct.8,2009,atp.5.
3452Lehman, Moodys Investor Service Q2 2008 Update (May 29, 2008), at pp. 1, 4, 68 [Moodys
ConfidentialSharedInformation11141159].
902

presentationtoMoodysnotedthatnetleveragewasexpectedtodecreasefrom15.4xto
12.6xand thatthe netbalance sheetreductionof $50.38billionin second quarter 2008
included key FID highrisk assets, such as commercial and residential mortgages.3453
Lehmanspresentationalsonotedthatthenetleverageratiowasheavilyquotedby
journalistsandanalysts.3454
On June 3, 2008, Lehman gave a similar presentation to Fitch, stating that
Lehman did not believe Q2 08 results justify any negative rating action for Lehman
Brothers.3455LehmantoldFitchthatits[c]apitalpositionisstrongerthaneverwithde
leveringbringingbothnetandgrossleverageratiostomultiyearlows.3456
OnJune5,2008,LehmanmadeasimilarpresentationtoS&PinwhichLehman
advanced its position that second quarter 2008 results [do not] justify any negative
rating action for Lehman Brothers3457 in part because of Lehmans shrinkage of the
balance sheet.3458 In that presentation, Lehman advised S&P that Net balance sheet
(primarilyinventory)isexpectedtobealmost$70billionlowerthanQ108,andgross
balance sheet is expected to be almost $140 billion lower.3459 The presentation also
projected that Lehmans net leverage ratio would drop to 12.1x in second quarter
3453Id.atpp.67.
3454Id.atp.8.
3455Lehman,FitchRatingsQ22008Update(June3,2008),atp.4[FITCHLEHBK00000151].
3456Id.atp.40.
3457Lehman,S&PRatingsQ22008Update(June5,2008),atp.4[S&PExaminer000946].
3458Id.atp.6.
3459Id.
903

2008.3460AnotherslideinthepresentationtoutedLehmanshistoricallylownetleverage
ratioandcontrasteditwiththatofpeerinvestmentbanks.3461
NowhereinthepresentationsthatLehmanmadetotheratingagenciesinMayor
June 2008 did Lehman disclose its use of Repo 105 transactions, the impact Repo 105
transactions had on the firms quarterend balance sheet, or the impact Repo 105
transactionsultimatelyhadonLehmansnetleverageratio.3462
Following Fitchs decision in June 2008 to downgrade Lehman by one ratings
grade, from AA to A+ (longterm) and F1+ to F1 (shortterm), Tonucci sent Fitch
another Lehman presentation to consider in the context of a potential appeal.3463
Lehman marshaled certain facts in defense of its disagreement with the ratings
downgradebyFitch.UndertheheadingSignificantShrinkageoftheBalanceSheet,
LehmaninformedFitchthatNetbalancesheet(primarilyinventory)isexpectedtobe
almost$70billionlowerthanQ108....3464Notincludingtheimpactofthe$4billion
common equity and $2 billion noncumulative preferred offering that Lehman had
undertakeninJune2008,LehmanboastedtoFitchthatitreduceditsnetleverageratio
3460Id.
3461Id.atp.8.
3462SeegenerallyLehman,MoodysInvestorServiceQ22008Update(May29,2008)[MoodysConfidential
Shared Information 11141159]; Lehman, Fitch Ratings Q2 2008 Update (June 3, 2008) [FITCHLEH BK
00000151];Lehman,S&PRatingsQ22008Update(June5,2008)[S&PExaminer000946].
3463Lehman,PresentationtoFitchRatingsRatingAppeal[Draft](June9,2008)[FITCHLEHBK00002449]
(attachedtoemailfromPaoloR.Tonucci,Lehman,toEileenA.Fahey,Fitch(June9,2008)[FITCHLEH
BK00002447]).
3464Id.atp.2.
904

from 15.4x in first quarter 2008 to an anticipated 12.0x in second quarter 2008.3465
Accountingfortheequityraise,Lehmantoutedthatithadreacheditslowestleverage
ratiossincebecomingapublicfirm.3466
Lehman,aswithitspriorpresentationstotheratingagencies,madenomention
initssecondpresentationtoFitchofitsrelianceonRepo105transactionstomanageits
balancesheetandnetleverage.3467Recallthatattheendofitssecondquarter2008,May
31, 2008 just weeks before Tonucci sent the presentation to Fitch Lehman had
reduced its net balance sheet by over $50.38 billion using Repo 105 transactions. Yet,
despite the significant role of the firms Repo 105 practice in its balance sheet
management,thisfactwasnotdisclosedinLehmanspresentations.
The Examiner interviewed representatives from the three leading ratings
agencies,Fitch,Standard&Poors,andMoodys,andnonehadknowledgeofLehmans
useofRepo105transactions,eitherbynameorbydescription.3468Notoneoftherating
agencies was aware that Lehman recorded some volume of repo transactions as true
sales to temporarily remove the securities inventory from its balance sheet at quarter
endtherebyreducingLehmanspubliclyreportedleverageratios.
3465Id.
3466Id.atp.3.
3467Seegenerallyid.
3468ExaminersInterviewofEileenA.Fahey,Sept.17,2009,atp.7;ExaminersInterviewofDianeHinton,
Sept.22,2009,atp.6;ExaminersInterviewofPeterE.Nerby,Oct.8,2009,atpp.56.
905

Eileen Fahey, an analyst at Fitch, said that she had never heard of repo
transactionsbeingaccountedforastruesalesonthebasisofatruesaleopinionletteror
repotransactionsknownasRepo105transactions.3469Faheystatedthatatransferof$40
billionor$50billionofsecuritiesinventoryregardlessoftheliquidityofthatinventory
from Lehmans balance sheet at quarterend would be material in Fitchs view, and
upon having a standard Repo 105 transaction described, Fahey remarked that such a
transactionsoundedlikefraud.3470
TheExaminerinquiredwhether,ifFitchhadknownaboutLehmansuseofsuch
transactionstoremoveassets offitsbalancesheetat quarterend,itlikely would have
affected the Fitch rating of Lehman.3471 Fahey replied that the transaction spoke to
3470Id.WhilefreelyadmittingthatLehmanmovedtensofbillionsofdollarsworthofinventoryoffthe
firms net balance sheet at quarterend through Repo 105 transactions, and that the moved inventory
camebackontothefirmsbalancesheetaweektotendayslater,KaushikAmin,formerHeadofLiquid
Markets, believed it was immaterial andcompletely irrelevant. Examiners Interview of Kaushik
Amin, Sept. 17, 2009, at p. 9. Amin believed that neither the rating agencies nor the investing public
would have cared about Lehmans Repo 105 practice because Lehman used liquid inventory. Id. In
Aminsview,ourriskwasnotrepresentedanydifferentlybecauseof[Repo]105.Id.Aminsviewis
beliedbythestatementsofrepresentativesofeachofthethreemainratingsagencies,oneofwhomsaid
thatLehmansundisclosedRepo105activitywouldhavebeenmaterialtotheagencysviewofLehman
andtheothertwowhosaidtheywouldhavewantedtoknowofLehmansRepo105activity.Examiners
atp.6;ExaminersInterviewofPeterE.Nerby,Oct.8,2009,atp.5.LikeFahey,whenaskedwhetherit
wouldhavechangedheranswersifthesecuritiesthatwereremovedfromthebalancesheetinRepo105
transactions were liquid, S&Ps Hinton responded that it would not. Examiners Interview of Diane
Hinton,Sept.22,2009,atp.6.
3471ExaminersInterviewofEileenA.Fahey,Sept.17,2009,atp.7.Fitchusedthreeleveragenumbersto
assessLehman,includingthenetleverageratio.Id.atp.6.
906

Lehmansliquidity,andthattheimpactonFitchsratingwoulddependonwhetherthe
describedtransactionwasdonerepeatedlyorifitwasaonetimeoccurrence.3472
Faheyalsoremarkedthattreatingarepotransactionasasale(therebyremoving
the securities from the transferors balance sheet) appears to be an accounting
manipulation done to make the business look better, as contrasted with an ordinary
repo transaction, which she described as a financing transaction done in the regular
course of business (and for which the securities remain on the transferors balance
sheet).3473 Fahey likened this manipulation to an investment bank telling regulators
that it did not own any mortgagebacked securities when, in fact, it owned them but
had temporarily transferred them to a counterparty and was obligated to repurchase
themshortlythereafter.3474
Diane Hinton, an analyst at Standard & Poors and the firms lead analyst for
LehmanfromApril2007untilJuly2008,likewisewasunawareofLehmanengagingin
Repo 105 transactions.3475 When the Examiner described the true sale accounting
treatmentofRepo105transactionstoHinton,shestatedthatS&Pwouldhavewanted
toknowifLehmanhadmoved$20billion,$40billion,or$50billioninnetassetsoffits
3472Id.atp.7.
3473Id.
3474Id.
3475ExaminersInterviewofDianeHinton,Sept.22,2009,atp.6.
907

balance sheet at quarterend.3476 When asked whether it would have changed her
answers if the securities that were removed from the balance sheet in Repo 105
transactionswereliquid,Hintonrespondedthatitwouldnot.3477
HintonexplainedthatS&Plookedatleverageratiosincludingthenetleverage
ratio in the context of its capital analysis of Lehman. Hinton further explained that
S&P began its calculation of the net leverage ratio with information taken solely from
Lehmans Forms 10K and 10Q, and that anything that affects the balance sheet is
something we would have wanted to know.3478 She further stated that S&P only
trackedLehmansleverageratiosatquarterend.3479Shesaidthatanychangeinthenet
leverage ratio would have been relevant, but whether such a change was relevant to
S&PsratingofLehmanwoulddependonotherfactorsandcommitteedeliberations.3480
Peter Nerby of Moodys similarly stated that Moodys had no knowledge of
Lehman engaging in Repo 105 transactions, either by name or by description.3481
However, unlike S&P and Fitch, the net leverage ratio did not drive many rating
decisionsatMoodys.3482NerbysaidthatLehmanwouldhavebeenawarethatMoodys
3476Id.WhileadvisingtheExaminerthatshewouldhavewantedtoknowaboutLehmansRepo105
practice,HintonneitherstatednordeniedthatinformationaboutLehmansuseofRepo105transactions
wouldhavebeenmaterial.
3477Id.atp.6.
3478Id.atpp.56.
3479Id.atp.6.
3481ExaminersInterviewofPeterE.Nerby,Oct.8,2009,atp.5.
3482Id.Moodysfocusedmoreontheriskeffectsofatransaction.Id.atp.6.Whilearepotransactionthat
wasrecordedasatruesaleaffectsafirmsnetleverageratio,itwouldnotaffectotherratios(e.g.,VaR,
908

considered net leverage ratio to have limited usefulness as revealed by Moodys
published rating methodology.3483 Still, Nerby stated that if Lehman reduced its net
balance sheet by $20 billion or up to $50 billion, he would have wanted to know and
that Moodys would have looked to see if and where the reduction was captured by
someriskmeasure.3484
AnumberofLehmanwitnessessaidthatLehmanremainedatriskfortheassets
it removed from its balance sheet as a result of Repo 105 transactions because of
Lehmans obligation to repurchase the securities and repay the cash borrowing.3485 A
June2008emailfromDominicGibbrecommendedtoMartinKellythatLehmanhave
anotherlookatitsdefinitionoflonginventoryatriskinthedailybalancesheetand
disclosurescorecardbecausethedefinitiondidnotincludeanyoftheassetsonrepo
105/108eventhoughtheyarestillatrisk.3486Gibbconcluded:[W]eareunderstating
whatwehaveatriskbyamaterialamountespeciallyaroundquarterends.3487
stresstestresults,LevelIIIassetstototalinventory)andMoodys,accordingtoNerby,examinedallof
these ratios. Id. Nerby speculated that if the transaction was off balance sheet, it would probably be
capturedbysomeotherriskmeasure.Id.WhentheExamineraskedNerbyifMoodysviewofRepo105
transactionswouldhavebeenimpactediftheassetsinvolvedwerepurelyliquidassets,Nerbyscounsel
instructed him not to answer thequestion, claiming that thequestion delved into Moodys deliberative
process.ExaminersInterviewofPeterE.Nerby,Oct.8,2009,atp.6.
3483Id.
3484Id.
McGarvey,Sept.11,2009,atp.8;ExaminersInterviewofTejalJoshi,Sept.15,2009,atp.6;Examiners
InterviewofAnurajBismal,Sept.16,2009,atp.9.
3486Email from Dominic Gibb, Lehman, to Martin Kelly, Lehman, et al. (June 19, 2008) [LBEXDOCID
3233813].
909

(5) GovernmentRegulatorsHadNoKnowledgeofLehmans
Repo105Program
LehmandidnotdisclosethefactofitsengaginginRepo105transactions,orany
other information regarding its use of Repo 105 transactions to manage its balance
sheet,toGovernmentregulators.3488
(a) OfficialsfromtheFederalReserveBankWouldHave
Transactions
From2003to2009,TreasurySecretaryTimothyGeithnerservedasPresidentof
the Federal Reserve Bank of New York (FRBNY). The Examiner described to
SecretaryGeithnerhowLehmanusedRepo105transactionstoremoveapproximately
$50billionofliquidassetsfromthebalancesheetatquarterendin2008andexplained
that this practice reduced Lehmans net leverage. Secretary Geithner did not recall
beingawareofLehmansRepo105program,butstated:Ifthishadbeenabankwe
3488Forexample, Lehmans external regulatory reporting did not disclose Lehmans use of Repo 105
transactions to the Office of Thrift Supervision (OTS) of the Department of the Treasury. OTS was
responsible for reviewing Lehman Brothers Bank, FSB (LBB) and examined the holding company
(LBHI)todetermineitsinfluenceandconnectionswithLBB.Inresponsetotheeconomicdownturn,
the OTS decided in 2008 to create a continuous supervision program of Lehman, Merrill Lynch, and
Morgan Stanley. Examiners Interview of Ronald S. Marcus, Nov. 4, 2009, at p. 5. The purpose, as to
Lehman, was to obtain a general understanding of Lehmans risk as it related to LBB. Id. The OTS
documented all of LBHIs repo transactions in its Report of Examination on the secured funding and
lendingactivitiesofLBIandLBIE,theprincipalbrokerdealersubsidiariesofLehmanBrothersHoldings
Inc.(LBHI).SeeOTS,Dept.ofTreasury,ReportofExaminationforLehmanBrothersBank,FSB(Aug.6,
2007), at pp. 45 [LBEXOTS 000082]. This report was the endproduct of an onsite field visit OTS
conductedonMay30,2008.Id.AbsentfromthereportisanyreferencetoRepo105transactions,either
bynameordescription(i.e.,asrepotransactionsthataretreatedastruesalesforaccountingpurposes).Id.
RonaldMarcus,whoservedastheexaminerforthecontinuousprogramatLehmanbeginninginMarch
2008andcompletedtwotargetedreviewspriortothebankruptcy,hadnoknowledgeofLehmansuseof
Repo105transactions.ExaminersInterviewofRonaldS.Marcus,Nov.4,2009,atp.11.
910

weresupervising,that[i.e.,LehmansRepo105program]wouldhavebeenahugeissue
fortheNewYorkFed.3489
Jan Voigts, who was an Examining Officer in FRBNYs Bank Supervision
Department,hadnoknowledgeofLehmanremovingassetsfromitsbalancesheetator
near quarterend via a repo trade treated as a true sale under a United Kingdom
opinionletter.3490Voigtswassurprisedatandunfamiliarwiththeideaofusingarepo
to remove assets from the balance sheet under a true sale opinion where those assets
would return to the balance sheet the following quarter.3491 When the Examiner
described to Voigts the steps Lehman undertook in a standard Repo 105 transaction,
Voigts said that knowledge of such a practice by Lehman would have been very
importanttohim.3492
After having Repo 105 transactions described to him generally, Voigts
differentiatedRepo105transactionsfromotherformsofbalancesheetmanagementlike
certain matched book repo trading.3493 Voigts said that he also found interesting that
3489Examiners Interview of Treasury Secretary Timothy F. Geithner, Nov. 24, 2009, at p. 5. By his
commentifthishadbeenabankweweresupervising,SecretaryGeithnermeantthattheSECandnot
theFRBNYwastheprimaryregulatorofLehman.Id.
3490ExaminersInterviewofJanH.Voigts,Oct.1,2009,atp.5.
3491Id.
3492Id.
3493Id.Thematchedbookbusinessconsistedofenteringintooffsettinglongandshortpositionsthrough
repo and reverse repo transactions of the same government securities. Under OFFSETTING OF AMOUNTS
RELATED TO CERTAIN REPURCHASE AND REVERSE REPURCHASE AGREEMENTS, FASB Interpretation No. 41
(Fin. Accounting Standards Bd. 1994) (FIN 41), which may be applied only to repo and reverse repo
transactions if certain criteria are satisfied, Lehman could offset the asset (reverse repo) and liability
(repo).Asaconsequenceofoffsettingthereversereposandrepos,Lehmancouldincludeinitsbalance
911

Lehmanwasrepoingouttreasurysecuritiesatahigherhaircutthanwouldnormallybe
used for such liquid collateral.3494 Voigts said he would have wanted to know more
aboutanyoffmarkettransactionsLehmanundertook.3495
ArthurAngulo,whowasaSeniorVicePresidentinFRBNYsBankSupervision
department, likewise was unaware that Lehman engaged in repo transactions at
quarterend,underaUnitedKingdomtruesaleopinionletter,wheretheassetswould
be returned to Lehmans balance sheet following the end of the reporting period.3496
Angulosaidthatthedescribedrepotransactionsappearedtogobeyondothertypesof
[permissible] balance sheet management.3497 Angulo also said that he would have
sheettotalsforrepoandreverserepoagreementsonlyasanetamountwitheachofitscounterparties,
resulting in a reduction in the size of the gross balance sheet. Offsetting under FIN 41 is optional and
permittedonlyifallofthefollowingrequirements(providedinsummaryform)aremet:(1)therepoand
reverse are executed with the same counterparty; (2) the repo and reverse have the same explicit
settlement date specified at inception of the agreement; (3) the repo and reverse are executed in
accordancewithamasternettingagreement;(4)thesecuritiesunderlyingthereposandreversesexistin
book entry form; (5) the repos and reverses are settled in a securities transfer system that transfers
bookentrysecuritiesandbankingarrangementsareinplacesothattheentitiesmustonlykeepcashon
depositsufficienttocovernetpayables;and(6)thesameaccountattheclearingbankisusedforthecash
inflowsofthesettlementofthereversesandforsettlementofthecashoutflowsoftherepos.SeeFIN 41,
3.NettingunderFIN41isverydifferentfrombalancesheetreductionachievedbymeansofRepo
105transactions.WithRepo105,Lehman:(1)recharacterizedarepotransaction(aliability)asasale,and
thereby removed inventory from its balance sheet and (2) borrowed cash without reflecting the
borrowingonitsfinancialstatementsandrelateddisclosures.WithFIN41,twocounterpartiesthatowe
eachothermoneyaresimplynettingidenticaltransactionsandshowingthenetamountsonthebalance
sheet.
3495Id.
3496ExaminersInterviewofArthurG.Angulo,Oct.1,2009,atp.2.
3497Id. The question of whether and why some windowdressing may be considered acceptable by the
financial community is beyond the scope of the Examiners Report. The Examiner has investigated
Lehmans use of Repo 105 transactions and has concluded that the balance sheet manipulation was
intentional, for deceptive appearances, had a material impact on Lehmans net leverage ratio, and,
912

wantedtoknowaboutoffmarkettransactionswhereLehmanacceptedahigherhaircut
thanareposellernormallywouldacceptforacertaintypeofcollateral.3498
Thomas Baxter, FRBNY General Counsel, had no knowledge of Repo 105
transactions, either by name or design.3499 Baxter was generally aware of firms using
quarterend and monthend balance sheet windowdressing, but did not recall this
beinganissuelinkedtoLehmanspecifically.3500
(b) SecuritiesandExchangeCommissionCSEMonitorsWere
UnawareofLehmansRepo105Program
The Examiner interviewed multiple employees of the Securities and Exchange
CommissionwhohadsomeresponsibilitytomonitorLehmansbusinessoperationsas
part of the Consolidated Supervised Entity (CSE) division: Michael Macchiaroli,
PhillipMinnick, JamesGiles,Michelle Danis, GinaLai,andRaymond Doherty.None
hadbeeninformedofLehmansuseofRepo105transactions.3501
TheSECsMatthew Eichner, whowasinvolvedwith theCSEdivision, wasnot
aware of Lehmans use of Repo 105 transactions, by name or description, to remove
assets from the balance sheet and impact its leverage ratios.3502 Asked if the SEC in
connection with its monitoring responsibilities under the CSE division would have
because Lehman did not disclose the accounting treatment of these transactions, rendered Lehmans
Forms10Kand10Q(financialstatementsandMD&A)deceptiveandmisleading.
3498Id.
3499ExaminersInterviewofThomasC.Baxter,Jr.,Aug.31,2009,atpp.34,9.
3500Id.
3501ExaminersInterviewofSECStaff,Aug.24,2009,atpp.3,10.
3502ExaminersInterviewofMatthewEichner,Nov.23,2009,atp.9.
913

wanted to know that Lehmans net leverage calculation was based, in part, on true
saleaccountingforcertainrepotransactions,EichnerexplainedthatbecausetheSECs
CSEmonitorsdidnotputmuchstockinleveragenumbers,knowledgeofthevolumes
ofRepo105transactionswouldnothavesignaledtothemthatsomethingwasterribly
wrong.3503TheSECsCSEdivisionhadthestrongviewthat,forcomplicatedfinancial
institutions,leverageinformationisnotoftengoingtogiveyoutherightanswerfora
varietyofbusinessreasons.3504
oftheFirm
Many former members of senior Lehman management recalled generally
Lehmans use of Repo 105 transactions such as the existence of Lehmans Repo 105
program,thatLehmanusedthesetransactionstomanageitsbalancesheet,andthatthe
internal Repo 105 accounting policy had been vetted by outside auditors and
lawyers.3505Thesesamewitnesses,however,disavowedanyknowledgeonanumberof
significanttopics:3506
3503Id. Note that Eichner was not involved in monitoring public disclosures. His comments about net
leverage were made in reference to the SECs role in monitoring Lehman under the CSE division. See
SectionIII.A.6.bofthisReport(discussingtheSECsoversightofLehmanandtheCSEprogram).
3505Examiners Interview of Christopher M. OMeara, Aug. 14, 2009, at p. 4 (stating he knew that Repo
105transactionsnetteddownthebalancesheet);ExaminersInterviewofHerbertH.BartMcDadeIII,
Sept.16,2009,atp.4(statingthatLehmanhadvetteditsRepo105policywithErnst&Youngandthat
inventory was removed from Lehmans balance sheet as a result of Lehmans Repo 105 transactions);
Examiners Interview of Erin M. Callan, Oct. 23, 2009, at pp. 1719 (acknowledging she was aware, as
CFO,thatLehmansRepo105practiceimpactednetbalancesheet,thatthetransactionshadtoberouted
through Europe); Examiners Interview of Ian T. Lowitt, Oct. 28, 2009, at pp. 1012, 14 (acknowledging
thathewasawareofLehmansRepo105programformanyyears,thatLehmanusedthetransactionsto
914

the volumes of Repo 105 transactions that Lehman engaged in at quarter

end;
that Lehman more than doubled its Repo 105 usage from late 2006 to
FebruaryandMay2008;
thatLehmanvastlyexceededitsselfimposedlimitsonRepo105transactions
in2007and2008;
that Lehmans use of Repo 105 transactions had a material impact on the
firmsnetleverageratio;and
that securities of United Statesbased Lehman entities were used for Repo
105transactions.
Notwithstandingtheprofessedignorancebywitnessesofvirtuallyany ofthese
issues central to the scope of Lehmans Repo 105 program, contemporaneous
documentsdemonstratethatmanyformertopexecutiveswereregularlyapprisedofthe
scopeofthefirmsRepo105usage.3507Forexample,areportentitledtheBalanceSheet
meetbalancesheettargets,thatRepo105transactionsusedonlyliquidinventory,andthatLehmanset
internallimitsonRepo105usagebutthatChrisOMearawasinvolvedwithlimitsetting).
3506Examiners Interview of Christopher M. OMeara, Sept. 23, 2009, at pp. 78 (disavowing any
knowledgeofacaponRepo105usageorvolumeofLehmansRepo105usage);ExaminersInterviewof
ErinM.Callan,Oct.23,2009,atpp.17,20(disavowingknowledgeofthevolumeofLehmansRepo105
transactions and stating she had no awareness of or discussions regarding a cap on Repo 105 usage);
Examiners Interview of Ian T.Lowitt, Oct. 28,2009, at pp.1213 (stating thathe had no recollection of
volume of Lehmans Repo 105 usage or that senior management had decided by mid2008 to reduce
Lehmans Repo 105 usage). When the Examiner first interviewed Bart McDade in September 2009,
McDade disavowed any knowledge that Lehmans Repo 105 usage every exceeded $20 billion.
Examiners Interview of Herbert H. Bart McDade III, Sept. 16, 2009, at p. 4. When the Examiner
interviewed McDade a second time, McDade acknowledged that he was aware of the volume of
LehmansRepo105usageandthatin2008,hehadorderedafirmwidecaponRepo105usageforthird
quarter 2008 of $25 billion down from more than $50 billion at the end of the second quarter 2008.
ExaminersInterviewofHerbertH.BartMcDadeIII,Jan.28,2010,atpp.28.
3507TheExaminersroleisnottomakecredibilitydeterminationsbutrathertopointoutwhereatrierof
factwouldbejustifiedindoingsoand,therefore,thatacolorableclaimexists.TheExaminerdoesnot
opineonewayoranotheronthecredibilityofthestatementsofvariousofficersdenyinganysubstantive
knowledgeofRepo105transactions.ButtheExaminernotesthatatrieroffactwouldhavetoassessthe
credibility of individual denials of recollection against the notable, collective lack of memory of a $50
915

andDisclosureScorecard,whichwascirculatedtovariousmembersofseniorLehman
managementonadailybasisfromApril2008throughSeptember2008,tracked,among
otherthings,thedailybenefitthatRepo105transactionsprovidedtoLehmansbalance
sheet.3508 Lehman created the Daily Balance Sheet and Disclosure Scorecard in April
billionongoingprogram,disclosedonmultipledocuments,thatimpactedthereportofacriticalmetric,
bythefirmsoneCEO,aCOOandthreeCFOs.
3508ThisDailyBalanceSheetandDisclosureScorecardwasamorecomprehensivePowerPointversionof
a daily balance sheet and disclosures scorecard email report that was distributed regularly. The
condensedemailsummaryofthereportalsocontainedfrequentreferencestoRepo105.ThePowerPoint
version of the report contained an Executive Summary that also contained frequent references to Repo
105transactions,aswellasglobalandregionalNetBalanceSheet,GrossBalanceSheet,BalanceSheetat
Risk,andCashCapitalschedules.ThisreportwasregularlydistributedtoBartMcDade,ChrisOMeara,
Erin M. Callan, Ian T. Lowitt, and many other top Lehman executives and members of senior
management between April 2008 and September 2008. See, e.g., Lehman, Balance Sheet and Disclosure
ScorecardforTradeDateApril7,2008(Apr.9,2008)[LBEXDOCID520619](attachedtoemailfromTal
Litvin, Lehman, to Herbert H. (Bart) McDade III, Lehman, et al. (Apr. 9, 2008) [LBEXDOCID 523578]);
Lehman, Balance Sheet and Disclosure Scorecard for Trade Date April 8, 2008 (Apr. 10, 2008) [LBEX
DOCID520620](attachedtoemailfromTalLitvin,Lehman,toHerbertH.(Bart)McDadeIII,Lehman,et
al. (Apr. 10, 2008) [LBEXDOCID 523579]); Lehman, Balance Sheet and Disclosure Scorecard for Trade
DateApril9,2008(Apr.10,2008)[LBEXDOCID251339](attachedtoemailfromTalLitvin,Lehman,to
Herbert H. (Bart) McDade III, Lehman, et al. (Apr. 10, 2008) [LBEXDOCID 258560]); Lehman, Balance
Sheet and Disclosure Scorecard for Trade Date April 10, 2008 (Apr. 14, 2008) [LBEXDOCID 251342]
(attached to email from Tal Litvin, Lehman, to Herbert H. (Bart) McDade III, Lehman, et al. (Apr. 14,
2008)[LBEXDOCID275231];Lehman,BalanceSheetandDisclosureScorecardforTradeDateApril11,
2008 (Apr. 14, 2008) [LBEXDOCID 251344] (attached to email from Tal Litvin, Lehman, to Herbert H.
(Bart) McDade III, Lehman, et al. (Apr. 14, 2008) [LBEXDOCID 258562]; Lehman, Balance Sheet and
DisclosureScorecardforTradeDateApril14,2008(Apr.15,2008)[LBEXDOCID012177](attachedtoe
mail from Tal Litvin, Lehman, to Herbert H. (Bart) McDade III, Lehman, et al. (Apr. 15, 2008) [LBEX
DOCID079620]);Lehman,BalanceSheetandDisclosureScorecardforTradeDateMay12,2008(May13,
2008) [LBEXLL 1950262], at p. 1 (attached to email from Tal Litvin, Lehman, to Herbert H. (Bart)
McDadeIII,Lehman,etal.(May13,2008)[LBEXDOCID3187357]andstatingRatesdecreasedby$(5.0B)
frompriordayduetoincreasedRepo105usage....);Lehman,BalanceSheetandDisclosureScorecard
forTradeDateMay22,2008(May27,2008),atp.1[LBEXLL1950706](attachedtoemailfromTalLitvin,
Lehman, to Herbert H. (Bart) McDade III, Lehman, et al. (May 27, 2008) [LBEXDOCID 275984] and
statingGlobalratesnetbalancesheetdecreased($2.0B),predominantlyduetoanincreaseinRepo105
benefit. . . .); Lehman, Balance Sheet and Disclosure Scorecard for Trade Date May 28, 2008 (May 30,
2008), at p. 1 [LBEXLL 1950670] (attached to email from Tal Litvin, Lehman, to Herbert H. (Bart)
McDade III, Lehman, et al. (May 30, 2008) [LBEXDOCID 275995] and stating Global rates net balance
sheetdecreasedby($3.1B)primarilyduetoadecreaseinAmericasdrivenbyanincreasedutilizationof
Repo105withintheAgencybusiness);Lehman,BalanceSheetandDisclosureScorecardforTradeDate
916

2008atBartMcDadesspecificrequestandinconnectionwithhisroleasbalancesheet
point person.3509 According to McDade, I needed a daily scorecard to know where I
wanted to push on balance sheet issues.3510 McDade recalled that he was focused on
theRepo105figuresthatappearedinmanyoftheDailyBalanceSheetandDisclosure
Scorecards.3511Forexample,acolumnentitledRepo105inthereportsConsolidated
Balance Sheet Summary clearly documented the volume of Repo 105 transactions
undertakenbyeachLehmanbusinessunitordivision.3512
(1) RichardFuld,FormerChiefExecutiveOfficer
Richard Fuld, Lehmans former Chief Executive Officer denied any recollection
of Lehmans use of Repo 105 transactions.3513 Fuld said he had no knowledge that
Lehman treated any kind of repo transaction as a true sale or that Lehman ever
removedfromitsbalancesheetassetstransferredinarepotransaction.3514Inaddition,
FulddidnotrecallhavingseenanyreportsreferencingtheamountofthefirmsRepo
105 activity.3515 Fuld further stated that he did not know that Lehman removed
Herbert H. (Bart) McDade III, Lehman, et al. (June 2, 2008) [LBEXDOCID 011127] and stating (Global
Ratesnetbalancesheetdecreased($6.5B)...[t]hedecreaseinEuropeiscomingfromincreasedutilization
ofRepo105).
3509ExaminersInterviewofHerbertH.(Bart)McDadeIII,Jan.28,2010,atp.8.
3510Id.
3511Id.atpp.89.
atp.9[LBEXDOCID520620];Lehman,BalanceSheetandDisclosureScorecardforTradeDateApril18,
2008(Apr.21,2008),atp.10[LBEXDOCID275233].
3514Id.
3515Id.
917

approximately $49 and $50 billion in inventory off its balance sheet at quarterend
throughtheuseofRepo105transactionsinfirstquarter2008andsecondquarter2008,
respectively.3516 Fuld said, however, that if he had learned that Lehman was
temporarily cleansing its balance sheet of assets at quarterend through Repo 105
transactions,itwouldhaveconcernedhim.3517
Fulds denial of recollection must be weighed by a trier of fact against other
evidence.Fuldrecalledhavingmanyconversationswithhisexecutivesaboutreducing
net leverage and emphasized to the Examiner how important it was for Lehman to
reduce its net leverage.3518 The night before the March 28, 2008 Executive Committee
meeting, Fuld received materials for the meeting, including an agenda of topics
including Repo 105/108 and Delever v Derisk and a presentation that referenced
Lehmans quarterend Repo 105 usage for first quarter 2008 $49.1 billion.3519 The
materialsalsowereforwardedbyFuldsassistanttootherLehmanexecutives.3520
3516Id.
3517Id.
3519Lehman, Balance Sheet and Cash Capital Update (Mar. 27, 2008), at p. 1 [LBEXDOCID 506399]
(attached to email from Angela Judd, Assistant to Richard S. Fuld, Jr., Lehman, to Scott J. Freidheim,
Lehman, et al. (Mar. 28, 2008) [LBEXDOCID 561761], containing Firm Balance Sheet Details with Repo
105/108 column showing total usage of $49.102 billion and breakout for Repo 105 usage by business
group);Lehman,ExecutiveCommitteeMeetingMaterial,Agenda(Mar.28,2008)[LBEXDOCID545869]
Lehman,etal.(Mar.28,2008)[LBEXDOCID561761],listingtopicsfordiscussionatExecutiveCommittee
meeting,includingRepo105/108andDelevervDerisk).
3520EmailfromAngelaJudd,AssistanttoRichardS.Fuld,Jr.,Lehman,toScottJ.Freidheim,Lehman,et
al.(Mar.28,2008)[LBEXDOCID561761].FuldsattorneyassertedtotheExaminerthatFulddoesnotuse
a computer, uses only a Blackberry and does not have the ability to open attachments. Examiners
MeetingwithPatriciaHynesre:RichardS.Fuld,Jr.,Jan.20,2010,atp.2.
918

It appears that Fuld did not attend the March 28 meeting, but Bart McDade
recalledhavingspecificdiscussionswithFuldaboutLehmansRepo105usageinJune
2008.3521Sometimethatmonth,McDadespoketoFuldaboutreducingLehmansuseof
Repo 105 transactions.3522 McDade walked Fuld through the Balance Sheet and Key
Disclosures document (reproduced in part below) and discussed with Fuld Lehmans
quarterendRepo105usage$38.6billionatyearend2007;$49.1billionatfirstquarter
2008;and$50.3billionatsecondquarter2008.3523
3521Richard S. Fuld, Jr., Lehman, Call Log, at pp. 67 [LBHI_SEC07940_016911] (showing Fuld had
telephone calls the morning of the Executive Committee meeting); Examiners Interview of Herbert H.
BartMcDadeIII,Jan.28,2010,atpp.34(statingthatFulddidnotattendtheMarch28,2008Executive
Committeemeetingbutthatinquarterthree,IcertainlytalkedtoFuldaboutRepo105.).
3523Id.atp.5;seealsoLehman,BalanceSheetandKeyDisclosures20083QTargets(Draft)(June16,2008),
atp.3[LBHI_SEC07940_641516].
919

Basedupontheirconversation,McDadeunderstoodthatFuldknew,atabasic
level,thatRepo105wasusedinthefirmsbondbusinessandthatFuldwasfamiliar
withthetermRepo105.3524McDaderecalledthatwhenheadvisedFuldinJune2008
thatLehmanshouldreduceitsRepo105usageto$25billion,Fuldunderstoodthatthis
920

would put pressure on traders.3525 McDade also recalled that Fuld knew about the
accountingofRepo105.3526
(2) LehmansFormerChiefFinancialOfficers
AlthoughinterviewstatementsgiventotheExaminerwereinconsistentattimes,
no reasonable dispute exists that each of Lehmans Chief Financial Officers from late
2007 to September 2008 possessed some knowledge of and/or involvement with
multiple aspects of Lehmans Repo 105 program, including the existence of firmwide
Repo 105 limits, the volume of Repo 105 activity Lehman engaged in at quarterend,
andLehmanseffortstomanageitsbalancesheetusingRepo105transactions.
(a) ChrisOMeara,FormerChiefFinancialOfficer
ChrisOMearaservedasLehmansCFOfromDecember2004throughDecember
2007.3527 No later than July 2006, OMeara and Ed Grieb, then Global Financial
Controller,setalimitorcaponLehmansfirmwideRepo105usage.3528Accordingtoa
July2006internalLehmanpresentation,OMearaandGriebsetthelimitforRepo105at
$17billionor1xleverageandthelimitforRepo108at$5billion.3529TheExaminer
3525Id.atp.6.
3526Id.
3528Lehman, Global Balance Sheet Overview of Repo 105 (FID)/Repo 108 Equities (July 2006), at p. 2
[LBEXWGM748489];ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.8.
3529Lehman, Global Balance Sheet, Overview of Repo 105 (FID)/Repo 108 Equities (July 2006), at p. 2
[LBEXWGM748489].ThesamedocumentalsosuggeststhattotalRepo105usageshouldbemaintained
at80%tangibleequityintramonth.SeeSectionIII.A.4.f.3ofthisReport(discussingcontinualuserule).
WhenquestionedaboutthecalculationoftheRepo105limitsetoutintheGlobalBalanceSheetOverview
Presentation,Griebcouldnotrecallthecalculationofthelimitorwhetherthe1xleverageor$17billion
921

questioned OMeara about Lehmans Repo 105 program on two separate occasions.
Duringhisfirstinterview,OMearadisavowedknowledgeoftheprogram,statingthat
he was not that close to the Repo 105 issue.3530 OMeara further stated during his
initialinterviewthatheneverinstructedLehmansbusinessunitstolowertheirbalance
sheetsatquarterendusingRepo105transactions.3531
Internal Lehman documents and interview statements of other witnesses
evidencegreaterinvolvementthanOMeararecalls.Forexample,theJuly2006internal
Lehman Power Point presentation titled Overview of Repo 105 (FID)/108 (Equities)
identifies numerous Operating Rules related to Lehmans Repo 105 program,
including Repo 105 is capped at $17B (1 x leverage) [per Chris OMeara and Ed
Grieb];Repo108iscappedat$5B[perChrisOMearaandEdGrieb];andRepo105
transactionsmustbeexecutedonacontinualbasisandremaininforcethroughoutthe
definition referred to one of Lehmans leverage ratios or, rather, to tangible equity capital. Examiners
InterviewofEdwardGrieb,Oct.2,2009,atp.9.LehmansForm10QfromthesameperiodastheGlobal
BalanceSheetOverviewPresentationshowsthatLehmanstangibleequitycapitalwas$17.4billionand
thatthefirmsnetleverageratiowas13.8,suggestingthatthecalculationofLehmansRepo105limitmay
havebeentiedtotangibleequitycapital.LehmanBrothersHoldingsInc.,QuarterlyReportasofMay31,
2006(Form10Q)(filedonJuly10,2006),atp.58(LBHI10Q(filedJuly10,2006)).TheGlobalBalance
SheetOverviewPresentationitselfsuggestedthattangibleequityistheappropriatemeasureofleverage.
Lehman,GlobalBalanceSheet,OverviewofRepo105(FID)/Repo108Equities(July2006),atp.5[LBEX
WGM 748489]; see also Duff & Phelps, Repo 105/108 Usage vs. Limit Comment (Oct. 16, 2009), at p. 1.
Bismaldescribedthe1xleveragemetricas1xthenetleverageratio.ExaminersInterviewofAnuraj
Bismal,Sept.16,2009,atp.10.Theconclusionthat1xleveragemeansthatthelimitwas1xtangible
equity metric is also supported by the fact that the denominator of the net leverage ratio is tangible
equity.Duff&Phelps,Repo105/108Usagevs.LimitComment(Oct.16,2009),atp.1&n.4.Thesetting
oftheRepo105limitat1xtangibleequityimpliesthatseniorLehmanmanagementdeterminedRepo105
usagewouldbepermittedbythefirmtoreduceLehmansnetleverageratiobyuptoonemultiple.Duff
&Phelps,Repo105/108Usagevs.LimitComment(Oct.16,2009),atp.2.
3531Id.
922

month. To meet this requirement, the amount outstanding at any time should be
maintainedatapproximately80%oftheamountatmonthend.[perChrisOMearaand
EdGrieb].3532
During OMearas second interview, the Examiner showed OMeara the July
2006presentation.3533OMearasaidhehadneverbeforeseenthepresentationanddid
notknowwhodraftedit.3534OMearacontinuedthathe hadnospecificrecollection
that he was involved in setting firmwide limits or caps for Lehmans Repo 105
usage.3535WhentheExamineraskeddirectlywhetherhewasthesourceforthecapon
Repo105,OMearasaidno.3536OMearafurthersaidthathecouldnotrecallifanyone
evertoldhimthatRepo105transactionswouldhelpreduceLehmansbalancesheetor
netleverage.3537
Finally, when asked why Lehman would choose to engage in Repo 105
transactionsinsteadofordinaryrepotransactions,giventhehigherhaircutforRepo105
transactions,OMearacouldnotexplain,sayingonlyImjustnotcloseenoughtoit.3538
OMeara stated also that he could not recall having any conversations regarding
3532Lehman, Global Balance Sheet, Overview of Repo 105 (FID)/Repo 108 Equities (July 2006), at p. 2
[LBEXWGM748489].
3533ExaminersInterviewofChristopherM.OMeara,Sept.23,2009atp.6.
3534Id.atpp.68.
3535Id.
3536Id.
3537Id.
3538ExaminersInterviewofChristopherM.OMeara,Sept.23,2009,atp.7.
923

LehmansRepo105programwithRichardFuld,JoeGregory,ErinCallan,EdGrieb,any
Governmentpersonnel,oranyonefromtheratingsagencies.3539
Grieb, on the other hand, recalled many conversations with OMeara about
LehmansuseofRepo105transactions.3540Griebcommunicatedregularly,throughout
his tenure as Global Financial Controller which Grieb recalled lasted for several
years and ended on December 1, 2007 with OMeara and Reilly about firmwide
limitsortargetsforLehmansRepo105program.3541
According to Grieb, he, OMeara, and Reilly shared responsibilities in setting
firmwide Repo 105 limits for several years, as late as November 2007.3542 Griebsaid
thathealonedidnothavetheauthoritytochangeorincreasethelimitortoauthorizea
personorgrouptoexceedthelimit;instead,achangeinLehmansfirmwideRepo105
limitrequiredconsensusamongGrieb,OMearaandReilly.3543
3539Id.
3540ExaminersInterviewofEdwardGrieb,Oct.2,2009,atpp.10,1213.
3541Id.GriebstatedthatheneverdiscussedRepo105relatedissueswithCallanorLowitt,eachofwhom
becameCFOafterGrieblefthisFinancialControllerposition.
3542Id.;seealsoLehman,GlobalBalanceSheetOverviewofRepo105(FID)/Repo108Equities(July2006),
atp.2[LBEXWGM748489].
3543Examiners Interview of Edward Grieb, Oct. 2, 2009, at p. 8. Although acknowledging that he had
someroleinsettingtheRepo105limits,GriebdeniedanyrecollectionoftheformulabywhichLehman
calculatedthelimits.Id.atp.9.WhentheExaminerattemptedtorefreshhisrecollectionwiththeJuly
2006LehmanpresentationwhichstatedthatthefirmwidecaponRepo105wassetat1xleverage,or
$17billion,Griebstatedhisbeliefthatthecapwasrelatedtofirmsoverallleverageratio.Id.Butwhen
shown Lehmans Form 10Q for second quarter 2006 (the same general time period as the July 2006
presentation), which disclosed that Lehmans firmwide shareholder equity was approximately $17
billionandthefirmsnetleverageratiowas13.8x,GriebstatedhewaslesscertainthattheRepo105limit
wascalculatedonthebasisofleverage.Id.
924

AnumberofotherdocumentsshowthatOMearawasinvolvedwithLehmans
Repo105program:
As CFO, OMeara regularly received a report titled Weekly Finance

Update,atleastoneversionofwhichincludedareferencetothefirmsuse
ofRepo105transactions.3544
InAugust2007,KentaroUmezakiwrotetoOMearaandothers: FYI:John
FeracaisworkingonRepo105forourIGmortgageandrealestateassetsto
reduceourQ3balancesheet.WeveagreedwedregrouponTuesdaytosee
to whatextentwe can utilize thatfacility for Qend.3545Thefollowingday,
Reilly replied to OMeara alone: I thought 105 would be a better answer
thanthecdsstructurewetalkedabout.Maybenoappetite.3546
AnotherAugust2007emailchainregardingRepo105usagewasforwarded
toOMearafromReilly.3547AroundthesametimethatGriebrecommended
to Lehmans Accounting Policy Group that Lehman use the Repo 105
program to remove from the balance sheet certain residual positions from
mortgagebackedsecuritizations,Reillywaspursuingasimilareffort.3548Ina
seriesofemailsfromAugust2007,Reillyunsuccessfulattemptedtotransfer
nonagencymortgagebackedsecuritiesintotheRepo105program.3549Reilly
3544Lehman, Weekly Finance Update, Week Ended August 11, 2006 (Aug. 15, 2006), at p. 11 [LBEX
DOCID 1346667] (IRPs Net Balance Sheet increased by $5B mostly due to Repo 105.) (attached to e
mail from Polina Savelieva, Lehman to Christopher M. OMeara, Lehman, et al. (Aug. 15, 2006) [LBEX
DOCID1361132].
3545Email from Kentaro Umezaki, Lehman, to Christopher M. OMeara, Lehman, et al. (Aug. 17, 2007)
[LBEXDOCID197155].
3546Email from Gerard Reilly, Lehman, to Christopher M. OMeara, Lehman (Aug. 18, 2007) [LBEX
DOCID197155].
DOCID 4553354]; email from Gerard Reilly, Lehman, to Christopher M. OMeara, Lehman (Aug. 20,
2007)[LBEXDOCID4553358].
3548Email from Marie Stewart, Lehman, to Brett Beldner, Lehman, et al. (Aug. 17, 2007) [LBEXDOCID
3223803](discussingGriebsideaofplacingmortgagebackedsecuritiesintoRepo105program).
3549EmailfromJohnFeraca,Lehman,toGerardReilly,Lehman(Aug.18,2007)[LBEXDOCID4553350];
emailfromGerardReilly,Lehman,toJohnFeraca,Lehman(Aug.18,2007)[LBEXDOCID4553351];e
mailfromJohnFeraca,Lehman,toDavidSherr,Lehman,etal.(Aug.19,2007)[LBEXDOCID4553352];e
mailfromDavidSherr,Lehman,toGerardReilly,Lehman,etal.(Aug.19,2007)[LBEXDOCID4553353];
email from Gerard Reilly, Lehman, to John Feraca, Lehman, et al. (Aug. 19, 2007) [LBEXDOCID
4553356];emailfromJohnFeraca,Lehman,toDavidSherr,Lehman,etal.(Aug.20,2007)[LBEXDOCID
4553357].
925

enlistedthehelpofJohnFeracaandDavidSherrinthiseffortsothatLehman
could reduce its mortgage positions through the Repo 105 program.3550
Notably,ReillykeptOMearainformedoftheseeffortsbyforwardingtohim
theemailcommunicationswithFeracaandSherr.3551Atthesametime,per
OMearasrequest,Griebmadeinquiriesregardingapotentialcreditdefault
swap structure for Lehmans RMBS and CMBS securities in addition to the
plantomovethemintotheRepo105program.3552Specifically,OMearatold
Reilly that the plan is to do both [Repo 105 and credit default swap] if all
checksoutfinewithlegalandaccounting.3553
Documents also establish that OMeara continued to be involved in Lehmans
Repo105programafterleavingtheCFOpositioninDecember20073554andtakingonthe
roleofChiefRiskOfficer:
3550EmailfromJohnFeraca,Lehman,toGerardReilly,Lehman(Aug.18,2007)[LBEXDOCID4553350];
emailfromGerardReilly,Lehman,toJohnFeraca,Lehman(Aug.18,2007)[LBEXDOCID4553351];e
mailfromJohnFeraca,Lehman,toDavidSherr,Lehman,etal.(Aug.19,2007)[LBEXDOCID4553352];e
mailfromDavidSherr,Lehman,toGerardReilly,Lehman,etal.(Aug.19,2007)[LBEXDOCID4553353];
email from Gerard Reilly, Lehman, to John Feraca, Lehman, et al. (Aug. 19, 2007) [LBEXDOCID
4553356];emailfromJohnFeraca,Lehman,toDavidSherr,Lehman,etal.(Aug.20,2007)[LBEXDOCID
4553357].
DOCID 4553354]; email from Gerard Reilly, Lehman, to Christopher M. OMeara, Lehman (Aug. 20,
2007)[LBEXDOCID4553358].
DOCID197157].
3553Id.
3554LehmansfiscalyearendedonNovember30,2007.ThoughLehmandidnotfileits200710Ksigned
byCallanuntilJanuary29,2008,OMearaservedasCFOfortheentireperiodreflectedinthe200710K.
Moreover, the Examiner has located evidence suggesting that OMeara subcertified the 2007 10K for
CallanandwasresponsibleforcertainfinancialreportinginLehmansForm10Qforfirstquarter2008.
See Lehman Brothers Holdings Inc., Reporting Instructions, Quarter Ended February 29, 2008 (Feb. 22,
2008), at p. 5 ( [LBEXDOCID 3756724] (stating that OMeara was the certifier for the Review of Risk
Management narrative for accuracy of MD&A discussions of credit risk, market risk, operational risk,
reputationalrisk,valueatrisk,othermeasuresofriskanddistributionoftradingrevenues);emailfrom
MartinKelly,Lehman,toIanT.Lowitt,Lehman(July8,2008)[LBEXDOCID2329856]([W]ouldyoulike
to have Erin sign a subcertification letter (not necessary strictly speaking but we did have Chris sub
certifytoErinatyearend.);emailfromMartinKelly,Lehman,toErinM.Callan,Lehman(July9,2008)
[LBEXDOCID 1536331] (asking Callan if I could have you subcertify on the quarter[ly report] (Chris
[OMeara] subcertified to you at year end)); email from Ian T. Lowitt, Lehman, to Martin Kelly,
Lehman (July 9, 2008) [LBEXDOCID 2329856] (I spoke to Tom [Russo about subcertification] and he
926

OMearareceivedaMarch2008emailtransmittinganinternalpresentation,
Balance Sheet and Cash Capital Update, that illustrated the quarterend
volume of Repo 105 transactions for first quarter 2008, $49.102 billion, and
brokeouttheamountofRepo105usagebybusinesssegment.3555
AnApril11,2008emailfromOMearatoReillyindicatesthatthetwomen
wereplanningtodiscussLehmansRepo105programonApril14,2008.3556
AnemailfromTraversaritoOMeararevealsthatOMearaaskedTraversari
questions about daily balance sheet management at Lehman compared to
traditional banks.3557 Traversari wrote to OMeara that one reason why
Lehmans balance sheet was larger intramonth than at monthend was
because,unlikeotherbanks,LehmanusedRepo105transactionswhichare
UKbased specific transactions on opinions received by LEH from
Linklaters.3558
WhenLehmanwasfacingsignificantreductioninrepo105availabilityfor
month end only ten days before the close of the second quarter 2008
because certain counterparties retrenched and Lehman had already used
its available credit line with Mizuho, Matthew Pinnock asked Tonucci to
speak[]withOMearaforatempincrease[inrepo105]togetusovermonth
end.3559 Tonucci inquired: Any room to upsize Mizuho?3560 OMeara
thereaftercontinuedthediscussionwithTonuccibytelephone.3561
thinksbetterifdidntcomefromhimandbettertopresentasconsistentwithwhatChrisdidwhenErin
overlapped.).
(attached to email from Christopher M. OMeara, Lehman, to James Emmert, Lehman (Mar. 28, 2008)
[LBEXDOCID574581]).
3556Email from Christopher M. OMeara, Lehman, to Gerard Reilly, Lehman (Apr. 11, 2008) [LBEX
DOCID4553298].
3557Email from Ryan Traversari, Lehman, to Christopher M. OMeara, Lehman (May 16, 2008) [LBEX
DOCID3233899].
3558Id.
3559EmailfromMatthewPinnock,Lehman,toPaoloR.Tonucci,Lehman(May21,2008)[LBEXDOCID
1548431].TonuccirepliedthathewouldspeakwithOMearaaboutaRepo105increase.Seeemailfrom
PaoloR.Tonucci,Lehman,toMatthewPinnock,Lehman(May21,2008)[LBEXDOCID1548433].
3560EmailfromPaoloR.Tonucci,Lehman,toChristopherM.OMeara,Lehman(May21,2008)[LBEX
DOCID1533687];seealsoemailfromJeffMichaels,Lehman,toKaushikAmin,Lehman(May21,2008)
[LBEXDOCID3234376](regardingRepo105counterparties,PinnockreportsthatTonucciunderstands
urgencyandisdiscussingwithOMeara);emailfromJeffMichaels,Lehman,toKaushikAmin,Lehman
927

AJune17,2008emailfromReillytoOMeara,McDade,Lowitt,andMorton,
attached a strawman target doc for Q3 entitled Balance Sheet and Key
Disclosures 2008 3Q Targets.3562 The attachment, dated June 16, 2008,
identified not only net and gross balance sheet targets for various Lehman
businessgroups,butalsocontainedaRepo105targetchart.3563TheRepo105
target chart noted the total volume of Repo 1053564 transactions Lehman
engagedinatquarterendforfourthquarter2007($38.6billion),firstquarter
2008 ($49.1 billion), and second quarter 2008 ($50.3 billion).3565 On June 17,
2008, OMeara replied to Reilly and the other recipients of Reillys email,
stating:Ameetingisbeingsetuptodiscussthis,thisweek.3566
When Bank of France terminated a Repo 105 trade in September 2008,

OMeara received an email with subject line IRP LBI inventory risk
informinghimofthefail.3567
In addition, OMeara received a recurring report between April and

September2008,theDailyBalanceSheetDisclosureScorecard,whichoften
referencedRepo105activityanditsimpactonLehmansbalancesheet.3568
(May 21, 2008) [LBEXDOCID 3234378] (stating, in response to Amins request, that Amin can get an
additional$3.5billionofRepo105withMizuho[i]fOMearaandPaololetus).
3561EmailfromChristopherM.OMeara,Lehman,toPaoloR.Tonucci,Lehman(May21,2008)[LBEX
DOCID1533688].
3562Lehman, Balance Sheet and Key Disclosures 2008 3Q Targets [Draft] (June 16, 2008) [LBEXDOCID
3363493](attachedtoemailfromGerardReilly,Lehman,toChristopherM.OMeara,Lehman,etal.(June
17,2008)[LBEXDOCID3383643].
DOCID3363493].
3564ThechartrefersonlytoRepo105,butLehmanfrequentlyusedRepo105torefertobothRepo105
andRepo108.ThefiguresusedinthechartareconsistentwiththetotalcombinedRepo105/108amounts
reportedinotherdocuments.
3565Brothers, Balance Sheet and Key Disclosures 2008 3Q Targets [Draft] (June 16, 2008), at p. 3 [LBEX
DOCID3363493].
3566EmailfromChristopherM.OMeara,Lehman,toGerardReilly,Lehman,etal.(June17,2008)[LBEX
DOCID033813].ThemeetingappearstohavetakenplaceonThursday,June19,2008.Seeemailfrom
Gerard Reilly, Lehman, to Janet Marrero, Lehman (June 19, 2008) [LBEXDOCID 4553465] (Can you
printme6copiesofthis[Lehman,BalanceSheetandKeyDisclosures20083QTargets]forthemeetingat
3:30[?]).
3567Email from Jeffrey Goodman, Lehman, to Christopher M. OMeara, Lehman, et al. (Sept. 17, 2008)
[LBEXDOCID 182776] (Jeff Michaels: Just to be clear, I am not hedging this risk because I know it is
substantiallywrong.BankofFranceterminatedarepo105tradeyesterdayasitwentthroughLBIE.
Goodman:Canwegetops/motobookterminates/salesforpositionsthatweknowtobeterminatedso
wecanhaveasemblanceofrealityinwhatweareshowinginthesystems?)
928

3568See,e.g.,Lehman,BalanceSheetandDisclosureScorecardforTradeDateApril7,2008(Apr.9,2008)
[LBEXDOCID520619],atp.9(attachedtoemailfromTalLitvin,Lehman,toChristopherM.OMeara,
Lehman,etal.(Apr.9,2008)[LBEXDOCID523578]andshowingconsolidatedFIDandEquitiesbalance
sheetreducedby$18.527billionandPrimeServicesbalancesheetreducedby$4.458billionthroughRepo
105 transactions as of April 7, 2008); Lehman, Balance Sheet and Disclosure Scorecard for Trade Date
April8,2008(Apr.10,2008)[LBEXDOCID520620],atp.9(attachedtoemailfromTalLitvin,Lehman,
to Christopher M. OMeara, Lehman, et al. (Apr. 10, 2008) [LBEXDOCID 523579] and showing
consolidatedFIDandEquitiesbalancesheetreducedby$18.853billionandPrimeServicesbalancesheet
reducedby$4.562billionthroughRepo105transactionsasofApril8,2008);Lehman,BalanceSheetand
DisclosureScorecardforTradeDateApril9,2008(Apr.10,2008)[LBEXDOCID251339],atp.9(attached
to email from Tal Litvin, Lehman, to Christopher M. OMeara, Lehman, et al. (Apr. 10, 2008) [LBEX
DOCID258560]andshowingconsolidatedFIDandEquitiesbalancesheetreducedby$19.688billionand
PrimeServicesbalancesheetreducedby$4.548billionthroughRepo105transactionsasofApril9,2008);
Balance Sheet and Disclosure Scorecard for Trade Date April 10, 2008 [LBEXDOCID 251342], at p. 9
(attached to email from Tal Litvin, Lehman to Christopher M. OMeara, Lehman, et al. (Apr. 14, 2008)
[LBEXDOCID 275231] and showing consolidated FID and Equities balance sheet reduced by $19.967
billion and Prime Services balance sheet reduced by $4.491 billion through Repo 105 transactions as of
April 10, 2008); Balance Sheet and Disclosure Scorecard for Trade Date April 11, 2008 [LBEXDOCID
251344],atp.9(attachedtoemailfromTalLitvin,Lehman,toChristopherM.OMeara,Lehman,etal.
(Apr.14,2008)[LBEXDOCID258562]andshowingconsolidatedFIDandEquitiesbalancesheetreduced
by $20.260 billion and Prime Services balance sheet reduced by $4.517 billion through Repo 105
transactionsasofApril11,2008);Lehman,BalanceSheetandDisclosureScorecardforTradeDateMay
12, 2008 (May 13, 2008) [LBEXLL 1950262], at p. 1 (attached to email from Tal Litvin, Lehman, to
Christopher M. OMeara, Lehman, et al. (May 13, 2008) [LBEXDOCID 3187357] and stating Rates
decreasedby$(5.0B)frompriordaydueto...increasedRepo105usage....);Lehman,BalanceSheet
and Disclosure Scorecard for Trade Date May 22, 2008 (May 27, 2008), at p. 1 [LBEXLL 1950706]
(attached to emailfromTal Litvin, Lehman, to Christopher M.OMeara, Lehman, et al. (May27,2008)
[LBEXDOCID275984]andstatingGlobalratesnetbalancesheetdecreased($2.0B),predominantlydue
toanincreaseinRepo105benefit....);Lehman,BalanceSheetandDisclosureScorecardforTradeDate
ChristopherM.OMeara,Lehman,etal.(May30,2008)[LBEXDOCID275995]andstatingGlobalrates
net balance sheet decreased by ($3.1B) primarily due to a decrease in Americas driven by an increased
utilization of Repo 105 within the Agency business); Lehman, Balance Sheet and Disclosure Scorecard
Lehman, to Christopher M. OMeara, Lehman, et al. (June 2, 2008) [LBEXDOCID 011127] and stating
(Global Rates net balance sheet decreased ($6.5B)[t]he decrease in Europe is coming from increased
utilizationofRepo105);Lehman,BalanceSheetandDisclosureScorecardforTradeDateJune18,2008
(June 20, 2008) [LBEXLL 1950514] (attached to email from Tal Litvin, Lehman, to Christopher M.
OMeara,Lehman,etal.(June20,2008)[LBEXDOCID275942]andstatingthatGlobalratesnetbalance
sheetdecreased...drivenbya[n]...increaseinRepo105utilization....);Lehman,BalanceSheetand
mailfromTalLitvin,Lehman,toChristopherM.OMeara,Lehman,etal.(Aug.14,2008)[LBEXDOCID
4214810]andstatingthatGlobalratesnetbalancesheetdecreased...drivenbyanincreaseinRepo105
benefit....);Lehman,BalanceSheetandDisclosureScorecardforTradeDateAugust25,2008(Aug.26,
2008) [LBEXLL 782924] (attached to email from Tal Litvin, Lehman, to Christopher M. OMeara,
Lehman, et al. (Aug. 26, 2008) [LBEXDOCID 079536] and stating that Global Rates net balance sheet
929

(b) ErinCallan,FormerChiefFinancialOfficer
Erin Callan served as Lehmans CFO from December 1, 2007 until June 12,
2008.3569InherinterviewwiththeExaminer,CallanrecalledverylittleaboutLehmans
Repo 105 program.3570 Callan said she had little to no independent recollection of
Lehmans use of Repo 105 transactions, but that her memory had been refreshed to a
limited extent by documents the Examiner provided to her in advance of her
interview.3571
MartinKellytoldtheExaminerthathespoketoCallanaboutKellysdiscomfort
withLehmansuseofRepo105transactions,raisingfivediscreteconcernsaboutRepo
105:(1)KellysdiscomfortwiththepossiblereputationalriskLehmanwouldsufferif
the investing public and analysts learned that Lehman used Repo 105 transactions
solelytoreduceitsbalancesheet;(2)thesizeofLehmansRepo105program,thatis,the
volume of Repo 105 transactions that Lehman undertook at quarterend to reduce its
balance sheet; (3) the technical basis, from an accounting perspective, by which
LehmanwasauthorizedtoengageinRepo105transactions;(4)Kellysbeliefthatnone
of Lehmans peer investment banks used Repo 105 transactions; and (5) the fact that
Lehmans Repo 105 activity was skewed at quarterend, in other words, that the
decreaseddriven by an increase in repo 105 usage .); Lehman, Balance Sheet and Disclosure
ScorecardforTradeDateAugust28,2008(Aug.29,2008)[LBEXLL782966](attachedtoemailfromTal
Litvin, Lehman, to Christopher M. OMeara, Lehman, et al. (Aug. 29, 2008) [LBEXDOCID 275880] and
statingthatGlobalrates[netbalancesheet]wasdowndrivenbyincreasedRepo105benefit.).
3570Id.atp.17.
3571Id.
930

firms Repo 105 usage spiked at quarterend, during Lehmans reporting periods.3572
Kelly recalled having several conversations with Callan about Lehmans use of Repo
105transactions.3573
With regard to Kellys discussion with Callan of the very technical accounting
basisunderlyingLehmansrelianceonRepo105transactions,KellywantedCallanto
makesureRepo105transactionswerebeingaccountedforproperly.3574Indeed,Kelly
recalledadetaileddiscussionwithCallanabouteachofSFAS140srequirementsfora
transactiontoreceivetruesaleaccountingtreatment.3575Kellywantedtopresent[to
Callan] a balanced analysis of the transactions . . . what GAAP requires and . . .
[whether]wecompl[ied]withGAAP.3576
With respect to the issue that none of Lehmans peer investment banks used
Repo 105 transactions, Kelly informed Callan of this understanding because he was
trying to give Callan a balanced presentation or analysis and wanted to frame the
quantumofriskinvolvedintheprogram.3577
CallanrecalledspeakingtoKellyinlateFebruaryorMarch2008aboutRepo105
transactions,andrecalledthatKellyadvisedherthathewasunsurewhetherLehmans
3572ExaminersInterviewofMartinKelly,Oct.1,2009,atp.8;seealsoSectionIII.A.4.fofthisReport.
3574Id.
3575Id.
3576Id.
3577Id.atp.10.
931

peerCSEfirmswerealsoengaginginRepo105transactionsatthattime.3578Callandid
not dispute Kellys account of his conversations with her about the potential
reputationalriskLehmansRepo105programmighthaveposedtothefirm,butdid
not specifically recall Kellys comments.3579 Callan speculated that Kellys concerns
aboutreputationalrisklikelyweresubsumedinhisconcernsaboutwhetherLehman
wastheonlyWallStreetfirmusingRepo105typetransactions.3580
AccordingtoCallan,sheandKellyagreedthatKellyshoulddeterminewhether
Lehman was the lone user of Repo 105type transactions on Wall Street and, if so, to
ensurethepracticewasappropriate.3581Inaddition,CallanrecalledthatsheandKelly
agreedthatKellywouldconsultwithErnst&YoungandcertainofLehmansbusiness
unitsaboutthefirmsRepo105practices.3582Callan,however,couldnotrecallwhether
Kelly followed through on their conversation or whether he ever reported back to
Callan with his findings.3583 Callan suggested that Kellys concerns about Lehmans
Repo105programlikelyfellbythewayside,givenBearStearnsnearcollapseshortly
after their conversation, and that she and Kelly became deeply engaged in more
pressingissuesatthattime,suchascapitalraisesandsettingbalancesheetlimits.3584
3578ExaminersInterviewofErinM.Callan,Oct.23,2009,atp.17.
3579Id.
3580Id.
3581Id.
3582Id.
3584Id.
932

Kelly advised the Examiner that, based upon Callans reaction to his concerns
about Lehmans use of Repo 105 transactions, Kelly inferred general awareness of
what the program was and how it was used at the senior management level within
Lehman and that assuaged his concerns at least to a certain extent.3585 According to
Kelly, Callans initial response was to gather facts and think about it but she
eventually acknowledged there was risk and that [Kelly] felt discomfort.3586 Kelly
[couldnt]sayshe[Callan]sharedtheconcern.3587
Specifically as regards the issue of quarterend spikes in Repo 105 usage, Kelly
recalledthatCallanmerelyacknowledgedorunderstoodKellysconcernthatthe
program increased significantly at quarterend, but that Callan appeared not to be
surprisedatthequarterendincreases.3588Alltold,Kellysaidthatitwashisimpression
that Callan understood each of the issues he raised, but nonetheless that Callan
authorized Lehmans continued use of Repo 105 transactions.3589 Although one
3585ExaminersInterviewofMartinKelly,Oct.1,2009,atpp.8,10.
3586Id.
3587Id.
3588Id. Although he agreed that the volume of Lehmans Repo 105 transactions gave him concern as a
general matter, Kelly was unable to specifically recall the approximate volume ofLehmans Repo 105
usage at each quarterend. Id. Kelly had no specific recollection of the tens of billions of dollars in
Lehmans total Repo 105 usage at quarterend for fourth quarter 2007, first quarter 2008 and second
quarter2008,eventhoughthosefigureswerereportedinnumerouschartsandemailsKellyreceivedand
whichtheExaminerusedasexhibitsduringtheinterview.ExaminersInterviewofMartinKelly,Oct.1,
2009,atp.11;seealsoRepo105&Repo108CurrentDayReport(Nov.30,2007)[LBEXDOCID3238268]
(showing over $38 billion of total Repo 105 usage on November 30, 2007 and attached to email from
Anuraj Bismal, Lehman, to Martin Kelly, Lehman, et al. (Dec. 5, 2007) [LBEXDOCID 3223389] (stating
Weendedtheyearwith$38Billionofrepo105/8nettings)).
933

December 2007 document states that Repo 105 [was] a conversation at the CFO
level,3590CallansaidthatLehmansuseofRepo105transactionswasnothighon[her]
list,andthatshedidnotrecallspendinganymeaningfulamountoftimeonthetopic
atall.3591 Askedifshe recalledLehmanhaving engagedin$50billion worthof Repo
105 transactionsat the endof firstquarter2008, Callansaidno,and saidthatshehad
thoughtthetotalamountwasapproximatelytwentysomething.3592
Callan told the Examiner that she did not recall engaging in any discussions
aboutRepo105transactionswithFuld,McDade,Gregory,Tonucci,LehmansExecutive
Committee,orErnst&Young.3593Callansaidshehadnorecollectionofanyinternally
setcapsorlimitsonLehmansRepo105usage.3594
Callan, however, attended the March 28, 2008 Executive Committee meeting
requested by McDade to make certain balance sheet reduction recommendations.3595
The night before the meeting, McDades assistant circulated to Callan and other
membersoftheExecutiveCommitteetwodocumentsinconnectionwiththemeeting:
3590Email fromMarie Stewart, Lehman, to Dominic Gibb, Lehman, et al. (Dec. 21,2007)[LBEXDOCID
3223846]([O]uruseofRepo105isaconversationattheCFOlevelatthispoint.Also,Ithinkanymore
onthistopicisbestbyconversationsandnotemail.).
3592Id.
3593Id.
3594Id. Callan and Kellys direct predecessors, OMeara and Grieb, respectively set the firms Repo 105
limits.SeeLehman,GlobalBalanceSheetOverviewofRepo105(FID)/108(Equities)(July2006),atp.2
[LBEXWGM754587](Repo105iscappedat$17B(1xleverage)[perChrisOMearaandEdGrieb]and
Repo108iscappedat$5B[perChrisOMearaandEdGrieb].).
3595Examiners Interview of Herbert H. Bart McDade III, Jan. 28, 2010, at p. 4 (stating that the entire
ExecutiveCommittee,exceptforFuld,andexofficiomembersLowittandFriedheimattendedtheMarch
28,2008meeting).
934

(1)anagenda,listingRepo105/108asoneofseventopicstobediscussed,and(2)a
Balance Sheet and Cash Capital Update, the first page of which included various
firmwide financial data, including a column titled Repo 105/108, which listed the
$49.1billioninRepo105transactionsthatLehmanhadundertakenattheendofthefirst
quarter 2008.3596 The presentation also broke out the volumes of Repo 105 usage by
business segment.3597 McDade specifically recalled discussing with Executive
Committee members on March 28, 2008, Lehmans use of Repo 105 transactions and
recommendingthatLehmanplaceacaponRepo105.3598OnApril9,2008,twelvedays
after McDades presentation to the Executive Committee, Callan signed Lehmans
quarterlyreportforfirstquarter2008.3599
During her tenure as CFO, Callan received numerous other documents that
referencedLehmansuseofRepo105transactionstomeetbalancesheettargets.
In a January 2008 email, Reilly forwarded Callan an email in which

McGarveyinformedBernardthatRates(abusinesswithintheFixedIncome
Division) was running over its balance sheet target for December 2007 by
$72.3 billion and that a contributing factor was that Rates was using $18
billion less in Repo 105 transactions in December 2007 because there was
3596HerbertH.(Bart)McDadeIII,Lehman,BalanceSheetandCashCapitalUpdate(Mar.27,2008),atp.1
[LBEXDOCID095966](attachedtoemailfromGerardReilly,Lehman,toErinM.Callan,Lehman,etal.
(Mar.28,2008)[LBEXDOCID124422]andindicatingthattheattachmentisfortheExecutiveCommittee
meeting)); see also Herbert H. (Bart) McDade III, Lehman, Executive Committee Meeting Material,
Agenda(Mar. 28,2008) [LBEXDOCID115827](attached to email from Patricia Lombardi,Assistant to
HerbertH.(Bart)McDadeIII,toLehmanExecutiveCommitteeMembers,Lehman(Mar.28,2008)[LBEX
DOCID 120929] and listing among seven topics of discussion for March 28, 2008 Executive Committee
meetingRepo105/108andDelevervDerisk).CallanwasamemberoftheExecutiveCommittee.
3597Lehman,BalanceSheetandCashCapitalUpdate(Mar.27,2008),atp.1[LBEXDOCID095966].
3598Id.atpp.34.
3599LBHI,10Q(filedApr.9,2008),atp.92,31.02.
935

little counterparty appetite.3600 In his email to Callan, Reilly referenced the

balance sheet overage and stated, Repo 105 liquidity was very tight (this
shouldonlybeayearendissuebutIdontrecallitbeingthismaterialinthe
past).3601
InFebruary2008,ReillyagainwroteCallan,forwardingtoheranemailwith
an attached FID Balance Sheet PowerPoint presentation that was used to
educate sr fid guys on the bs and generate ideas to make the bs target.3602
TheemailforwardedtoCallannotedthattheFIDteamworkingonbalance
sheet issues had reached the recommendation that Repo 105 program is
expanded.3603
In March 2008, Reilly emailed Callan, as well as Lowitt and McDade, to

reportonthenetbalancesheettrendsincetheendofthefirstquarter.Reilly
wrote:RatesiswayupwPTtradeanddropoffinRepo105.3604
FromAprilthroughtheendofJune2008,CallanreceivedtheDailyBalance
Sheet Scorecard, which routinely referenced the impact of Lehmans Repo
105transactionsonthefirmsdailybalancesheet.3605
3600EmailfromGerardReilly,Lehman,toErinM.Callan,Lehman(Jan.3,2008)[LBEXDOCID3383445].
3601Id.
3602EmailfromGerardReilly,Lehman,toErinM.Callan,Lehman(Feb.1,2008)[LBEXDOCID3383459]
(transmittingLehmanBrothers,FIDBalanceSheet(Jan.17,2007)[LBEXDOCID3363222]).
3604Email from Gerard Reilly, Lehman, to Erin M. Callan, Lehman (Mar. 20, 2008) [LBEXDOCID
3221723](transmittingDailyNetAverageAssetsMarch2008schedule[LBEXDOCID3215629]).
atp.9[LBEXDOCID520619](attachedtoemailfromTalLitvin,Lehman,toErinM.Callan,Lehman,et
al. (Apr. 9, 2008) [LBEXDOCID 523578] and showing consolidated FID and Equities balance sheet
reducedby$18.527billionandPrimeServicesbalancesheetreducedby$4.458billionthroughRepo105
transactions); Lehman, Balance Sheet and Disclosure Scorecard for Trade Date April 10, 2008 (Apr. 14,
2008), at p. 9 [LBEXDOCID 251342] (attached to email from Tal Litvin, Lehman, to Erin M. Callan,
105transactions);Lehman,BalanceSheetandDisclosureScorecardforTradeDateApril11,2008(Apr.14,
105transactions);Lehman,BalanceSheetandDisclosureScorecardforTradeDateMay12,2008(May13,
2008),atp.1[LBEXLL1950262](attachedtoemailfromTalLitvin,Lehman,toErinM.Callan,Lehman,
etal.(May13,2008)[LBEXDOCID3187357]andstatingRatesdecreasedby$(5.0B)frompriordaydue
to...increasedRepo105usage....);Lehman,BalanceSheetandDisclosureScorecardforTradeDate
936

(c) IanLowitt,FormerChiefFinancialOfficer
Ian Lowitt served as Lehmans CFO from June 12, 2008 through LBHIs
bankruptcy filing on September 15, 2008.3606 Prior to his appointment to the CFO
position,LowittservedasLehmanscoCAO.3607
LowittacknowledgedthatLehmaninitiateditsRepo105programatsomepoint
intheearly2000s.3608AskedtodescribehowhecametobeawareofLehmansRepo
105 program, Lowitt recalled that Lehman had established a regime of monthend
balance sheet targets for each business unit, and that each business unit had the
discretiontodeterminehowtomeetthattargetwithsupportfromProductControland
Finance.3609 One means available to the Fixed Income and Equities Divisions for
reachingbalancesheettargets,Lowittrecalled,wasbysell[ing]downassetsthrough
Lehmans Repo 105 program.3610 Lowitt recalled senior Lehman management setting
aggressive targets to reduce commercial and residential real estate inventory, but he
ErinM.Callan,Lehman,etal.(May27,2008)[LBEXDOCID275984]andstatingGlobalratesnetbalance
sheet decreased ($2.0B), predominantly due to an increase in Repo 105 benefit. . . .); Lehman, Balance
SheetandDisclosureScorecardforTradeDateMay28,2008(May30,2008),atp.1[LBEXLL1950670]
(attached to email from Tal Litvin, Lehman, to Erin M. Callan, Lehman, et al. (May 30, 2008) [LBEX
DOCID 275995] and stating Global rates net balance sheet decreased by ($3.1B) primarily due to a
decrease in Americas driven by an increased utilization of Repo 105 within the Agency business);
[LBEXLL1950658](attachedtoemailfromTalLitvin,Lehman,toErinM.Callan,Lehman,etal.(June2,
2008) [LBEXDOCID 011127] and stating Global Rates net balance sheet decreased ($6.5B) . . . [t]he
decreaseinEuropeiscomingfromincreasedutilizationofRepo105).
3607Id.
3608Id.pp.1011.
3609Id.
3610Id.
937

statedthathehadnospecificrecollectionofRepo105targetseventhoughherecalled
thatRepo105wasoneofthethingsthatthebusinessesweredoingtooperateattheir
[balancesheet]limits.3611
Lowitt believed that Ernst & Young had approved the firms use of Repo 105
transactionsearlyintheRepo105process(sometimeintheearly2000s),andasaresult,
LowittneverwasconcernedaboutLehmansuseofthetransactions.3612Lowittalsosaid
hewasunawareofanygeographicallimitationswithrespecttoRepo105forinstance,
he did not know that Lehmans internal Repo 105 Accounting Policy limited the
transactionstoLBIE.3613LowitthadnorecollectionofeverhavingreadtheAccounting
Policy, but he recalled that only the most liquid assets could be used in Repo 105
transactions.3614
Despite recalling very little specific information about his own involvement in
Lehmans Repo 105 program, Lowitt generally recalled that OMeara played a role in
Lehmans Repo 105 program.3615 Lowitt stated that OMeara and Grieb were
responsibleforsettingfirmwidelimitsonRepo105usage.3616Inaddition,whenLowitt
3612Id.atp.3.
3613Id.atp.11.
3614Id.atpp.11,14.
3615Id.atpp.11,14.
3616Id.AsexplainedelsewhereintheReport,OMearatoldtheExaminerthathehadnoinvolvementin
thesettingofRepo105limits.ExaminersInterviewofChristopherM.OMeara,Aug.14,2009atpp.28
29(statinghewasnotclosetoLehmansRepo105program);ExaminersInterviewofChristopherM.
OMeara,Sept.23,2009,atpp.67(stating,withrespecttoLehmansRepo105usageandlimitsIdont
havearecollectionofanyofthis).Ontheotherhand,GriebrecalledOMearasinvolvementintheRepo
938

was Lehmans Chief Administrative Officer in Europe, between 2005 and 2006, he
recalled that OMeara felt some need to establish guidelines for Repo 105 usage in
LehmansEuropeanoffices.3617
Kelly raised with Lowitt the same Repo 105related concerns that Kelly raised
withCallan,includingconcernsaboutLehmans relianceon Repo105transactionsfor
balancesheetrelief,theexpandingnatureofthatreliance,thetechnicalaccountingbasis
for the transactions, the quarterend spikes in usage, and the possible reputational
risk to Lehman.3618 Kelly noted, however, that his Repo 105 discussions with Lowitt
were more truncatedbecause, unlike Callan, Kelly viewed Lowitt as quite familiar
withtheprogramand[Lowitt]understooditsdetails.3619
Kelly recalled that after he expressed the same reservations to Lowitt about
Lehmans use of Repo 105transactionsthatKelly hadpreviously expressedtoCallan,
hisconcernsmetasimilarresultwithLowitt:Even[aftera]considerationofthesizeof
105 program. Examiners Interview of Edward Grieb, Oct. 2, 2009, at pp. 10, 1213; see also Lehman,
GlobalBalanceSheetOverviewofRepo105(FID)/108(Equities)(July2006),atp.2[LBEXWGM754587].
3618ExaminersInterviewofMartinKelly,Oct.1,2009,atpp.810.Kellycontinuedtopresshisconcerns
with Lehmans Repo 105 program following his discussion with Callan. Id. In a May 2008 internal
Lehman Power Point presentation to Finance Control entitled Information, Controls and Issues,
discussingproblemsfacedbyFinanceControlandstrategiesfordealingwiththem,KellyincludedRepo
105/108asanissuefordiscussioninthethirdquarter2008.MartinKelly,Lehman,Information,Control
andIssues(May2008),atp.10[LBEXDOCID1999716].
939

the program and the risks involved did not change the fact that the program should
continue.3620
Lowitt said that no one raised [Repo 105] to me as something I should be
spendinganymoreattentiononandhedidnotrecallanyconversationswithKellyon
the subject.3621 Similarly, Lowitt did not recall discussing Lehmans use of Repo 105
transactions with Fuld, McDade, Gregory, Callan, OMeara, Lehmans Executive
Committee,orErnst&Young.3622
Lowitt,however,attendedasanexofficiomembertheMarch28,2008Executive
Committeemeeting,andreceivedtheagendaandbalancesheetdocumentcirculatedby
McDades assistant.3623 Lowitt received two other copies of the balance sheet
3620Id.
3621ExaminersInterviewofIanT.Lowitt,Oct.282009,atp.11.
3622Id.
The Examiner attempted to refresh Lowitts recollection of his involvement in the Repo 105
program through documents (including emails in which Lowitt specifically inquired about Repo 105
transactions),andbyrecountingcommunicationsthatKellytoldtheExaminerhehadwithLowitt.But,
Lowittsmemorywasnotrevivedandhecontinuallystatedthatheknew[Repo105]wassomethingthe
firmengagedinbutthatitwasnotanissuehefocusedonorunderstood.Id.
[LBEXDOCID095961](attachedtoemailfromGerardReilly,Lehman,toIanT.Lowitt,Lehman,etal.
meeting)); see also Herbert H. (Bart) McDade III, Lehman, Executive Committee Meeting Material,
HerbertH.(Bart)McDadeIII,toIanT.Lowitt,Lehman,etal.(Mar.28,2008)[LBEXDOCID120929]and
listing among seven topics of discussion for March 28, 2008 Executive Committee meeting Repo
105/108andDelevervDerisk).
940

presentation on March 28, 2008 one set sent personally by McDade3624 and the other
sentbyReilly.3625
OnJune17,2008,ReillysenttoLowitttheBalanceSheetandKeyDisclosures
documentthatincorporatedMcDadesplanneddirectivetoreduceLehmansfirmwide
Repo 105 usage by half from $50 billion to $25 billion in third quarter 2008.3626 The
report also stated that Lehmans firmwide Repo 105 usage at quarterend for second
quarter 2008 was $50.3 billion.3627 Lowitt met with McDade, Reilly, OMeara, and
Morton to discuss the Balance Sheet and Key Disclosures document, which was then
updatedandredistributedtoLowittandtheothers.3628Thesediscussionsandmeeting
tookplaceonlyweeksbeforeLehmanfileditssecondquarter2008Form10Q,signed
byLowitt,onJuly10,2008.
DOCID095965](attachedtoemailfromHerbertH.(Bart)McDadeIII,Lehman,toIanT.Lowitt,Lehman,
etal.(Mar.28,2008)[LBEXDOCID110658]).
3625Id.
DOCID3363493](attachedtoemailfromGerardReilly,Lehman,toIanT.Lowitt,Lehman,etal.(June17,
2008)[LBEXDOCID3383643]).
3627Id.
Key Disclosure 2008 3Q Targets document); email from Gerard Reilly, Lehman, to Ian T. Lowitt,
Lehman,etal.(June19,2008)[LBEXDOCID2962369](transmittingupdatedversionofLehman,Balance
SheetandKeyDisclosures20083QTargets(June19,2008)[LBEXDOCID2932594]).
941

In addition, Lowitt received a number of other documents that referenced
LehmansuseofRepo105transactionsbothpriortoandduringhistenureasLehmans
CFO:
In an August 2007 email, Kentaro Umezaki informed Lowitt about John

FeracasattemptstoplacerealestatesecuritiesintotheRepo105program.3629
OnFebruary28,2008,FeracanotifiedLowittandTonuccithatLehmanhad
executed $11 billion in Repo 105 trades via LBIE with Barclays, UBS, and
Mizuho, using agencies securities.3630 Feraca later informed Lowitt that the
final tally of Repo 105 trades using United States Liquid Markets Products
was close to $13 billion3631 and by the next day reported yet again another
revisednumberof$17billion.3632LowittquestionedFeracawhytheamount
ofRepo105changedfromquartertoquarter.3633
WhenLowittwasaskedabouttheFebruary28,2008email,hesaidthathewas
wonderingifweweredoingmoreorlessofit[i.e.,Repo105transactions],thathewas
attemptingtogaugehowmaterialLehmansRepo105usagewas.3634Askedwhyas
coChiefAdministrativeOfficer,hewouldhavebeencommunicatingwithFeracaofthe
Secured Funding Desk about Lehmans Repo 105 program, Lowitt replied that Feraca
likelythoughtitwasimportanttoreportonthestatusofLehmansRepo105usageto
3629EmailfromKentaroUmezaki,Lehman,toIanT.Lowitt,Lehman,etal.(Aug.17,2008)[LBEXDOCID
1533678].
3630Email from John Feraca, Lehman, to Ian T. Lowitt, Lehman, et al. (Feb. 28, 2008) [LBEXDOCID
3207903].
3207907].
3207911].
3633EmailfromIanT.Lowitt,Lehman,toJohnFeraca,Lehman(Feb.28,2008)[LBEXDOCID3207905];e
mailfromJohnFeraca,Lehman,toIanT.Lowitt,Lehman(Feb.28,2008)[LBEXDOCID3207908];email
fromJohnFeraca,Lehman,toIanT.Lowitt,Lehman,etal.(Feb.29,2008)[LBEXDOCID3207910].
942

Lowitt and Tonucci because of their involvement in Lehmans Asset Liability
Committee(ALCO).3635
InMarch2008,ReillyinformedLowittthattheRatesBusinessbalancesheet
was way up since the close of the first quarter because of a drop off in
Repo 105.3636 Reilly later provided more color to Lowitt regarding the
breakdownofthe$95billionincreaseintheRatesBusinesssbalancesheet
sincecloseoffirstquarter,$22.4billionofwhichwasareductioninRepo105
usagesincequarterend.3637
InMay2008,LowittaskedFeracaifLehmanwasexperiencinganyfunding
issueswithitssecuredtransactions.3638FeracarepliedtoLowittandTonucci,
Therewereafewcounterpartieslastweekwhohadatleastnotedsomeof
therumblingsinthepresslastweek....Daiwawho[was]contemplatinga
Repo105tradewithus.Notabigfunderforus.Ithinkcounterpartieswill
reservejudgmentfornow...3639
In a July 2008 email to Lowitt and Tonucci regarding FIDs plans for cash
capitallimitsandbalancesheettargetsinthirdquarter2008,RobertAzerad
saidthatFIDsplantoshrink[]therepobookpotentiallyalot(20bn)...is
notconsistentwithB/StargetsgiventoFID(flatexcludingRepo105).3640
3635Id.Whenshownthesameemail,Feracacouldnotrecall,specifically,whyLowittandTonucciwould
haveaskedhimforinformationaboutRepo105.ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.
11. Feraca recalled generally that [b]alance sheet targets were more important at this time. There was
moreheightenedconcernregardingbalancesheetandleverageratio.Id.
3636Email from Gerard Reilly, Lehman, to Ian T. Lowitt, Lehman, et al. (Mar. 20, 2008) [LBEXDOCID
103526] (transmitting March Net Balance Sheet Daily Trend Excel Sheet (Mar. 20, 2008) [LBEXDOCID
103961]).
3637Email from Gerard Reilly, Lehman, to Ian T. Lowitt, Lehman, et al. (Mar. 20, 2008) [LBEXDOCID
2973597].
3638Email from Ian T. Lowitt, Lehman, to John T. Feraca, Lehman, et al. (May 27, 2008) [LBEXDOCID
070831].
3639Email from John Feraca, Lehman, to Ian T. Lowitt, Lehman, et al. (May 27, 2008) [LBEXDOCID
070831].
3640Email from Robert Azerad, Lehman, to Ian T. Lowitt, Lehman, et al. (July 9, 2008) [LBEXDOCID
8961].
943

Lowitt also received the Daily Balance Sheet and Disclosures Scorecard
betweenAprilandSeptember2008,whichfrequentlyreferredtotheimpact
ofRepo105transactionsonLehmansfirmwidebalancesheet.3641
atp.9[LBEXDOCID520619](attachedtoemailfromTalLitvin,Lehman,toChristopherM.OMeara,
April8,2008(Apr.10,2008),atp.9[LBEXDOCID520620](attachedtoemailfromTalLitvin,Lehman,
DisclosureScorecardforTradeDateApril9,2008(Apr.10,2008),atp.9[LBEXDOCID251339](attached
PrimeServicesbalancesheetreducedby$4.548billionthroughRepo105transactionsasofApril9,2008);
Lehman,BalanceSheetandDisclosureScorecardforTradeDateApril10,2008[LBEXDOCID251342],at
p. 9 (attached to email from Tal Litvin, Lehman, to Christopher M. OMeara, Lehman, et al. (Apr. 14,
2008) [LBEXDOCID 275231] and showing consolidated FID and Equities balance sheet reduced by
$19.967billionandPrimeServicesbalancesheetreducedby$4.491billionthroughRepo105transactions
asofApril10,2008);Lehman,BalanceSheetandDisclosureScorecardforTradeDateApril11,2008(Apr.
14,2008),atp.9[LBEXDOCID251344](attachedtoemailfromTalLitvin,Lehman,toChristopherM.
OMeara, Lehman, et al. (Apr. 14, 2008) [LBEXDOCID 258562] showing consolidated FID and Equities
TradeDateMay12,2008(May13,2008),atp.1[LBEXLL1950262](attachedtoemailfromTalLitvin,
Lehman,toChristopherM.OMeara,Lehman,etal.(May13,2008)[LBEXDOCID3187357]andstating
Ratesdecreasedby$(5.0B)frompriordaydueto...increasedRepo105usage....);Lehman,Balance
(attached to emailfromTal Litvin, Lehman, to Christopher M.OMeara, Lehman, et al. (May27,2008)
[LBEXDOCID275984]andstatingGlobalratesnetbalancesheetdecreased($2.0B),predominantlydue
toanincreaseinRepo105benefit....);Lehman,BalanceSheetandDisclosureScorecardforTradeDate
ChristopherM.OMeara,Lehman,etal.(May30,2008)[LBEXDOCID275995]andstatingGlobalrates
net balance sheet decreased by ($3.1B) primarily due to a decrease in Americas driven by an increased
utilization of Repo 105 within the Agency business); Lehman, Balance Sheet and Disclosure Scorecard
Lehman, to Christopher M. OMeara, Lehman, et al. (June 2, 2008) [LBEXDOCID 011127] and stating
GlobalRatesnetbalancesheetdecreased($6.5B)...[t]hedecreaseinEuropeiscomingfromincreased
utilizationofRepo105);Lehman,BalanceSheetandDisclosureScorecardforTradeDateJune18,2008
(June 20, 2008) [LBEXLL 1950514] (attached to email from Tal Litvin, Lehman, to Christopher M.
OMeara,Lehman,etal.(June20,2008)[LBEXDOCID275942]andstatingthatGlobalratesnetbalance
sheetdecreased...drivenbya[n]...increaseinRepo105utilization....);Lehman,BalanceSheetand
mailfromTalLitvin,Lehman,toChristopherM.OMeara,Lehman,etal.(Aug.14,2008)[LBEXDOCID
944

(3) LehmansBoardofDirectors
Without exception, former Lehman directors were unaware of Lehmans Repo
105programandtransactions.3642
Asdiscussedingreaterdetailbelow,LehmansownCorporateAuditgroupled
byBethRudofker,togetherwithErnst&Young,investigatedallegationsaboutbalance
sheet substantiation problems made in a May 16, 2008 whistleblower letter sent to
seniormanagementbyMatthewLee.3643OnJune12,2008,duringtheinvestigation,Lee
informedErnst&YoungaboutLehmansuseof$50billionofRepo105transactionsin
the second quarter of 2008.3644 At a June 13, 2008 meeting, Ernst & Young failed to
disclosethatallegationtotheBoardsAuditCommittee.3645
FormerLehmandirectorCruikshankrecalledthathemadeveryclearhewanted
a full and thorough investigation into each allegation made by Lee, whether the
4214810]andstatingthatGlobalratesnetbalancesheetdecreased...drivenbyanincreaseinRepo105
benefit....);Lehman,BalanceSheetandDisclosureScorecardforTradeDateAugust25,2008(Aug.26,
2008) [LBEXLL 782924] (attached to email from Tal Litvin, Lehman, to Christopher M. OMeara,
Lehman, et al. (Aug. 26, 2008) [LBEXDOCID 079536] and stating that Global Rates net balance sheet
decreased . . . driven by an increase in repo 105 usage . . . .); Lehman, Balance Sheet and Disclosure
ScorecardforTradeDateAugust28,2008(Aug.29,2008)[LBEXLL782966](attachedtoemailfromTal
Litvin, Lehman, to Christopher M. OMeara, Lehman, et al. (Aug. 29, 2008) [LBEXDOCID 275880] and
statingthatGlobalrates[netbalancesheet]wasdown...drivenbyincreasedRepo105benefit....).
3642ExaminersInterviewofDr.HenryKaufman,Sept.2,2009,atp.21;ExaminersInterviewofJerryA.
Grundhofer, Sept. 16, 2009, at p. 10; Examiners Interview of Roland Hernandez, Oct. 2, 2009, at p. 22;
Examiners Interview of Sir Christopher Gent, Oct. 21, 2009, at p. 22; Examiners Interview of Roger
Berlind, Dec. 18, 2009, 4; Examiners Interview of Michael L. Ainslie, Dec. 22, 2009, at p. 4; Examiners
InterviewofThomasCruikshank,Jan.20,2010,atp.2;ExaminersInterviewofSirChristopherGent,Jan.
20,2010,atp.4.
3643SeeSectionIII.A.4.i.4ofthisReport(discussingMatthewLeesstatementstoErnst&Young).
3644Id.
3645Id.
945

allegationwascontainedinLeesMay16,2008letterorraisedbyLeeinthecourseof
theinvestigation.3646AnotherformerLehmandirector,Berlind,similarlystatedthatthe
Audit Committee explicitly instructed Lehmans Corporate Audit Group and Ernst &
YoungtokeeptheAuditCommitteeinformedofallofLeesallegations.3647Berlindalso
saidthathewouldhavewantedtoknowaboutLehmansRepo105programandthatif
hehadknownaboutLehmansRepo105transactions,hewouldhaveaskedLehmans
auditorstotestthetransactionstoensuretheywereappropriate.3648Uponlearningfrom
theExaminerthevolumeofRepo105transactionsatquarterendinlate2007and2008,
SirChristopherGentsaidthathebelievedthevolumemandateddisclosuretotheAudit
Committeeandfurtherinvestigation.3649
Dr. Kaufman, on the other hand, stated that he would have wanted to know
about Repo 105 transactions only if they were huge and fraudulent, by which he
meant in violation of specific accounting rules or in violation of the law.3650 Dr.
Kaufmandidnotbelievethat$50billioninRepo105transactionswassignificantevenif
thatvolumechangedLehmansnetleverageratiobyapproximatelytwopoints.3651Dr.
3646ExaminersInterviewofThomasCruikshank,Oct.8,2009,atp.7.
3647ExaminersInterviewofRogerBerlind,Dec.18,2009,atp.4.
3648Id.
3649ExaminersInterviewofSirChristopherGent,Jan.20,2010,atp.3.
3650ExaminersInterviewofHenryKaufman,Dec.22,2009.
3651Id.
946

Kaufman considered a four or five point change in the net leverage ratio to be
significant.3652
In late 2007 and 2008, management made numerous presentations to the Board
regardingbalancesheetreductionanddeleveraging;innocasewastheuseofRepo105
transactionsdisclosedinthosepresentations.3653
3652Id.
3653See,e.g.,LehmanBrothersHoldingsInc.,MinutesofMeetingoftheBoardofDirectors(Sept.11,2007),
at p. 3 [LBHI_SEC07940_026364] (including OMeara statements regarding leverage ratios); Lehman

Brothers Holdings Inc., Minutes of Meeting of the Board of Directors (Oct. 15, 2007), at p. 3
[LBHI_SEC07940_026407];LehmanBrothersHoldingsInc.,MinutesofMeetingoftheBoardofDirectors
(Nov. 8, 2007), at p. 4 [LBHI_SEC07940_026650] (same); Lehman Brothers Holdings Inc., Minutes of
MeetingoftheFinanceandRiskCommittee(Jan.29,2008),atpp.2[LBEXAM067022];LehmanBrothers,
ConfidentialPresentationtoFinanceandRiskCommitteeoftheBoardofDirectors,2008FinancialPlan
(Jan.29,2008),atp.8[LBHI_SEC07940_068559](statingWeplantodeploythecapitalcreatedtoreduce
leverageandsupport$60billionofassetgrowthandthat[b]alancesheetgrowthinDecember[2007]
was largely in highly liquid asset classes for which we were able to source repo financing.); Lehman
Brothers,ConfidentialPresentationtoFinanceandRiskCommittee,AdditionalMaterials(Jan.29,2008),
at pp. 12 [LBEXAM 067269] (stating We have been able to grow repo financing to meet the balance
sheet and leverage increases, and that Lehmans net assets and leverage grew in 2007 across all asset
classes and leverage increased at a lesser rate than peer firms); Eric Felder, Lehman, 2008 Financial
Supply/Demand Dynamics, Presentation to Lehman Board of Directors (Jan. 28, 2008), at p. 10
[LBHI_SEC07940_027353](notingriseinleverageratiosamongthefivebiginvestmentbanks);Lehman
Brothers Holdings Inc., Minutes of Meeting of the Finance and Risk Committee (Mar. 25, 2008), at p. 2
[LBEXAM 003592] (informing the Board of industrywide pressure to delever and that the firm was
working on a plan for reducing total assets which would most likely focus on the Fixed Income and
Principal Investment business units); Erin M. Callan, Lehman, Estimated March 2008 Financial
Information, Confidential Presentation to Lehman Brothers Board of Directors (Apr. 15, 2008), at p. 8
[LBHI_SEC07940_027952](explainingthataspartofthedeleveringplan,Lehmans[t]argetedbalance
sheet reduction by Q2 08 included a reduction of net assets by $55 billion to $342 billion); Lehman
Brothers Holdings Inc., Finance and Risk Committee of the Board, Liquidity and Risk Management
Update(May7,2008),atp.10[LBEXAM067320](TheFirmhassetaggressivetargetstoreducebalance
sheetandcashcapitalusagebelowtheirQ42007levelsbytheendofthisquarter.Thisshouldresultin
bringingnetleverageto12x,grossleverageto25xandgeneratingacashcapitalsurplusof$810billion
large enough to avoid the need to issue in public debt markets for the rest of the year.); id. at p. 16
(stating lower leverage going forward will help reduce the Firms liquidity risk); Lehman Brothers
Holdings Inc., Minutes of Meeting of the Board of Directors (June 19, 2008), at p. 3 [LBEXAM 003764]
(discussing Lehmans plans regarding leverage, and potential changes in GAAP which would
potentially require companies to bring certain assets back onto the balance sheet); Lehman Brothers
Holdings Inc., Minutes of Meeting of the Board of Directors (July 22, 2008), at p. 7 [LBEXAM 003866]
947

i) Ernst&YoungsKnowledgeofLehmansRepo105Program
During several Rule 30(b)(6)type3654 interview sessions, the Examiner
interviewed members of Ernst & Youngs Lehman audit team regarding Ernst &
YoungsknowledgeofandinvolvementinLehmansRepo105program.
(1) Ernst&YoungsComfortwithLehmansRepo105Accounting
Policy
The Examiner interviewed Ernst & Youngs lead partner on the Lehman audit
team, William Schlich, regarding Lehmans Repo 105 program. According to Schlich,
Ernst&YounghadbeenawareofLehmansRepo105policyandtransactionsformany
years.3655 Consistent with the statements of Lehmans John Feraca (Secured Funding
Desk), Schlich stated that Lehman introduced its Repo 105 Accounting Policy on the
heels of the FASBs promulgation of SFAS 140.3656 During that time, Ernst & Young
discussed the Repo 105 Accounting Policy (including Lehmans structure for Repo
105transactions)andErnst&Youngsteamhadanumberofadditionalconversations
withLehmanaboutRepo105overtheyears.3657However,accordingtoSchlich,Ernst&
(informingtheBoardthatitwasimportanttosizetheFirmsfinancialleveragetomaintaintheFirms
AcreditratinginordertomaintainthevalueoftheFirmsfranchise).
3654Federal Rule of Civil Procedure Rule 30(b)(6) governs depositions of a corporation or organization.
Theorganizationdesignatesoneormorerepresentativestotestifyontheidentifiedareasofinquiry.The
representativespeaksfortheorganization.
3655ExaminersInterviewofErnst&Young,Repo105Session,Oct.16,2009,atp.4.
3656Id.atp.5.
3657Id.
948

Young had no role in the drafting or preparation of Lehmans Repo 105 Accounting
Policy.3658
SchlichstateddefinitivelythatErnst&Younghadnoadvisoryrolewithrespect
to Lehmans use of Repo 105 transactions and that Ernst & Young did not approve
theAccounting Policy.3659 Rather, according to Schlich, Ernst & Young bec[a]me
comfortablewiththePolicyforpurposesofauditingfinancialstatements.3660
Following consultation and dialogue about the proper interpretation and
applicationofSFAS140,Ernst&Youngclearly...concurredwithLehmansapproach
to SFAS 140 and subsequent literature by FASB on the issue of control of assets
involvedinarepotransactions.3661Ernst&Youngsview,however,wasnotbasedupon
ananalysisofwhetheractualRepo105transactionscompliedwithSFAS140.3662Rather,
Ernst & Youngs review of Lehmans Repo 105 Accounting Policy was purely
theoretical.3663 In other words, Ernst & Young solely assessed Lehmans
understanding of the requirements of SFAS 140 in the abstract and as reflected in its
AccountingPolicy;Ernst&Youngdidnotopineontheproprietyofthetransactionsas
3658Id.
3659Id.
3661Id.atpp.56.
3662Id.atp.6.
3663Id.
949

abalancesheetmanagementtool.3664Ernst&YoungdidnotreviewtheLinklatersletter,
referencedintheAccountingPolicyManual.3665
AccordingtoMartinKelly,itwasnotunusualforhimtodiscussvariousissues,
includingRepo105,withErnst&Young.3666Indeed,Kellyrecalledspecificallyspeaking
with Schlich about Repo 105 transactions soon after becoming Financial Controller on
December 1, 2007, in an effort to learn more about the program and to understand
[Ernst&Youngs]approachbeforetalkingtoCallan.3667
KellywantedtoensurethatErnst&Younganalyzedtheprograminthesame
way that [Marie] Stewart [Global Head of Accounting Policy] had analyzed it.3668
KellysconversationswithErnst&YoungfocusedontheaccountingtreatmentofRepo
105 transactions.3669 According to Kelly, Ernst & Young was comfortable with the
treatment underGAAPforthesamereasonsthat Lehmanwascomfortable.3670Kelly
alsodiscussedwithErnst&YoungLehmansinabilitytogetatruesaleopinionunder
3664Id.
3665The Examiner asked Schlich a series of questions to establish whether a goodfaith basis existed for
showinghimtheLinklatersletter.SchlichtoldtheExaminerthathedidnotknowifanyoneatErnst&
YoungLLP(i.e.,theUnitedStatesbasedErnst&Young)everreviewedtheLinklatersletter.Examiners
InterviewofErnst&Young,Repo105Session,Oct.16,2009,atp.10.SchlichfurtherstatedthatLBIEs
booksandrecordswereauditedbyErnst&YoungUnitedKingdom,notErnst&YoungLLP,thoughhe
acknowledgedthatLBIEsfinancialsrolledupintoLBHIspubliclyfiledfinancialstatements,whichErnst
&YoungLLPaudited.Id.atpp.1011.Because,baseduponSchlichsstatements,theExaminerdidnot
have a good faith basis to believe Ernst & Young LLP previously had seen the Linklaters letter (as is
requiredundertheExaminersprotectiveorderwithAlvarez&Marsal/LBHItoshowthelettertoErnst&
YoungLLP),theExaminerdidnotshowSchlichtheLinklatersletter.
3667Id.
3668Id.
3669Id.
3670Id.
950

United States law for Repo 105 transactions.3671 Kelly could not recall whether he
discussedwithErnst&YounghisdiscomfortwithLehmansRepo105program.3672
(2) TheNettingGrid
Throughout 2007, Lehman maintained a document entitled Accounting Policy
Review Balance Sheet Netting and Other Adjustments, known colloquially among
Lehmans Accounting Policy and Balance Sheet Groups, as well at Ernst & Young, as
the Netting Grid. The Netting Grid identified and described various balance sheet
netting mechanisms employed by Lehman: one such balance sheet mechanisms was
LehmansuseofRepo105transactions.3673
LehmanprovidedtheNettingGridtoErnst&YoungatleastinAugust2007(the
close of Lehmans third quarter 2007) and in November 2007 (the close of Lehmans
fiscalyear2007).3674Notably,theNettingGridprovidedbyLehmantoErnst&Youngin
August2007andNovember2007onlycontainedRepo105volumesfromNovember30,
3672Id.
3673See, e.g., Lehman, Accounting Policy Review Balance Sheet Netting and Other Adjustments (Aug.
2007)[LBEXDOCID2720761](attachedtoemailfromMarieStewart,Lehman,toMartinKelly,Lehman
(Nov.6,2007)[LBEXDOCID2736621]([T]hisisthedocthatsummarizeseveryreasonwenetdownthe
b/sheet. As discussed, E&Y are in the process of reviewing it.); Lehman, Accounting Policy Review
Balance Sheet Netting and Other Adjustments (Nov. 2007) [LBEXDOCID 2720762] (attached to email
fromMarieStewart,Lehman,toMartinKelly(Nov.6,2007)[LBEXDOCID2736622]).
3674Email from Margaret Sear, Lehman, to Jerry Gruner, Ernst & Young, et al. (Aug. 15, 2007) [LBEX
DOCID 3235498] (Here is the netting grid as you requested.); Lehman, Accounting Policy Review
Balance Sheet Netting and Other Adjustments (Aug. 2007) [LBEXDOCID 3213803] (attached to email
from Margaret Sear, Lehman, to Jerry Gruner, Ernst & Young, et al. (Aug. 15, 2007) [LBEXDOCID
3235498]); email from Margaret Sear, Lehman, to Jerry Gruner, Ernst & Young, et al. (Nov. 6, 2007)
[LBEXDOCID 3235499] (transmitting, Accounting Policy Review Balance Sheet Netting and Other
Adjustments[Draft](Nov.2007)[LBEXDOCID3213271]).
951

2006 and February 28, 2007.3675 Schlich was unaware whether Ernst & Young asked
Lehman to provide its second quarter 2007 and third quarter 2007 Repo 105 usage
figuresoraforecastofLehmansfourthquarter2007Repo105numbers.3676
Ernst & Young reviewed the Netting Grid, analyzed the various balance sheet
netting mechanisms identified in the Netting Grid, and used the document in
connectionwithits2007yearendauditofLehman.3677According to Schlich, Ernst &
Young,aspartofitsreviewofLehmansNettingGrid,approvedofLehmansinternal
Repo105AccountingPolicyonly,anddidnotpassupontheactualpractice.3678
The Netting Grid described thetransactions and United StatesGAAP reference
as follows: Under certain conditions that meet the criteria described in paragraphs 9
and 218 of SFAS 140, Lehman policy permits reverse repo and repo agreements to be
recharacterizedaspurchasesandsalesofinventory.3679WithrespecttoLehmansuse
ofRepo105transactionstoreduceitsnetbalancesheet,theNettingGridsetsforththe
3675Lehman,AccountingPolicyReviewBalanceSheetNettingandOtherAdjustments(Aug.2007),atp.
26[LBEXDOCID3213803](statingtotalRepo105usageforNovember30,2006was$24.519billionand
total Repo 105 usage for February 28, 2007 was $29.258 billion); Lehman, Accounting Policy Review
Balance Sheet Netting and Other Adjustments [Draft] (Nov. 2007), at p. 26 [LBEXDOCID 3213271]
(same).
3676ExaminersInterviewofErnst&Young,Repo105Session(Oct.16,2009),atp.9(statementofWilliam
Schlich).
3677Id. at p. 8. By this, Ernst & Young referred to its audit of other balance sheet netting mechanisms.
Ernst&YoungUnitedStatesdidnotauditRepo105transactions.
3678Id.
3679Lehman Brothers, Accounting Policy Review Balance Sheet Netting and Other Adjustments (Aug.
2007), at p. 26 [LBEXDOCID 3213803]; Lehman, Accounting Policy Review Balance Sheet Netting and
OtherAdjustments[Draft](Nov.2007),atp.26[LBEXDOCID3213271].
952

conclusionthatLehmanscurrentpractice[forRepo105]iscorrect.3680Schlichnoted
thatthisconclusionabouttheRepo105practicewasLehmans,notErnst&Youngs.3681
TotestLehmansconclusion,however,Ernst&YoungreviewedhowLehmanapplied
thecontrolprovisionsoftheaccountingrules.3682
Ernst&Youngsreview,however,appliedonlytotheaccountingbasisforthese
transactions,nottotheirvolumeorpurpose.Specifically,Ernst&Youngsreviewand
analysis of Lehmans Repo 105 program did not account for the volumes of Repo 105
transactions Lehman undertook at quarterend.3683 Indeed, Schlich was unable to
confirmordenythevolumesofRepo105transactionsLehmanundertookatLehmans
fiscalyearend2007,orinthefirsttwoquarterendsof2008.3684NorwasSchlichableto
confirmordenythatLehmansuseofRepo105transactionswasincreasinginlate2007
andintomid2008.3685
(a) QuarterlyReviewandAudit
ThroughSchlich,Ernst&YoungmaintainedthatitsdutiesasLehmansauditor
required it to ensure that transactions were accounted for correctly (i.e., that they
complied with accounting rules) and that Lehmans financial disclosures were not
3680Id.AlthoughLehmansinternalRepo105AccountingPolicycouldhavetheoreticallybeenappliedto
reverserepos,thepolicyexplicitlystatedthatLehmandidnot,infact,usetheRepo105mechanismfor
reverse repos. See Lehman Brothers Holdings Inc., Accounting Policy Manual Repo 105 and Repo 108
3682Id.
3683Id.
3684Id.
3685Id.
953

materially misstated.3686 According to Schlich, Ernst & Youngs audit did not require
Ernst&YoungtoconsiderorreviewthevolumeortimingofRepo105transactions.3687
Accordingly, as part of its yearend 2007 audit, Ernst & Young did not ask Lehman
about any directional trends, such as whetherits Repo 105 activity was increasing
during fiscal year 2007.3688 Notably, as part of its quarterly review process, Ernst &
YoungdidnotauditanyofLehmansRepo105transactions.3689
(3) Ernst&YoungWouldNotOpineontheMaterialityof
LehmansRepo105Usage
Ernst&Young,throughSchlich,wasunwillingtocommenttotheExamineron
thematerialityofthevolumeofLehmansquarterendRepo105transactions.3690Asked
whether,aspartofitsresponsibilitytoensureLehmansfinancialstatementswerenot
materially misstated, Ernst & Young should have considered the possibility that strict
technicaladherencetoSFAS140oranyotherspecificaccountingrulecouldnonetheless
lead to a material misstatement in Lehmans publiclyreported financial statements,
Schlichrefrainedfromcomment.3691
When pressed further, Schlich stated that the volume of any particular
transaction impacts neither the question of whether accounting rules are applied
3686ExaminersInterviewofErnst&Young,Repo105Session,Oct.16,2009,atpp.67.
3687Id.atp.6.
3688Id.atp.9.
3689Id.atp.3.
3690Id.atp.6.
954

correctly,northequestionofwhetherafinancialstatementismateriallymisleading.3692
However, Schlich eventually acknowledged that when you look at a balance sheet
issue,volumeisafactor.3693
Notably,thedefinitionofmaterialitycontainedinawalkthroughdocument
relatedtoErnst&Youngs2007fiscalyearendauditofLehmanwas:anytransaction
thatwouldmoveLehmansfirmwidenetleverageby0.1ormore.3694Thisdefinition
reflected Lehmans determination of a materiality threshold in connection with
Lehmans own criteria for when to consider reopening and adjusting its balance
sheet.3695
WhenSchlichwasaskedwhatlevelofimpacttoLehmansfirmwidenetassets
Ernst&Youngwouldhaveconsideredmaterial,SchlichrepliedthatErnst&Young
didnothaveahardandfastruledefiningmaterialityinthebalancesheetcontext,and
that, with respect to balance sheet issues, materiality depends upon the facts and
circumstances.3696SchlichagreedthatLehmanmadenospecificdisclosuresaboutRepo
3692Id.
3693Id.atp.7.
p.14[EYLELBHICORPGAMX07033384](Materialityisusuallydefinedasanyitemindividually,or
intheaggregate,thatmovesnetleverageby0.1ormore(typically$1.8billion).).Accordingly,anitem
that impacted net leverage by 0.1 point was deemed material enough to reopen the books. The
walkthroughpaperalsostated,Netleverageisanimportantratioanalyzedbytheratingagenciesand
includedinLehmansearningsreleases.Id.
3696Id.
955

105 transactions in its Forms 10K and Form 10Q, including the MD&A section.3697
Schlich believed, however, that Lehmans public filings would have included general
languageregardingsecuredborrowingsandcompliancewithSFAS140.3698Schlichwas
notawarewhetherErnst&YoungeverdiscussedLehmansdisclosuresvelnonofRepo
105activitywithseniorLehmanmanagement.3699
(4) MatthewLeesStatementsRegardingRepo105toErnst&
Young
On May 16, 2008, Matthew Lee, thenSenior Vice President in the Finance
Division responsible for Lehmans Global Balance Sheet and Legal Entity Accounting,
sent a letter to certain members of Lehmans senior management identifying possible
violations of Lehmans Ethics Code related to accounting/balance sheet issues.3700
3697Id.
3698Id.AsnotedinSectionIII.A.4.j.2.c.ii.a,however,languageregardingSFAS140inLehmansForms10
Kand10QrelatesolelytoLehmanssecuritizationactivities.
3700Letterfrom Matthew Lee, Lehman, to Martin Kelly, Lehman, et al. (May 16, 2008) [EYLELBHI
KEYPERS5826885].Leeslettercontainedthefollowingsixallegations:(1)onthelastdayofeachmonth,
Lehmans books and records contained approximately $5 billion of net assets in excess of what was
managedonthelastdayofthemonth,therebysuggestingthatthefirmsseniormanagementwasnotin
control of its assets to be able to present full, fair, and accurate financial statements to the public; (2)
Lehmanhadtensofbillionsofdollarsofunsubstantiatedbalances,whichmayormaynotbebador
nonperformingassetsorrealliabilities;(3)Lehmanhadtensofbillionsofdollarsofilliquidinventory
anddidnotvalueitsinventoryinafullyrealisticorreasonableway;(4)givenLehmansrapidgrowth
andincreasednumberofaccountsandentities,ithadnotinvestedsufficientlyinfinancialsystemsand
personnel to cope with the balance sheet; (5) the India Finance office lacked sufficient knowledgeable
management, resulting in the real possibility of potential misstatements of material facts being
distributed by that office; and (6) certain senior level audit personnel were not qualified to properly
exercisetheauditfunctionstheyareentrustedtomanage.Id.
956

LehmaninvolvedErnst&YounginitsinvestigationoftheconcernsraisedinLeesMay
16,2008letter.3701
Subsequently,lessthanamonthlater,onJune12,2008,Ernst&YoungSchlich
and Hillary Hansen interviewed Lee.3702 Hansens notes of the interview reveal that
Lee made certain statements to Ernst & Young about Lehmans Repo 105 practice,
including, most notably, the volume of Repo 105 activity that Lehman engaged in at
quarterend(May31,2008).3703HansensnotesspecificallyrecountLeesallegationthat
Lehman moved $50 billion of inventory off its balance sheet at quarterend through
Repo105transactionsandthattheseassetsreturnedtothebalancesheetapproximately
aweeklater.3704
3701ExaminersInterviewofThomasCruikshank,Oct.8,2009,atp.7(statingthatalthoughBethRudofker
led the investigation, as Chair of the Audit Committee, he made sure Ernst & Young was involved as
well); Examiners Interview of Michael L. Ainslie, Dec. 22, 2009, at p. 3; Examiners Interview of Roger
Berlind, Dec. 18, 2009, at pp. 23; Examiners Interview of Sir Christopher Gent, Jan. 20, 2010, at p. 2;
Examiners Interview of Beth Rudofker, Dec. 15, 2009, at p. 7; see also Employee Letter Review,
PresentationtotheAuditCommittee(July22,2008),atp.2[LBEXAM067664](notingthatCorporate
Audithaslargelycompletedanevaluationof[Lees]observationsinpartnershipwithFinancialControl
andErnstandYoung).
3702ExaminersInterviewofErnst&Young,Nov.3,2009,atp.14(statementofWilliamSchlich)(noting
thatLehmanscounselJoePolizzottowaspresentinitiallybutleftsoSchlichandHansencouldinterview
Lee privately); see also email from William Schlich, Ernst & Young, to Hillary Hansen, Ernst & Young
(June10,2008)[EYLELBHIKEYPERS0853892(schedulingmeetingwithLeeforJune12,2008).
3703Hansens notes indicate that Lehmans Rates [and] Liquid Markets businesses engaged in Repo
105/Repo 108 [to] reduce[] assets by50B [by] moving offB/S[i.e., balance sheet] in Europe& backin5
days later. Hillary Hansen, Ernst & Young, Handwritten Notes (June 12, 2008), at p. 1 [EYLELBHI
KEYPERS 5826869]. This is consistent with the Examiners conclusions that at quarterend in second
quarter 2008, Lehman reduced its balance sheet by slightly more than $50 billion through Repo 105
transactions.
3704Id.
957

When interviewed by the Examiner, Schlich did not recall Lee saying anything
about Repo 105 transactions during that interview, although he did not dispute the
authenticity of Hansens notes from the Lee interview.3705 In spite of Hansens notes,
Schlich maintained that Ernst & Young did not know that Lehman engaged in the
followingRepo105activityduringthelistedtimeperiods:$49.1billionatfirstquarter
2008(Feb.29,2008);and$50.38billionatsecondquarter2008(May31,2008).3706
DuringtheExaminersinterviewofHansen,HansenrecalledthatwhileErnst&
YoungquestionedLeeabouthisMay16,2008letter,Leerattledoffalistofadditional
issues and concerns he held, one of which was Lehmans use of Repo 105
transactions.3707Ernst&YounghadnofurtherconversationswithLeeaboutRepo105
transactions.3708PriortoherinterviewofLeeinJune2008,Hansenhadheardtheterm
Repo 105 thrown around but she did not know its meaning; according to Hansen,
SchlichdescribedRepo105transactionstohershortlyaftertheymetwithLee.3709
Following Ernst & Youngs June 12, 2008 interview of Lee,Schlich and Hansen
met with Lehmans Gerard Reilly to discussLees assertions regarding improper
3705ExaminersInterviewofErnst&Young,Oct.9,2009,atp.5;ExaminersInterviewofErnst&Young,
Repo105Session,Oct.16,2009,atp.5;ExaminersInterviewofErnst&Young,Nov.3,2009,atp.16.
3706Examiners Interview of Ernst & Young, Repo 105 Session, Oct. 16, 2009, at p. 12 (Schlich (1)
disavowedanyknowledgeonthepartofErnst&YoungofLehmansactualRepo105usageforthefirst
andsecondquarterof2008and(2)saidhewasnotpersonallyawareofLehmansRepo105usageatthe
closeoffiscalyear2007).
3708Id.
3709Id. Schlich maintains that he does not recall discussing Repo 105 either during or after Lees
interview.Id.
958

valuations.3710Duringthatmeeting,HanseninformedReillyofthe$50billionRepo105
figureLeeprovidedduringErnst&YoungsinterviewofLee.3711AccordingtoSchlich,
Reilly (now deceased) told the auditors that he had no knowledge that Lehman used
Repo 105 transactions to move $50 billion in assets off its balance sheet.3712 Hillary
[Hansen]tookawayfromthemeetingwithReillythathedidnotknowanditwasnot
$50billion.3713
OnJune13,2008thedayafterLeeinformedErnst&Youngofthe$50billionin
Repo105transactionsthatLehmanundertookattheendofthesecondquarter2008
Ernst&YoungspoketoLehmansAuditCommitteebutdidnotinformthecommittee
of Lees allegation, even though the Chairman of the Audit Committee had clearly
statedthathewantedeveryallegationmadebyLeewhetherinLeesMay16letteror
duringthecourseoftheinvestigationtobeinvestigated.3714Ernst&Youngmetwith
theAuditCommitteeonJuly8,2008,toreviewthesecondquarterfinancialstatements
3710ExaminersInterviewofErnst&Young,Oct.9,2009,atp.6(statementofWilliamSchlich);Examiners
InterviewofErnst&Young,Nov.3,2009,atp.16(statementofWilliamSchlich).
Schlich).
3712Id.
3713Id.atp.12(statementofWilliamSchlich).SchlichhadnopersonalrecollectionofdiscussingRepo105
withReillyduringthemeeting.Id.atp.11.HesaidheonlyknewthatHansenrecalleddiscussingthe
issuewithReillyandReillysresponse.Id.TherearenonotesfromSchlichandHansensmeetingwith
Reilly.ExaminersInterviewofErnst&Young,Nov.3,2009,atp.17(statementofHillaryHansen).
3714Examiners Interview of Thomas Cruikshank, Oct. 8, 2009, at p. 7 (stating that Internal Audit and
Ernst & Young were explicitly instructed to report and investigate any allegation made by Lee during
courseofinvestigation);ExaminersInterviewofRogerBerlind,Dec.18,2009,atp.2(same);Examiners
Interview of Michael L. Ainslie, Dec. 22, 2009, at p. 3 (same); Examiners Interview of Sir Christopher
Gent, Jan. 20, 2010, at p.2 (same); Examiners Interview of Thomas Cruikshank, Jan. 20, 2010, at p. 3;
ExaminersInterviewofBethRudofker,Dec.15,2009,atpp.67;seealsoLehmanBrothersHoldingsInc.,
MinutesoftheMeetingofAuditCommittee(June13,2008)[LBEXAM003759].
959

and again did not mention Lees allegations regarding Repo 105.3715 On July 22, 2008,
Ernst&YoungwasalsopresentwhenBethRudofker,HeadofCorporateAudit,gavea
presentation to the Audit Committee on the results of the investigation into Lees
allegations.3716
Ernst & Young did not disclose to the Audit Committee either during the
meetingsorinprivateexecutivesessionsafterthatLeemadeanallegationrelatedto
Repo105transactionsbeingusedtomoveassetsoffLehmansbalancesheetatquarter
end.3717 Cruikshank told the Examiner that he would have expected to be told about
Lees Repo 105 allegations.3718 Similarly, Sir Gent told the Examiner that the alleged
3715Lehman Brothers Holdings Inc., Minutes of Meeting of Audit Committee (July 8, 2008), at pp. 12
[LBEXAM003831].
3716Lehman Brothers Holdings Inc., Minutes of Meeting of Audit Committee (July 22, 2008), at p. 4
[LBEXAM003861];seealsoEmployeeLetterReview,PresentationtotheAuditCommittee(July22,2008),
atp.2[LBEXAM067664](concludingthat[n]omaterialissueshavebeenidentifiedduringthereview
[of Lees allegations] and this report to the Audit Committee summarizes the findings and
recommendations).ThepresentationcontainsnoreferencetoLeesallegationregardingRepo105.Id.
Ernst & Young did not inform Rudofker about Lees allegation regarding Repo 105. Examiners
InterviewofBethRudofker,Dec.15,2009,atp.7.
3717Examiners Interview of Thomas Cruikshank, Jan. 20, 2010, at p. 3; Examiners Interview of Roger
Berlind, Dec. 18, 2009, at p. 4; Examiners Interview of Michael L. Ainslie, Dec. 22, 2009, at p. 3;
Examiners Interview of Sir Christopher Gent, Jan. 20, 2010, at pp. 2, 3; Examiners Interview of Beth
Rudofker, Dec. 15, 2009, at p. 7.; see also Lehman Brothers Holdings Inc., Minutes of Meeting of Audit
Committee (June 13, 2008) [LBEXAM 003759]; Lehman Brothers Holdings Inc., Minutes of Meeting of
AuditCommittee(July8,2008)[LBEXAM003831];LehmanBrothersHoldingsInc.,MinutesofMeeting
ofAuditCommittee(July22,2008)[LBEXAM003861].
3718Examiners Interview of Thomas Cruikshank, Jan. 20, 2010, at p. 3. Cruikshank, who had no
knowledgeofLehmansinternalRepo105AccountingPolicy,saidthatitwastheresponsibilityofErnst
& Young and Lehman management to analyze the accounting treatment for Repo 105 transactions and
ensurethestandardswereproperlyappliedtothesetransactions.Id.atpp.23.
960

volume of Lehmans Repo 105 transactions mandated disclosure to the Audit
Committeeaswellasfurtherinvestigation.3719
Ernst&YoungdidnotfollowuponeitherLeesallegationsregardingLehmans
Repo105activityorReillysclaimthathehadnoknowledgeofLehmansalleged$50
billion Repo 105 usage figure.3720 Ernst & Young signed a Report of Independent
Registered Public Accounting Firm for Lehmans second quarter 2008 Form 10Q on
July10,2008,lessthanfourweeksafterSchlichandHanseninterviewedLee.3721
3719ExaminersInterviewofSirChristopherGent,Jan.20,2010,atp.3.
3720ExaminersInterviewofErnst&Young,Nov.3,2009,atp.16(statementofWilliamSchlich)
3721LBHI10Q(filedJuly10,2008),atp.53(statingthat[b]aseduponourreview,wearenotawareof
anymaterialmodificationsthatshouldbemadetotheconsolidatedfinancialstatementsreferredtoabove
forthemtobeinconformitywithU.S.generallyacceptedaccountingprinciples);ExaminersInterview
of Ernst & Young, Nov. 3, 2009, at p. 17 (statement of William Schlich) (stating that Ernst & Young
signedoffonLehmanssecondquarter200810Q).OnJune5,2008,onlyafewdaysafterthecloseof
Lehmanssecondquarter2008andafewdaysbeforeLehmans$6billionequityraise,Schlichwroteto
Ernst & Youngs Carmine DiSibio and Stephen Howe about Lehmans second quarter financial results
andageneralreportonLehmansperformance.EmailfromWilliamSchlich,Ernst&Young,toCarmine
DiSibio,Ernst&Young,etal.(June5,2008)[EYLELBHIKEYPERS0853883].SchlichsnotetoDiSibio
and Howe also referenced Matthew Lees letter to senior Lehman management, as well as certain off
balancesheetitems:
[W]earealsodealingwithawhistleblowerletter,thatisonitsfacepretty
uglyandwilltakeusasignificantamountoftimetogetthrough.Iam
confident from what I have seen it shouldnt result in any significant
issuesaroundfinancialreporting,butagainthereisalotofworktodo
yet. This combined with some very difficult accounting issues around
offbalancesheetitemsisaddingstresstoeveryone.
Id.Schlichdeniedthattheoffbalancesheetitems...addingstresstoeveryonereferencedinhisnote
wereRepo105transactions.ExaminersInterviewofErnst&Young,Oct.9,2009,atp.10(statementof
William Schlich). Rather, Schlich maintained, the stress referenced in his message was due to the
public criticism Lehman was then facing over its sale of certain assets to the R3 hedge fund, an
approximately $4.5 billion deal. Id. The total dollar amount of offbalance sheet items resulting from
LehmansRepo105transactionsattheendofsecondquarter2008,whenSchlichwrotehisnote,wasover
$50billion,ormorethaneleventimesthesizeoftheR3deal.
961

(5) AccountingMotivatedTransactions
Ernst& Youngdidnotevaluatethepossibility that Repo 105 transactions were
accountingmotivated transactions that lacked a business purpose.3722 Schlich
characterized the offbalance sheet treatment of Lehmans assets in Repo 105
transactions as a consequence of the accounting rules, rather than a motive for the
transactions.3723
j) TheExaminersConclusions
There is sufficient evidence to support a determination by a trier of fact that
Lehmans failure to disclose that it relied upon Repo 105 transactions to temporarily
reducethefirmsnetbalancesheetandnetleverageratiowasmateriallymisleading.In
addition, a trier of fact could find that Lehman affirmatively misrepresented its
accounting treatment for repos by stating that Lehman treated repo transactions as
financingtransactionsratherthansalesforfinancialreportingpurposes,despitethefact
thatLehmantreatedtensofbillionsofdollarsinrepotransactionsnamely,Repo105
transactionsastruesaletransactions.
Schlich). An SEC staff paper discourages accountingmotivated structured transactions because a

company engaging in such transactions runs the risk of presenting an inaccurate picture of its true
financial condition. See OFFICE OF THE CHIEF ACCOUNTANT, SEC, REPORT AND RECOMMENDATIONS
PURSUANTTOSECTION401(C)OFTHESARBANESOXLEYACTOF2002ONARRANGEMENTSWITHOFFBALANCE
SHEET IMPLICATIONS, SPECIAL PURPOSE ENTITIESAND TRANSPARENCYOF FILINGSBY ISSUERS, atp. 100(2005)
[SEC SOX Off Balance Sheet Report]. According to this report, accountingmotivated structured
transactionsaretransactionsthatarestructuredinanattempttoachievereportingresultsthatarenot
consistent with the economics of the transaction, and thereby impair the transparency of financial
reports.Id.[A]ttempt[s]toportraythetransactionsdifferentlyfromtheirsubstancedonotoperatein
theinterestsofinvestors,andmaybeinviolationofthesecuritieslaws.Id.
3723Id.
962

TheExaminerthusconcludesthatsufficientevidenceexistsfromwhichatrierof
factcouldfindtheexistenceofacolorableclaimthatcertainLehmanofficersbreached
their fiduciary duties to Lehman and its shareholders by causing the company to file
deficientandmateriallymisleadingfinancialstatements,therebyexposingthecompany
topotentialliability.CertainofficersofLehmannotonlyfailedtoinformthepublicof
its reliance on Repo 105 transactions to reduce its balance sheet, they also failed to
adviseLehmansBoardofDirectorsofthefirmsRepo105practice.Thus,theExaminer
concludes that a trier of fact could find that certain Lehman officers breached their
fiduciary duties to Lehmans Board of Directors by failing to inform them of: (1) the
firmsrelianceuponRepo105toreducethebalancesheetatquarterend,(2)theramp
upinRepo105usageinmidtolate2007and2008,(3)theimpactofthesetransactions
on Lehmans publicly reported net leverage ratio, or (4) the fact that Lehman did not
discloseitsRepo105practiceinitspubliclyreportedfinancialsstatementsandMD&A.
(1) Materiality
Thematerialityofinformationisevaluatedfromtheperspectiveofareasonable
investor.3724Informationisdeemedmaterialifthereisasubstantiallikelihoodthatthe
disclosure of the omitted fact would have been viewed by the reasonable investor as
3724SeeSEC v. Stanard, No. 06 Civ.7736(GEL),2009WL 196023, at *26 (S.D.N.Y. Jan.27,2009)(citations
omitted).
963

having significantly altered the total mix of information made available.3725
Materiality does not require, however, that the information be of a type that would
causeaninvestortochangehisinvestmentdecision.3726
(a) WhetherLehmansRepo105TransactionsTechnically
ColorableClaimExists
This Report does not reach the question of whether Lehmans Repo 105
transactionstechnicallycompliedwiththerelevantfinancialaccountingstandard,SFAS
140, because the answer to that question does not impact whether a colorable claim
exists regarding Lehmans failure to disclose its Repo 105 practice and whether that
failurerenderedthefirmsfinancialstatementsmateriallymisleading.
Even if Lehmans use of Repo 105 transactions technically complied with SFAS
140,financialstatementsmaybemateriallymisleadingevenwhentheydonotviolate
GAAP.3727TheSecondCircuithasexplainedthatGAAPitselfrecognizesthattechnical
compliance with particular GAAP rules may lead to misleading financial statements,
3725Basic,Inc.v.Levinson,485U.S.224,23132(1988)(quotingTSCIndus.,Inc.v.Northway,Inc.,426U.S.
438,449(1976)).
3726Ganinov.CitizensUtils.Co.,228F.3d154,162(2d.Cir.2000).Lehmansauditwalkthroughpapers
definedasmaterialanyitemthataloneorintheaggregatehadaonetenth(0.1)ofapointimpactonfirm
widenetleverageratio(or$1.8billion).SeeErnst&Young,LBHI/LBIWalkthroughTemplateforBalance
SheetCloseProcess(Nov.30,2007),atp.14[EYLELBHICORPGAMX07033384](definingmateriality
inthecontextofreopeningaclosedbalancesheet).
3727SeegenerallyUnitedStatesv.Ebbers,458F.3d110(2dCir.2006),cert.denied,127S.Ct.1483(2007).
964

andimposesanoverallrequirementthatthestatementsasawholeaccuratelyreflectthe
financialstatusofthecompany.3728
Similarly, as noted in In re Global Crossing Ltd. Securities Litigation, even if a
defendantestablishedthatitsaccountingpracticeswereintechnicalcompliancewith
certain individual GAAP provisions . . . this would not necessarily insulate it from
liability. This is because, unlike other regulatory systems, GAAPs ultimate goals of
fairnessandaccuracyinreportingrequiremorethanmeretechnicalcompliance.3729Thecourt
explained that when viewed as a whole, GAAP has no loopholes because its
purpose,sharedbythesecuritieslaws,istoincreaseinvestorconfidencebyensuring
transparency and accuracy in financial reporting.3730 Technical compliance with
specific accounting rules does not automatically lead to fairly presented financial
statements. Fair presentation is the touchstone for determining the adequacy of
disclosure in financial statements. While adherence to generally accepted accounting
principles is a tool to help achieve that end, it is not necessarily a guarantee of
fairness.3731Moreover,registrantsarerequiredtoprovidewhateveradditionalinformation
3728Id.at126.
3729InreGlobalCrossing,Ltd.Sec.Litig.,322F.Supp.2d319,339(S.D.N.Y.2004)(emphasisadded).
3730Id.
3731Id.at340(internalcitationsomitted).
965

wouldbenecessarytomakethestatementsintheirfinancialreportsfairandaccurate,andnot
misleading.3732
This view is echoed in an SEC enforcement order, concluding that GAAP
compliance does not excuse a misleading or less than full disclosure regarding a
transaction, especially if the transactions purpose is the attainment of a particular
financialreportingresult.3733[E]venifthetransactionscomplywithGAAP,theissuer
isrequired to evaluate the material accuracy and completeness of the presentation
madebyitsfinancialstatements.3734 Issuersmustensurethatthewaytheypublicly
portraythemselvesdiscloses,asrequired,thematerialelementsof[their]economicand
businessrealitiesandrisks.3735
3732Id. (citing 17 C.F.R. 240.10b5(b) and 17 C.F.R. 230.408 (requiring that in addition to the
information expressly required to be included in a registration statement, there shall be added such
furthermaterialinformation,ifany,asmaybenecessarytomaketherequiredstatements,inthelightof
thecircumstancesunderwhichtheyaremade,notmisleading)(emphasisadded);seealsoSECv.Seghers,
298 Fed. Appx 319, 331 (5th Cir. 2008) (The Commissions proof of Seghers misrepresentations and
omissions does not depend on compliance with GAAP, but instead depends on evidence that Seghers
statementsandomissionswerefalseormisleadingtoinvestors.);UnitedStatesv.Olis,CivilActionNo.
H073295,CriminalNo.H0321701,2008WL5046342,at*20(S.D.Tex.Nov.21,2008)(Theschemeto
defraudallegedandprovedinthiscasedidnotturnonwhetherthetreatmentaccordedtoProjectAlpha
in Dynegys financial statements technically complied with GAAP or whether Olis and his co
conspiratorsintendedtoviolateGAAPbut,instead,onwhetherthedefendantsdisclosuresaboutProject
Alpha intentionally omitted material facts that caused Dynegys financial statements to be materially
falseandmisleading.)(citingUnitedStatesv.Rigas,490F.3d208,221(2dCir.2007),andUnitedStatesv.
Ebbers,458F.3d110,12526(2dCir.2006)).
3733In re PNC Fin. Servs. Group, Inc., 2002 WL 1585523, at*14(Securities Act Release No. 338112,
ExchangeActReleaseNo.3446225)(July18,2002).
3734Id.
3735Id.
966

(2) DisclosureRequirementsandAnalysis
Section 13(a) of the Securities Exchange Act of 1934 required Lehman to file
periodicreportswiththeSEC,includingitsannualreportsonForm10Kandquarterly
reportsonForm10Q.3736LehmanalsofiledregistrationstatementsundertheSecurities
ActwithrespecttoitspublicofferingsofsecuritiesintheUnitedStates.Eachofthese
filings required certain disclosures, in each instance subject to the requirement that
Lehman provide such further material information, if any, as may be necessary to
maketherequiredstatements,inlightofthecircumstancesunderwhichtheyaremade,
notmisleading.3737
A review of Lehmans public filings confirms that Lehman did not disclose its
useofRepo105transactions,eitherbynameorcharacterization,initsForms10Kor10
Q.Moreover,Lehmanaffirmativelyrepresentedthatittreateditsrepotransactionsas
financing transactions that is, not as sales for purposes of financial reporting.
Further, the net leverage ratio Lehman reported was misleading because Lehman did
not disclose how it achieved this result.3738 Lehmans MD&A statements about its
3736Section 13(a) is codified at 15 U.S.C. 78m(a). It requires the filing of such annual and quarterly
reports as the SEC prescribes. 17 C.F.R. 249.310 prescribes the Form 10K and 17 C.F.R. 249.308a
prescribestheForm10Q.
3737Securities Exchange Act Rule 12b20, 17 C.F.R. 240.12b20; Securities Act Rule 408, 17 C.F.R.
230.408.
3738AccordingtotwoofLehmansformerGlobalFinancialControllersandLehmansformerGlobalHead
of Accounting Policy, each of whom was responsible in some fashion for preparing and/or reviewing
Lehmanspublicfilings,LehmandidnotinanywaydiscloseorreportitsRepo105activityinitsForms
10K or 10Q. Examiners Interview of Marie Stewart, Sept. 2, 2009, at p. 15; Examiners Interview of
Martin Kelly, Oct. 1, 2009, at p. 9; Examiners Interview of Edward Grieb, Oct. 2, 2009, at p. 14. In
967

liquidityandliabilities(i.e.,obligationtorepurchasethesecurities)werealsodeficient
and misleading; in contrast to a borrowing under an ordinary repurchase agreement,
the amount borrowed under a Repo 105 was not reflected in Lehmans MD&A
statements.3739
(a) DisclosureObligations:RegulationSKandtheMD&A
Item303ofRegulationSK,ManagementsDiscussionandAnalysisofFinancial
Condition and Results of Operations (the MD&A), requires management to discuss
theissuersfinancialcondition,changesinfinancialcondition,andresultsofoperations.
MD&Aineachperiodicreport(Form10K/10Q)mustcontainthefollowing:3740
MD&A requires not only a discussion, but also an analysis of known

material trends, events, demands, commitments, and uncertainties. The
particular, Martin Kelly, who served as Lehmans Global Financial Controller from December 1, 2007
until September 20008, stated that if an individual read Lehmans Forms 10K and 10Q from cover to
cover, they would have no transparency into the Repo 105/108 program. Examiners Interview of
MartinKelly,Oct.1,2009,atp.9.KellyhimselfmetregularlywiththeSECandtheNewYorkFederal
ReserveBankasamatterofcourseinhisroleasGlobalFinancialController,bothbeforethenearcollapse
of Bears Stearns in March 2008 and after federal regulators arrived onsite at Lehman following Bears
Stearns collapse. Id. Kelly stated that he personally never disclosed to the regulators the fact that
Lehman engaged in Repo 105 transactions. Id. Grieb, who served as Lehmans Global Financial
Controller for several years until November 30,2007 and then served as Lehmans Director of Investor
Relations, similarly said that Lehman did not disclose its Repo 105 practice in its Forms 10K or 10Q.
Examiners Interview of Edward Grieb, Oct. 2, 2009, at p. 14. Nor did Grieb recall ever discussing
Lehmans Repo 105 program, or the fact of its Repo 105 transactions, with any analyst who covered
Lehman.Id.
3739Inanordinaryrepurchaseagreement,asdemonstratedbytheaccountingentriesinSectionIII.A.4.d.2
of this Report, aliabilitywould havebeen createdreflectinganobligation torepay the borrowing, and

securitiesusedascollateralwouldhaveremainedonthebalancesheetinsecuritiesinventory.
374017C.F.R.229.303(2009).
968

MD&A should not be merely a restatement of financial statement

informationinanarrativeform.3741
When a description of known material trends, events, demands,

commitments, and uncertainties is set forth, companies should consider
including, and may be required to include, an analysis explaining the
underlying reasons or implications, interrelationships between constituent
elements,ortherelativesignificanceofthosematters.3742
As set forth in SEC guidance regarding MD&A, the principal objectives of
MD&Aaretoprovide:(1)anarrativeexplanationofacompanysfinancialstatements
thatenablesinvestorstoseethecompanythroughtheeyesofmanagement;(2)context
within whichfinancial informationshould beanalyzed;and(3)information aboutthe
quality of, and potential variability of, a companys earnings and cash flow so that
investors can ascertain the likelihood that past performance is indicative of future
performance.3743
Regulation SK together with SEC guidance supports the Examiners
conclusion that the trier of fact could find that Lehman had an obligation to disclose
certainaspectsofitsRepo105programintheMD&A:
Liquidity:
Identify any known trends or any known demands, commitments, events

oruncertaintiesthatwillresultinorthatarereasonablylikelytoresultinthe
registrants liquidity increasing or decreasing in any material way Also
3741Guidance Regarding Managements Discussion and Analysis of Financial Condition and Results of
Operation,SecuritiesActReleaseNo.8350,ExchangeActReleaseNo.48,960,81SECDocket2905(Dec.
19,2003).
3742Id.
3743Id.
969

identify and separately describe internal and external sources of

liquidity.3744
Identifying the intermediate effects of trends, events, demands,

commitments and uncertainties alone, without describing the reasons
underlying these effects, may not provide sufficient insight for a reader to
seethebusinessthroughtheeyesofmanagement.3745
CapitalResources:
Describe any known material trends, favorable or unfavorable, in the

registrantscapitalresources.Indicateanyexpectedmaterialchangesinthe
mix and relative cost of such resources. The discussion shall consider
changes between equity, debt and any offbalance sheet financing
arrangements.3746
ResultsofOperationsoftheMD&A:
Describe any known trends or uncertainties that have had or that the
registrant reasonably expects will have a material favorable or unfavorable
impactonnetsalesorrevenuesorincomefromcontinuingoperations.3747
Offbalancesheetarrangements:
In a separatelycaptioned section, discuss the registrants offbalance sheet

arrangements that have or are reasonably likely to have a current or future
effect on the registrants financial condition, changes in financial condition,
revenuesorexpenses,resultsofoperations,liquidity,capitalexpendituresor
capitalresourcesthatismaterialtoinvestors.3748
Thedisclosureofoffbalancesheetarrangementsshallincludethefollowing
itemstotheextentnecessarytoanunderstandingofsucharrangementsand
3744Item303(a)(1)ofRegulationSK.
19,2003).
3746Item303(a)(2)(ii)ofRegulationSK(emphasisadded).
3747Item303(a)(3)ofRegulationSK.
3748Item303(a)(4)(i)ofRegulationSK.
970

effect and shall also include such other information that the registrant
believesisnecessaryforsuchanunderstanding3749:
The nature and business purpose to the registrant of such offbalance

sheetarrangements;3750
Theimportancetotheregistrantofsuchoffbalancesheetarrangements
in respect of its liquidity, capital resources, market risk support, credit
risksupportorotherbenefits;3751
The amounts of revenues, expenses and cash flows of the registrant

arisingfromsucharrangements;[];andthenatureandamountsofany
other obligations or liabilities (including contingent obligations or
liabilities) of the registrant arising from such arrangements that are or
are reasonably likely to become material and the triggering events or
circumstancesthatcouldcausethemtoarise;3752
Anyknownevent,demand,commitment,trendoruncertaintythatwill
result in or is reasonably likely to result in the termination or material
reduction in availability to the registrant, of its offbalance sheet
arrangements that provide material benefits to it, and the course of
actionthattheregistranthastakenorproposestotakeinresponsetoany
suchcircumstances.3753
SECguidanceexplainswhendisclosureisrequired:
Where the reported financial information is NOT indicative of the future

i.e.,whereadditionalexplanationisrequiredtoenhancetheindicativevalue
ofreportedresults.3754
To describe unusual events and transactions, demands, commitments, and

uncertaintiesinordertoreveal,identify,orfurtherdefineapparenttrends.3755
3749Id.
3750Item303(a)(4)(i)(A)ofRegulationSK.
3751Item303(a)(4)(i)(B)ofRegulationSK.
3752Item303(a)(4)(i)(C)ofRegulationSK.
3753Item303(a)(4)(i)(D)ofRegulationSK.
19,2003).
3755Id.
971

If management determines that a trend, demand, commitment, event or

uncertainty is reasonably likely to occur, disclosure is required unless
management determines that a material effect on the companys financial
conditionorresultsofoperationisnotreasonablylikelytooccur.3756
Disclosure of the agreement to repurchase component of Repo 105 transactions
wasrequiredintheMD&A.Lehmansrepurchaseofthesecuritieswasaknownevent
that was reasonably likely to occur and would have had a material effect on the
companys financial condition or results of operations. Lehmans disclosure in the
LiquidityandCapitalResourcessectionshouldhaveincludedadiscussionofwhatwas
known with respect to the timing and/or amounts of the cash flow created by the
repaymentoftheRepo105cashborrowinginthefirstseventotendaysafterquarter
end,specifically:(1)theavailabilityofcashasaresultoftherepaymentoftheRepo105
cash borrowing; (2) the ability to borrow more capital because of a reduction in debt
rating or deterioration in leverage ratio due to the repayment of the Repo 105 cash
borrowing;(3)theeffectoftherepaymentoftheRepo105cashborrowingonthecostof
capital/creditrating;and(4)theeconomicsubstanceandbusinesspurposeoftheRepo
105arrangements.
(b) DutytoDisclose
SEC Rule 12b20 requires that all filings contain such additional information
necessary to make the information contained in the filing not misleading. Moreover,
3756Managements
Discussion and Analysis of Financial Condition and Results of Operation; Certain
Investment Company Disclosures, Securities Act Release 336835, Exchange Act Release No. 26,831,
InvestmentCompanyActReleaseNo.16,461,43SECDocket1330(May18,1989).
972

Once defendants choose to speak about their company, they undertake a duty to
speak truthfully and to make such additional disclosures asnecessary to avoid
renderingthestatementsmisleading.3757
(c) LehmansPublicFilings
An investor reviewing Lehmans 2007 Form 10K and two 2008 Forms 10Q
would not have been able to discern that Lehman was engaged in Repo 105
transactions.3758 Indeed, Lehman made no disclosures in its Statement of Income,
Statement of Financial Condition, Statement of Cash Flows, or MD&A sections
(including its section on liquidity) from which an investor could infer that Lehman
treated a certain volume of repo transactions as sales under SFAS 140, thereby
decreasingitsnetassetsanditsnetleverageratio.3759
3757Hall v. The Childrens Place, 580 F. Supp.2d 212, 226 (S.D.N.Y. 2008) (citing In re Par Pharm., Inc. Sec.
Litig.,733F.Supp.668,675(S.D.N.Y.1990);seealsoLapinv.GoldmanSachsGroup,Inc.,506F.Supp.2d221,
237 (S.D.N.Y. 2006) (holding that upon choosing to speak one has a duty to be both accurate and
complete)(quotingCaiolav.Citibank,N.A.,295F.3d312,331(2dCir.2002);InreAlstomSASec.Litig.,,
406F.Supp.2d433,445(S.D.N.Y.2005)(TheSecondCircuithasheldthatonecircumstancecreatinga
dutytodiscloseariseswhendisclosureisnecessarytomakepriorstatementsnotmisleading.)(quoting
InreTimeWarner,Inc.Sec.Litig.,9F.3d259,268(2dCir.1993)).
3758FormerLehmanGlobalFinancialControllersGriebandKelly,aswellastheformerLehmanGlobal
Head of Accounting Policy, confirmed that Lehman made no disclosures in its Forms 10K and 10Q
about its Repo 105 practice. Examiners Interview of Marie Stewart, Sept. 2, 2009, at p. 15; Examiners
InterviewofMartinKelly,Oct.1,2009,atp.9;ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.
14.
3759As discussed in Section III.A.4.d.2 of this Report, Lehman used incoming cash from Repo 105
transactions to pay down other liabilities, so an investor reading Lehmans publiclyfiled statements
wouldnothaveseenanincreaseinLehmanscashholdings.SeeLBHI200710K,atp.86(reportingthat
Lehmanhad$7.286billionincashandcashequivalentsasofNovember30,2007);LBHI10Q(filedApr.
9,2008),atp.5(reportingthatLehmanhad$7.564billionincashandcashequivalentsasofFebruary29,
2008);LBHI10Q(filedJuly10,2008),atp.5(reportingthatLehmanhad$6.513billionincashandcash
equivalentsasofMay31,2008).WhileLehmansRepo105transactionsspikedatquarterends,Lehmans
973

(i) SummaryofLehmans2000through2007Public
Filings
The Examiner reviewed Lehmans Forms 10K and Forms 10Q from 2000
throughthirdquarter2007.Severalitemsareworthnoting:
FASB issued SFAS 140 in September 2000. Lehmans first disclosure

regardingSFAS140isfoundinitsForm10K405for2000.3760InitsForm10
K405(Nov.30,2000),LehmanexplainedthatSFAS140changedthecriteria
usedtoevaluatewhetherafinancialassetiscontrolledandwhetheravehicle
constitutesaQualifyingSpecialPurposeEntity(QSPE).3761
Lehman never disclosed in any of its Forms 10K and 10Q from 2000
through third quarter 2007 that it treated some repo transactions as sales
pursuanttoSFAS140.3762BecauseLehmantreatedRepo105transactionsas
ordinaryrepobalancesdroppedoffsignificantlyduringthesametimeperiods.Duff&Phelps,Repo105
BalanceSheetAccountingEntryandLeverageRatiosSummary(Oct.2,2009),atp.5.
3760LehmanBrothersHoldingsInc.,AnnualReportfor2000asofNov.30,2000(Form10K405)(filedon
Feb.28,2001),atp.52(LBHI200010K405).
3761Id.;seealsoLehmanBrothersHoldingsInc.,QuarterlyReportasofMay31,2002(Form10Q)(filedon
July15,2002),atp.7(LBHI10Q(filedJuly15,2002)).
3762See generally Lehman Brothers Holdings Inc., Annual Report for 2001 as of Nov. 30, 2001 (Form 10
K405)(filedonFeb.28,2002)(LBHI200110K405);LehmanBrothersHoldingsInc.,AnnualReportfor
2002 as of Nov. 30, 2002 (Form 10K) (filed on Feb. 28, 2003) (LBHI 2002 10K); Lehman Brothers
HoldingsInc.,QuarterlyReportasofAug.31,2003(Form10Q)(filedonOct.15,2003)(LBHI10Q(filed
Oct.15,2003));LehmanBrothersHoldingsInc.,AnnualReportfor2003asofNov.30,2003(Form10K)
(filedonFeb.26,2004)(LBHI200310K);LehmanBrothersHoldingsInc.,QuarterlyReportasofFeb.
29, 2004 (Form 10Q) (filed on Apr. 14, 2004) (LBHI 10Q (filed Apr. 14, 2004)); Lehman Brothers
HoldingsInc.,QuarterlyReportasofMay31,2004(Form10Q)(filedonJuly14,2004)(LBHI10Q(filed
July14,2004));LehmanBrothersHoldingsInc.,QuarterlyReportasofAug.31,2004(Form10Q)(filed
onOct.15,2004)(LBHI10Q(filedOct.15,2004));LehmanBrothersHoldingsInc.,AnnualReportfor
2004 as of Nov. 30, 2004 (Form 10K) (filed on Feb. 14, 2005) (LBHI 2004 10K); Lehman Brothers
HoldingsInc.,QuarterlyReportasofFeb.28,2005(Form10Q)(filedonApr.11,2005)(LBHI10Q(filed
Apr.11,2005));LehmanBrothersHoldingsInc.,QuarterlyReportasofMay31,2005(Form10Q)(filed
onJuly11,2005)(LBHI10Q(filedJuly11,2005));LehmanBrothersHoldingsInc.,QuarterlyReportas
ofAug.31,2005(Form10Q)(filedonOct.11,2005)(LBHI10Q(filedOct.11,2005));LehmanBrothers
Holdings Inc., Annual Report for 2005 as of Nov. 30, 2005 (Form 10K) (filed on Feb. 13, 2006) (LBHI
200510K);LehmanBrothersHoldingsInc.,QuarterlyReportasofFeb.28,2006(Form10Q)(filedon
Apr.10,2006)(LBHI10Q(filedApr.10,2006));LehmanBrothersHoldingsInc.,QuarterlyReportasof
May31,2006 (Form 10Q) (filed onJuly 10, 2006) (LBHI 10Q(filedJuly10,2006)); Lehman Brothers
Oct.10,2006));LehmanBrothersHoldingsInc.,AnnualReportfor2006asofNov.30,2006(Form10K)
974

salesratherthanborrowings(asittreatedotherrepotransactions),Lehman
did not disclose its liabilities arising from the obligation to repay the cash
borrowing.
Lehmanconsistentlyrepresentedthatittreatedrepotransactionsassecured
financing transactions for financial reporting purposes, without
disclosingthatittreatedsomereposassales.3763
Lehman repeatedly disclosed that SFAS 140 required it to classify in its

financialstatementscertaincollateralthatLehmanowned,butpledgedtoits
counterparty, as financial instruments and other inventory owned but
pledged as collateral.3764 One example of collateral that is owned but
pledged consists of securities that are transferred in an ordinary repo
transaction.Lehmanstatedthatitwasrequiredtoclassifyasaseparateline
item(SecuritiesOwnedPledgedasCollateral)onthebalancesheetunder
Assets those securities that were owned by Lehman but pledged to its
counterpartyifthecounterpartyhadtheright,bycontractorcustom,tosell
or repledge the securities.3765 Accordingly, securities that Lehman
(filedonFeb.13,2007)(LBHI200610K);LehmanBrothersHoldingsInc.,QuarterlyReportasofMay
31, 2007 (Form 10Q) (filed on July 10, 2007) (LBHI 10Q (filed July 10, 2007)); Lehman Brothers
Oct.10,2007)).
3763LBHI 2001 10K405, at p. 67; LBHI 2002 10K, at p. 69; LBHI 10Q (filed Oct. 15, 2003), at pp. 1011;
LBHI200310K,atp.76;LBHI10Q(filedApr.14,2004),atp.10;LBHI10Q(filedJuly14,2004),atp.11;
LBHI10Q(filedOct.15,2004),atp.11;LBHI200410K,atp.89;LBHI10Q(filedApr.11,2005),atpp.
1112;LBHI10Q(filedJuly11,2005),atpp.1112;LBHI10Q(filedOct.11,2005),atp.11;LBHI200510
K,atp.81;LBHI10Q(filedApr.10,2006),atp.11;LBHI10Q(filedJuly10,2006),atp.12;LBHI10Q
(filedOct.10,2006),atpp.1112;LBHI200610K,atpp.8586;LBHI10Q(filedJuly10,2007),atp.12;
LBHI10Q(filedOct.10,2007),atp.12.
3764LBHI200010K405,atp.2;LehmanBrothersHoldingsInc.,QuarterlyReportasofFeb.28,2001(Form
10Q)(filedonApr.16,2001),atp.26(LBHI10Q(filedApr.16,2001));LehmanBrothersHoldingsInc.,
QuarterlyReportasofMay31,2001(Form10Q)(filedonJuly16,2001),atp.29(LBHI10Q(filedJuly
16,2001));LBHI200110K405,atp.57.
3765LBHI 2001 10K405, at p. 66; Lehman Brothers Holdings Inc., Quarterly Report as of Aug. 31, 2002
(Form10Q)(filedonOct.15,2002),atp.17(LBHI10Q(filedOct.15,2002));LBHI200210K,atp.91;
LehmanBrothersHoldingsInc.,QuarterlyReportasofFeb.28,2003(Form10Q)(filedonApr.14,2003),
atpp.1213(LBHI10Q(filedApr.14,2003));LehmanBrothersHoldingsInc.,QuarterlyReportasof
May31,2003(Form10Q)(filedonJuly15,2003),atpp.1415(LBHI10Q(filedJuly15,2003));LBHI
10Q(filedOct.15,2003),atp.20;LBHI10Q(filedApr.14,2004),atp.16;LBHI10Q(filedJuly14,2004),
atpp.1617;LBHI10Q(filedOct.15,2004),atp.17;LBHI200410K,atp.99;LBHI10Q(filedApr.11,
2005),atp.19;LBHI10Q(filedJuly11,2005),atp.19;LBHI10Q(filedOct.11,2005),atp.18;LBHI10Q
(filedApr.10,2006),atp.21;LBHI10Q(filedJuly10,2006),atp.20;LBHI10Q(filedOct.10,2006),atp.
21;LBHI200610K(filedNov.30,2006),atp.95.
975

transferred in ordinary repo transactions where the repo counterparty had

therighttosellorrepledgethesecuritiesshouldhavebeenincludedamong
the assets reported on Lehmans balance sheet under Securities Owned
PledgedasCollateral.
Because Lehman treated financial instruments transferred and pledged in

Repo105transactionsassold,thosesecuritieswerenotincludedintheline
itemforSecuritiesOwnedPledgedasCollateral.
Lehman repeatedly disclosed that it obtained shortterm financing on a

secured basis through the use of repo transactions, which were primarily
collateralizedbygovernment,agency,andequitysecurities.3766
In a few of its financial statements, Lehman stated that The Company

accounts for transfers of financial assets in accordance with SFAS 140 and
followed this statement with a summary of SFAS 140s three criteria for
recognizing the transfer of financial assets as sales.3767 In these instances
where Lehman made the general disclosure regarding SFAS 140: (1) the
SFAS 140 disclosure was listed under Consolidation Accounting Policies
along with a disclosure regarding Special Purpose Entities or was part of a
Securitizationactivitiesdisclosure;(2)Lehmandidnotstatethatittreated
some repo transactions as sales under SFAS 140; and (3) the financial
statement contained other disclosure(s) stating that Lehman treats repo
transactions as secured financings (i.e., not as sales) and/or regarding
securitiesownedandpledgedascollateral(asdescribedabove).3768
3766See,e.g.,LBHI200010K405,atp.62;LBHI200110K405,atpp.6768;LBHI200210K,atp.69;LBHI
10Q(filedOct.15,2003),atpp.1011;LBHI200310K,atp.76;LBHI10Q(filedApr.14,2004),atp.10;
LBHI10Q(filedOct.15,2004),atp.11;LBHI200410K,atp.89(filedFeb.14,2005);LBHI10Q,atp.11
12(filedApr.11,2005);LBHI10Q,pp.1112(filedJuly11,2005);LBHI10Q,atp.11(filedOct.11,2005);
LBHI200510K,atp.81;LBHI10Q,atpp.1112(filedApr.10,2006);LBHI10Q,atp.12(filedJuly10,
2006);LBHI10Q,atpp.1112(filedOct.10,2006);LBHI200610K,atpp.8586;LBHI10Q,atp.12(filed
Apr.9,2007);LBHI10Q,atp.12(filedJul10,2007);LBHI10Q,atp.12(filedOct.10,2007).
3767LBHI 10Q (filed July 15, 2002), at p. 8; see also id. at p. 42 (discussing SFAS 140 in the context of
securitizationsandspecialpurposeentities).
3768SeeLBHI10Q(filedJuly15,2002),atpp.8,14;LBHI10Q(filedOct.15,2002),atpp.910,17;LBHI
2002 10K, at pp. 69, 71, 91; LBHI 10Q (filed Oct. 15, 2003), at pp. 1011, 1213, 20; Lehman Brothers
Holdings Inc., Quarterly Report as of Feb. 28, 2007 (Form 10Q) (filed on Apr. 9, 2007), at pp. 1112
(LBHI10Q(filedApr.9,2007));LBHI10Q(filedJuly10,2007),atpp.1112;LBHI10Q(filedOct.10,
2007),atpp.1112.
976

AtnotimedidLehmandisclosethatitrecharacterizedcertainrepotransactions
assalesortheimpactthisaccountingtreatmenthadonitsnetbalancesheetorleverage
ratios.Inaddition,althoughLehmaninits2006Form10Kdisclosedthat[t]heoverall
sizeofourbalancesheetwillfluctuatefromtimetotimeand,atspecificpointsintime,
maybehigherthantheyearendorquarterendamounts,andthat[o]urnetassetsat
quarterendswere,onaverage,approximately5%and6%lowerthanamountsbasedon
amonthlyaverageoverthefourandeightquartersendedNovember30,2006,Lehman
removed any such disclosure in its 2007 Form 10K and first and second quarter 2008
Forms10Q,attheverytimeLehmanescalateditsquarterendRepo105usage.3769
(ii) Lehmans2007Form10K,FirstQuarter2008Form10
Q,andSecondQuarter2008Form10Q
Nowhere in Lehmans 2007 Form 10K or Forms 10Q for the first and second
quarter2008didLehmandisclosethatitengagedinRepo105transactions.Moreover,
Lehman affirmatively misrepresented how it treated repo transactions for financial
reportingpurposes.AsaresultofomittinginformationregardingitsRepo105practice,
Lehmans statements regarding its net leverage were rendered misleading.
Furthermore,Lehmansomissions,includingitslackofdisclosuresregardingRepo105
derivatives, precluded a reader of the periodic reports from ascertaining that Lehman
usedtemporaryoffbalancesheetrepotransactionstoimpactitsnetleverage.
3769LBHI200610K,atp.51;seegenerallyLBHI200710K;LBHI10Q(filedApr.9,2008);LBHI10Q(filed
July10,2008).
977

a. TreatmentofRepoTransactionsandSFAS140
In its 2007 Form 10K, first quarter 2008 Form 10Q, and second quarter 2008
Form10Q,Lehmanaffirmativelyrepresentedthatittreatedrepurchaseagreementsas
financingsnotassales.InNote1toLehmansConsolidatedFinancialStatementsin
each filing, Lehman stated that it treated [r]epurchase and resale agreements, as
collateralized agreements and financings for financial reporting purpose which
Lehman described were collateralized primarily by government and government
agencysecurities.3770Inaddition,Lehmanfurtherstatedineachfiling:Othersecured
borrowings principally reflect transfers accounted for as financings rather than sales
underSFAS140.3771
Lehman disclosed that it recognized the transfer of financial assets as sales
pursuanttoSFAS140butitsaidsoonlywithrespecttosecuritizationactivities.3772
Securitizationactivities,however,bearnorelationtorepotransactionsgenerally,orto
16 (emphasis added). This disclosure is under the heading Collateralized Lending Agreements and
Financings.
16 (emphasis added). In Note 5 to its financial statements, Lehman disclosed that it pledged its own
assets to collateralize financing arrangement. LBHI 2007 10K, at p. 110. It further stated that [t]hese
pledged securities, where the counterparty has the right by contract or custom to sell or repledge the
financialinstruments,wereapproximately$63billionatNovember30,2007.Id.;seealsoLBHI10Q
(filed Apr. 9, 2008), at p. 26 (same); LBHI 10Q (filed July 10, 2008), at p. 34 (same). Note 5 refers to a
subsetofordinaryrepotransactionsnottoRepo105transactions,whichLehmantreatedassalesrather
thanfinancingarrangementsanddidnotidentifyordisclose.
3772LBHI200710K,atp.96;LBHI10Q(filedApr.9,2008),atp.13;LBHI10Q(filedJuly10,2008),atpp.
1516.SecuritizationactivitiesisaseparateheadingintheNote.
978

Repo 105 transactions specifically.3773 Just as Lehmans disclosures dealt with
securitization activities and repo transactions separately, SFAS 140 addressed these
distincttransactionsseparatelyaswell.3774
LehmansMD&Aforits2007Form10KandForms10Qforthefirstandsecond
quarter 2008 were also misleading with respect to Lehmans liabilities, i.e., the
obligationtorepaytheRepo105cashborrowing.LehmansrepaymentoftheRepo105
cash borrowing (the repurchase of the Repo 105 securities) was a known event that
wouldhaveamaterialimpactonLehmanscashflowandliabilities.3775
3773Securitizationoccurswhenapooloffinancialassetssuchasmortgageloans,automobileloans,trade
receivables, credit card receivables,and other revolving charge accounts is created and then securities
representing interests in that pool are sold. ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL
ASSETSAND EXTINGUISHMENTSOF LIABILITIES,StatementofFinancialAccountingStandardsNo.140,73
(Fin. Accounting Standards Bd. 2000) (SFAS 140). The pool is created by transferring the financial
assets to a special purpose entity (SPE). An originator of a typical securitization (the transferor)
transfers a portfolio of financial assets to an SPE, commonly a trust. SFAS 140, 74. Beneficial
interests in the SPE are sold to investors and the proceeds are used to pay the transferor for the assets
transferred. SFAS 140, 75. When the criteria of SFAS 140 are met, a company can remove from its
balancesheettheloans,receivablesorotherassetsthatittransferredtothespecialpurposevehicleasthe
first step in the securitization activity. In contrast, and as discussed at length at the beginning of this
Report,arepotransactionallowsarepoborrowertoborrowcashfromarepolenderinexchangeforthe
transferofsecurities.Whenthetermoftherepomatures,therepoborrowerrepurchasesthesecurities
fromtherepolenderandpaysanadditionalinterestrateontheborrowedcash.SeeSFAS140,96.
3774SFAS 140 deals with securitizations in Paragraphs 73 through 84, and with repo agreements in
Paragraphs96through101.
3775IfaRepo105transactiontechnicallycompliedwithSFAS140,SFAS140didnotrequirethatthecash
borrowingberecordedasaliabilitybecausetherepotransactionwasrecharacterizedasasale.However,
becauseLehmanmadenodisclosuresinitsperiodicreportsregardingitsaccountingtreatmentforand
volume of Repo 105 transactions, sufficient evidence exists for a finding that Lehmans MD&A was
deficientbecauseitdidnotdisclosethatLehmanhadborrowedtensofbillionsofdollarsitwasrequired
torepayintheshorttermandthatrepaymentoftheRepo105borrowingwouldrequireLehmantofind
financing.
979

b. NetLeverage
AsdiscussedearlierintheReport,LehmansMD&AdiscussionofCapitalRatios
stated that a more meaningful ratio than leverage ratio is net leverage, which is
the result of net assets divided by tangible equity capital.3776 According to Lehmans
MD&A, Lehman calculates net assets by excluding from total assets: (i) cash and
securities segregated and on deposit for regulatory and other purposes; (ii)
collateralized lending agreements; and (iii) identifiable intangible assets and
goodwill.3777Lehmaninformedtheinvestingpublicthatitviewednetleveragebased
onnetassetstobeamoreusefulmeasureofleverage,becauseitexcludescertainlow
risk, noninventory assets and utilizes tangible equity capital as a measure of equity
base.3778
LehmansnetleverageratioonNovember30,2007,asreportedinits2007Form
10K,was16.1x.3779IfLehmanhadusedordinaryreposinsteadofitsundisclosedRepo
105transactionsfortheapproximately$38billioninRepo105transactionsthatLehman
88.
3777LBHI200710K,atp.63;LBHI10Q(Apr.9,2008),atp.72;LBHI10Q(July10,2008),atp.88.
88.
3779LBHI200710K,atp.29.
980

undertook at the close of its fiscal 2007, Lehmans net leverage at close of fiscal year
2007wouldhavebeen17.8x.3780
LehmansnetleverageratioonFebruary29,2008,asreportedinitsfirstquarter
2008 Form 10Q, was 15.4x.3781 If Lehman had used ordinary repo transactions rather
thanitsundisclosedRepo105transactionsforthe$49.1billioninRepo105transactions
thatLehmanundertookatthecloseofthefirstquarter2008,Lehmansnetleverageat
closeofitsfirstquarter2008wouldhavebeen17.3x.3782
Lehmans net leverage ratio on May 31, 2008, as reported in its second quarter
2008Form10Q,was12.06x.3783IfLehmanhadusedordinaryrepotransactionsrather
thanitsundisclosedRepo105transactionsfortheapproximately$50.38billioninRepo
105 transactions that Lehman undertook at the close of the second quarter 2008,
Lehmansnetleverageatclosesecondquarter2008wouldhavebeen13.9x.3784
c. Derivatives
AsdiscussedsupraatSectionIII.A.4.d.2.doftheReport,whenLehmanemployed
Repo105transactions,itestablishedalonginventoryderivativeassetrepresentingthe
3780SeeSectionIII.A.4.g.2ofthisReport(discussingtheimpactofLehmansRepo105practiceuponitsnet
leverage);Duff&Phelps,Repo105BalanceSheetAccountingEntryandLeverageRatiosSummary(Oct.
2,2009),atp.8.
3781LBHI10Q(filedApr.9,2008),atp.72.
2,2009),atp.8.
2,2009),atp.8.
981

obligationunderaforwardcontracttorepurchasethefullamountofsecuritiessoldin
a Repo 105 transaction.3785 Assuming Lehman borrowed $100 cash in exchange for a
pledge of $105 of fixed income collateral, Lehman booked a $5 derivative, which
representedLehmansobligationtorepurchasethesecuritiesattheendofthetermof
therepotransaction.3786The$5reflectedthemarketvalueoftheovercollateralizationof
theRepo105transaction.
A comprehensive review of Lehmans 2007 Form 10K, first quarter 2008 Form
10Q,andsecondquarter2008Form10Qdoesnotallowauserevenonewhoknows
oftheexistenceofLehmansRepo105practice,includingthecreationofaderivativeto
identify the amount of the Repo 105 borrowing, or the existence of and size of the
derivative asset created that would represent Lehmans obligation to repurchase the
securities.3787
3785Lehman Brothers Holdings Inc., Accounting Policy Manual Repo 105 and Repo 108, at p. 2 [LBEX
DOCID3213293].
3786Id.
3787LehmansformerGlobalFinancialController,MartinKelly,advisedtheExaminerthattheriskofa
Repo 105 transaction was represented in the derivatives created by these transactions, which were
aggregated with other derivatives. Examiners Interview of Martin Kelly, Oct. 1, 2009, at p. 13. Kelly
statedthatriskreportingwasjustanaggregateyoucouldnothaveknownaboutRepo105fromrisk
disclosures.Id.Lehmans200710KMD&AdiscussionofOffBalanceSheetArrangementsincludeda
disclosureofthenotionalamountofoffbalancesheetarrangementsincludingderivativecontracts.LBHI
200710K,atp.66.AfootnotetothetableincludedinthisMD&Adiscussionstatesthatthefairvalueof
LehmansderivativecontractsasofNovember30,2007,was$38.6billion.Id.atp.67.Nomention(by
name or description) or break out of Repo 105 derivatives is included. The 2007 10K MD&As risk
management discussion also references derivatives, breaking out the fair value of OTC derivatives by
maturity.Id.atp.72.LehmanstatedthatthefairvalueofitsOTCderivativeassetsatNovember30,2007
was$41.3billion.Id.Again,thereisnomentionorbreakoutofRepo105derivatives.Thevolumeof
Repo105derivativeassets(roughly$4billion)wouldpresumablyfeedintothe$313.129billionlineitem
Financial Instruments and Other Positions Owned on Lehmans Consolidated Statement of Financial
982

ConditionasofNovember30,2007,butagain,nomentionorbreakoutofRepo105isgiven.Id.atp.86.
Note1tothefinancialstatementsdiscussesDerivativeFinancialInstrumentswithoutmentionorbreak
outofRepo105derivatives.Id.atp.95.Note3regardingFinancialInstrumentsandOtherInventory
Positionsprovidesdetailonthesinglelineitemfromthebalancesheet,mentionedabove.Itstatesthat
$44.595 billion of the $313.129 billion line item is comprised of derivatives and other contractual
agreements. LBHI 2007 10K, at p. 103. No break out or disclosure of the Repo 105 derivative exists.
Later in the same Note, Lehman broke out individual derivative segments in a table on Fair Value of
Derivativesand Other Contractual Agreements. Id. at p.106. Again, thereis no disclosure regarding
Repo105derivatives.Note4tothefinancialstatementsbreaksoutthefairvalueofderivativesaccording
toFAS157level.Id.atp.107.LehmanstatedthatitstotalderivativeassetsatfairvalueasofNovember
30,2007was$44.595billion.Id.Repo105derivativesarenotidentifiedorbrokenout.Derivativesare
mentionedinNote8solelyasinterestrateliabilitytools.Seeid.at116(EndUserDerivativeActivities).
Note 9 on Commitments, Contingencies and Guarantees discusses derivative contracts that are
guarantees and duplicates the table from the MD&As discussion of OffBalance Sheet Arrangements
(discussed above and at LBHI 2007 10K, p. 67). Id. at p. 120. The notional amount of derivatives is
brokenoutbyyearanddiscussedinthecontextofguarantoraccountingofthosederivativesconsidered
to be guarantees. Id. The Note contains no mention or break out of Repo 105 derivatives. Lehmans
quarterlyreportssimilarlyfailedtodiscloseanyinformationregardingtheRepo105derivative.SeeLBHI
10Q (filed Apr. 9, 2008), at p. 5 (balance sheet line item Financial instruments and other inventory
positionsownedwas$326.569billionandcontainsnomentionorbreakoutofRepo105derivatives);id.
at p. 12 (Note 1s discussion of Derivative financial instruments makes no reference to Repo 105
derivatives); id.at p.19 (Note 3sdiscussion of Financial Instruments andOther Inventory Positions
contains derivatives and other contractual agreements line item of $55.612 billion, but no break out or
mention of Repo 105 derivative); id. at p. 21 (Note 3 table Fair Value of Derivatives and Other
Contractual Agreements breaks out some derivative segments but makes no mention of Repo 105
derivative); id. at p. 31 (Note 8 on Commitments, Contingencies and Guarantees discusses derivative
contractsthatareguaranteeswithnomentionofRepo105derivatives);LBHI10Q(filedApr.9,2008),at
p.75(MD&AOffBalanceSheetArrangementscontainsdisclosureofthenotionalamountofoffbalance
sheetarrangementsincludingderivativecontracts,butnobreakoutormentionofRepo105derivatives);
id.atp.80(discussionofderivatives,breakingoutthefairvalueofOTCderivativesbymaturity,butno
breakout or mention of Repo 105 derivatives); see also LBHI 10Q (filed July 10, 2008), at p. 5 (balance
sheet line item Financial instruments and other inventory position owned was $269.409 billion and
containsnomentionorbreakoutofRepo105derivatives);id.atp.12(Note1sdiscussionofDerivative
financial instruments makes no reference to Repo 105 derivatives); id. at p. 24 (Note 3s discussion of
Financial Instruments and Other Inventory Positions contains derivatives and other contractual
agreementslineitemof$46.991billion,butnobreakoutormentionofRepo105derivative);id.atp.26
(Note3tableFairValueofDerivativesandOtherContractualAgreementsbreaksoutsomederivative
segments but makes no mention of Repo 105 derivative); id. at p. 40 (Note 8 on Commitments,
Contingencies and Guarantees discusses derivative contracts that are guarantees with no mention of
Repo105derivatives);LBHI10Q(filedJuly10,2008),atp.91(MD&AOffBalanceSheetArrangements
contains disclosure of the notional amount of offbalance sheet arrangements including derivative
contracts, but no break out or mention of Repo 105 derivatives); id. at p. 97 (discussion of derivatives,
breaking out the fair value of OTC derivatives by maturity, but no breakout or mention of Repo 105
derivatives).
983

d. AReaderofLehmansForms10Kand10QWould
NotHaveBeenAbletoAscertainThatLehman
EngagedinTemporarySalesUsingLiquid
Securities
Inaddition,evenasophisticatedreaderofLehmansfinancialstatementswould
nothave beenable toascertainfromLehmans2007 Form10Koritsfirstandsecond
quarter 2008 Forms 10Q the amount of Lehmans Repo 105 usage, nor even ascertain
thefactthatLehmanwasengagedinthesetransactions,byattemptingtoquantifythe
amountofliquidsecuritiestemporarilyremovedfromthebalancesheet,asreportedin
Lehmanspublicfinancialstatements.
Note 3 of Lehmans financial statements provided a break out of the

Financial Instruments and Other Inventory Positions balance sheet line
item.3788 Note 3 presented Lehmans long and short inventory using very
highlevel, generalized descriptions of security type.3789 The securities
inventorythatLehmansoldthroughRepo105transactionswereexcluded
fromtheaggregatenumbersinthefinancials,andLehmansForms10Kand
10Q contained no textual disclosures about the exclusions (or the
subsequentobligationtorepurchasethetemporarilysoldassets).Evenif
auserofthefinancialswasawareoftheexistenceofRepo105transactions,
theuserwouldbeunabletodeducethesizeoftheRepo105programorthe
securitiesbeingused.SinceRepo105transactionsweredoneonacontinual
basisandwereindistinguishablefromordinaryassetsalesforthepurposes
of financial presentation, and since maturities of Repo 105 were staggered,
i.e.,one week, two week,multimonth ormultiquarter,itwouldhave been
impossibletodisaggregate thefluctuationsinassets without being privy to
additionalinformationthatisnotpresentedinthefinancialstatements.
Further,areaderofLehmansForms10Kand10Qwouldhavehadnoidea
thatLehmanwassellinghighlyliquidsecuritiesinRepo105transactionson
24.
24.
984

atemporarybasis.Thecategoriesofassetclasseswereverybroad,andthe
disclosuresaresnapshotsofquarterendonly,whichdonotallowtheuserto
determinebalancesofsecuritiesmovingonoroffbalancesheetonanintra
quarter basis. Additionally, to the extent that the reader could see various
security balances increasing or decreasing, i.e., thatLehman sold liquid
securities, the reader would not know the sales were temporary from the
informationprovided.
Moreover, sophisticated readers of financial statements the professional

analystswhocoveredLehmanaskedLehmanofficersduringearningscalls
whatLehmanwassellinginordertoascertainwhattypesofassetsLehman
wasmovinginitseffortstodeleverage.3790FormerCFOErinCallaninformed
analyststhatLehmanwassellingilliquidpositionstodeleverage.3791
(d) ConclusionsRegardingLehmansFailuretoDisclose
SECFilings.Asdiscussedabove,Section13(a)oftheSecuritiesExchangeActof
1934requiredLehmantofileperiodicreportswiththeSEC,includingitsannualreport
on Form 10K and quarterly reports on Form 10Q. Those filings must contain the
information required by the SECs Rules and Interpretations, including the MD&A
requirement discussed above. In addition, SEC Rule 12b20 requires that all filings
containsuchadditionalinformationnecessarytomaketheinformationcontainedinthe
filing not misleading. There is sufficient evidence to support a determination by the
trier of fact that Lehmans filings were deficient and misleading. In the wake of the
Enron scandal, at the request of four major accounting firms, the SEC provided
additional guidance with respect to the duty to provide meaningful discussion of a
companysfinancialstatements.Amongotherthings,SECguidancefrom2002stated:
3790SeeSectionIII.A.4.e.6.aofthisReport(discussinganalyststatements).
3791Id.
985

TheCommissionhaslongrecognizedtheneedforanarrativeexplanation
of the financial statements, because numerical presentations and brief
accompanyingfootnotesalonemaybeinsufficientforaninvestortojudge
the quality of earnings and the likelihood that past performance is
indicativeoffutureperformance.MD&Aisintendedtogivetheinvestor
anopportunitytolookatthecompanythroughtheeyesofmanagement
by providing both a short and longterm analysis of the business of the
company.
And, as we said in 1989, [t]he MD&A requirements are intended to

provide in one section of a filing, material historical and prospective
textual disclosure enabling investors and other users to assess the
financial condition and results of operations of the registrant, with
particularemphasisontheregistrantsprospectsforthefuture.3792
Lehman made no disclosure with respect to its use of Repo 105 transactions.
Lehmanhadadutytodisclosethisinformationbecausetheomissionrenderedseveral
statementsmisleading.
Lehmans MD&A stated that the firm considered the net leverage ratio to be a
more meaningful measurement of leverage than other calculations. When Lehman
embarkedonanaggressivedeleveragingcampaign,itannouncedimprovementstothis
net leverage ratio to shareholders on its periodic reports, as well as press releases,
particularly during the runup to an equity raise. The point of these announcements
was to indicate to current and potentially new shareholders that Lehman was
financiallyhealthyandagoodinvestment.
3792Statement
About Managements Discussion and Analysis of Financial Condition and Results of
Operation,SecuritiesActNo.8056,ExchangeActNo.45,321,67Fed.Reg.3746(Jan.22,2002).
986

Sufficientevidenceexiststosupportafindingbythetrieroffactthatasaresult
of failing to disclose its use of and accounting treatment for Repo 105 transactions,
Lehman misled readers of its Forms 10K and 10Q about its financial condition.
Typically, seven or ten days after executing Repo 105 transactions, Lehman had to
repay the Repo 105 cash borrowing (i.e., repurchasethe assets). In order to repay the
cashborrowing(plusaninterestrate)shortlyafterthereportingperiod,Lehmanhadto
obtain financing. The obligation to repay the cash borrowing (repurchase the assets)
wasnotreflectedinLehmansperiodicreports.Asaresult,Lehmansstatementsinits
MD&A regarding liquidity were rendered misleading. This is exactly the kind of
informationtheSEChasexpresslyrequired:
Disclosureismandatorywherethereisaknowntrendoruncertaintythat
is reasonably likely to have a material effect on the registrants financial
condition or results of operations. Accordingly, the development of
MD&A disclosure should begin with managements identification and
evaluation of what information, including the potential effects of known
trends,commitments,events,anduncertainties,isimportanttoproviding
investorsandothersandaccurateunderstandingofthecompanyscurrent
andprospectivefinancialpositionandoperatingresults.3793
Forthereasonsoutlinedabove,sufficientevidenceexistsfromwhichafinderof
factcouldconcludethatthepictureLehmanpaintedofitsfinancialpositioninlate2007
andinto2008wasmateriallymisleadingbecauseLehmanfailedtoinforminvestorsand
themarketthatitmanageditsbalancesheetbyaccountingforalargevolumeofrepo
transactionsastruesalesonthebasisofanEnglishopinionletter.Lehmanemployed
3793Id.
987

temporaryaccountingmotivatedtransactions,i.e.Repo105transactions,andthenfailed
todisclosetheminordertopubliclyreportareverseengineerednetleverageratioinits
periodic reports. Consequently, Lehmans statement that the net leverage ratio was a
more meaningful measurement of leverage was rendered misleading because that
ratio as reported by Lehman was not an accurate indicator of Lehmans actual
leverage, and in fact, understated Lehmans leverage significantly. In light of the
markets focus on the leverage of investment banks in late 2007 and 2008, sufficient
evidence exists from which a trier of fact could conclude that Lehmans reported net
leverageratiowasmateriallymisleadingduringthatperiod.
Inaddition,Lehmanwasrequiredbylawtodisclose,initsMD&A,offbalance
sheetarrangementsthathaveorarereasonablylikelytohaveacurrentorfutureeffect
on the registrants financial condition, revenues or expenses, results of operations,
liquidity, capital expenditures or capital resources that is material to investors.3794
LehmanmadenosuchdisclosureintheMD&AofitsuseofRepo105transactionseven
though the use of these offbalance sheet arrangements impacted Lehmans financial
reporting by lowering its net leverage ratio by almost two entire points, thereby
improvingitscreditrating,anditsliquiditybyrequiringLehmantofinancethecostof
repurchasingalltheassetswhentherepotransactionmatured.
3794Item303(a)(4)(i)ofRegulationSK.
988

Moreover, Lehman made affirmative misstatements about its practice for
recording repo transactions on its financial statements. Lehman stated in its publicly
filed financial statements that securities sold under agreements to repurchase are
collateralized primarily by government and government agency securities and are
treated as collateralized agreements and financings for financial reporting
purposes.3795
Earnings Calls. In its earnings calls from late 2007 through mid 2008, Lehman
spoke extensively about the size of its firmwide balance sheet, balance sheet
management, and a firmwide deliberate, aggressive effort to deleverage. Though
Callan stated during the first quarter 2008 earnings call that Lehman was being
transparentwithitsmanagementofthebalancesheet,atnotimedidLehmandisclose
to analysts that it used Repo 105 transactions, either by name or characterization, to
manageitsbalancesheeteventhoughLehmantransferredapproximately$50billion
ininventorytemporarilyoffitsbalancesheetatquarterendinthefirstquarterof2008
through the use of Repo 105 transactions. As Lehman continued to boast of its
deleveragingsuccessduringearningscallsinthesecondquarterof2008,neitherCallan
nor Lowitt disclosed that Lehman managed its balance sheet and leverage, in part,
throughRepo105transactions,whichwereonlytemporary.
16.ThisdisclosureisundertheheadingCollateralizedLendingAgreementsandFinancings.
989

(3) ColorableClaims
The Examiner finds that sufficient evidence exists to support the finding of
colorable claims against Richard Fuld, Christopher OMeara, Erin Callan, and Ian
Lowittinconnectionwiththeiractionsin causingorallowingLehmantofileperiodic
reportsthatdidnotdiscloseLehmansuseofRepo105transactionsandagainstErnst&
Young for its failure to meet professional standards in connection with that lack of
disclosure.
AfterreachingthetentativeconclusionthatclaimsexistedagainstFuld,OMeara,
Callan, Lowitt, and Ernst & Young, the Examiner reached out to counsel for each,
advisedthemofthebasisforthepotentialfinding,andinvitedeachofthemtopresent
any additional facts or materials that might bear on the final conclusion. All counsel
acceptedtheExaminersoffer.IntheweeksleadinguptothesubmissionofthisReport,
the Examiner had individual, face to face meetings with counsel for Fuld, OMeara,
Callan, Lowitt, and Ernst & Young, and carefully considered the materials raised by
each.Whiletherewerecrediblefactsandargumentspresentedbyeachthatmayform
thebasisforasuccessfuldefense,theExaminerconcludedthatthesepossibledefenses
do not change the now final conclusion that there is sufficient evidence to support a
findingthatclaimsofbreachoffiduciarydutyexistagainstFuld,OMeara,Callan,and
990

Lowitt and a colorable claim of professional malpractice exists against Ernst &
Young.3796
(4) FiduciaryDutyClaims
(a) BreachofFiduciaryDutyClaimsAgainstBoardof
Directors
With the exception of Richard Fuld, there is not sufficient evidence to support
colorable claims of breach of fiduciary duty against Lehman directors arising from
LehmansuseofRepo105transactionsorthefirmsfailuretoadequatelydisclosethese
transactionsandthetransactionsimpactonLehmansfinancialpositioninitspublicly
filedfinancialstatements.
First,Lehman directors wereprotected by Lehmanscertificateofincorporation
frombreachofdutyofcareclaims:
A director shall not be personally liable to the Corporation or its

stockholders for monetary damages for breach of fiduciary duty as a
director; provided that this sentence shall not eliminate or limit the
liability of a director (i) for any breach of his duty of loyalty to the
Corporationoritsstockholders,(ii)foractsoromissionsnotingoodfaith
or which involve intentional misconduct or a knowing violation of law,
(iii)underSection174ofthe[DelawareGeneralCorporationLaw],or(iv)
3796PriortothisinvitationandduringSchlichsfourdayinterviewasanErnst&Youngrepresentative,
the Examiner invited Ernst & Young to opine on why Repo 105 transactions were proper and did not
result in Lehman filing materially misleading financial statements. Examiners Interview of Ernst &
Young,Repo105Session,Oct.16,2009,atp.14.Schlichrepliedthatthetransactionswereproperifthey
complied with Lehmans selfdefinedAccounting Policy. Id. Despite an additionalinvitation from the
Examiner,Ernst&Younghasnotofferedanyfurtherexplanation.
991

foranytransactionfromwhichthedirectorderivesanimproperpersonal
benefit.3797
Courtswillupholdsuchaclauseasprotectingdirectorsfromliabilitysolongasthereis
notaconcurrentviolationofthedutyofloyalty,whichwasnotimplicatedhere.3798
Second,LehmansdirectorswerenotinformedabouttheexistenceofLehmans
Repo 105 program. No director had even heard of Repo 105 transactions, either by
nameordescription.
(b) BreachofFiduciaryDutyClaimsAgainstSpecificLehman
Officers
There is sufficient evidence to support a colorable claim that certain Lehman
officers Richard Fuld, Chris OMeara, Erin Callan, and Ian Lowitt breached their
fiduciarydutiesbyengaginginoneormoreofthefollowing:(1)allowingandcertifying
the filing of financial statements that omitted or misrepresented material information
regardingLehmansuseofRepo105transactionsandtheiraccountingtreatment,thus
exposingthefirmtopotentialliability;and/or(2)failingtodisclosetoLehmanDirectors
informationaboutthefirmsRepo105program.
Asathresholdmatter,thebusinessjudgmentruleisastandardofjudicialreview
requiring a presumption that in making a business decision the directors of a
corporationactedonaninformedbasis,ingoodfaithandinthehonestbeliefthatthe
3797Lehman Brothers Holdings, Inc., Certificate of Incorporation, at 10.1, Limitation of Liability of

Directors.
3798Stonev.Ritter,911A.2d362,367(Del.2006)(Suchaprovisioncanexculpatedirectorsfrommonetary
liabilityforabreachofthedutyofcare,butnotforconductthatisnotingoodfaithorabreachofthe
dutyofloyalty.).
992

action taken was in the best interests of the company.3799 Thus, a court will not
substituteitsjudgmentforthatoftheboardifthelattersdecisioncanbeattributedto
any rational business purpose.3800 The business judgment rule presumption may be
surmountedwhenthedecisionwastheproductofanirrationalprocessor...directors
failedtoestablishaninformationandreportingsystemreasonablydesignedtoprovide
the senior management and the board with information regarding the corporations
legal compliance and business performance, resulting in liability.3801 Moreover, the
businessjudgmentruledoesnotprotectadirectororofficerfrompersonalliabilityfor
inactionunlessthefailuretoactresultedfromaconsciousdecisiontotakenoaction.3802
The business judgment rule does not protect directors or officers decisions
madeinbadfaith.3803Afailuretoactingoodfaithmaybeshown,forinstance,where
thefiduciaryintentionallyactswithapurposeotherthanadvancingthebestinterestsof
3799UnocalCorp.v.MesaPetroleumCo.,493A.2d946,954(Del.1985)(internalquotationomitted)..
3800Id.(internalquotationomitted).
3801InreTowerAir,Inc.,416F.3d229,238(3dCir.2005).
3802In re Dwights Piano, Co., No. 1:04CV066, 2009 WL 2913942, at *18 (Bankr. S.D. Ohio Sept. 9, 2009)
(applying Delaware law) (The business judgment rule does not apply to director inaction. The
appropriate standard for determining liability for director inaction is generally gross negligence.)
(internal citations omitted); see also See McMullin v. Beran, 765 A.2d 910, 922 (Del. 2000) (The business
judgmentruleisrebuttediftheplaintiffshowsthatthedirectorsfailedtoexerciseduecareininforming
themselves before making their decision.); see also Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985),
overruledonothergroundsbyGantlerv.Stephens,965A.2d695,713(Del.2009);Aronsonv.Lewis,473A.2d
805,812(Del.1984),overruledonothergroundsbyBrehmv.Eisner,746A.2d244,254(Del.2000).
3803SeeUnocal,493A.2dat954.
993

the corporation . . . or where the fiduciary intentionally fails to act in the face of a
knowndutytoact,demonstratingaconsciousdisregardforhisduties.3804
Sufficient evidence exists to support a finding by the trier of fact that Fuld,
OMeara,Callan,andLowittarenotentitledtothebusinessjudgmentrulepresumption
with respect to Lehmans use of Repo 105 transactions because they: (1) were at least
grossly negligent in causing Lehman to file deficient and misleading periodic reports
thatfailedtodisclosethefirmsuseofRepo105transactions,thusexposingLehmanto
potential liability; or (2) withheld from the Board, which relies upon the accurate
transmission of information, material information regarding Lehmans Repo 105
program, thereby depriving the Board of the opportunity to make wellinformed
decisions about Lehmans leverage and deceiving the Board of Directors regarding
Lehmans financial statements. Either one of these factors alone is sufficient to
overcomethebusinessjudgmentrulepresumption.3805
InreAmericanIntlGroup,Inc.(InreAIG)isinstructive.There,thecourtheld
thatshareholdersstatedaclaimforbreachofdutyofloyaltyandfailuretomonitorby
AIGs top managers, including its Chairman/CEO and his inner circle, for allowing
AIG to file materially misleading financial statements that overstated the value of the
3804InreWaltDisneyCo.Deriv.Litig.,906A.2d27,67(Del.2006).
3805SeeBrehm,746A.2dat264n.66([D]ecisionswillberespectedbycourtsunlessthedirectorshavea
conflictinginterestsorlackindependencewithrespecttothedecision,donotactingoodfaith,actina
manner that cannot be attributed to a rational business purpose, or reach their decision by a grossly
negligentprocessthatincludesthefailuretoconsiderallmaterialfactsreasonablyavailable.).
994

corporation by billions of dollars and made AIG appear more secure than it really
was.3806 The single largest deception involved an elaborate $500 million sham
transactionstagedtomakeAIGsbalancesheetlookbetter.3807Thoughtheplaintiffs
couldnotallegewithgreatspecificitythepreciseinvolvementofeachofthedefendants
for each of the schemes and deceptions, the complaint detailed the sham transaction
andotherschemeswithsuchspecificitythatthecourtwasunwillingtoinferthatAIG
engaged in risky and innovative transactions of such magnitude without the
involvement or knowledge of the Chairman/CEO and his inner circle.3808 Specifically,
the court rejected the notion that the disputed products came to market through the
spontaneous,unsupervisedactionsoflowerlevelAIGactors.3809
Onedefendantinparticular,whopossessedknowledgethatthesolepurposeof
the$500millionshamtransactionwastodressupthecompanysbalancesheet,triedto
escape liability for fraud by imputing his knowledge onto the corporation. The court
rejectedthisargument,stating:
[U]nder Delaware law, where officers and directors have disabling

conflicts that give them an interest in hiding information from a
corporations independent directors and stockholders, the conflicted
fiduciaries knowledgeisnotimputedtothecorporationforpurposesof
holding those fiduciaries liable for the harm they caused to the
corporation. In colloquial terms, a fraud on the board has long been a
fiduciary violation under our law and typically involves the failure of
3806InreAmericanIntlGroup,Inc.(InreAIG),965A.2d763,77475(Del.Ch.2009).
3807Id.at775.
3808Seeid.at79599.
3809Id.at797.
995

insiders to come clean to the independent directors about their own

wrongdoing, the wrongdoing of other insiders, or information that the
insiders fear will be used by the independent directors to take actions
contrarytotheinsiderswishes.Delawarelawprovidesnosafeharborto
highlevel fiduciaries who group together to defraud the board. The
StockholderPlaintiffshaveallegedthatTizzioandtheotherAIGinsiders
who participated in the Gen Re Transaction [the sham transaction]
violated their fiduciary duties by causing AIG to engage in illegal
conduct.Iftrue,thatwasbadfaithconductthatgaveTizzioandtheother
guiltyinsidersaninterestinhidingwhattheyhaddone.3810
InreAIGillustrateshowfiduciariesthatcausetheircompanytoengageinillegal
conduct breach their duty of loyalty and good faith to the company, and as a result
acquireamotivetobreachtheirdutyofcandortotheboardbyintentionallyfailingto
discloseinformationrelatingtotheirwrongdoing.3811
The Examiner finds that sufficient evidence exists to support a colorable claim
thateachofthefollowingofficersbreachedhisorherfiduciarydutiestoLehmanand/or
itsBoardofDirectors:
(i) RichardFuld
HavingbeenadvisedbyBartMcDadeinJune2008thatthefirmreliedonRepo
105 transactions to manage the balance sheet, and that McDade believed Lehman
shouldcurtailandeventuallyceaseitsuseofRepo105transactions,Fuldtooknoaction
to determine whether Lehmans use of Repo 105 transactions materially impacted its
publicly filed financial statements and related disclosures. There is sufficient credible
3810Id.at8067(emphasisadded).
3811Cf.InreAIG,965A.2dat795([T]hosewhoengageinsophisticatedformsoffinancialfrauddotheir
bestnottoleaveanobviouspapertrail.Rather,consistentwiththeirimproperobjectives,thoseatthetop
ofsuchschemestrytoconcealtheirrolesandnotleavemarkedpathsleadingtotheirdoorsteps.).
996

evidence to support a determination that Fulds failure to make a deliberate decision
about Lehmans disclosure obligations was grossly negligent or demonstrated a
consciousdisregardofhisduties.3812
a. ThereIsSufficientEvidencetoSupportaFinding
BytheTrierofFactThatFuldWasatLeastGrossly
NegligentinCausingLehmantoFileMisleading
PeriodicReports
Thedutyofcarerequiresthat(1)directorsandofficersinformthemselves,prior
to making a business decision, of all material information reasonably available to
them and (2) directors and officers act with requisite care in the discharge of their
duties.3813 A claim that an officer acted with gross negligence is the same as a claim
thathebreachedhisdutyofcare.3814
3812Pursuant to Section 302 of the SarbanesOxley Act, the SEC adopted Rules 13a14 and 15d14,
promulgatedundertheSecuritiesExchangeActof1934,requiringtheprincipalexecutiveandfinancial
officers to certify, among other things, that [b]ased on the officers knowledge, the report does not
containanyuntruestatementofamaterialfactoromittostateamaterialfactnecessaryinordertomake
the statements made, in light of the circumstances under which such statements were made, not
misleadingandthat[b]asedonsuchofficersknowledge,thefinancialstatements,andotherfinancial
informationincludedinthereport,fairlypresentinallmaterialrespectsthefinancialcondition,resultsof
operationsandcashflowsoftheissuerasof,andfor,theperiodspresentedinthereport.SeePub.L.No.
107204302,116Stat.777(codifiedat15U.S.C.7241(2006));CertificationofDisclosureinCompanies
QuarterlyandAnnualReports,ExchangeActReleaseNo.338124,67Fed.Reg.57,276,57,277(Aug.28,
2002). A fair presentation of an issuers financial condition, results of operations and cash flows
requires the disclosure of financial information that is informative and reasonably reflects the
underlyingtransactionsandeventsandtheinclusionofanyadditionaldisclosurenecessarytoprovideinvestors
withamateriallyaccurateandcompletepictureofanissuersfinancialcondition,resultsofoperationsandcash
flows.Id.at57,279(emphasisadded).
3813Aronson,473A.2dat812,overruledonothergroundsbyBrehmv.Eisner,746A.2d244,254(Del.2000).
3814Albertv.AlexBrownMgmt.Servs.Inc.,C.A.Nos.04C05250PLA,04C05251PLA,2004WL2050527,
at*6(Del.Super.Sept.15,2004);seealsoSmithv.VanGorkom,488A.2d858,873(Del.1985),overruledon
othergroundsbyGantlerv.Stephens,965A.2d695,713(Del.2009).
997

Lehmans exculpatory charter shielded directors, but not officers, from liability
forgoodfaithbreachesofthedutyofcare.3815AlthoughFuldservedLehmanasbothan
officer and a director, Lehmans exculpatory charter for directors does not shield him
fromliabilityforbreachofthedutyofcarewithrespecttohisdutiesasanofficer.3816
There is sufficient evidence to support a determination that by no later than
March28,2008twelvedaysbeforesigningLehmansfirstquarterForm10QFuld
kneworshouldhaveknownthatLehmansquarterendRepo105transactionsforfirst
quarter 2008 reduced Lehmans net balance sheet by $49.1 billion.3817 Fuld met
regularly,atleasttwiceaweek,withGregoryandmembersoftheExecutiveCommittee
todiscussthestateofthefirm.OnMarch28,2008,McDaderequestedaspecialmeeting
oftheExecutiveCommitteetodiscussLehmansRepo105programandotherbalance
3815See Lehman Brothers Holdings, Inc., Certificate of Incorporation, at 10.1, Limitation of Liability of
Directors;seealsoDEL. CODE ANN.tit.8,102(b)(7)(2009);Stonev.Ritter,911A.2d362,367(Del.2006)

(Suchaprovisioncanexculpatedirectorsfrommonetaryliabilityforabreachofthedutyofcare,butnot
forconductthatisnotingoodfaithorabreachofthedutyofloyalty.).
3816SeeArnoldv.SocietyforSavingsBancorp.Inc.,650A.2d1270,1288(Del.1994)(statingthatofficerswho
are also directors are protected by the exculpatory charter for their actions as directors only and that
whereadefendantisadirectorandofficer,onlythoseactionstakensolelyinthedefendantscapacityas
anofficerareoutsidethepurviewofSection102(b)(7))(citingR.FranklinBalotti&JesseA.Finkelstein,
DelawareLawofCorp.&BusinessOrg.4.19,at4335(Supp.1992)).
(attachedtoemailfromAngelaJudd,AssistanttoRichardS.Fuld,Jr.,Lehman,toScottFriedheim,etal.
Lehman(Mar.28,2008)[LBEXDOCID561761]andcontainingFirmBalanceSheetDetailswithRepo105
column showing total quarterend usage of $49.102 billion); see also Lehman Brothers, Executive
Committee Meeting Material, Agenda (Mar. 28, 2008) [LBEXDOCID 545869] (attached to email from
AngelaJudd,AssistanttoRichardS.Fuld,Jr.,Lehman,toScottJ.Freidheim,etal.Lehman(Mar.28,2008)
[LBEXDOCID 561761] and containing topics for discussion lineitem Repo 105/108); email from
JenniferFitzgibbon,Lehman,toLeonardScicutella,etal.Lehman(Mar.28,2008)[LBEXDOCID1854825]
(transmittingcopyofBalanceSheetandCashCapitalUpdate(Mar.27,2008)[LBEXDOCID1698670]and
stating please [see] attached balance sheet presentation discussed in todays executive committee
meeting).
998

sheetreductionissues,andtorequestGregorysblessinginfreezingLehmansRepo105
usage.3818AlthoughFuldmaynothaveattendedthemeetingbecausehewasononeor
more telephone calls, both Fuld and his assistants received the meeting materials.3819
The materials also were forwarded by Fulds assistant to other Lehman executives.3820
The meeting materials included a presentation that referenced Lehmans $49.1 billion
quarterendRepo105usageforfirstquarter2008.3821
In light of Fulds receipt of the presentation, the fact that Fuld regularly
communicated with other Executive Committee members including Gregory, Fulds
admittedfocusonbalancesheetandnetleveragereductionin2008,andthesignificance
thatMcDadeplacedontheneedtoimposedisciplineonLehmansRepo105program,
thereissufficientevidencetosupportacolorableclaimthatFuldkneworshouldhave
known before signing Lehmansfirst quarter Form 10Q that Lehman had reduced its
3818SeeSectionIII.A.4.e.2.aofthisReport.
DOCID 120929]); Lehman, Executive Committee Meeting Material, Agenda (Mar. 28, 2008) [LBEX
DOCID120929]).
3820EmailfromAngelaJudd,AssistanttoRichardS.Fuld,Jr.,Lehman,toScottJ.Freidheim,Lehman,et
al.(Mar.28,2008)[LBEXDOCID561761].
Lehman, et al. (Mar. 28, 2008) [LBEXDOCID 561761], containing Firm Balance Sheet Details with Repo
105columnshowingtotalusageof$49.102billionandbreakoutforRepo105usagebybusinessgroup);
Lehman, Executive Committee Meeting Material, Agenda (Mar. 28, 2008) [LBEXDOCID 545869]
Lehman,etal.(Mar.28,2008)[LBEXDOCID561761],listingtopicsfordiscussionatExecutiveCommittee
meeting,includingRepo105/108andDelevervDerisk).
999

net balance sheet by $49.1 billion using Repo 105 transactions. Such a finding could
supportaclaimofgrossnegligenceagainstFuldforfailingtoensurethatLehmansfirst
quarter 2008 Form 10Q fairly presented its financial condition, thereby exposing
Lehmantopotentialliability.
Inaddition,sufficientevidenceexiststosupportafindingthatinJune2008,only
weeks before he signed Lehmans second quarter Form 10Q, Fuld had actual
knowledgeofLehmansquarterendRepo105usageforthatquarter.McDaderecalled
havingspecificdiscussionswithFuldinJune2008aboutLehmansRepo105usageand
McDades plan to reduce the firms use of Repo 105 transactions by half in the third
quarter2008.3822McDadewalkedFuldthroughareportofLehmansquarterendRepo
105usage$38.6billionatyearend2007;$49.1billionatfirstquarter2008;and$50.38
billion at second quarter 2008.3823 The Examiner reproduces below one page from the
documentMcDadewalkedFuldthroughinmidJune2008.3824
3822Examiners Interview of Herbert H. Bart McDade III, Jan. 28, 2010, at p. 4 ([I]n quarter three, I
certainlytalkedtoFuldaboutRepo105.).
3823Id.atp.5;seealsoLehman,BalanceSheetandKeyDisclosures20083QTargets(Draft)(June16,2008),
atp.3[LBHI_SEC07940_641516].
3824 Lehman, Balance Sheet and Key Disclosures 2008 3Q Targets (Jun. 19, 2008), at p. 3 [LBEXDOCID
2932594].
1000

McDaderecalledthatwhenheadvisedFuldthatLehmanshouldreduceitsRepo
105usageto$25billion,Fuldunderstoodthatthiswouldputpressureontraders.3825
McDade also recalled that Fuld knew about the accounting of Repo 105.3826 Fulds
Repo 105 discussions with McDade took place only weeks before Lehman filed its
second quarter 2008 Form 10Q on July 10, 2008. Fuld denied any recollection of
conversations with McDade or other members of Lehmans Executive Committee
3825ExaminersInterviewofHerbertH.BartMcDadeIII,Jan.28,2010,atp.at6
3826Id.
1001

regardingRepo105.3827AfinderoffactwillhavetofurtherevaluateFuldsstatements
in light of other evidence of his knowledge of Repo 105 and his interest in reducing
Lehmansnetleverage.
Accordingly, there is sufficient evidence to support a colorable claim that Fuld
wasatleastgrosslynegligentforfailingtoensureLehmanssecondquarter2008Form
10Q fairly presented Lehmans financial condition and for allowing Lehman to file
financial statements that misrepresented Lehmans accounting treatment for repo
transactions.
(ii) ChrisOMeara
There is credible evidence that, as CFO from December 2004 until December 1,
2007, OMeara actively managed Lehmans Repo 105 program. Although OMeara
professed limited knowledge of and involvement with Lehmans Repo 105 program,
contemporaneousdocumentsshowthat:
OMearawasinvolvedinestablishingfirmwidelimitsonRepo105activity
nolaterthanmid2006andthroughDecember1,2007.3828
An increase in the Repo 105 cap required OMearas authorization.3829

OMeara was involved with and the evidence shows he approved an
increaseofthecap,from$22billionto$25billioninFebruary2007.3830
WGM754587](statingthatGriebandOMearasetcapontotalRepo105andRepo108usage);Examiners
Interview of Edward Grieb, Oct. 2, 2009, at p. 8 (stating that Grieb, Reilly and OMeara shared
responsibilitiesinsettinglimitsthroughDecember2007).
1002

OMeararegularlydiscussedRepo105limitsandLehmansrelianceonRepo
105withGriebandReilly,includinginmidtolate2007atapproximatelythe
sametimethatLehmanbegantorampupitsuseofRepo105transactions.3831
OMeara was instrumental in creating the 80/20 or continual use and

120% rules that, according to Grieb, were intended to ensure Repo 105
transactions were not undertaken solely at quarterend.3832 Based upon
documents and witness statements, sufficient credible evidence exists from
which a reasonable inference could be drawn that there was no legitimate
businesspurposeforthe80%ruleotherthantomaskLehmansRepo105
practice.
As CFO until December 2007, OMeara worked with other members of

Lehmans Finance Committee to set balance sheet targets and net leverage
ratio targets.3833 During several Board meeting in 2007, OMeara discussed
Lehmansnetleverageratio.3834OMearaalsowasinvolvedinbalancesheet
tighteningeffortsinFID.3835
3829ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.8(statingthatGriebwasnotempoweredto
authorize FID to exceed its Repo 105 limit and that an excession or change in limit required consensus
amongOMearaandReilly).GriebreporteddirectlytoOMeara.
3830See email from Joseph Gentile, Lehman, to Michael Gelband, Lehman, et al. (Feb. 21, 2007) [LBEX
DOCID4553218](Ihavebeenabletogetatemplimitof3bnforrepo105activity,whichcoversknown
real estate issues. . . .); email from Joseph Gentile, Lehman, to Gerard Reilly, Lehman (Feb. 21, 2007)
[LBEXDOCID4553220](respondingtoquestionWheredidthe3bncomefrom?bywriting:Wespoke
with grieband he was ok with a temporary excession of $3. . . .); email from Michael McGarvey,
Lehman,toAnurajBismal,Lehman,etal.(May9,2007)[LBEXDOCID3223356](17bnwastheyearend
limitforFID.InQ1JoeGentilespoketoEdGriebaboutraisingitto20bn(basedontheattacheddoc)and
according to Joe Ed agreed.). Grieb recalled generally that in 2007 as a result of discussions with
OMearaandReilly,weraisedthelimit.ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.12.
Griebfurtherstatedthathedidnothavetheauthoritytochangethelimitaloneandthatanincreaseor
changetothelimitrequiredconsensusamongOMearaandReilly.Id.
3831Id.atpp.10,12.
WGM748489];ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.13;ExaminersInterviewofIan
T.Lowitt,Oct.28,2009,atp.13.
McGarvey,Sept.11,2009,atp.5;ExaminersInterviewofTejalJoshi,Sept.15,2009,atp.5;Examiners
InterviewofAnurajBismal,Sept.16,2009,atp.5;ExaminersInterviewofKaushikAmin,Sept.17,2009,
atp.5;ExaminersInterviewofMartinKelly,Oct.1,2009,atp.11;ExaminersInterviewofJohnFeraca,
Oct.9,2009,atp.9;ExaminersInterviewofJosephGentile,Oct.21,2009,atp.5.
3834See,e.g.,LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Sept.11,2007),at
p.3[LBHI_SEC07940_026364];LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors
1003

OMearas involvement with Lehmans balance sheet targets continued in

2008,whilehewasCRO.3836
OMeara understood that the motivation for, and a consequence of,

undertakingRepo105transactionswasbalancesheetreduction,particularly
at quarterend.3837 For example, on a regular basis between April 2008 and
September2008whilehewasCRO,OMearareceivedthedailybalancesheet
scorecard, wherein the consolidated balance sheet routinely tracked the
reductiontoLehmansbalancesheetcausedbyRepo105.3838
(Oct.15,2007),atp.3[LBHI_SEC07940_026407];LehmanBrothersHoldingsInc.,MinutesofMeetingof
theBoardofDirectors(Nov.8,2007),atp.4[LBHI_SEC07940_026650].
3835SeeemailfromKentaroUmezaki,Lehman,toChristopherM.OMeara,Lehman,etal.(Apr.18,2007)
[LBEXDOCID187618];emailfromKentaroUmezaki,Lehman,toChristopherM.OMeara,Lehman,et
al.(Apr.19,2007)[LBEXDOCID318475];emailfromIanT.Lowitt,Lehman,toChristopherM.OMeara,
Lehman, et al. (Sept. 7, 2007) [LBEXDOCID 1357178]; Examiners Interview of Joseph Gentile, Oct. 21,
2009,atp.6(discussingOMearascriticismofGentileifFIDbreacheditsbalancesheetlimit);emailfrom
Christopher M. OMeara, Lehman, to Gerard Reilly, Lehman (Nov. 20, 2007) [LBEXDOCID 578184]
(stating we should be pressuring everywhere to try to end year in good way on balance sheet . . .
especiallysincetherevsarenotmaterializing).
3836See email from Jackson Tam, Lehman, to Christopher M. OMeara, Lehman, et al. (May 29, 2008)
[LBEXDOCID079846](transmittingLehman,May2008BalanceSheetProjection(May28,2008)[LBEX
DOCID019912]).
3837SeeemailfromRyanTraversari,Lehman,toChristopherM.OMeara,Lehman(May16,2008)[LBEX
DOCID3233899](statingthatLehmansbalancesheetislargerintramonththanatmonthendbecauseof
Repo 105 transactions). Moreover, Grieb, who reported directly to OMeara and said that he was not
authorized to make decisions about Repo 105 limits without OMearas approval, informed Joseph
Gentile of Lehmans FID that Repo105 wasa toolthat could be used to reduce Lehmansnet balance
sheetwhenFIDwasinbreachofitsbalancesheetlimit.SeeExaminersInterviewofJosephGentile,Oct.
21, 2009, at p. 6. Given that OMeara established the Repo 105 cap, authorized increases in Repo 105
volumes, established the continual use rule, and communicated regularly with Grieb and Reilly who
were deeply involved in Lehmans Repo 105 program and acknowledged its primary purpose was
balance sheet reduction, sufficient evidence exists from which a trier of fact could make a finding that
OMearaalsowasawareofthemotiveforundertakingRepo105transactions.
atp.9[LBEXDOCID520619](attachedtoemailfromTalLitvin,Lehman,toChristopherM.OMeara,
April8,2008(Apr.10,2008),atp.9[LBEXDOCID520620](attachedtoemailfromTalLitvin,Lehman,
DisclosureScorecardforTradeDateApril9,2008(Apr.10,2008),atp.9[LBEXDOCID251339](attached
1004

OMearaunderstoodthatReillyandotherswithinLehmanviewedRepo105
as a temporary means of dealing with sticky inventory.3839 When Reilly
Prime Services balance sheet reduced by $4.548 through Repo 105 transactions as of April 9, 2008);
Balance Sheet and Disclosure Scorecard for Trade Date April 10, 2008 (Apr. 14, 2008), at p. 9 [LBEX
DOCID251342](attachedtoemailfromTalLitvin,Lehman,toChristopherM.OMeara,Lehman,etal.
transactionsasofApril10,2008);BalanceSheetandDisclosureScorecardforTradeDateApril11,2008
(Apr.14,2008),atp.9[LBEXDOCID251344](attachedtoemailfromTalLitvin,Lehman,toChristopher
M. OMeara, Lehman, et al. (Apr. 14, 2008) [LBEXDOCID 258562] and showing consolidated FID and
Equities balance sheet reduced by $20.260 billion and Prime Services balance sheet reduced by $4.517
billion through Repo 105 transactions as of April 11, 2008); Lehman, Balance Sheet and Disclosure
ScorecardforTradeDateMay12,2008(May13,2008),atp.1[LBEXLL1950262](attachedtoemailfrom
Tal Litvin, Lehman, to Christopher M. OMeara, Lehman, et al. (May 13, 2008) [LBEXDOCID 3187357]
and stating Rates decreased by $(5.0B) from prior day due to . . . increased Repo 105 usage . . . .);
[LBEXLL1950706](attachedtoemailfromTalLitvin,Lehman,toChristopherM.OMeara,Lehman,et
al. (May 27, 2008) [LBEXDOCID 275984] and stating Global rates net balance sheet decreased ($2.0B),
predominantly due to an increase in Repo 105 benefit . . . .); Lehman, Balance Sheet and Disclosure
ScorecardforTradeDateMay28,2008(May30,2008),atp.1[LBEXLL1950670](attachedtoemailfrom
TalLitvin,Lehman,toChristopherM.OMeara,Lehman,etal.(May30,2008)[LBEXDOCID275995]and
stating Global rates net balance sheet decreased by ($3.1B) primarily due to a decrease in Americas
drivenbyanincreasedutilizationofRepo105withintheAgencybusiness);Lehman,BalanceSheetand
DisclosureScorecardforTradeDateMay29,2008(May30,2008),atp.1[LBEXLL1950658](attachedto
emailfromTalLitvin,Lehman,toChristopherM.OMeara,Lehman,etal.(June2,2008)[LBEXDOCID
011127] and stating Global Rates net balance sheet decreased ($6.5B) . . . [t]he decrease in Europe is
coming from increased utilization of Repo 105); Lehman, Balance Sheet and Disclosure Scorecard for
TradeDateJune18,2008(June20,2008)[LBEXLL1950514](attachedtoemailfromTalLitvin,Lehman,
toChristopherM.OMeara,Lehman,etal.(June20,2008)[LBEXDOCID275942]andstatingthatGlobal
rates net balance sheet decreaseddriven by a[n]increase in Repo 105 utilization . . . .); Lehman,
BalanceSheetandDisclosureScorecardforTradeDateAugust13,2008(Aug.14,2008)[LBEXLL782812]
(attachedtoemailfromTalLitvin,Lehman,toChristopherM.OMeara,Lehman,etal.(Aug.14,2008)
[LBEXDOCID 4214810] and stating that Global rates net balance sheet decreased . . . driven by an
increase in Repo 105 benefit . . . .); Lehman, Balance Sheet and Disclosure Scorecard for Trade Date
August 25, 2008 (Aug. 26, 2008) [LBEXLL 782924] (attached to email from Tal Litvin, Lehman, to
ChristopherM.OMeara,Lehman,etal.(Aug.26,2008)[LBEXDOCID079536]andstatingthatGlobal
Ratesnetbalancesheetdecreased...drivenbyanincreaseinrepo105usage....);Lehman,Balance
Sheet and Disclosure Scorecard for Trade Date August 28, 2008 (Aug. 29, 2008) [LBEXLL 782966]
(attachedtoemailfromTalLitvin,Lehman,toChristopherM.OMeara,Lehman,etal.(Aug.29,2008)
[LBEXDOCID 275880] and stating that Global rates [net balance sheet] was down . . . driven by
increasedRepo105benefit....).
3839SeeemailfromGerardReilly,Lehman,toChristopherM.OMeara,Lehman(Aug.19,2007)[LBEX
DOCID4553354](forwardingtoChristopherM.OMearaemailchaindiscussionsbetweenJohnFeraca,
Reilly, and David Sherr regarding possibility of placing mortgagebacked securities into the Repo 105
program);emailfromGerardReilly,Lehman,toChristopherM.OMeara,Lehman,etal.(Aug.20,2007)
1005

andothersattemptedtomovestickyinventoryintotheRepo105program,
theyinformedOMearaandrequestedhisopinion.3840
By no later than June 17, 2008, OMeara knew that the actual volumes of
firmwide Repo 105 for the fourth quarter 2007, first quarter 2008, and
second quarter 2008 were $38.6 billion, $49.1 billion and $50.38 billion,
respectively.3841Lehmanfileditssecondquarter2008Form10Q,signedby
FuldandLowitt,onJuly10,2008,lessthanfourweekslater.
OMearahadknowledgeoftheproposedfirmwide$25billionRepo105cap
forthirdquarter2008.3842
OMeara was involved in reestablishing and/or extending credit lines with

Repo105counterparties.3843
(same);seealsoemailfromJohnFeraca,Lehman,toGerardReilly,Lehman(Aug.18,2007)[LBEXDOCID
4553350] (discussing possibility of moving either CMBS or RMBS into Repo 105); email from Gerard
Reilly, Lehman, to John Feraca, Lehman (Aug. 18, 2007) [LBEXDOCID 4553351] (Many benefits to us
gettingtheseassets[CMBSandRMBS]intothe[Repo105]program.);emailfromJohnFeraca,Lehman,
to David Sherr, Lehman, et al. (Aug. 19, 2007) [LBEXDOCID 4553352] ([W]e are looking at the
possibility of Repo 105 for AAA RMBS and CMBS positions . . . only want to focus on nonagency
productsforthisexerciseasbothagencypassthrusandagencyCMOsrollupasgovernmentoragency
products in the balance sheet, not mortgages.); email from David Sherr, Lehman, to John Feraca,
Lehman,etal.(Aug.19,2007)[LBEXDOCID4553353](same);emailfromGerardReilly,Lehman,toJohn
Feraca,Lehman,etal.(Aug.19,2007)[LBEXDOCID4553356](same);emailfromJohnFeraca,Lehman,
to David Sherr, Lehman, et al. (Aug. 20, 2007) [LBEXDOCID 4553357] (We spoke to the 3 of the 4
counterpartieswecurrentlyuseforRepo105onUSTandAgenciesviaLBIE(theMTSequivalent)andall
3declinedourproposaltouseAAAprivatelabelRMBSandCMBS...ouronlyotherchoicewillbeto
lookifanyofourexistingcounterpartiesinLBIwouldbewillingtotransactthroughLBIE.).
3840See note 993, supra; see also email from Kentaro Umezaki, Lehman, to John Feraca, Lehman, et al.
(Aug.20,2007)[LBEXDOCID4553359](UmezakirepliestoFeraca,notsurethatisworththeeffort...
weneedChris[OMeara]toopine.).
DOCID012458](attachedtoemailfromGerardReilly,Lehman,toChristopherM.OMeara,Lehman,et
al. (June 17, 2008) [LBEXDOCID 011380]); email from Christopher M. OMeara, Lehman, to Gerard
Reilly,Lehman,etal.(June17,2008)[LBEXDOCID033813].
al.(June17,2008)[LBEXDOCID011380]).
3843See email from Matthew Pinnock, Lehman, to Paolo R. Tonucci, Lehman (May 21, 2008) [LBEX
DOCID 1548431] (asking for authorization from OMeara for Repo 105 increase with Mizuho); email
from Paolo R. Tonucci, Lehman, to Matthew Pinnock, Lehman (May 21, 2008) [LBEXDOCID 1548433]
(same); email from Paolo R. Tonucci, Lehman, to Christopher M. OMeara, Lehman (May 21, 2008)
[LBEXDOCID 1533687] (same); email from Christopher M. OMeara, Lehman, to Paolo R. Tonucci,
1006

Moreover,netleveragereductionwasanissueofimportanceduringOMearas
tenureasCFO.OMearareportedtotheFinanceandRiskCommitteeonLehmansnet
leverageratio.3844InaNovember2007email,OMearawrote:Irealizewereinatough
spotgivenmkt,butweshouldbepressuringeverywheretotrytoendyearingoodway
onbalancesheet...especiallysincetherevsarenotmaterializing.3845
ColorableClaimThatOMearaWasatLeast
GrosslyNegligentinAllowingLehmantoFile
MisleadingFinancialStatementsandEngagein
MaterialVolumesofRepo105Transactions
TheExaminerfindsthereissufficientevidencetosupportacolorableclaimthat
OMearabreachedhisfiduciarydutiesbypermittingtheexpansionofLehmansRepo
105practicewhiletheprogramanditsimpactonLehmansreportednetleverageratio
remained undisclosed in the firms publicly reported financial statements. Although
OMeara was no longer Lehmans CFO when the firm filed its 2007 Form 10K on
January29,2008,theExaminerconcludesthatthereissufficientevidencetosupporta
finding that OMeara continued to have culpable knowledge and involvement in
Lehman (May 21, 2008) [LBEXDOCID 1533688] (same); see also email from Christopher M. OMeara,
Lehman,toGerardReilly,Lehman(Apr.11,2008)[LBEXDOCID4553298](settingupmeetingtodiscuss
LehmansRepo105program);emailfromChristopherM.OMeara,Lehman,toGerardReilly,Lehman,
etal.(June17,2008)[LBEXDOCID033813].
Committee of Lehman Board of Directors (Sept. 11, 2007), at pp. 2, 30 [WGM_LBEX_02247] (with
Weliksons Handwritten Notes); Lehman Brothers Holdings Inc., Finance and Risk Committee Minutes
(Sept.11,2007), at pp.23[LBEXAM067018]; see also Lehman,Presentation on Risk,Liquidity, Capital
andBalanceSheetUpdatetoFinanceandRiskCommitteeofLehmanBoardofDirectors(Sept.11,2007),
atp.50[LBEXAM067167].
3845Email from Christopher M. OMeara, Lehman, to Gerard, Reilly, Lehman (Nov. 20, 2007) [LBEX
DOCID578184].
1007

Lehmans Repo 105 practice in late 2007 and early 2008 as well as involvement in the
preparationofLehmans2007Form10K.3846
As CFO through December 1, 2007 and the highest ranking officer overseeing
LehmansRepo105program,OMearahadadutyto:(1)monitorLehmansuseofRepo
105transactionsand(2)ensureLehmanfiledaccurateandcompleteForms10Kand10
Q.
OMearaandGriebestablishedaninternallimitof$22billionforfirmwideRepo
105 transactions, which they increased to $25 billion in February 2007. The limit was
notrequiredunderaccountingrules,andappearstohavebeenadecisionontheirpart
tokeepLehmansRepo105activitywithinarangetheydeemedimmaterial.
In late 2007 and early 2008, the volume of Lehmans undisclosed Repo 105
transactions was material. Under OMearas watch, the volume of Repo 105
3846Though Erin M. Callan took over the role of CFO in December 2007, OMeara continued to be
involvedinthedraftingsessionsforLehmans2007Form10K.EmailfromJoyFernandez,Lehman,to
Erin M. Callan, Lehman (Nov. 5, 2007) [LBEXDOCID 2974570] (stating that Chris OMeara was
scheduled to attend January 14, 2008 meeting to review LBHI 2007 10K along with Erin M. Callan,
Edward Grieb, Steve Rossi, and Ryan Traversari). Moreover, the Examiner has located evidence
suggestingthatOMearasubcertifiedthe200710KforCallanandwasresponsibleforcertainfinancial
reportinginLehmansForm10Qforfirstquarter2008..SeeLehmanBrothersHoldingsInc.,Reporting
Instructions,QuarterEndedFebruary29,2008(Feb.22,2008),atp.5[LBEXDOCID3756724](statingthat
OMeara was the certifier for the Review of Risk Management narrative for accuracy of MD&A
discussionsofcreditrisk,marketrisk,operationalrisk,reputationalrisk,valueatrisk,othermeasuresof
riskanddistributionoftradingrevenues);emailfromMartinKelly,Lehman,toIanT.Lowitt,Lehman
(July8,2009)[LBEXDOCID2329856]([W]ouldyouliketohaveErinsignasubcertificationletter(not
necessarystrictlyspeakingbutwedidhaveChrissubcertifytoErinatyearend.);emailfromMartin
Kelly, Lehman, to Erin M. Callan, Lehman (July 9, 2008) [LBEXDOCID 1536331] (asking Callan if I
could have you subcertify on the quarter[lyreport since] (Chris [OMeara] subcertified to youat year
end)); email from Ian T. Lowitt, Lehman, to Martin Kelly, Lehman (July 9, 2008) [LBEXDOCID
2329856](IspoketoTom[Russoaboutsubcertification]andhethinksbetterifdidntcomefromhim
andbettertopresentasconsistentwithwhatChrisdidwhenErinoverlapped.).
1008

transactionsroseto$38billionatthecloseofLehmansfourthquarter2007$13billion
(and more than 50%) over the last known limit of $25 billion. The expansion of
LehmansRepo105activitywasdueprimarilytoalackofpolicinganditwasnotan
issue for management.3847 The volume of Lehmans Repo 105 usage was known to
senior management, but because FID needed more Repo 105 to make balance sheet
targets,therewasnostoppage.3848
In light of OMearas knowledge of the volume of Lehmans Repo 105
transactions,hisinvolvementinsettinginternalmanagementrulesforRepo105usage,
andhisawarenessofthepurposeofRepo105transactions,sufficientevidenceexiststo
support a colorable claim that OMeara was at least grossly negligent in permitting
Lehmantofileamateriallymisleading2007Form10K.
b. ThereIsSufficientEvidenceToSupporta
ColorableClaimThatOMearaBreachedHis
FiduciaryDutiesbyFailingtoInformtheBoard
andHisSuperiorsofLehmansRepo105Practice
The Examiner also finds that sufficient evidence exists to support a colorable
claimthat,asCROfromDecember1,2007throughSeptember2008,OMearabreached
hisfiduciarydutiestotheBoardofDirectorsandhissuperiors,includingtheCEOand
CFO who were responsible for certifying Lehmans financial statements, by failing to
reportmaterialinformationwithinthescopeofhisagency.
3848Id. Ed Grieb also recalled reading reports on the firmwide volume of Repo 105 transactions on at
leastamonthlybasis.ExaminersInterviewofEdwardGrieb,Oct.2,2009,atp.12.
1009

OMeara had a duty to inform his superiors of material information regarding
Lehmans Repo 105 usage. Officers and key managerial personnel of Lehman are
agentsofthecorporationthatemploysthem.3849Principlesofagencylawsquarelyhold
that an agent has a duty of candor or a duty to disclose relevant information to his
principal.3850
Commentators agree that officers have an obligation to inform the superior
officertowhom,ortheboardofdirectors...towhich,theofficerreportsofinformation
abouttheaffairsofthecorporationknowntotheofficer,withinthescopeoftheofficers
3849SeeScienceAccessoriesCorp.v.SummagraphicsCorp.,425A.2d957,962(Del.1980).InScienceAccessories
Corp,theDelawareSupremeCourtheldthattheprinciplesandlimitationsofagencylawcarryoverinto
the field of corporate employment so as to apply not only to officers and directors, but also key
managementpersonnel.Id.[U]nderelementalprinciplesofagencylaw,anagentoweshisprincipala
duty of good faith, loyalty and fair dealing. Encompassed within such general duties of an agent is a
duty to disclose information that is relevant to the affairs of the agency entrusted to him. Id. The
impositionofthesedutiesreflectsthecourtsconcernfortheintegrityoftheemploymentrelationship,
whichhasledcourtstoestablisharulethatdemandsofacorporateofficeroremployeeundividedand
unselfish loyalty to the corporation. Id. (quoting Md. Metals, Inc. v. Metzner, 382 A.2d 564, 568 (Md.
1978);seealsoCahallv.Lofland,114A.224,228(Del.Ch.1921)(statingthatunderwellestablishedand
familiar rules of equity, a director of a corporation is not accountable to the stockholder for
withholding information about the value of the stock, but to the corporation) (quoting Du Pont v. Du
Pont,242F.98,136 (D.C.Del.1917)). The Delaware Supreme Court has characterized these employee
agentobligationsasfiduciaryduties.ScienceAccessoriesCorp,425A.2dat965(formeremployeesfailure
to disclose offduty development of competing business was not, without more, a violation of their
fiduciarydutyofloyalty);seealsoLewisv.Vogelstein,699A.2d327,334(Del.Ch.1997)(describingagents
dutiestoprincipalasfiduciaryincharacter).
3850SeeRESTATEMENT (THIRD) AGENCY8.11(Anagenthasadutytousereasonableefforttoprovidethe
principalwithfactsthattheagentknowsorshouldknowtheprincipalwouldwishtohaveorare
material to the agents duties to the principal.); RESTATEMENT (SECOND) AGENCY 381 ([A]n agent is
subject to a duty to use reasonable efforts to give his principal information which is relevant to affairs
entrustedtohimandwhich,astheagencyhasnotice,theprincipalwoulddesiretohaveandwhichcan
becommunicatedwithoutviolatingasuperiordutytoathirdperson.).
1010

functions, and known to the officer to be material to such superior officer, board or
committee.3851
Thereissufficientevidencetosupportafindingthatin2008,asheassistedother
Lehman officers with the firms balance sheet reduction efforts, OMeara had
knowledgeofthemechanicsandmagnitudeofLehmansRepo105practice.OMeara
receivedacopyofMcDadesMarch28,2008balancesheetreductionpresentationtothe
Executive Committee, which included a reference to Lehmans quarterend Repo 105
usage for first quarter 2008.3852 After he became President in June 2008, McDade
broughtOMearabackinthe[balancesheet]processtohelpinlightofOMearaspast
experienceasLehmanCFO.3853InJune2008,OMearametwithMcDadeandothersto
discusstheBalanceSheetandKeyDisclosuresdocument,whichreportedthefirmwide
quarterendRepo105usage.3854
3851ABA Commn on Corporate Laws, Changes in the Model Business Corporations Act, 60 BUS. LAW.
943,951(2005);seealsoShannonGerman,WhatTheyDontKnowCantHurtThem:CorporateOfficers
DutyofCandortoDirectors,34DEL. J. CORP. L.221,223(2009)(Extendingthedutyofcandortoimpose
oncorporateofficersadutytoprovideinformationtotheboardofdirectorswouldgivethecorporationa
waytoseekredressforharmcausedbymisconductwithinthecorporationofwhichtheboardwasnot
aware.);Z.JillBarclift,SeniorCorporateOfficersandtheDutyofCandor:DotheCEOandCFOHavea
Duty to Inform?, 41 VAL. U. L. REV. 269, 270 (2006) (The broadening of the definition of the duty to
inform that senior officers owe directors to include an underlying affirmative duty to provide
information,evenwhendirectororshareholderactionisnotrequested,offersanopportunityforgreater
monitoringofcorporategovernancebyfocusingonthoseoftenmostculpable.).
3852Lehman,BalanceSheetandCashCapitalUpdate(Mar.27,2008)[LBEXDOCID197391](attachedto
emailfromGerardReilly,Lehman,toChristopherM.OMeara,Lehman(Mar.28,2008)[LBEXDOCID
214211]).
al.(June17,2008)[LBEXDOCID3383643]);emailfromChristopherM.OMeara,Lehman,toHerbertH.
1011

To form a basis for a fiduciarys personal liability for breaching the duty of
candortohisprincipal,theundisclosedormisrepresentedfactsmustbematerialtothe
principals decisions or responsibilities.3855 While materiality for purposes of
information to shareholders is determined under the total mix of information
standard,theDelawareSupremeCourthasadoptedalowerstandardofmaterialitywith
respecttomanagementsdisclosureofinformationtotheboard.3856Informationmustbe
disclosed if it is relevant to the board and of sufficient magnitude to be
important.3857Similarly,underagencylawprinciples,anagentbreacheshisdutyofcare
to the principal when he fails to provide information to the principal that may be
material to the principals decisionmaking, such as by enabling the principal to: (1)
reconsider a course of action or make alternate arrangements; (2) take action to avoid
harmtothirdparties;or(3)takeactiontoprotecttheprincipalsinterests.3858
When an agent has an ongoing relationship with his principal and the
relationshipinvolvesmorethantheexecutionofspecificorders,thedutytoinformthe
(Bart) McDade III, Lehman, et al. (June 17, 2008) [LBEXDOCID 033813] (replying to receipt of Balance
SheetandKeyDisclosures20083QTargets[Draft](June16,2008)andstatingthatmeetingisbeingset
uptodiscussthedocument);emailfromGerardReilly,Lehman,toIanT.Lowitt,Lehman,etal.(June
19, 2008) [LBEXDOCID 2962369] (transmitting updated version of Lehman, Balance Sheet and Key
Disclosures20083QTargets(June19,2008)[LBEXDOCID2932594]andindicatingthatameetingamong
Reilly,Lowitt,OMeara,McDadeandPatrickWhalentookplace).
3855SeeRESTATEMENT(THIRD)OFAGENCY8.11,cmt.d.
3856SeeBrehmv.Eisner,746A.2d244,260n.49(Del.2000).
3857Id. at n.49 (The term material is used in this context to mean relevant and of a magnitude to be
importanttodirectorsincarryingouttheirfiduciarydutyofcareindecisionmaking.).
3858SeeRESTATEMENT(THIRD)OFAGENCY8.11cmts.bd.
1012

principal is wide in scope.3859 Thus, although OMeara was primarily responsible for
riskmanagementin2008,healsohadinvolvementinLehmansbalancesheetreduction
effortsandcontinuedtohaveadutytoreporttohisprincipal(s)materialinformationof
whichhewasaware.Ifanagentfailstoprovideinformationtotheprincipalthatis
material to decisions that the principal will make, the agent may not have acted with
the due diligence and care reasonably to be expected of an agent in a particular
position.3860
Given OMearasextensivepriorinvolvement in the Repo105 programand his
continued access to information regarding Lehmans use of Repo 105 transactions,
OMearaunderstoodtheimpactofthetransactionsonLehmansbalancesheetandthe
purpose for engaging in these transactions, was aware of FIDs difficulties in making
balance sheet targets, and knew of the volumes at which FID engaged in Repo 105
transactions. Under agency law principles, OMeara had a duty to report this
information to any of his superiors responsible for Lehmans publicly filed financial
statements,includingtheBoardofDirectors,CEOandCFO.
(iii) ErinCallan
Callan became Lehmans CFO on December 1, 2007. As early as January 2008,
Callan received emails from Reilly, Lehmans Global Product Controller, and others
3859SeeRESTATEMENT(THIRD)OFAGENCY8.11cmt.c.
3860RESTATEMENT(THIRD)OFAGENCY8.11cmt.d.
1013

regardingLehmansRepo105programanditsrelationtobalancesheetmanagement.3861
One email that was forwarded to Callan indicated that Lehmans Fixed Income
DivisionhadrecommendedthattheRepo105programbeexpanded.3862
Duringmeetingsinearly2008,CallanwaswarnedbyLehmansGlobalFinancial
Controller,MartinKelly,that:
ThelargesizeoftheRepo105programpresentedheadlinerisk;
Because Lehmandid notdiscloseRepo 105transactions in its publicly filed

statements, Lehman exposed itself to reputational risk if its use of Repo
105weretobecomepublic;
Repo 105 transactions lackedeconomicsubstance, and were usedto reduce

netbalancesheetprimarilyatquarterend;and
Kelly and other Lehman employees believed that none of Lehmans peer
investmentbanksusedRepo105typetransactions.3863
InadditiontotheredflagsraisedbyKelly,Callanwasputonfurthernoticeof
potentialrisksorproblemswithLehmansRepo105programduringtheMarch28,2008
Executive Committee meeting in which McDade recommended to the Executive
Committee that Lehman cap its Repo 105 usage.3864 Callan received the materials the
night before the meeting, which listed the $49.1 billion in Repo 105 transactions that
3861EmailfromGerardReilly,Lehman,toErinM.Callan,Lehman(Jan.3,2008)[LBEXDOCID3383445].
(transmittingLehman,FIDBalanceSheet(Jan.17,2008)[LBEXDOCID3363222]).
1014

Lehmanhadundertakenattheendofthefirstquarter2008.3865McDadediscussedwith
Executive Committee members on March 28, 2008, Lehmans use of Repo 105
transactions and recommended to the Executive Committee during the meeting that
LehmanlimititsfirmwideRepo105usagetoacertaindollaramount.3866OnApril9,
2008, twelve days after McDades presentation to the Executive Committee, Callan
signedLehmansquarterlyreport.3867
Starting in April 2008, Callan received the Daily Balance Sheet and Disclosure
Scorecard, through which she was informed on a regular basis of the impact of Repo
105transactionsonLehmansfirmwidebalancesheet.3868
[LBEXDOCID095966](attachedtoemailfromGerardReilly,Lehman,toErinM.Callan,Lehman,etal.
meeting);seealsoHerbertH.(Bart)McDadeIII,LehmanBrothers,ExecutiveCommitteeMeetingMaterial,
HerbertH.(Bart)McDadeIII,toLehmanExecutiveCommitteeMembers(Mar.28,2008)[LBEXDOCID
120929] and listing among seven topics of discussion for March 28, 2008 Executive Committee meeting
Repo105/108andDelevervDerisk).CallanwasamemberoftheExecutiveCommittee.
3866Id.atpp.34.
3867LBHI,10Q(filedApr.9,2008),atp.92.
atp.9[LBEXDOCID520619](attachedtoemailfromTalLitvin,Lehman,toErinM.Callan,Lehman,et
al. (Apr. 9, 2008) [LBEXDOCID 523578] and showing consolidated FID and Equities balance sheet
reducedby$18.527billionandPrimeServicesbalancesheetreducedby$4.458billionthroughRepo105
transactions); Lehman, Balance Sheet and Disclosure Scorecard for Trade Date April 10, 2008 (Apr. 14,
105transactions);Lehman,BalanceSheetandDisclosureScorecardforTradeDateApril11,2008(Apr.14,
105transactions);Lehman,BalanceSheetandDisclosureScorecardforTradeDateMay12,2008(May13,
2008),atp.1[LBEXLL1950262](attachedtoemailfromTalLitvin,Lehman,toErinM.Callan,Lehman,
1015

Callan thus had ample red flags to alert her to potential problems arising from
Lehmans Repo 105 program before she signed Lehmans first quarter Form 10Q.
CallanignoredtheseredflagseventhoughshetrustedthejudgmentofKellyandhand
pickedhimtoserveasLehmansGlobalFinancialController.Callandidnotreportto
her superiors or the Board of Directors Kellys discomfort with Lehmans Repo 105
program or the risks that nondisclosure in Lehmans publicly filed statements
entailed.3869
Callan told the Examiner that following her meetings with Kelly in early 2008,
Kellys concerns likely fell by the wayside because of other more pressing issues
following BearStearnsnearcollapse.3870LehmansRepo105programwasnothigh
onCallanslistsoshedidnotspendanymeaningfulamountoftimeonit.3871While
etal.(May13,2008)[LBEXDOCID3187357]andstatingRatesdecreasedby$(5.0B)frompriordaydue
to...increasedRepo105usage....);Lehman,BalanceSheetandDisclosureScorecardforTradeDate
ErinM.Callan,Lehman,etal.(May27,2008)[LBEXDOCID275984]andstatingGlobalratesnetbalance
sheet decreased ($2.0B), predominantly due to an increase in Repo 105 benefit. . . .); Lehman, Balance
(attached to email from Tal Litvin, Lehman, to Erin M. Callan, Lehman, et al. (May 30, 2008) [LBEX
DOCID 275995] and stating Global rates net balance sheet decreased by ($3.1B) primarily due to a
decrease in Americas driven by an increased utilization of Repo 105 within the Agency business);
[LBEXLL1950658](attachedtoemailfromTalLitvin,Lehman,toErinM.Callan,Lehman,etal.(June2,
2008) [LBEXDOCID 011127] and stating Global Rates net balance sheet decreased ($6.5B)[t]he
decreaseinEuropeiscomingfromincreasedutilizationofRepo105).
3869CallantoldtheExaminerthatshedidnotdiscussRepo105withFuld,McDade,Gregory,Tonucci,the
ExecutiveCommittee,orErnst&Young.ExaminersInterviewofErinM.Callan,Oct.23,2009,atpp.18
19.
3870Id.atp.17.
3871Id.
1016

atrieroffactcouldacceptthatexplanation,Callansfailuretoact,whichdidnotresult
fromareasoneddecision,isnotprotectedbythebusinessjudgmentrule.3872
a. ThereIsSufficientEvidenceToSupportaFinding
BytheTrierofFactThatCallanBreachedHer
FiduciaryDutiesbyCausingLehmantoMake
MateriallyMisleadingStatements
To establish director liability based on a disclosure violation, plaintiffs must
pleadfactsthatshowthattheviolationwasmadeknowinglyorinbadfaith,ashowing
thatrequiresallegationsregardingwhatthedirectorsknewandwhen.3873ADelaware
court would apply the same standard to officer liability.3874 The evidence of Callans
knowledgeofLehmansRepo105programandthewarningsshereceivedfromKelly,
coupled with Callans responsibilities as the firms CFO, is sufficient to support a
colorable claim that she breached her fiduciary duties when she knowingly or in bad
faithcausedLehmantopubliclyfileperiodicreportsthatcontainedmaterialomissions
and/ormisrepresentations.
Corporate fiduciaries breach their duty of loyalty under Delaware law by
intentionallyfailingtoactinthefaceofaknowndutytoact,demonstratingaconscious
3872Thebusinessjudgmentruledoesnotprotectanofficerfrompersonalliabilityforinactionunlessthe
failuretoactwastheresultofaconsciousandreasoneddecisiontotakenoaction.McMullinv.Beran,765
A.2d910,922(Del.2000)(Thebusinessjudgmentruleisrebuttediftheplaintiffshowsthatthedirectors
failed to exercise due care in informing themselves before making their decision.). Alternatively,
Callans failure to act in the face of a known duty to act also rebuts the business judgment rule
presumption.
3873InreCitigroup,964A.2dat13334.
3874See Gantler v. Stephens, 965 A.2d 695, 709 (Del. 2009) (stating that fiduciary duties of officers and
directorsareidentical).
1017

disregardfortheirdutiesandalackoftruedevotiontotheinterestsofthecorporation
anditsshareholders.3875
Through her discussions with Kelly regarding the potential reputational harm
Lehman would suffer if the public were to learn about the firms use of Repo 105
transactionstomanageitsbalancesheetandnetleverageratio,Callanwaswarnednot
onlyofthepotentialharmtoLehman,butalsoofthelikelymaterialityofinformation
regardingLehmansRepo105program.WithknowledgeoftheseaspectsofLehmans
Repo105program,CallannonethelesscausedLehmantofileitsfirstquarterForm10Q
inApril2008withoutdisclosingthefirmsrelianceuponRepo105transactions,thereby
exposingLehmantopotentialliability.3876
SufficientevidencealsoexiststosupportacolorableclaimthatCallanbreached
her fiduciary duties to Lehman by exposing the firm to potential liability for making
misleadingstatementsduringLehmansearningscallsforthefirstquarterandsecond
quarterof2008.TheMarch18,2008earningscalldemonstratesthattransparencyon
thebalancesheetandLehmanseffortsatdeleveragingwereofinteresttoanalystsand
the market. During the call, Callan reported to analysts the drop in Lehmans net
leverageratiofromthefourthquarter2007tothefirstquarter2008,butdidnotdisclose
thatthereductioninleveragewaspartiallyattributabletoanapproximately$11billion
3875LyondellChem.Co.v.Ryan,970A.2d235,24344(Del.2009)(statingthatdirectorsbreachtheirdutyof
loyaltyiftheyknowinglyandcompletelyfail[]toundertaketheirresponsibilities).
3876SeeSectionsIII.A.4.j.12ofthisReport(discussingmaterialityanddisclosureobligations).
1018

increase in quarterend Repo 105 usage between fourth quarter 2007 and first quarter
2008(fromapproximately$38billionattheendoffiscalyear2007toapproximately$49
billion at the end of first quarter 2008). When asked repeatedly about the means by
which Lehman deleveraged, Callan only mentioned the sale of assets, at no time
mentioningLehmansuseofoffbalancesheetrepotransactionstomanagethebalance
sheetandimprovenetleverage.Similarly,duringthepreliminarysecondquarter2008
earningscall,CallanfocusedonLehmansreducedleveragebutfailedtomentionthat
Lehman had temporarily removed $50 billion in assets from its balance sheet using
Repo105transactions.
b. ThereIsSufficientEvidencetoSupporta
ColorableClaimThatCallanBreachedHer
FiduciaryDutyofCarebyFailingtoInformthe
BoardofDirectorsofLehmansRepo105Program
On March 25, 2008, Callan spoke to the Boards Finance and Risk Committee
about the industrywide pressure to delever and the firms plan for reducing total
assets, focusing primarily on the Fixed Income Division, but she failed to disclose in
thatpresentationthattheFixedIncomeDivisionreliedheavilyonRepo105transactions
formanagingitsbalancesheetatquarterend.3877DuringanApril15,2008meetingof
theBoardofDirectors,CallanreportedLehmansnetleverageratioandthefirmsplan
3877Lehman Brothers Holdings Inc., Minutes of Meeting of the Finance and Risk Committee (Mar. 25,
2008),atp.2[LBEXAM003592].
1019

at further reducing leverage through targeted reductions in net assets, but again said
nothingaboutthefirmsuseofRepo105transactions.3878
In light of the market demand that Lehman deleverage and Kellys concerns
abouttherisksofLehmansRepo105practice,Callankneworshouldhaveknownthat
information regarding Lehmans Repo 105 practice (e.g., accounting treatment, lack of
disclosure, volumes of quarterend transactions, and impact on Lehmans publicly
reported net leverage ratio) would have been material to Lehmans directors.3879
Information must be disclosed if it is relevant to the board and of sufficient
magnitudetobeimportant.3880
Given Callans actual knowledge about Lehmans Repo 105 program when
speaking to the Board of Directors and the likely potential materiality of information
relating to Repo 105 transactions impact on the firmwide balance sheet and net
leverage ratio, the Examiner concludes that sufficient evidence exists to support a
colorable claim that Callan violated her duties of loyalty, good faith, and due care by
failingtodisclosematerialinformationtotheBoard.
3878Lehman Brothers Holdings Inc., Minutes of Meeting of Board of Directors (Apr. 15, 2008), at p. 4
[LBEXAM003654].
3879Toformabasisforanofficerspersonalliabilityforbreachingthedutyofcandor,theundisclosedor
misrepresented facts must be material to the principalsdecisions or responsibilities. While materiality

forpurposesofinformationtoshareholdersisdeterminedunderthetotalmixofinformationstandard,
theDelawareSupremeCourthasadoptedalowerstandardofmaterialitywithrespecttomanagements
disclosureofinformationtotheboard.SeeBrehm,746A.2dat25960n.49.
3880Id.at260n.49(Thetermmaterialisusedinthiscontexttomeanrelevantandofamagnitudetobe
important to directors in carrying out their fiduciary duty of care in decisionmaking.); see also
RESTATEMENT(THIRD)OFAGENCY8.11cmts.bd.
1020

(iv) IanLowitt
There is sufficient evidence to support a finding by the trier of fact that Lowitt
wasatleastgrosslynegligentincausingLehmantofilemateriallymisleadingfinancial
statements.AccordingtoKelly,bythetimeLowittbecameLehmansCFOinJune2008,
Lowitt was quite familiar with Lehmans use of Repo 105 transactions to reduce its
balance sheet at quarterend and understood [the] details of the program.3881 In
addition:
While serving as coCAO, Lowitt was informed of John Feracas ultimately

unsuccessful attempts to place real estate securities into the Repo 105
program.3882LowittrecalledthatFeracawouldreportonLehmansRepo105
use to him because Lowitt was a member of Lehmans Asset Liability
Committee(ALCO).3883FeracaalsoinformedLowittofthevolumeofRepo
105 transactions with specific counterparties at the close of the first quarter
2008.3884 Lowitt recalled that at the close of the first quarter 2008, he
attempted to gauge the materiality of Lehmans Repo 105 usage and asked
Feraca for information to determine whether Lehman was increasing its
Repo105activity.3885
3881ExaminersInterviewofMartinKelly,Oct.1,2009,atp.10(statingthatwhenheraisedhisconcerns
about Repo 105 to Lowitt, Lowitt was already quite familiar with the program and understood its
details);ExaminersInterviewofIanT.Lowitt,Oct.28,2009,atp.10(recallingthatLehmanhadinitiated
its Repo 105 program in the early 2000s and that FID and Equities division would use Repo 105
transactionstoreachbalancesheettargets).
3882Email from Kentaro Umezaki, Lehman, to Christopher M. OMeara, Lehman, et al. (Aug. 17, 2007)
[LBEXDOCID1533678].
3207903];emailfromJohnFeraca,Lehman,toIanT.Lowitt,Lehman,etal.(Feb.28,2008)[LBEXDOCID
3207910].
1021

During the second quarter 2008, Lowitt was told that the intraquarter
balancesheetincreaseof$95billioninFIDsratesbusinesswasdue,inpart,
toa$22.4billionreductioninRepo105sincequarterend.3886
LowittreceivedtheDailyBalanceSheetandDisclosureScorecardfromApril
toSeptember2008,whichmadefrequentmentionoftheimpactofRepo105
transactionsonLehmansbalancesheet.3887
3886SeeemailfromGerardReilly,Lehman,toIanT.Lowitt,Lehman,etal.(Mar.20,2008)[LBEXDOCID
4220790];Lehman,MarchNetBalanceSheetDailyTrend(Mar.20,2008)[LBEXDOCID4070215];email
fromGerardReilly,Lehman,toIanT.Lowitt,Lehman,etal.(Mar.20,2008)[LBEXDOCID2973597].
atp.9[LBEXDOCID520619](attachedtoemailfromTalLitvin,Lehman,toIanT.Lowitt,Lehman,etal.
transactionsasofApril7,2008);Lehman,BalanceSheetandDisclosureScorecardforTradeDateApril8,
2008(Apr.10,2008),atp.9[LBEXDOCID520620](attachedtoemailfromTalLitvin,Lehman,toIanT.
Lowitt,Lehman,etal.(Apr.10,2008)[LBEXDOCID523579]andshowingconsolidatedFIDandEquities
TradeDateApril9,2008(Apr.10,2008),atp.9[LBEXDOCID251339](attachedtoemailfromTalLitvin,
Lehman,toIanT.Lowitt,Lehman,etal.(Apr.10,2008)[LBEXDOCID258560]andshowingconsolidated
FIDandEquitiesbalancesheetreducedby$19.688billionandPrimeServicesbalancesheetreducedby
$4.548billionthroughRepo105transactionsasofApril9,2008);Lehman,BalanceSheetandDisclosure
ScorecardforTradeDateApril10,2008(Apr.14,2008),atp.9[LBEXDOCID251342](attachedtoemail
from Tal Litvin, Lehman, to Ian T. Lowitt, Lehman, et al. (Apr. 14, 2008) [LBEXDOCID 275231] and
showing consolidated FID and Equities balance sheet reduced by $19.967 billion and Prime Services
balance sheet reduced by $4.491 billion through Repo 105 transactions as of April 10, 2008); Lehman,
Balance Sheet and Disclosure Scorecard for Trade Date April 11, 2008 (Apr. 14, 2008) [LBEXDOCID
251344],atp.9(attachedtoemailfromTalLitvin,Lehman,toIanT.Lowitt,Lehman,etal.(Apr.14,2008)
[LBEXDOCID 258562] and showing consolidated FID and Equities balance sheet reduced by $20.260
billion and Prime Services balance sheet reduced by $4.517 billion through Repo 105 transactions as of
April11,2008);Lehman,BalanceSheetandDisclosureScorecardforTradeDateMay12,2008(May13,
2008),atp.1[LBEXLL1950262](attachedtoemailfromTalLitvin,Lehman,toIanT.Lowitt,Lehman,et
al.(May13,2008)[LBEXDOCID3187357]andstatingRatesdecreasedby$(5.0B)frompriordaydueto.
..increasedRepo105usage....);Lehman,BalanceSheetandDisclosureScorecardforTradeDateMay
22,2008(May27,2008),atp.1[LBEXLL1950706](attachedtoemailfromTalLitvin,Lehman,toIanT.
Lowitt,Lehman,etal.(May27,2008)[LBEXDOCID275984]andstatingGlobalratesnetbalancesheet
decreased ($2.0B), predominantly due to an increase in Repo 105 benefit. . . .); Lehman, Balance Sheet
and Disclosure Scorecard for Trade Date May 28, 2008 (May 30, 2008), at p. 1 [LBEXLL 1950670]
(attachedtoemailfromTalLitvin,Lehman,toIanT.Lowitt,Lehman,etal.(May30,2008)[LBEXDOCID
275995] andstatingGlobal rates net balance sheet decreased by ($3.1B) primarily due toa decrease in
AmericasdrivenbyanincreasedutilizationofRepo105withintheAgencybusiness);Lehman,Balance
(attachedtoemailfromTalLitvin,Lehman,toIanT.Lowitt,Lehman,etal.(June2,2008)[LBEXDOCID
1022

Four days before the close of second quarter 2008, Lowitt was informed of
fundingproblemswithcertainRepo105counterparties.3888
Furthermore, Lowitt attended the March 28, 2008 special meeting of the
Executive Committee requested by McDade.3889 Lowitt received the same documents
thatlistedthe$49.1billioninRepo105transactionsLehmanhadundertakenattheend
of the first quarter 2008, and was present when McDade discussed Lehmans use of
Repo105transactions.3890
011127] and stating Global Rates net balance sheet decreased ($6.5B) . . . [t]he decrease in Europe is
coming from increased utilization of Repo 105); Lehman, Balance Sheet and Disclosure Scorecard for
TradeDateJune18,2008(June20,2008)[LBEXLL1950514](attachedtoemailfromTalLitvin,Lehman,
toIanT.Lowitt,Lehman,etal.(June20,2008)[LBEXDOCID275942]andstatingthatGlobalratesnet
balancesheetdecreased...drivenbya[n]...increaseinRepo105utilization....);Lehman,Balance
Sheet and Disclosure Scorecard for Trade Date August 13, 2008 (Aug. 14, 2008) [LBEXLL 782812]
(attached to email from Tal Litvin, Lehman, to Ian T. Lowitt, Lehman, et al. (Aug. 14, 2008) [LBEX
DOCID4214810]andstatingthatGlobalratesnetbalancesheetdecreased...drivenbyanincreasein
Repo105benefit....);Lehman,BalanceSheetandDisclosureScorecardforTradeDateAugust25,2008
(Aug.26,2008)[LBEXLL782924](attachedtoemailfromTalLitvin,Lehman,toIanT.Lowitt,Lehman,
etal.(Aug.26,2008)[LBEXDOCID079536]andstatingthatGlobalRatesnetbalancesheetdecreased...
drivenbyanincreaseinrepo105usage....);Lehman,BalanceSheetandDisclosureScorecardforTrade
DateAugust28,2008(Aug.29,2008)[LBEXLL782966](attachedtoemailfromTalLitvin,Lehman,to
Ian T. Lowitt, Lehman, et al. (Aug. 29, 2008) [LBEXDOCID 275880] and stating that Global rates [net
balancesheet]wasdown...drivenbyincreasedRepo105benefit....).
3888Email from John Feraca, Lehman, to Ian T. Lowitt, Lehman, et al. (May 27, 2008) [LBEXDOCID
070831]
3889Examiners Interview of Herbert H. Bart McDade III, Jan. 28, 2010, at p. 4 (stating that the entire
ExecutiveCommittee,exceptforFuld,andexofficiomembersLowittandFriedheimattendedtheMarch
28,2008meeting).
3890Examiners Interview of Herbert H. Bart McDade III, Jan. 28, 2010, at pp. 34; Herbert H. (Bart)
McDade III, Lehman, Balance Sheet and Cash Capital Update (Mar. 27, 2008), at p. 1 [LBEXDOCID
095961](attachedtoemailfromGerardReilly,Lehman,toIanT.Lowitt,Lehman,etal.(Mar.28,2008)
[LBEXDOCID120929]andindicatingthattheattachmentisfortheExecutiveCommitteemeeting));see
also Herbert H. (Bart) McDade III, Lehman, Executive Committee Meeting Material, Agenda (Mar. 28,
2008) [LBEXDOCID 115827] (attached to email from Patricia Lombardi, Assistant to Herbert H. (Bart)
McDade III, to Ian T. Lowitt, Lehman, et al. (Mar. 28, 2008) [LBEXDOCID 120929] and listing among
seventopicsofdiscussionforMarch28,2008ExecutiveCommitteemeetingRepo105/108andDelever
vDerisk).
1023

LowittalsoreceivedtheJune2008BalanceSheetandKeyDisclosuresdocument
thatincorporatedMcDadesplanneddirectivetoreduceLehmansfirmwideRepo105
usage by half from $50 billion to $25 billion in third quarter 2008 and met with
McDade,Reilly,OMeara,andMortontodiscusstheissues.3891Thus,atthetimeLowitt
signed the second quarter 2008 Form 10Q, sufficient evidence exists to support a
colorable claim that he was aware of the material impact that Lehmans Repo 105
practicehadonthefirmwidebalancesheetandpubliclyreportedleverageratios.
Lowitt took no action to ensure Lehman filed accurate and complete financial
statements and MD&A. Lowitt certified Lehmans second quarter 2008 Form 10Q,
exposing Lehman to potential liability for making material misstatements and
omissionsinpubliclyfiledfinancialstatementsandMD&A;thereissufficientevidence
tosupportacolorableclaimthatLowittbreachedhisfiduciarydutyofcare.
(c) Remedies
The primary remedy for a breach of fiduciary duty is forcing the fiduciary to
disgorge his or her profits. A fiduciary is liable to disgorge profits regardless of
Key Disclosure 2008 3Q Targets document); email from Gerard Reilly, Lehman, to Ian T. Lowitt,
Lehman,etal.(June19,2008)[LBEXDOCID2962369](transmittingupdatedversionofLehman,Balance
SheetandKeyDisclosures20083QTargets(June19,2008)[LBEXDOCID2932594]andindicatingthata
meetingwithReilly,Lowitt,OMeara,andMcDadetookplace).
1024

whether it can be proven that the breach injured the fiduciarys principal.3892 If a
plaintiff is seeking disgorgement of salary, however, then the plaintiff must also
demonstrate a quantifiable harm to the principal.3893 Outside Delaware, there is
considerableauthorityforthepropositionthatacorporateofficermustdisgorgeallof
thecompensationpaidforservicesduringtheperiodofthebreach.3894Courtsapplying
Delaware law, however, appear to be split between applying this rule of full
disgorgementandrequiringdisgorgementofonlythecompensationattributabletothe
breachingconduct.3895
3892Thorpe ex rel. Castleman v. CERBCO, Inc., 676 A.2d 436, 445 (Del. 1996) (finding defendant liable for
disgorgement plus reimbursement of any expenses, including legal and due diligence costs, that the
corporationincurred).
3893SeeCintronv.MerrittChapman&ScottCorp.,407A.2d1040,1045(Del.1979).
3894See, e.g., Wilshire Oil Co. of Texas v. Riffe, 406 F.2d 1061, 1062 (10th Cir. 1969) (holding that, under
Oklahoma law, a corporation was entitled to judgment against former officer in an amount equal to
seventwelfths of the salary and bonus paid him for services during a calendar year, where he was in
breachforperiodofsevenmonthsinthatyear);seealsoCarcoGroup,Inc.v.Maconachy,644F.Supp.2d
218, 244 (E.D.N.Y. 2009) (Under New York law, an employee is required to forfeit all compensation,
including commissions or salary, paid beginning with his first disloyal act.); Aramony v. United Way
Replacement Benefit Plan, 191 F.3d 140, 153 (S.D.N.Y. 1999) (holding that, under New York law, an
unfaithful fiduciary was obligated to return all salary paid to him during the time in which he was in
violationofhisfiduciaryduties);InreOmniMech.Contractors,Inc.,114B.R.518,541(Bankr.E.D.Tenn.
1990)(Thegeneralrule...isthatcorporateofficerswhobreachtheirdutyofloyaltyorwhowillfully
breachtheircontractofemploymentarenotentitledtoanycompensationforservicesperformedduring
thattimeperiodeventhoughsomeserviceswereperformedproperly.).
3895Compare Borden v. Sinskey, 530 F.2d 478, 49798 (3d Cir. 1976) (disgorging unfaithful fiduciary
defendant of all salaries earned from companies that he wrongfully acquired for himself instead of
presenting his employer with the opportunity to acquire them), and Guth v. Loft, 5 A.2d 503, 508 (Del.
1939) (upholding a decision requiring an officer to turn over to his former employer all salary or
compensation paid to him by a competing interest from the time he beganself dealingas wellasany
compensationpaidabovewhatwasreasonableafterhisfiduciaryrelationshipwiththeplaintiffended)
with Technicorp Intern. II, Inc. v. Johnston, No. Civ. A. 15084, 2000 WL 713750, at *53 (Del. Ch. May 31,
2000)(permittingagentstoretainanamountrepresentingreasonablecompensationfortheservicesthey
had legitimately and beneficially performed for the corporations.), and Julian v. E. States Const. Serv.,
Inc.,Civ.A.No.1892VCP,2008WL2673300at*1(Del.Ch.July8,2008)(disgorgingonlythebonuses
1025

While the most common remedies for breach of fiduciary duty are in equity, a
plaintiffsrecoveryisnotlimitedtodisgorgementorotherremediesthatmaybetraced
directly to the breach.3896 Indeed, Delaware courts have wide latitude to craft damage
remediestocompensateapartywithrespecttowhomadefendantbreachedafiduciary
duty.3897 Another remedy that may be available to a party asserting a breach of
fiduciary duty would be compensatory damages, which would attempt to rectify any
financial harm caused to the beneficiary by a fiduciarys breach of his duties.3898 The
Restatement of Torts supports the contention that, in the case of a breach of fiduciary
directors awarded themselves in violation of their fiduciary duties instead of all compensation paid to
themwhiletheywereinviolationoftheirduties).
3896See, e.g., Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1166 (Del. 1995) (citations omitted) ([T]he
measureofdamagesforanybreachoffiduciaryduty,underanentirefairnessstandardofreview,isnot
necessarilylimitedtothedifferencebetweenthepriceofferedandthetruevalueasdeterminedunder
the appraisal proceedings. . . . [T]he [Court of Chancery] may fashion any form of equitable and
monetaryreliefasmaybeappropriate,includingrescissorydamages.);Weinbergerv.UOP,Inc.,457A.2d
701, 714 (Del. 1983) (Under such circumstances [involving a breach of fiduciary duty], the [courts]
powers are complete to fashion any form of equitable and monetary relief as may be appropriate,
including rescissory damages.); Harman v. Masoneilan Intl, Inc., 442 A.2d 487, 500 (Del. 1982) ([T]he
relief available in equity for tortious conduct by one standing in a fiduciary relation with another is
necessarilybroadandflexible.).
3897SeeWeinbergervUOP,Inc.,457A.2d701,714(Del.1983)([T]heChancellorspowersarecompleteto
fashion any form of equitable and monetary relief as may be appropriate, including rescissory
damages.).
3898See,e.g.,Noerrv.Greenwood,No.14320NC,2002WL31720734,at*5(Del.Ch.Nov.22,2002)(granting
classcertificationtoaclaimrequestingprimarilycompensatorydamagesbasedonabreachoffiduciary
duty);PainewebberR&DPartnersII,L.P.v.Centocor,Inc.,No.14405,1999WL160123,at*15(Del.Ch.Mar.
15, 1999) (approving settlement agreement including compensatory damages for alleged breaches of
fiduciaryduty);seealsoThorpe,676A.2dat445(holdingthatDelawarecaselawdidnotonlyrequirethat
thedefendantnotprofitfromdisloyalconductbutthatthebeneficiaryofthedutyalsosufferharmasa
resultofthebreachand,therefore,damagescouldbeappropriateifproven);cf.InreJPMorganChase&
Co.SHolderLitig.,906A.2d766,772(Del.2006)(denyingplaintiffsclaimforcompensatorydamagesnot
becausecompensatorydamageswereinapplicabletoaclaimforbreachoffiduciarydutybutbecausethe
requesteddamagescouldnotbeconnectedtotheallegedbreach).
1026

duty, compensatory damages may be awarded.3899 A party seeking compensatory
damageswouldhavetoprovedamagesandcausationinordertobesuccessful.3900
IntheeventthatLehmaniseventuallysubjecttoliabilityasaconsequenceofthe
actions ofone or more of its officers, those officers may be liable to Lehman
accordingly.
(5) MalpracticeClaimsAgainstErnst&Young
The Examiner concludes that sufficient evidence exists to support colorable
claims against Ernst & Young LLP (Ernst & Young) for professional malpractice
arising from Ernst & Youngs failure to follow professional standards of care with
respect to communications with Lehmans Audit Committee, investigation of a
whistleblowerclaim,andauditsandreviewsofLehmanspublicfilings.3901
3899RESTATEMENT (SECOND) OF TORTS 874 cmt. b (1979) (The remedy of a beneficiary against a
defaulting or negligent trustee is ordinarily in equity; the remedy of a principal against an agent is
ordinarily at law. However, irrespective of this, the beneficiary is entitled to tort damages for harm
causedbythebreachofdutyarisingfromtherelation....).
3900SeeLNCInvs.,Inc.v.FirstFidelityBank,N.A.,N.J.,173F.3d454,465(2dCir.1999)([W]heredamages
are sought for breach of fiduciary duty under New York law, the plaintiff must demonstrate that the
defendants conduct proximately caused injury in order to establish liability.); Am. Fed. Group, Ltd v.
Rothenberg,136F.3d897,908n.7(2dCir.1998)(statingthatinbreachoffiduciarydutycaseswherethe
remedy sought is damages to compensate for loss, the usual damagescausation rule for tort cases
applies).
3901The Examiner consulted with an industry expert, Gary L. Holstrum, PhD, CPA, to assist in the
analysis of professional auditing standards. Dr. Holstrum earned a PhD in accounting from the
UniversityofIowasSchoolofBusiness.HerecentlyservedasanAssociateChiefAuditorandDirector
ofResearch,andhasbeenaconsultanttotheOfficeofChiefAuditor,atthePublicCompanyAccounting
OversightBoard.Hehasbeenaprofessorofaccountancyatseveraluniversities,includingtheUniversity
ofSouthernCalifornia,theUniversityofTexasatAustin,theUniversityofFlorida,andtheUniversityof
South Florida. In 2009, Dr. Holstrum received the Distinguished Service in Auditing Award from the
Auditing Section of the American Accounting Association. Dr. Holstrums experience, including
publications and service on the Auditing Standards Board, is more fully described in his resume,
Appendix17,Repo105Appendix.Dr.HolstrumconcurswiththefindingsinthisSectionoftheReport,
1027

(a) BackgroundandLegalStandards
(i) ProfessionalStandards
Oneoftheprimaryresponsibilitiesofanexternalauditoristoexpressanopinion
whetherthecompanysfinancialstatementsarepresentedfairly,inallmaterialrespects,
in accordance with Generally Accepted Accounting Principles (GAAP). Professional
standardshavebeenestablishedtoensurethatexternalauditorsfulfilltheirobligations
when auditingandreviewingfinancial statementsandotherinformationcontained in
SEC filings. Those standards are known as generally accepted auditing standards, or
GAAS. GAAS consists of authoritative standards, originally established by the
American Institute of Certified Public Accountants (AICPA), which auditors must
complywithwhentheyconductauditsandreviews.
The SarbanesOxley Act of 2002 authorized the Public Accounting Oversight
Board (PCAOB) to establish auditing and related professional practice standards to
be used by registered public accounting firms.3902 PCAOB Rule 3100, Compliance with
AuditingandRelatedProfessionalPracticeStandards,issuedbythePCAOBandapproved
by the SEC, requires registered public accounting firms to comply with all applicable
auditing and related professional practice standards of the PCAOB in their
andinhisopinion,avalidclaimforprofessionalmalpracticecanberaisedonthesefacts.TheExaminer
metwithcounselforErnst&YoungtodiscussthecolorableclaimsidentifiedinthisSection,andcounsel
presented several arguments as to why Ernst & Young did not commit malpractice. Following that
presentation, the Examiner discussed Ernst & Youngs presentations with Dr. Holstrum, and Dr.
Holstrumsopinionastotheexistenceofcolorableclaimsdidnotchange.
3902SeePub.L.No.107204,103(a)(d),2002U.S.C.C.A.N.(116Stat),745,75557(codifiedat15U.S.C.
73213(2006)).
1028

engagements relating to documents filed with the SEC, including audits of annual
financial statements and reviews of interim financial information of public
companies.3903 The PCAOB adopted as interim auditing standards the generally
accepted auditing standards described in the AICPAs Auditing Standards Board
(ASB)StatementonAuditingStandardsNo.95,GenerallyAcceptedAuditingStandards,
inexistenceonApril16,2003.3904
GAAS consists of ten standards (three general standards, three fieldwork
standards, and four reporting standards) that are further interpreted and defined in
Statements on Auditing Standards or SASs which are referred to by reference to
AUsections.3905Amongthetenauditingstandardsarethefollowing:
Dueprofessionalcareistobeexercisedintheperformanceoftheauditand
thepreparationofthereport.
3903SeeOrderApprovingProposedRuleRelatingtoCompliancewithAuditingandRelatedProfessional
PracticeStandards,ExchangeActReleaseNo.48,730,81SECDocket1509(Oct.31,2003).
3904See Order Regarding Section 103(A)(3)(B) of the SarbanesOxley Act of 2002, Securities Act Release
No. 8222, Exchange Act Release No. 47,745, 80 SEC Docket 142 (Apr. 25, 2003). Ernst & Young is
registered with and regulated by the PCAOB, and Ernst & Youngs audits and reviews for public
companies such as Lehman are subject to the PCAOBs auditing standards. The PCAOB Auditing
Standards,whichareapplicabletotheErnst&Youngannualauditandinterimreviewengagementsof
LehmanduringtheperiodsaddressedinthisReport,areshownintheStandardssectionofthePCAOB
web site (www.pcaob.org). The PCAOB adopted as its Interim Auditing Standards only those SASs
issued by the ASB that were issued before April 16, 2003. After that date, the PCAOB issued its own
additionalAuditingStandardsandrevisionsoftheInterimAuditingStandardsasitdeemedappropriate,
subjecttoitsdueprocessrequirements,includingapprovalbytheSEC.AnySASissuedbytheASBafter
April16,2003(essentiallyafterSASNo.101)didnotanddoesnotbecomeaPCAOBAuditingStandard,
applicabletoauditsofpubliccompanies(and,consequently,isnotshownonthePCAOBwebsite).
3905CODIFICATION OF ACCOUNTING STANDARDS AND PROCEDURES, Statement on Auditing Standards No.
95, AU 150.02 (Am. Inst. of Certified Pub. Accountants 2002). The AU standards adopted by the
PCAOB are available at http://www.pcaobus.org/Standards/Interim_Standards/Auditing_Standards/
index.aspx. They are referenced by the applicable section and paragraph number for the remainder of
thisSectionoftheReport.
1029

A sufficient understanding of internal control is to be obtained to plan the

audit and to determine the nature, timing, and extent of tests to be
performed.
Sufficientcompetentevidentialmatteristobeobtainedthroughinspection,
observation,inquiries,andconfirmationstoaffordareasonablebasisforan
opinionregardingthefinancialstatementsunderaudit.
The auditors report must state whether the financial statements are
presentedinaccordancewithGAAP.
Informative disclosures in the financial statements are to be regarded as

reasonablyadequateunlessotherwisestatedinthereport.
The report shall contain either an expression of opinion regarding the

financial statements, taken as a whole, or an assertion to the effect that an
opinioncannotbeexpressed.Whenanoverallopinioncannotbeexpressed,
thereasonsthereforeshouldbestated.
SeeAU150.02.
The objective of an auditors review of quarterly financial information is to
provide a basis for reporting whether the reviewer is aware of material modifications
that should be made to the information to conform with GAAP. See AU 722.07. A
reviewincludesobtainingsufficientknowledgeoftheentitysbusinessanditsinternal
controlasitrelatestothepreparationofbothannualandinterimfinancialinformation
to: (1) identify the types of potential material misstatements in the interim financial
informationandconsiderthelikelihoodoftheiroccurrence;and(2)selecttheinquiries
and analytical procedures that will provide the accountant with a basis for
communicatingwhetherheorsheisawareofanymaterialmodificationsthatshouldbe
made to the interim financial information for it to conform with GAAP. See AU
1030

722.09.Inthecourseofreviewinginterimfinancialinformation,auditorsarerequired
tomakeinquiriesofmembersofmanagementwhohaveresponsibilityforfinancialand
accounting matters concerning, among other things, significant transactions occurring
orrecognizedinthelastseveraldaysoftheinterimperiod.SeeAU722.18(c).
(ii) CommonLawStandards
To state a claim of auditor malpractice under New York law,3906 a client must
allege the existence of a duty, a breach of that duty, proximate causation, and
damages.3907 Generally, breaches of duty are demonstrated by a showing that the
auditor departed from accepted standards of practice and that this departure was the
proximatecauseofplaintiffsinjury.3908Indeterminingwhetheranauditorhasdeviated
from accepted standards, courts and tribunals routinely look to the recognized and
3906LehmansengagementletterwithErnst&Youngdoesnotcontainachoiceoflawprovision,butNew
YorklawwouldlikelyapplytoamalpracticeactiongiventhatLehmanwasheadquarteredinNewYork
andmostofErnst&YoungsauditworkwascenteredinNewYork.SeeAIGv.Greenberg,965A.2d763,
81722(Del.Ch.2009)(NewYorklawgovernedmalpracticeandbreachofcontractclaimsagainstauditor
where auditing work was performed primarily in New York and audited client was headquartered in
NewYork).Theengagementletterforthe2007auditcontainsamandatoryarbitrationclause,seeLetter
fromErnst&YoungtoChristopherM.OMeara,Lehman,re:2007auditservices(May15,2007),at33
[EYLEKEYPERS 2641786] (Engagement Letter (May 15, 2007)), and such clauses are generally
adhered to in bankruptcy proceedings in this jurisdiction. See In re Refco, Inc. Sec. Litig., Nos. 07 MDL
1992(GEL),07Civ.11604(GEL),2008WL2185676,at*5(S.D.N.Y.May21,2008)(holdingthatthetrustee
wasbound by arbitration clause in engagement letters between debtor and auditing firm);In re
Hagerstown Fiber Ltd. PShip, 277 B.R. 181, 206 (Bankr. S.D.N.Y. 2002) (If the debtor agreed in a pre
petitioncontracttoarbitrateadispute,thetrustee,suingassuccessortothedebtor,islikewiseboundby
thearbitrationclause.).LehmanandErnst&Younghadnotyetsignedthe2008engagementletter,but
the2007engagementletterstatesthatErnst&Youngwillcontinuetoprovideauditservicesinlateryears
pursuant to the terms of the 2007 agreement unless terminated by Lehman or Ernst & Young.
EngagementLetter(May15,2007)at9[EYLEKEYPERS2641786].
3907SeeVTechHoldings,Ltd.v.PricewaterhouseCoopers,LLP,348F.Supp2d255,262(S.D.N.Y.2004).
3908Id.;Hous.Works,Inc.v.Turner,179F.Supp2d177,215(S.D.N.Y.2001).
1031

accepted professional standards for accountants and auditors, generally measured by
GAAPandGAAS.3909
(b) ThereIsSufficientEvidencetoSupportaColorableClaim
ThatErnst&YoungWasNegligent
The Examiner finds that sufficient evidence exists to support at least three
colorable claims that could be asserted against Ernst & Young relating to Lehmans
Repo 105 activities and reporting: (1) negligence in connection with the investigation
intowhistleblowerMatthewLeesclaimsconcerning$50billioninRepo105activitiesat
the end of the second quarter 2008, including failing to conduct an adequate inquiry
into the allegations prior to the filing of Lehmans Form 10Q, and failing to properly
inform management and the Audit Committee of Lees allegations; (2) at least with
respect to Lehmans first quarter and second quarter 2008 Forms 10Q, if not with
respect to earlier filings, negligence by failing to take proper action when Ernst &
Young was made aware that the financial information may be materially misleading
becauseofthefailuretodisclosetheeffectofthetimingandvolumeofLehmansRepo
105 activities (which had a material effect on interim financial statement items), and
failingtotakeproperactionwithrespecttomateriallymisleadingstatementscontained
intheMD&AsectionsoftheForms10Qforthesequarters;and(3)atleastwithrespect
3909See,e.g.,CumisIns.SocyInc.v.Tooke,739N.Y.S.2d489,493(App.Div.2002).AsdiscussedinSection
III.A.4.j.5.a.ioftheExaminersReport,thePCAOBstandardsincorporateGAASandmustbefollowedfor
allauditsandreviewsofpubliccompaniesbypublicaccountingfirms,whichinturnmustberegistered
withthePCAOB.
1032

toLehmans2007Form10K,ifnotwithrespecttoearlierForms10K,negligenceby
failing to take proper action when Ernst & Young was made aware that the financial
statementsmaybemateriallymisleadingbecauseofthefailuretodisclosetheeffectof
thetimingandvolumeofLehmansRepo105activities(whichhadamaterialeffecton
financial statement items), and failing to take proper action with respect to materially
misleadingstatementscontainedintheMD&AsectionsoftheForm10K.3910
(i) MalpracticeinFailuretoAdviseAuditCommitteeof
Repo105ActivityandLeesAllegations
The Examiner concludes that sufficient evidence exists to support a colorable
claimformalpractice3911againstErnst&YoungarisingfromErnst&Youngsfailureto
apprise the Audit Committee of Matthew Lees allegations relating to Lehmans
extensivequarterendRepo105activity:
3910Professionalnegligenceclaimsmayalsobepresentedasbreachofcontractclaims,althoughasimilar
liabilitystandardwouldbeappliedundereithercauseofaction.Inaddition,ifLehmanweresubjecttoa
securities fraud claim and sought to allocate fault to Ernst & Young, Lehman would likely need to
demonstratescienteronthepartofErnst&Young,ratherthanmerenegligence.Rothmanv.Gregor,220
F.3d81,98(2dCir.2000)(securitiesfraudcomplaintallegedaccountingfirmhadviolatedvariousGAAP
provisions; those allegations, withoutcorresponding fraudulent intent, were insufficient to state claim);
Decker v. MasseyFerguson, Ltd., 681 F.2d 111, 12021 (2d Cir. 1982) (assumingaccountants
recklessnesscould satisfy scienter requirement of securities fraud action, such recklessness must be
conduct that is highly unreasonable and represents an extreme departure from the standards of
ordinarycare). TheExaminerhasnotanalyzedwhetheranyoftheactionsorinactionofErnst&Young
couldamounttorecklessnesssufficienttosatisfythemoredemandingstandardofscienter.
3911Based on these facts, the Examiner also considered whether there also is a colorable claim against
Ernst&Youngforaidingandabettingbreachesoffiduciaryduty.TheExaminerconcludedthatthereis
not sufficient, credible evidence identified at this time to support a claim. That said, however, with
furtherdiscovery,suchaclaimmaybeuncovered.
1033

InMay/June2008,theChairmanoftheAuditCommitteeandinternalaudit
requested that Ernst & Young assist with the investigation into allegations
madebyLeeinaMay16,2008letter.3912
Leesletterallegedanumberofpossibleaccountingirregularities,including
balance sheet substantiation discrepancies, valuation issues, and the lack of
competence and independence of Lehmans internal audit department.3913
LeesletterdidnotmentionRepo105transactions.
Aspartoftheinvestigation,WilliamSchlich(Ernst&YoungAuditPartner)
andHillaryHansen(anotherErnst&Youngpartner)metwithLeeonJune
12, 2008, and during that meeting, Lee raised an additional allegation not
containedinhisletter;specifically,headvisedSchlichandHansenthatatthe
end of the second quarter 2008, Lehman moved $50 billion in assets off its
balance sheet using Repo 105 transactions, only to move those assets back
onto the balance sheet a few days later.3914 Although Schlich stated that he
had no recollection of Lees Repo 105 assertions, those assertions were
prominentinHansenscontemporaneousnotesofthemeetingwithLeeand
3912Examiners Interview of Thomas Cruikshank, Oct. 8, 2009, at p. 7; Examiners Interview of Thomas
Cruikshank,Jan.20,2010,atp.3;ExaminersInterviewofRogerBerlind,Dec.18,2009,atp.3;Examiners
InterviewofMichaelL.Ainslie,Dec.22,2009,atp.2;ExaminersInterviewofSirChristopherGent,Jan.
20,2010,atp.2;ExaminersInterviewofBethRudofker,Dec.15,2009,atp.5.
3913Letter from Matthew Lee, Lehman, to Martin Kelly, Lehman, et al. (May 16, 2008) [EYLELBHI
KEYPERS5826885].Leeslettercontainedthefollowingsixallegations:(1)onthelastdayofeachmonth,
Lehmans books and records contained approximately $5 billion of net assets in excess of what was
managedonthelastdayofthemonth,therebysuggestingthatthefirmsseniormanagementwasnotin
control of its assets to be able to present full, fair, and accurate financial statements to the public; (2)
Lehmanhadtensofbillionsofdollarsofunsubstantiatedbalances,whichmayormaynotbebador
nonperformingassetsorrealliabilities;(3)Lehmanhadtensofbillionsofdollarsofilliquidinventory
anddidnotvalueitsinventoryinafullyrealisticorreasonableway;(4)givenLehmansrapidgrowth
andincreasednumberofaccountsandentities,ithadnotinvestedsufficientlyinfinancialsystemsand
personnel to cope with the balance sheet; (5) the India Finance office lacked sufficient knowledgeable
management, resulting in the real possibility of potential misstatements of material facts being
distributed by that office; and (6) certain senior level internal audit personnel were not qualified to
properlyexercisetheauditfunctionstheyareentrustedtomanage.
3914Examiners Interview of Ernst & Young, Nov. 3, 2009, at p. 14 (statement of Hillary Hansen);
ExaminersInterviewofMatthewLee,July1andJuly10,2009,atp.17;seealsoHillaryHansen,Ernst&
Young,NotesfrommeetingwithMatthewLee,June12,2009,atp.1[EYLELBHIKEYPERS5826869].
1034

Schlich,andHansenspecificallyrecalledconferringwithSchlichaboutLees
Repo105allegations.3915
ThenextdayonJune13,2008SchlichmetwiththeAuditCommitteeand
participated in an update to the committee on the Lee investigation.3916
SchlichdidnotinformtheAuditCommitteeabouttheRepo105claimsmade
by Lee, even though the Audit Committee asked to be told about each
allegation.3917
On July 8, 2008, the Audit Committee met with Schlich, Kelly, Lowitt, and
Beth Rudofker to review the second quarter MD&A and financial
statements.3918 At that meeting, Schlich did not raise any issues concerning
theadequacyofthedisclosuresorfinancialstatements,andstatedthatErnst
&Youngwouldissueanunqualifiedreviewreport.3919
On July 10, 2008, Ernst & Young issued an unqualified review report in
connectionwiththeissuanceofLehmansForm10Q.3920
On July 22, 2008, Schlich again remained silent as to Lees Repo 105
allegation at an Audit Committee meeting, where internal audit presented
the results of the investigation into each of the claims made by Lee in his
May16,2008lettertomanagement.3921Atthatmeeting,theAuditCommittee
3915ExaminersInterviewofErnst&Young,Nov.3,2009atp.14(statementofHillaryHansen);Id.atp.16
(statementofWilliamSchlich);ExaminersInterviewofErnst&Young,Oct.9,2009,atp.5(statementof
WilliamSchlich).
3916Examiners Interview of Roger Berlind, Dec. 18, 2009, at p. 4; Examiners Interview of Michael L.
Ainslie,Dec.22,2009,atp.2;ExaminersInterviewofSirChristopherGent,Jan.20,2010,atp.2.;seealso
Lehman Brothers Holdings Inc., Minutes of Meeting of Audit Committee (June 13, 2008) [LBEXAM
003759].
3917ExaminersInterviewofRogerBerlind,Dec.18,2009,atpp.2,4;ExaminersInterviewofMichaelL.
Ainslie, Dec. 22, 2009, at pp. 2, 3; Examiners Interview of Sir Christopher Gent, Jan. 20, 2010, at p. 2;
Examiners Interview of Thomas Cruikshank, Jan. 20, 2010, at p. 3; Examiners Interview of Beth
Rudofker, Dec. 15, 2009, at p. 7; see also Lehman Brothers Holdings Inc., Minutes of Meeting of Audit
Committee(June13,2008)[LBEXAM003759].
3918LehmanBrothersHoldingsInc.,MinutesofMeetingofAuditCommittee(July8,2008)atp.2[LBEX
AM003831].
3919Id.
3921Employee Letter Review, Presentation to the Audit Committee (July 22, 2008) [LBEXAM 067664];
ExaminersInterviewofThomasCruikshank,Jan.20,2010,atpp.2,3;ExaminersInterviewofMichaelL.
Ainslie,Dec.22,2009,atp.3;ExaminersInterviewofRogerBerlind,Dec.18,2009,atpp.34;Examiners
1035

was told that [c]orporate audit has largely completed an evaluation of

[Lees] observations in partnership with Financial Control and Ernst and
Young.3922
There is sufficient evidence to support a colorable claim that Ernst & Young
failedtoexercisedueprofessionalcarebyfailingtonotifytheAuditCommitteeofLees
allegations about endofquarter Repo 105 transactions as a means to manipulate
publicly reported balance sheet reductions.3923 See, e.g., AU 316.79 (Whenever the
auditorhasdeterminedthatthereisevidencethatfraudmayexist,thatmattershould
bebroughttotheattentionofanappropriatelevelofmanagement.Thisisappropriate
even if the matter might be considered inconsequential, . . . Fraud involving senior
management and fraud . . . that causes a material misstatement of the financial
statements should be reported directly to the audit committee); AU 317 (if auditor
becomesawareofpossibleviolationsoflawsorregulationswhichmayhaveadirector
indirect effect on the financial statements, he or she must make inquiries, perform
additionaltests,andinformmanagementandtheauditcommitteeoftheissue).3924
InterviewofSirChristopherGent,Jan.20,2010,atpp.23;ExaminersInterviewofBethRudofker,Dec.
15,2009,atp.7.
3922Employee Letter Review, Presentation to the Audit Committee (July 22, 2008), at p. 2 [LBEXAM
067664];seealsoLehmanBrothersHoldingsInc.,MinutesofMeetingofAuditCommittee(July22,2008),
atpp.45[LBEXAM003861].
3923On two occasions during the course of the examination, the Examiner offered Ernst & Young the
opportunity to provide the Examiner with a presentation, narrative, or explanation regarding the
businesspurposeofLehmansRepo105transactions.Ernst&Youngdeclinedthatinvitation.
3924 See also In re Allou Distribs., Inc., 395 B.R. 246, 27273 (Bankr. E.D.N.Y. 2008) (finding that plaintiff
sufficientlypledthatauditingfirmcommittedmalpracticebyfailingtoreportsuspiciouscircumstances
andmaterialdiscrepanciestotheauditcommittee);Springer,ExchangeActReleaseNo.44858,75S.E.C.
Docket 2095 (Sept. 27, 2001) (finding, in addition to other auditing violations, that an accountant had
violatedSection10AoftheSecuritiesExchangeActandengagedinprofessionalmisconductbyfailingto
1036

Moreover,inadditiontoitsdutytoreportadeterminationthatthereisevidence
thatfraudmayhaveoccurred,Ernst&YoungwasrequiredtodiscusswiththeAudit
Committee the quality of Lehmans accounting principles as applied to financial
reporting,seeAU380.11,whichwouldincludemoving$30$50billiontemporarilyoff
thebalancesheetatquarterendthroughoverseastruesalelegalopinionsthatcould
not be obtained in the United States. Indeed, AU Section380.11 states that auditors
should discuss accounting policies, unusual transactions, the clarity and completeness
of the financial statements, and unusual transactions with the audit committee.
Specifically,thatstandardstatesthatanauditor:
notify the clients audit committee that he had detected information indicating that the client had
reported$1.3millioninfalserevenuesinitsquarterlyreport).Section10A(b)oftheSecuritiesExchange
Actof1934,15US.C.78j1(b),providesthat:
If, in the course of conducting an audit pursuant to this title to which

subsection (a) applies, the registered public accounting firm detects or
otherwise becomes aware of information indicating that an illegal act
(whether or not perceived to have a material effect on the financial
statements of the issuer) has or may have occurred, the firm shall, in
accordance with generally accepted auditing standards, as may be
modifiedorsupplementedfromtimetotimebytheCommission
(A) (i)determinewhetheritislikelythatanillegalacthas
occurred;and
(ii)ifso,determineandconsiderthepossibleeffectof
theillegalactonthefinancialstatementsoftheissuer,
includinganycontingentmonetaryeffects,suchasfines,
penalties,anddamages;and
(B) as soon as practicable, inform the appropriate level of the
managementoftheissuerandassurethattheauditcommitteeof
theissuer,ortheboardofdirectorsoftheissuerintheabsenceof
suchacommittee,isadequatelyinformedwithrespecttoillegal
acts that have been detected or have otherwise come to the
attentionofsuchfirminthecourseoftheaudit,unlesstheillegal
actisclearlyinconsequential.
1037

should discuss with the audit committee the auditors judgments about
thequality,notjusttheacceptability,oftheentitysaccountingprinciples
asappliedinitsfinancialreporting...Thediscussion...shouldinclude
such matters as the consistency of the entitys accounting policies and
theirapplication,andtheclarityandcompletenessoftheentitysfinancial
statements,whichincluderelateddisclosures.Thediscussionshouldalso
include items that have a significant impact on the representational
faithfulness, verifiability, and neutrality of the accounting information
included in the financial statements. Examples of items that may have
suchanimpactarethefollowing:
Selectionofneworchangestoaccountingpolicies
Estimates,judgments,anduncertainties
Unusualtransactions
Accounting policies relating to significant financial statement

items,includingthetimingoftransactionsandtheperiodinwhich
theyarerecorded.
See AU 380.11. Contrary to that standard, Ernst & Young never communicated
anythingabouttheRepo105transactionstoLehmansAuditCommitteememberslet
alonediscussthesubstantialandincreasingvolumesatquarterend.3925
3925Examiners Interview of Thomas Cruikshank, Jan. 20, 2010, at pp. 12.; Examiners Interview of
MichaelL.Ainslie,Dec.22,2009,atp.3;ExaminersInterviewofRogerBerlind,Dec.18,2009,atpp.3,4;
ExaminersInterviewofSirChristopherGent,Jan.20,2010,atpp.3,4;seealsoLehmanBrothersHoldings
Inc., Minutes of Meeting of Audit Committee (June 13, 2008) [LBEXAM 003759]; Lehman Brothers
Holdings Inc., Minutes of Meeting of Audit Committee (July 8, 2008) [LBEXAM 003831]; Lehman
BrothersHoldingsInc.,MinutesofMeetingofAuditCommittee(July22,2008)[LBEXAM003861].The
ExaminerreviewedErnst&Youngsworkpapersforthe2007yearendauditand2008quarterlyreviews
andfoundnoreferencetoanycommunicationwiththeAuditCommitteeaboutRepo105.TheExaminer
alsoreviewedrelevantdocuments,datedfromJanuary1,2007throughSeptember15,2008,fromthee
mail accounts and desk files of 43 midtoseniorlevel auditors at Ernst & Young, and uncovered no
communicationswithorreferencestocommunicationswithLehmansAuditCommitteeregardingRepo
105.Ernst&YoungdoesnotdisputethefactthatitdidnotdiscussLeesRepo105allegationswiththe
AuditCommittee.
1038

The Examiner thereforeconcludes that Ernst& Youngsfailuretodiscussthese
matters with the Audit Committee gives rise to a colorable claim of malpractice,
particularlyin lightof: (1) the failure todisclose in publicfilings theuseofRepo 105
transactionstoreducethebalancesheetitemsthatwereusedtocalculateLehmansnet
leverage ratio; (2) the impact of the Repo 105 transactions on Lehmans net leverage
ratio;3926(3)Lehmansemphasistothepublicoftheimportanceofitsnetleverageratio;
(4)thesheersizeandtimingoftheendofquarteractivitythatLeehighlightedtoErnst
&Young($50billion);and(5)theAuditCommitteesexplicitrequesttobeapprisedof
allofLeesallegations.
3926GAAS requires an auditor to understand its clients business, and therefore, Ernst & Young had a
dutytounderstandtheimportanceofnetleverageratiostoLehmanandtheinvestingpublic.SeeAU
722.10 (auditor/reviewer has responsibility of becoming sufficiently knowledgeable about clients
businesstoallowauditortoidentifythetypesofpotentialmaterialmisstatementsandtoselectinquiries
andanalyticalproceduresthatwillprovidetheauditorwithabasisforcommunicatingwhetherheorshe
is aware of any material modifications that should be made for such financial information to conform
withGAAP).HerethereisnoquestionthatErnst&Younghadafullunderstandingofthenetleverage
ratio.Ernst&Youngsdocumentscontaincalculationsofmaterialitywithrespecttonetleverageratios,
and Ernst & Young reviewed financial statements and other public disclosures emphasizing the
importance of the ratio. See, e.g., Ernst & Young, LBHI/LBI Walkthrough Template for Balance Sheet
CloseProcess(Nov.30,2007)atp.14[EYLELBHICORPGAMX07033384](statingthat,withrespectto
reopening a closed balance sheet, [m]ateriality is usually defined as any item individually, or in the
aggregate,thatmovesnetleverageby0.1ormore(typically$1.8billion)andthat[n]etleverageisan
importantratioanalyzedbytheratingagenciesandincludedinLehmansearningsrelease);emailfrom
WilliamSchlich, Ernst& Young, to Carmine DiSibio, Ernst & Young, et al. (June 5, 2008) [EYLELBHI
KEYPERS0853883](notingthatLehmansgameplanforcombatingthereleaseofitssecondquarterloss
istoemphasizeitscapitalraiseandsignificantdeleveringofthebalancesheet);emailfromWilliam
Schlich, Ernst & Young, to Ryan Traversari, Lehman, et al. (June 14, 2008) [LBEXDOCID 2374461]
(providing Schlichs comments on the attached draft version of the second quarter 2008 preliminary
earnings call speech); Transcript of Lehman Brothers Holdings Inc. Second Quarter 2008 Preliminary
EarningsCall[Draft](June16,2008),atp.15[LBEXDOCID2046258](notingthatdeleveragingandde
riskingthebalancesheetwasanimportantgoalthisquarterandthatnetleverageasofMay31hadbeen
reducedfrom15.4xto12.0x).
1039

(ii) Lehmans2008Forms10Q
The Examiner also finds that sufficient evidence exists to support colorable
claims formalpractice against Ernst & Young arising from Ernst & Youngs review of
Lehmans first and second quarter Form 10Q financial statements and MD&A
sections.3927
Sufficient evidence exists to support a finding that the financial statements in
bothquartersof2008weremisleadingbecause:(1)thenotesstatedthatLehmantreated
repos as collateralized agreements and financings, as opposed to disclosing that a
significant volume of repo transactions were treated as sales (and thus were off
balance sheet); and (2) the notes referred to the transfer of certain financial assets as
sales pursuant to SFAS 140, but only with respect to securitization activities, without
anywheredisclosingLehmansRepo105activity.3928
Althoughareviewofinterimfinancialstatementsissubstantiallylessinscope
thananaudit,seeAU722.09,theSECrequiresaregistrantsuchasLehmantoengage
an independent accountant to review its interim financial information before the
registrantfilesitsForm10Q.3929TheSECfurtherrequiresthatanaccountantsreview
reportbefiledwiththeinterimfinancialinformationiftheentitystatesthattheinterim
3927Forpurposesofthisanalysis,theExaminerdoesnotreachtheissueofwhetherthetreatmentofthe
Repo 105 transactions as sales under SFAS 140 is proper. However, as discussed in Section III.A.4.j.2,
thereissufficientevidencetosupportadeterminationbythetrieroffactthatthenotestothefinancial
statementsandotherwrittendisclosurespresentedamisleadingpictureofLehmansfinancialcondition
byfailingtodisclosetheeffectofthevolumeandtimingofLehmansRepo105activity.
3928SeeSectionIII.A.4.j.2.c.iioftheExaminersReport.
3929SeeRule1001(d)ofRegulationSX,17C.F.R.210.1001(d)(2009).
1040

financialinformationhasbeenreviewedbyanindependentpublicaccountant.3930Ernst
&YoungfiledsuchreviewreportsinconnectionwithbothofLehmansForms10Qin
2008.3931
An auditor can, of course, be liable for violating professional standards in
connection with the preparation of interim financial reports.3932 Auditing and related
professionalpracticestandardsapplicabletotheExaminersfindingofacolorableclaim
againstErnst&YounginthecontextofErnst&Youngs2008quarterlyreviewsofthe
notestoLehmansquarterlyfinancialstatementsinclude:
AUSection722.4143appliesinsituationswheretheauditorisawarethatthe
interimfinancialscontaininadequatedisclosuresordonotconformtoGAAP
inotherways.Inthoseinstances,theauditorshouldissueamodifiedreview
reportthatdescribestheinadequaciesornonGAAPcompliantmatters.The
auditing standards define conformance with GAAP to mean not only that
theaccountingprinciplesappliedhavegeneralacceptance,butalsotomean
thatthefinancialstatements,includingtherelatednotes,areinformativeof
matters that may affect their use, understanding, and interpretation. See
AU 411.04 (addressing the meaning of present fairly in conformity with
[GAAP]).3933
3930Id.
3931SeeLBHI10Q(filedApril9,2008),at42;LBHI10Q(filedJuly10,2008),at53.
3932See,e.g.,WilliamIselin&Co.,Inc.v.Landau,522N.E.2d21,23(N.Y.1988)(regardlessofwhetherthe
activity is characterized as an audit or a review, the accountant owes the party contracting for the
services a duty to exercise due care in the performance of professional accounting services); Collins v.
Esserman & Pelter, 681 N.Y.S.2d 399, 401 (App. Div. 1998) (Even with respect to a review . . . the
accountantisobligatedtoexerciseduecareintheperformanceoftheengagement.);Kantor,Geisler&
Oppenheimer, P.A., PCAOB Release No. 1052007009 (Dec. 14, 2007) (finding that accounting firm
violated Section 10A(b) of the Exchange Act and PCAOB standards in quarterly review when, upon
learning information indicating that an illegal act may have occurred, the firm failed to address
appropriatelythethresholdquestionofwhetheritwaslikelythatanillegalacthadoccurred).
3933See also AU 431.02 (under GAAP, financial statements should contain adequate disclosure of
material matters. . . [regarding] form, arrangement, and content of the financial statements and their
appended notes, including, for example, the terminology used, the amount of detail given, the
1041

AUSection722.07relatingtoInterimFinancialInformationstatesthatthe
objectiveofareviewofinterimfinancialsistoprovidetheaccountantwitha
basis for communicating whether the accountant is aware of any material
modificationsthatshouldbemadetotheinterimfinancialinformationforit
toconformwithGAAP.
AUSection722.07statesthataninterimreviewtypicallydoesnotrequirethe
auditortoperformtestsoforobtainevidencethatcorroboratesthefinancial
information, but that the review instead principally consists of performing
analytical procedures and making inquiries of persons responsible for
accountingandfinancialmatters.3934
AU Section 722.10 charges the auditor with the responsibility of becoming

sufficientlyknowledgeableabouttheentitysbusinesstoallowtheauditorto
identify the types of potential material misstatements and to select the
inquiries and analytical procedures that will provide the accountant with a
basis for communicating whether he or she is aware of any material
modificationsthatshouldbemadetotheinterimfinancialinformationforit
toconformwithGAAP.
AUSection722.18(c)providesthatanauditorengagedinaninterimreview
should inquire of management about significant transactions occurring or
recognizedinthelastseveraldaysoftheinterimperiod.
AU Section 722.18(c) states that an auditor engaged in an interim review

shouldinquireofmanagementaboutallegationsoffraudorsuspectedfraud
affecting the entity, for example, received in communications from
employees,formeremployees,analysts,regulators,shortsellers,orothers.
AUSection722.18(c)providesthatanauditorengagedinaninterimreview
should inquire of management about unusual or complex situations that
mayhaveaneffectontheinterimfinancialinformation.
classification of items in the statements, and the bases of amounts set forth. An independent auditor
considerswhetheraparticularmattershouldbedisclosedinlightofthecircumstancesandfactsofwhich
heisawareatthetime).
3934 Note that the standard goes on to require that when the reviewer becomes aware that the interim
financial information may not be in conformity with GAAP in all material respects (which includes
adequacy of disclosure), the reviewer is required to make additional inquiries and perform other
procedurestocorroboratethefinancialinformation.SeeAU722.22,infra.
1042

AUSection722.22specifiesthatifareviewerofinterimfinancialinformation
becomes aware of information leading the reviewer to believe that the
interim financial information may not be in conformity with GAAP in all
material respects, the reviewer should make additional inquiries and
performotherproceduresthatthereviewerconsidersappropriatetoprovide
a basis for communicating whether the reviewer is aware of any material
modificationsthatshouldbemadetotheinterimfinancialinformation.The
standards set forth the following example: [I]f the accountants interim
review procedures lead him or her to question whether a significant sales
transaction is recorded in conformity with [GAAP], the accountant should
perform additional procedures, such as discussing the terms of the
transaction with senior marketing and accounting personnel, reading the
salescontract,orboth,toresolvehisorherquestions.
AUSection722.26statesthatifaninadequatedisclosureisbroughttothe
auditors attention during an interim review, the auditor should evaluate
matters such as the nature, cause, amount, and materiality of the likely
misstatement.Footnote18ofAUSection722.26remindsthereviewerofthe
requirements concerning adequacy of disclosure that are contained in Rule
1001 of Regulation SX, including that [t]he interim financial information
shall include disclosures either on the face of the financial statements or in
accompanying footnotes sufficient so as to make the interim information
presentednotmisleading....
AUSection722.28providesthatareviewershouldnotissueareviewreport
ifthereviewerhasnotcompletedthenecessaryreviewproceduresorifthe
client does not provide the reviewer with the written representations the
reviewerbelievesarenecessarytoachievetheobjectiveofaninterimreview.
AU Section 722.2831 states that if the auditor performing the review

becomes aware of matters that cause him or her to believe that material
modificationsshouldbemadetomaketheinteriminformationconformwith
GAAP (which includes adequacy of disclosure) such matters should be
communicated to management, and if management does not respond
appropriately, then the auditor should inform the audit committee. If the
audit committee does not respond appropriately, then the auditor should
considerwhethertoresignfromthereviewengagementand astheentitys
auditor.
AU Section 722.32 states that if the auditor becomes aware of information

indicatingthatfraudoranillegalacthasormayhaveoccurred,theauditor
1043

must also determine his or her responsibilities under AU Section 316,

Consideration of Fraud in a Financial Statement Audit, AU Section 317, Illegal
ActsbyClients,andSection10AoftheSecuritiesExchangeActof1934.
AU Section 722.34 incorporates AU Section 380, which concerns

communicationswiththosechargedwithgovernance.3935
AUSection722.36providesthatiftheaccountanthasidentifiedmatterstobe
communicated to those charged with governance, the accountant should
attempttomakesuchcommunicationstotheauditcommittee,oratleastto
thechairoftheauditcommittee,andarepresentativeofmanagementbefore
theentityfilesitsinterimfinancialinformationwitharegulatoryagency.
These and other professional standards are also incorporated into Ernst &
YoungsengagementletterwithLehman:
If we determine that there is evidence that fraud or possible illegal acts

may have occurred, we will bring such matters to the attention of an
appropriatelevelofmanagement.Ifwebecomeawareoffraudinvolving
senior management or fraud (whether by senior management or other
employees) that causes a material misstatement of the consolidated
financial statements, we will report this matter directly to the Audit
Committee.WewillensurethattheAuditCommitteeisadequatelyinformed
of illegal acts that come to our attention unless they are clearly
inconsequential....3936
The Examiner concludes that sufficient evidence exists to support a colorable
claimthatErnst&Youngshouldhavemadeappropriateinquiriesofmanagementand
performedanalyticalproceduresconcerningsignificanttransactionsthatoccurredatthe
ends of the quarters in 2008 and analyzed their impact upon the financial statements,
including the footnotes. Particularly after Lee alerted Ernst & Young to $50 billion in
3935SeeSectionIII.A.4.j.5.b.i.ofthisReport,whichdiscussestherequirementsofAUSection380.
3936Letter from Ernst & Young to Christopher M. OMeara, Lehman, re: 2007 audit services (May 15,
2007),at9[EYLEKEYPERS2641786](emphasisadded).
1044

Repo 105 transactions prior to the filing of the second quarter Form 10Q, Ernst &
Young should have reported to senior management and the Audit Committee that
LehmanwasusingRepo105transactionstotemporarilyandartificiallyreducebalance
sheetanditsnetleverageratioforreportingpurposes,withoutdisclosingthepracticeto
thepublic.3937
SufficientevidenceexiststosupportacolorableclaimthatErnst&Youngknew
or should have known that the notes to the financial statements were false and
misleadingbecause,amongotherthings,thosenotesdescribeallreposasfinancings,
whichErnst&Youngknewwasnotthecase,andthosenotesdidnotdisclosetheRepo
105transactions.Ernst&Younghadaprofessionalobligationtocommunicatetheissue
tobothseniormanagementandtheAuditCommitteeandtorecommendcorrectionsof
theForms10Q,andalsotoeitherissuemodifiedreviewreportsnotingthematerially
inadequatedisclosures,ortowithholditsreviewreportsaltogether.
There is also sufficient evidence to support the existence of a colorable claim
against Ernst & Young for malpractice in connection with the misleading statements
concerning Lehmans net leverage ratio contained in the MD&A sections of Lehmans
3937Before issuing its first and second quarter 2008 review reports, Ernst & Young obtained standard
writtenrepresentationsfromLehmanmanagementstatingthatmanagementwasnotawareoffraudor
allegedfraud,andalsodisclosingtransfersinvolvingqualifyingspecialpurposeentitiesthatweretreated
assalesunderSFAS140.SeeLetterfromRichardS.Fuld,Jr.,Lehman,etal.toErnst&Young,re:Lehman
Management Representations (Apr. 9, 2008), at pp. 2, 67 [EYSECLBHIGAMX1Q08 002679]; Letter
fromRichardS.Fuld,Jr.,Lehman,etal.toErnst&Young,re:LehmanManagementRepresentations(July
9, 2008), at pp. 2, 67 [EYSECLBHIWP2Q 000277]. Ernst & Young cannot, however, rely on these
lettersasadefensetoitsfailuretoactonLeesallegations,giventhat,amongotherthings,Leepresented
hisallegationsdirectlytoErnst&Young(andoutsidethepresenceofmanagement).
1045

two 2008 Forms 10Q. Sufficient evidence exists to find that those disclosures were
materiallyinadequateandmisleadingbecauseLehmandidnotdisclosethefactthatthe
reported assets, net assets, leverage ratio and the reduction in the net leverage ratio
weremateriallyaffectedbytemporaryRepo105transactions.
Auditors have a far more limited responsibility for disclosures and other
informationin filings accompanying financialstatements, as opposedto thefinancial
statementsandaccompanyingfootnotes,butthestandardsrequiretheauditortoread
theotherinformation[e.g.,theMD&A]andconsiderwhethersuchinformation,orthe
mannerofitspresentation,ismateriallyinconsistentwithinformation,orthemannerof
itspresentation,appearinginthefinancialstatements.SeeAU550.04.Inaddition,
AU Section 550.05 states that if the auditor becomes aware of information that he
believes is a material misstatement of fact that is not a material inconsistency, . . . he
should discuss the matter with the client. . . . If the auditor concludes he has a valid
basis for concern, he should propose that the client consult with some other party
whoseadvicemightbeusefultotheclient,suchastheclientslegalcounsel.3938Ifthe
misstatementisnotresolved,thentheauditorshouldconsideractionssuchasnotifying
3938See
generally AU 312.10 (assessment of materiality involves both quantitative and qualitative
considerations,includingwhethertheomissionofinformationwouldmakeitprobablethatthejudgment
ofareasonablepersonrelyingontheinformationwouldhavebeenchangedorinfluenced).
1046

theclientinwritingofhisorherviews.SeeAU550.06.3939Here,Ernst&Youngdid
noneofthosethings.
There is sufficient evidence for a trier of fact to conclude that Ernst & Young
should have insisted on proper disclosures of Repo 105 transactions in the interim
information that it reviewed or withheld an unmodified review report because the
interim information disclosures were materially inadequate and misleading.
Furthermore,theMD&AinformationimpliedthatLehmanhadachieveddesirablenet
leverage numbers by balance sheet reductions, without disclosing that those net
numberswouldhavebeensignificantlyhigherbutfortheRepo105transactions.There
is credible evidence that Ernst & Young was aware of Lehmans Repo 105 policy as
early as 2001,3940 that Ernst & Young was aware of over $29 billion in Repo 105
transactionsin2007whenitreceivedtheNettingGrid,3941andthatErnst&Youngwas
onnoticeastothe$50billioninsuchtransactionsbynolaterthanJune2008.3942Ernst&
YoungwasawareoftheimportanceinLehmansindustryofthenetleveragenumber,
3939Further,thestandardsstatethatiftheaccountantconcludesthatthereisamaterialinconsistency,or
becomes aware of information that he or she believes is a material misstatement of fact, the action taken will
dependonhisorherjudgmentunderthecircumstances.SeeAU722.18(f)(crossreferencingtoAU
550.0406)(emphasis added). In addition,as discussed in Section III.A.4.j.2.aof thisReport, there isan
SECrequirementthatcompaniesdiscloseknowntrendsinMD&Asections.
3940Examiners Interview of Ernst & Young, Repo 105, Oct. 16, 2009, at pp. 45 (statement of William
Schlich);ExaminersInterviewofJohnFeraca,Oct.9,2009,atp.7.
3941Lehman, Accounting Policy Review Balance Sheet Netting and Other Adjustments [Draft] (Nov.
2007), at p. 26 [LBEXDOCID 3213271] (stating total amount of Repo 105 for Feb. 28, 2007 was $29.258
billion),attachedtoemailfromMargaretSear,Lehman,toJerryGruner,Ernst&Young,etal.(Nov.6,
2007)[LBEXDOCID3235499].
3942See Sections III.A.4.i.4 and III.A.4.j.5.b.i of this Report, which discuss Lees statements to Ernst &
Young.
1047

as those numbers were being touted by Lehman in the press and investor calls.3943
Given those facts, the Examiner finds that sufficient evidence exists to support a
colorable claim against Ernst & Young in connection with its reviews of Lehmans
interim financial information and its responsibilities regarding Lehmans MD&A
informationinbothquartersof2008.
(iii) Lehmans2007Form10K
Lehmans2007Form10Kcontainedessentiallythesamestatementsasthosein
its later 2008 Forms 10Q. In its 2007 Form 10K, Lehman represented that it treated
repurchase agreements as financings (i.e., not as sales) even though Repo 105
transactions were treated as sales. In Note 1 to Lehmans Consolidated Financial
Statements, Lehman stated that Lehman treated [r]epurchase and resale agreements
as collateralized agreements and financings for financial reporting purpose which
Lehman described were collateralized primarily by government and government
agency securities.3944 In addition, Lehman stated that [o]ther secured borrowings
principally reflect transfers accounted for as financings rather than sales under SFAS
140.3945 Lehman disclosed that it recognized the transfer of financial assets as sales
pursuanttoSFAS140butitsaidsoonlywithrespecttosecuritizationactivities.3946
3944LBHI200710K,atp.97.ThisdisclosureisundertheheadingCollateralizedLendingAgreements
andFinancings.
3945Id.
3946Id.atp.96.SecuritizationactivitiesisaseparateheadingintheNote.
1048

ThereisalsosufficientevidenceforatrieroffacttoconcludethatErnst&Young
kneworshouldhaveknownthatthatthosestatementsweremateriallymisleadingand
failed to provide necessary disclosures concerning Lehmans use of Repo 105
transactions. Therefore, the Examiner finds sufficient evidence to support a colorable
claim of malpractice against Ernst & Young in connection with its 2007 audit of
Lehman.3947
The financial statements accompanying the 2007 Form 10K were audited as
opposed to reviewed by Ernst & Young and thus higher standards and
requirements of professional care applied. For example, while quarterly reviews
require the auditor to perform analytical procedures and make inquiries of
management, among many other things, yearend audits mandate that the auditor
perform tests, gather corroborating evidence that supports the financial statements,
obtainreasonableassuranceaboutwhetherthefinancialstatementsarefreeofmaterial
misstatements, and provide a positive opinion regarding whether the financial
statementsarefairlypresentedinconformitywithGAAP.See,e.g.,AU310,311,326.
Accordingly,inperformingits2007yearendaudit,Ernst&Youngwasrequired
to look at the data underlying the financial statements. Such an audit should have
3947While the issue concerning the lack of disclosure with respect to Lehmans Repo 105 activity goes
back to earlier periods, the Examiners investigation of potential claims against Ernst & Young has
focused on the late 2007 and early 2008 critical period because of the increasing volume of Repo 105
transactions, the emphasis on reducing net leverage, and Lehmans public touting of its deleveraging
duringthattime.
1049

revealed that a significant volume of Lehmans repo activity was not treated as
financings, but instead was reported as sales. In addition, the MD&A section to
Lehmans 2007 Form 10K discussed the net leverage ratio without disclosing the role
thatRepo105transactionsplayedinthatcalculation.Ernst&Youngsfailuretorequire
proper disclosures in the MD&A section and in footnotes to the financial statements
constitutessufficientevidencetofindacolorableclaimofmalpractice.
(iv) EffectonPriorFilings
Finally, while Ernst & Young should have required proper disclosures in the
2007Form10Kand2008firstquarterForm10Qpriortothosefilings,Ernst&Young
also had a duty, upon learning in June 2008 of Lees allegations concerning Repo 105
transactions, to revisit the earlier filings. The auditors responsibilities in such
situations is addressed in AU Section 561.0406, which states that when an auditor
becomes aware that facts may have existed at the date of a previously issued audit
report which might have affected the report had the auditor then been aware of such
facts,theauditorshouldinvestigatewhetherthenewinformationisreliableandexisted
at the time of the original report and whether the new information indicates that the
previously issued opinion is incorrect and should not be relied on. If the previously
issued audit report is incorrect, the auditor should consider action to prevent future
relianceonthepriorreports.
1050

(v) CausationandDamages
Onemeasureof damagesinanaudit malpracticeaction againstErnst& Young
would be the recovery of fees Lehman paid to Ernst & Young in connection with the
2007 audit and/or the 2008 reviews.3948 It also is possible that the estate could recover
additional damages beyond fees paid to Ernst & Young if it is shown that Lehman
suffered damages that could have been avoided had Ernst & Young adhered to
professional accounting standards. For example, had Ernst & Young fulfilled its
obligation to advise the Audit Committee of the extent and significance of Repo 105
activities, the Audit Committee may have insisted on measures to actually and
substantially reduce leverage or to take other remedial or strategic steps that might
3948See,e.g.,StanleyL.Bloch,Inc.v.Klein,258N.Y.S.2d501,508(Sup.Ct.1965)(holdingthatmeasureof
damagesforprofessionalnegligenceofaccountantinissuingbalancesheetcontainingsubstantialerrors
wasaccountingandauditingfeespaidtoaccountantforyearofserviceimmediatelypriortoissuanceof
balancesheetandaccountingandauditingfeesnecessitatedbyreviewthereof).
1051

have led to a different outcome.3949 Ernst & Young, in turn, may have a compelling
argumentthatsuchameasureofdamagesistoospeculative.3950
Inaddition,theestatemaybeabletoseekcompensationfromErnst&Youngfor
feesand expenses that the estateincurredorwillincurasaresultofErnst &Youngs
malpractice. For example, if an accountants negligencein the preparation or
certification of financial statements results in litigation against the accountants client
brought by purchasers of the clients securities, the client may be able to recover the
expensesofthelitigationandtheamountofanyjudgmentorreasonablesettlement.3951
3949See,e.g.,Bd.ofTrs.ofCmty.Coll.Dist.No.508,CountyofCookv.Coopers&LybrandLLP,775N.E.2d55,
63 (Ill. App. 2002) (applying Illinois law, holding that auditors failure to detect treasurers violation of
investmentpolicyduringauditscouldbetheproximatecauseofdamagescausedbyinvestmentsmade
after the audit, where members of the board testified that they would have ended those investment
practices had auditor detected them), revd on other grounds,803 N.E.2d 460 (Ill. 2003); Plan Comm. v.
PricewaterhouseCoopers, 335 B.R. 234, 24951 (D.D.C. 2005) (creditors committee adequately alleged
damagesagainstdebtorsauditingfirmunderDistrictofColumbialaw,wherecommitteeassertedthat
malpractice proximately caused debtors insolvency and bankruptcy and specifically alleged that the
board would have taken actions to avoid insolvency if it had been timely alerted by appropriately
audited financial statements to the fact that [company] was performing significantly worse than was
presented in the negligently audited financial statements), dismissed on other grounds, No. 0201487
(TFH),2007WL119917(D.D.C.Apr.20,2007).
3950See VTech Holdings Ltd. v. Pricewaterhouse Coopers 348 F. Supp 2d 255, 267 (S.D.N.Y. 2004) (buyer of
wiredbusinesscouldrecoverlostprofitsandconsequentialdamagesunderNewYorklawonaccountant
malpracticeclaimonlyiftheywerecapableofbeingmeasuredbasedonreliablefactors).
3951Aplaintiffgenerallyisentitledtoactualoutofpocketcoststhatflowasanaturalandcontinuous
consequencefromorareotherwiseproximatelycausedbythedefendantsbreachofitslegalduties.
Crowleyv.Chait,Civ.No.852441(HAA),2004U.S.Dist.LEXIS27238,at*39(D.N.J.Aug.25,2005);Baker
HughesOilfieldOperation,Inc.v.SeabulkTankers,Inc.,No.Civ.A.031230,2004WL1290576,at*1(E.D.La.
June8,2004)(BakerI);KeywellCorp.v.Piper&MarburyLLP,No.96CV0660E(SC),1999WL66700,at*5
(W.D.N.Y.Feb.11,1999).Amongtheexpensesthatcouldbeconsideredtoflowfromthebreachofalegal
dutyarethoseincurredtorepairharmtotheplaintiffcausedbythedefendantsbreach.See,e.g.World
Radio Labs., Inc. v. Coopers & Lybrand, 557 N.W.2d 1, 15 (Neb. 1996) (holding that client was entitled to
recoverdamagesforaccountingfeespaidtosecondauditingfirmasaresultofdefendantauditingfirms
negligence).
1052

(c) PossibleDefenses
The Examiner recognizes that Ernst & Young may have valid defenses to these
claims.Asageneralmatter,thequestionofwhetheranauditorcommittedmalpractice
isafactintensiveinquiryandrequiresthetestimonyandopinionofexpertsinthefield.
Indeed,manyoftheauditingstandardssetforthabovedonotimposebrightlinerules,
but instead provide general guidance and principles. Ernst & Young likely would
submitexperttestimonyinsupportofitsviewthatit adheredfullyto itsprofessional
responsibilities in its reviews and audits of Lehmans financial statements, and may
takethepositionthatsomeoftheprofessionalstandardscitedaboveapplyonlywhere
an auditor has a subjective belief that a disclosure or other information is materially
inaccurate. Ernst & Young also may take the position that preparation of financial
statementsistheresponsibilityofmanagementandnotoftheoutsideauditor.
TheExaminerconcludesthatthereissufficientbasisforclaimstobesubmittedto
atrieroffact,whowillhavetoevaluatethoseclaimsinlightofanydefensesraisedby
Ernst&Young.
1053

x
:
:
etal., :
Debtors. :
x
REPORTOF

Jenner&BlockLLP
353N.ClarkStreet
Chicago,IL606543456
3122229350

919ThirdAvenue
37thFloor
NewYork,NY100223908
2128911600


VOLUME4OF9
Section III.A.5: Secured Lenders
Section III.A.6: Government
EXAMINERSREPORT
TABLEOFCONTENTS
(SHORTFORM)
VOLUME1
Introduction...................................................................................................................................2
C. SystemsAccess..............................................................................................................33
SectionIII.A.1:Risk
b) Facts..................................................................................................................58
c) Analysis .........................................................................................................163
VOLUME2
2. Valuation ..............................................................................................................203
Portfolio .........................................................................................................215
Book................................................................................................................266
Positions.........................................................................................................356
Portfolio .........................................................................................................527
Positions.........................................................................................................568
DebtPositions ...............................................................................................583
ii

Stearns............................................................................................................622
VOLUME3
4. Repo105................................................................................................................732
b) Introduction ..................................................................................................750
Transactions ..................................................................................................764
oftheFirm .....................................................................................................914
iii

VOLUME4
a) Introduction ................................................................................................1482
iv

VOLUME5
(SecondBullet) ...................................................................................................1912
2. Facts .....................................................................................................................1965
5. Conclusions ........................................................................................................2063
vi

x
:
:
etal., :
Debtors. :
x
REPORTOF
TABLEOFCONTENTS
(1) JPMorgan..............................................................................................1068
(2) Citibank ................................................................................................1073
(3) HSBC.....................................................................................................1077
(4) OtherLenders ......................................................................................1080
(5) TheFederalReserveBankofNewYork..........................................1081
(6) LehmansLiquidityPool....................................................................1082
(1) Facts.......................................................................................................1084
(a) OverviewofJPMorganLehmanRelationship ....................... 1084
(b) TripartyRepoPriorto2008 ....................................................... 1089
(c) JPMorganRestructuresItsApproachtoTripartyRisk ......... 1094
(d) LehmanBeginsPostingAdditionalCollateral ....................... 1101
(e) JPMorganConcernOverLehmanCollateralinAugust
2008 ............................................................................................... 1105
(f) TheAugustAgreements ............................................................ 1113
(g) BackgroundtotheSeptember9CollateralRequestand
SeptemberAgreements .............................................................. 1125
(h) September9CallsBetweenStevenBlackandRichard
Fuld ............................................................................................... 1138
(i) SeptemberAgreements .............................................................. 1143
(j) DailyLiquidityPoolUpdatesFromLehmanto
JPMorgan ..................................................................................... 1156
(k) September11CollateralRequestPursuanttothe
September11 ............................................................................... 1165
(m) LehmanRequestsforReturnofCollateral.............................. 1168
(2) AnalysisofPotentialClaims .............................................................1172
(a) TheEvidenceDoesNotSupportaColorableClaim
AgainstJPMorganforEconomicDuress................................. 1173
(i) LegalBackground:EconomicDuress............................. 1173
1054

(ii) ThereIsNoAvailableEvidenceofanExpress
UnlawfulThreatMadebyJPMorganinConnection
WiththeFormationoftheSeptemberAgreements ..... 1174
(iii) TheAvailableEvidenceSuggestsJPMorganDid
NotHaveanImproperPurpose...................................... 1178
(iv) ThereWasaDegreeofNegotiationOvertheTerms
oftheSeptemberAgreements ......................................... 1181
(b) ThereIsInsufficientEvidencetoSupportaColorable
ClaimThattheSeptemberAgreementsAreInvalidfor
LackofConsideration ................................................................ 1183
(c) ThereisSufficientEvidencetoSupporttheExistenceofa
AgreementsAreInvalidforLackofAuthority...................... 1186
(i) TonucciMayHaveActedWithApparent
Authority ............................................................................ 1190
(ii) ThereIsSubstantialEvidenceThatLehman
RatifiedtheSeptemberAgreements............................... 1193
(d) ThereIsInsufficientEvidencetoSupportaColorable
ClaimThatJPMorganFraudulentlyInducedthe
(e) ThereIsInsufficientEvidencetoSupportaColorable
ClaimforBreachofContractoftheSeptember
AgreementsBasedonJPMorgansRefusaltoReturn
Collateral ...................................................................................... 1200
SeptemberAgreements .................................................... 1200
(ii) ThereWasNoWrittenNoticeforCollateralReturn ... 1208
(f) ThereIsEvidencetoSupportaColorable,ButNot
Strong,ClaimThatJPMorganBreachedtheImplied
CovenantofGoodFaithandFairDealingbyDemanding
ExcessiveCollateralinSeptember2008................................... 1210
(i) LegalStandardsGoverningImpliedCovenantof
GoodFaithandFairDealing ........................................... 1211
(ii) ThereIsSufficientEvidenceToSupporta
Colorable,ButNotaStrong,ClaimThatJPMorgan
ViolatedtheImpliedCovenantbyDemanding
ExcessiveCollateral .......................................................... 1214
1055

(iii) ATrierofFactWillLikelyHavetoResolvea
WaiverDefense.................................................................. 1220
(1) Facts.......................................................................................................1224
(a) CitigroupProvidedContinuousLinkedSettlement
ServiceandOtherClearingandSettlementOperationsto
Lehman......................................................................................... 1224
(i) BackgroundInformationontheContinuous
LinkedSettlementServiceCitiProvidedtoLehman... 1224
ProvidedtoLehman ......................................................... 1227
(iii) CitisClearingandSettlementExposureto
Lehman,Generally............................................................ 1229
(iv) TheTermsofLehmansCLSAgreementwithCiti ...... 1231
(b) LehmanProvideda$2BillionCashDepositwithCition
June12,2008ToSupportitsClearingNeeds.......................... 1233
DepositonJune12 ............................................................ 1235
(ii) ThePartiesDidNotSharetheSameUnderstanding
oftheTermsofthe$2BillionCashDeposit .................. 1242
a. WhatLehmanUnderstoodtheTermsofthe
DepositToBe.............................................................. 1243
b. WhatCitiUnderstoodtheTermsoftheDeposit
ToBe............................................................................. 1245
UnknownBecausetheTermsWereNot
ReducedtoWriting.................................................... 1250
(iii) CitiKnewtheComfortDepositwasIncludedin
LehmansLiquidityPool.................................................. 1250
BeganinJune2008andContinuedUntilSeptember2008 ... 1251
(i) TheUnexecutedPledgeAgreement:theParties
AgreedtoNegotiatetheTermsbutNotExecutethe
AgreementUntilItWasNeeded..................................... 1251
1056

(ii) CitiHadDifficultyPricingtheCollateralOffered
byLehmanasaSubstitutefortheCashDeposit .......... 1254
(iii) TheGuarantyAmendmentWasSignedinaFire
DrillonSeptember9,2008 ............................................. 1261
GuarantyAmendmentfromCitisPerspective ..... 1263
GuarantyAmendmentfromLehmans
Perspective .................................................................. 1265
c. NegotiationsBetweenLehmanandCiti
PersonnelRegardingWhichLehmanEntities
WereToBeAddedtotheParentGuarantyby
theSeptember9GuarantyAmendment................. 1268
(iv) September12,2008:ALehmanCollateralAccount
atCitiwasActivatedAfterTwoMonthsof
Discussion,andLehmanSignedanAmendmentto
theDirectCustodialServicesAgreement...................... 1273
(d) LehmansClearingEnvironmentatCitiDuringthe
WeekofSeptember8,2008........................................................ 1276
DaylightOverdraftLimits ............................................... 1276
(ii) LehmanDepositedAmountsinExcessofthe$2
BillionDepositatVariousTimesin2008WithCiti...... 1279
(iii) CitiEndeavoredToHelpLehmaninSeptember
2008,PriortotheBankruptcyFiling............................... 1281
(iv) LehmansAccountsatCitiClosedonFriday
September12WithFundsinExcessofthe$2
BillionDeposit ................................................................... 1284
(e) CitisParticipationinLehmanWeekendEvents................ 1285
BankruptcyProtection ............................................................... 1287
(i) CitiContinuedtoProvideCLSServicesfor
Lehman,ButNotinanEntirelyUninterrupted
Manner................................................................................ 1287
PortionoftheCashDeposit............................................. 1290
(2) AnalysisofPotentialColorableClaims ...........................................1291
1057

(a) ValidityoftheSeptember9GuarantyAmendment.............. 1291

(i) EconomicDuress ............................................................... 1291
a. LegalFramework ....................................................... 1292
b. TheEvidenceDoesNotSupporttheExistence
ofaColorableClaimAgainstCitiforEconomic
Duress .......................................................................... 1293
(ii) TheFailureofConsideration ........................................... 1297
a. LegalFramework ....................................................... 1298
b. TheEvidenceDoesNotSupporttheExistence
ofaColorableClaimAgainstCitiforFailureof
Consideration ............................................................. 1298
(b) BreachoftheDutyofGoodFaithandFairDealingin
ConnectionWiththeCLSServicesAgreement ...................... 1300
ColorableClaimAgainstCitiforBreachofthe
DutyofGoodFaithandFairDealinginConnection
WiththeCLSServicesAgreement.................................. 1301
(1) OverviewofHSBCsRelationshipWithLehman ..........................1305
(a) HSBCProvidedCRESTClearingandSettlementServices
toLehman .................................................................................... 1306
(b) OverviewoftheOperativeAgreements ................................. 1309
(2) TheExaminersInvestigationofParticularTransactions .............1311
(a) HSBCCancelleda$1BillionIntradayCreditFacility ........... 1311
(b) LehmanMaintaineda$1BillionSegregatedDeposit
withHSBC ................................................................................... 1312
(c) LehmanDeposited$750MillionwithHSBConJune24 ...... 1314
(d) LehmanCommitted$25MilliononAugust15toHSBCs
SyndicatedLendingFacility...................................................... 1315
(e) LehmanPledged$6MilliontoHSBCasCollateralfor
LettersofCredit .......................................................................... 1317
(f) OtherSignificantExposures...................................................... 1318
(3) HSBCRequiredLehmantoProvideApproximately$1
BillioninCollateralWhileQuietlyEndingTheir
Relationship .........................................................................................1319
(a) HSBCDeterminedtoEndItsRelationshipwithLehman .... 1319
1058

(b) HSBCDemandedCollateralforIntradayCredit ................... 1322

(c) HSBCAgreedToAccommodateLehmanatQuarterEnd ... 1325
(d) LehmanDepositedtheCashCollateralWithHSBC ............. 1326
Deeds ............................................................................................ 1327
(i) LehmanSecuredConcessionsintheU.K.Cash
Deeds................................................................................... 1327
(ii) LehmanExecutedtheHongKongCashDeedLate
onSeptember12 ................................................................ 1329
(f) HSBCandLBHIStipulatedToSetOffandReturnSome
oftheFundsCoveredbytheU.K.CashDeeds ...................... 1332
(4) OtherIssuesStemmingfromHSBCsCollateralDemand............1333
(a) LehmanIncludedtheDepositsCoveredbytheCash
DeedsinItsReportedLiquidityPool ...................................... 1333
(b) HSBCConsideredWithholdingPaymentsorRequiring
LehmansBankruptcy ................................................................ 1336
(5) TheEvidenceDoesNotSupporttheExistenceofColorable
CashCollateralandExecuteCashDeedsinOrderforHSBC
toContinueProvidingClearingandSettlementServices.............1336
(a) TheParametersoftheExaminersAnalysis ........................... 1336
(b) TheFactsProvideLittletoNoSupportforInvalidating
theU.K.CashDeeds................................................................... 1339
(i) AnalyticalFramework...................................................... 1339
a. EnglishLawGovernsContractClaimsArising
fromtheU.K.CashDeeds ........................................ 1339
b. EnglishContractLawTreatsDeedsDifferently
fromOtherContracts................................................. 1340
ColorableClaimThattheU.K.CashDeedsAre
InvalidforWantofConsideration.................................. 1341
(iii) TheEvidenceDoesNotSupporttheExistenceofa
CRESTAgreementAllowedHSBCToCease
ClearingandSettlementatItsAbsoluteDiscretion ..... 1343
1059

a. ElementsofEconomicDuress.................................. 1343
b. ApplicationtoLehmanFacts ................................... 1344
c. OtherTransactionsDoNotGiveRiseto
EconomicDuressClaims .......................................... 1346
(iv) TheEvidenceDoesNotSupporttheExistenceofa
ColorableClaimthatHSBCViolatedaDutyof
GoodFaithandFairDealingbyDemandingCash
Collateral ............................................................................ 1348
a. EnglishLawDoesNotRecognizeaPrincipleof
GoodFaithandFairDealingofGeneral
Application.................................................................. 1349
ProvisionoftheCRESTAgreement ............................... 1352
a. ConstructionofTerms............................................... 1352
(vi) TheCashDeedsWereNotContractsofAdhesion
orStandardFormContracts ............................................ 1355
ContractsofAdhesion............................................... 1355
(c) OtherPotentialTheoriesofLiability........................................ 1357
(i) EnglishLawGovernstheRemainingPotential
ClaimsEvenThoughTheyAreNotCoveredbythe
ChoiceofLawProvisionoftheCashDeeds................. 1357
a. AnalyticalFramework............................................... 1357
b. ApplicationtoRemainingPotentialClaims........... 1359
LehmansValidContractualObligations ...................... 1360
a. ElementsofUnjustEnrichment ............................... 1361
(iii) TheEvidenceDoesNotSupportaColorableClaim
ThatHSBCBreachedaFiduciaryDutytoLehman
1060

BecauseHSBCandLehmanWereSophisticated
PartiesinaRelationshipGovernedbyan
AgreementThatLimitedHSBCsObligations.............. 1363
Misappropriation ....................................................... 1364
(iv) TheEvidenceDoesNotSupportaColorableClaim
thatHSBCsDemandforCollateralTortiously
InterferedWithLehmansOtherBusinessor
ContractsBecauseHSBCWasActingToProtectIts
OwnEconomicInterests .................................................. 1367
a. ElementsofTortiousInterference ........................... 1368
(v) TheEvidenceDoesNotSupportaFindingthat
HSBCFraudulentlyorNegligentlyMisrepresented
ItsPlantoWithdraw......................................................... 1371
a. ElementsofFraudandMisrepresentation ............. 1371
(1) BNYMDemandsandReceivesaCollateralDeposit .....................1377
(2) TheDepositIsSignificantBecauseofInternalLehman
ConcernsAboutIncludingItinItsPool ..........................................1379
(1) TheFRBNYSupervisesDepositTakingInstitutionsand
AssistsinManagingMonetaryPolicy,butLacksAuthority
ToRegulateInvestmentBankHoldingCompanies ......................1385
(2) InResponsetotheBearStearnsNearCollapse,theFRBNY
BrokerDealers;Lehman,InTurn,DrewonTheseFacilities........1387
(a) ThePrimaryDealerCreditFacility .......................................... 1387
(b) TheMarketGreetedtheCreationofthePDCFasa
PositiveStepTowardBackstoppingBrokerDealer
Liquidity,andasShoringUpLehmansLiquidity ................ 1390
1061

PDCFasanOutletforItsIlliquidPositions............................ 1392
(d) LehmanWasReluctanttoDrawonthePDCFBecauseof
aPerceivedStigmaAttachedtoBorrowingfromthe
Facility .......................................................................................... 1396
(e) LehmanAccessedthePDCFTenTimesin2008;
LehmansUseofthePDCFWasConcentratedinPeriods
ImmediatelyAftertheBearStearnsNearCollapse,and
ImmediatelyAfterLBHIFiledforBankruptcy ...................... 1398
(3) OtherFRBNYLiquidityFacilities.....................................................1400
(a) TheTermSecuredLendingFacility ......................................... 1400
(b) OpenMarketsOperations ......................................................... 1401
(1) IntroductionandExecutiveSummary.............................................1401
(2) TheImportanceofLiquiditytoBrokerDealersand
InvestmentBankHoldingCompaniesGenerally ..........................1406
(3) LehmansLiquidityPool....................................................................1408
(a) ThePurposeandCompositionofLehmansLiquidity
Pool ............................................................................................... 1408
(b) LehmanTestedItsLiquidityPoolandSharedtheResults
ofTheseTestswithRatingAgencies ....................................... 1413
RepresentationsAboutItsLiquidityPool............................... 1415
(4) LehmansClearingBanksSoughtCollateralPledgesand
CashDepositsToSecureIntradayCreditRisk;Lehman
IncludedThisCollateralinItsLiquidityPool ................................1417
(a) LehmanPledgedCLOsandOtherSecuritiesto
JPMorganThroughouttheSummerof2008toMeet
TripartyRepoMarginRequirements ...................................... 1417
(b) TheSecuritiesPostedtoMeetJPMorgansMargin
RequirementsWereIncludedinLehmansLiquidity
Pool ............................................................................................... 1422
(c) OnJune12,2008,LehmanTransferred$2BilliontoCiti
asComfortforContinuingCLSSettlement ........................ 1424
1062

(d) TheCitiComfortDepositWasIncludedinLehmans
LiquidityPool.............................................................................. 1430
(e) OnAugust25,2008,LehmanExecutedaSecurity
AgreementwithBankofAmerica,GrantingtheBanka
SecurityInterestina$500MillionDeposit ............................. 1433
(f) LBHIandJPMorganExecutedanAmendmenttothe
June2000ClearanceAgreement,aSecurityAgreement
andaHoldingCompanyGuaranty,allDatedAugust26,
2008 ............................................................................................... 1436
(g) LehmanAssetsSubjecttotheAugustSecurity
AgreementWereIncludedinLehmansLiquidityPool ....... 1439
(h) September2,2008:LehmanTransferredJustUnder$1
BilliontoHSBCtoContinueClearingOperations,and
EncumberedThiswithCashDeedsExecutedon
September9andSeptember12................................................. 1441
(i) TheHSBCDepositWasRepresentedasLiquidand
WasIncludedinLBHIsLiquidityPool .................................. 1446
(j) LehmanandJPMorganExecutedAnotherRoundof
SecurityDocumentationDatedSeptember9,2008;
LehmanMade$3.6Billionand$5BillionPledgesto
JPMorganSubjecttotheTermsofTheseAgreements .......... 1446
(k) LehmanMadeaDeposittoBankofNewYorkMellonto
CoverIntradayExposure,andIncludedThatDepositin
ItsLiquidityPool ........................................................................ 1448
(l) TheCumulativeImpactofLehmansInclusionof
ClearingBankCollateralandDepositsinItsLiquidity
Pool ............................................................................................... 1450
(5) DisclosuresConcerningtheInclusionofClearingBank
CollateralinLehmansLiquidityPool.............................................1454
(a) LehmanDidNotDiscloseonItsJune16,2008Second
QuarterEarningsCallThatItWasIncludingthe$2
BillionCitiComfortDepositinItsLiquidityPool ............. 1454
(b) LehmanDidNotDiscloseinItsSecondQuarter200810
Q,FiledJuly10,2008,ThatItWasIncludingBoththe$2
BillionCitibankComfortDepositandApproximately
$5.5BillionofSecuritiesCollateralPledgedtoJPMorgan
inItsLiquidityPool .................................................................... 1455
1063

EarningsCallThataSubstantialPortionofItsLiquidity
PoolWasEncumberedbyClearingBankPledges ................ 1457
(d) SeniorExecutivesDidNotDisclosetotheBoardof
DirectorsattheSeptember9,2008FinanceCommittee
MeetingtheFactThataSubstantialPortionofIts
LiquidityPoolWasEncumberedbyClearingBank
Pledges.......................................................................................... 1460
(e) LehmanOfficersDidNotDisclosetotheBoardof
DirectorsThatItsLiquidityPositionWasSubstantially
ImpairedbyCollateralHeldatClearingBanksUntilthe
EveningofSeptember14,2008 ................................................. 1464
(f) LowittsViewsonIncludingClearingBankCollateralin
theLiquidityPool ....................................................................... 1466
(6) RatingAgenciesWereUnawareThatLehmanWas
IncludingClearingBankCollateralinItsLiquidityPool .............1467
(a) Fitch............................................................................................... 1467
(b) Standard&Poors....................................................................... 1468
(c) Moodys........................................................................................ 1469
(7) TheFRBNYDidNotViewtheClearingBankCollateralin
theLiquidityPoolasUnencumbered ..........................................1469
(8) TheSEC,LehmansPrimaryRegulator,WasUnawareofthe
CollateralinItsLiquidityPool;totheExtentItWasAware,
theSECDidNotViewThisPracticeasProper ..............................1472
(9) CertainLehmanCounselWereAwareThatAgreements
withItsClearingBanksWereStructuredtoInclude
ClearingBankCollateralinItsLiquidityPool,but
DisclaimedKnowledgeConcerningWhatAssetsWere
AppropriateorInappropriatefortheLiquidityPool ....................1476
(10) LehmansAuditorsMonitoredLehmansLiquidityPool,but
ViewedtheCompositionofthePoolasaRegulatoryIssue.........1478
(11) ThereIsInsufficientEvidenceToSupportaDetermination
ConnectionWiththePublicDisclosureofLehmans
LiquidityPool ......................................................................................1479
1064

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1065

5. PotentialClaimsAgainstLehmansSecuredLenders
a) IntroductionandExecutiveSummary
Pursuanttotheeighthbulletofparagraph2oftheExaminerOrder,thisSection
oftheReportexaminestransactionsandtransfersamongthedebtorsandpreChapter
11 thirdparty lenders. The Examiner has consulted with the parties in interest,
reviewedissuesidentifiedbythoseparties,conductedhisownindependentreviewand
examination and exercised his discretion as to which issues to include in the Report.
This Section of the Report covers potential common law claims against Lehmans
lenders.SectionIII.Bcoverspotentialavoidanceandpreferenceactions.
Throughout 2008, and up to the date that Lehman filed for bankruptcy,
Lehmans clearing banks demanded collateral to secure risks they assumed in
connectionwithclearingandsettlingLehmanstripartyandcurrencytrades,andother
extensions of credit. This Section of the Report examines the circumstances
surroundingLehmansprovisionofapproximately$15to$21billionincollateral(both
in cash and securities) to its clearing banks, and Lehmans simultaneous inclusion of
thosefundsinitsreportedliquiditypool.
Assetforthinmoredetailbelow,theimportanceofliquiditytoinvestmentbank
holdingcompaniescannotbeoverstated.Brokerdealersaredependentonshortterm
financing to fund their daily operations, and a robust liquidity pool is critical to a
brokerdealers access to such financing. The Examiner has found that the size of
1066

Lehmans liquidity pool provided comfort to market participants and observers,
including rating agencies. The size of Lehmans liquidity pool encouraged
counterpartiestocontinueprovidingessentialshorttermfinancingandintradaycredit
to Lehman. In addition, the size of Lehmans liquidity pool provided assurance to
investors that if certain sources of shortterm financing were to disappear, Lehman
couldstillsurvive.
Critically, the collateral posted by Lehman with its various clearing banks was
initially structured in a manner that enabled Lehman to claim the collateral as
nominallylienfree(atleastovernight),andcontinuetocountitinitsreportedliquidity
pool. However, bySeptember2008, much of Lehmans reported liquidity was locked
upwithitsclearingbanks,andyetthisfactremainedundisclosedtothemarketpriorto
Lehmansbankruptcy.
What follows is a review of the demands for added credit protection by
JPMorgan,Citi,HSBC,BankofAmerica,BankofNewYorkMellonandStandardBank,
followed by a brief synopsis of the Examiners legal conclusions. The Examiner
concludesthattheremaybeacolorableclaimagainstoneclearingbankJPMorgan
arising from these collateral demands in 2008. Then, this Section discusses Lehmans
publicstatementsaboutitsliquiditypool.
1067

(1) JPMorgan
JPMorgan acted as LBIs principal clearing bank pursuant to a Clearance
AgreementbetweenJPMorganandLBI.ThemostsignificantcomponentofJPMorgans
clearing services was triparty repo clearing. Although tripartyrepo investors
typically required a brokerdealer such as LBI to post margin (that is, additional
collateral)overnighttoaccountforinvestorrisk,before2008,JPMorgandidnotretain
thatmarginintraday.
In February 2008, JPMorgan informed Lehman that JPMorgan would begin
retaining the same margin intraday that triparty investors required overnight. This
change JPMorgans retention of tripartyinvestor margin was implemented
graduallyin20percentincrementsoverthecourseofapproximatelyfivemonths.
JPMorganalsodeterminedthatitsriskvisvisbrokerdealerssuchasLBIwas
greater than the risk faced by overnight investors. JPMorgan therefore instituted an
additionalmarginrequirement,whichitcalledriskbasedmargin,andincrementally
imposed that margin on brokerdealers as well. Lehman initially responded to
JPMorgans riskbased margin requirement by posting approximately $5 billion in
securities in June 2008. Lehman continued to post additional collateral at JPMorgan
throughoutthesummerinresponsetoJPMorgansmarginrequirements.
In August 2008, JPMorgan raised concerns about collateral that Lehman had
posted. In particular, Lehman had posted illiquid and difficulttoprice CDOs that
1068

Lehman had selfpriced. JPMorgan was also concerned because LCPI (not LBI or its
holding company) had posted collateral to cover JPMorgans riskbased margin.
Lehman transferred much of this collateral from LCPI to LBHI in early August to
alleviateJPMorgansconcern.
At the end of August, after significant negotiation, Lehman and JPMorgan
enteredintothreeagreements:anAmendmenttotheClearanceAgreement,aGuaranty
and a Security Agreement. The Amendment to the Clearance Agreement added
additional Lehman parties to the Clearance Agreement. Under the Guaranty, LBHI
guaranteed the Lehman parties obligations under the Clearance Agreement. The
SecurityAgreementsecuredLBHIsGuaranty,grantingJPMorganasecurityinterestin
a Cash Account, Securities Account and certain related accounts. The Security
AgreementalsoprovidedforanOvernightAccountintowhichLBHIcouldtransfer
cashorsecuritiesovernightifnoobligationsremainedoutstandingundertheClearance
Agreementattheendoftheday.Thoseassets,however,generallyhadtobereturned
to Lehmans liened accounts by morning in order for JPMorgan to continue clearance
operations. Lehman understood the August Agreements as documenting existing
practice,notfundamentallyalteringitsrelationshipwithJPMorgan.
BylateAugustandearlySeptember,Lehmansdeterioratingfinancialcondition
became increasingly apparent. On September 4, 2008, Lehman and JPMorgan
executives met to discuss Lehmans third quarter earnings and survival strategies.
1069

JPMorganemergedconcernedwithLehmansplans.JPMorganalsoreviewedadraftof
Lehmans planned presentation to rating agencies, and JPMorgan expressed concerns
about that presentation as well. The following day (September 5), JPMorgans
Investment Bank Risk Committee met to discuss the Investment Banks exposures to
various brokerdealers, and expressed particular concerns about Lehman. Then, on
September 9, 2008, reports surfaced that acquisition talks between Lehman and KDB
hadfallenthrough,andLehmansstockplummeted.Inresponse,Lehmandecidedto
preannounceitsthirdquarterearningsthefollowingmorning,September10.Alsoon
September 9, JPMorgan requested $5 billion of additional collateral to cover all of
JPMorgans exposures to Lehman, not limited to tripartyrepo clearing exposure.
Lehman agreed to post $3 billion immediately, and posted the $3 billion in cash and
moneymarketfundsbythenextday.
JPMorgan further determined that it wanted a new mastermaster agreement
with Lehman to cover its entire relationship across all Lehman liabilities and entities.
For the collateral that JPMorgan requested on September 9 to cover all of JPMorgans
exposures to all Lehman entities, new documentation had to be executed. JPMorgan
insisted that an Amendment to the Clearance Agreement, Security Agreement and
Guaranty be in place before Lehmans earnings call the next morning. The evidence
does not suggest, however, that JPMorgan threatened to cease clearing for Lehman if
theagreementswerenotexecutedbythen.
1070

JPMorgans and Lehmans legal teams negotiated the documents through the
night. LehmansattorneysreceivedvirtuallynoinputfromLehmansseniorfinancial
officers or other business personnel, who were immersed in preparations for the
upcoming earnings call. Indeed, neither Lehmans Treasurer nor its Chief Financial
Officer reviewed the terms of the agreements or even a summary of the key terms
beforetheagreementsweresigned.
TheseagreementssignificantlyextendedJPMorgansrightstorequestandretain
collateralbyexpandingtheLehmanaccountsoverwhichJPMorganhadalienandthe
obligationsthatitsliensecured.TheSeptemberSecurityAgreementandGuarantyalso
requiredthreedayswrittennoticeforLBHItoattempttoretrieveanyofitscollateral.
On September 11, JPMorgan executives met to discuss significant valuation
problems with securities that Lehman had posted as collateral over the summer.
JPMorgan concluded that the collateral was not worth nearly what Lehman had
claimeditwasworth,anddecidedtorequestanadditional$5billionincashcollateral
from Lehman that day. The request was communicated in an executivelevel phone
call, and Lehman posted $5 billion in cash to JPMorgan by the afternoon of Friday,
September 12. Around the same time, JPMorgan learned that a security known as
Fenway, which Lehman had posted to JPMorgan at a stated value of $3 billion, was
actually assetbacked commercial paper creditenhanced by Lehman (that is, it was
Lehman, rather than a third party, that effectively guaranteed principal and interest
1071

payments). JPMorgan concluded that Fenway was worth practically nothing as
collateral.
NotwithstandingJPMorgansconcernswiththequantityandqualityofcollateral
postedbyLehman,LehmanbelievedthatJPMorganwasovercollateralized.Thereisno
evidence, however, that Lehman requested in writing the return of the billions of
dollars of collateral it had posted in September. Lehman did informally request the
return of at least some of its collateral, and JPMorgan returned some securities to
Lehman on September 12. JPMorgan did not, however, release any of the cash
collateral that Lehman had posted in response to the September 9 and September 11
requests.
The Examiner has analyzed a number of potential common law claims against
JPMorganinconnectionwiththeSeptemberAgreementsandcollateraldemands.The
Examinerconcludes:
The evidence does not support the existence of a colorable claim against
JPMorgan for economicduressprincipally because the Examiner hasfound
noevidenceofanexpressunlawfulthreatbyJPMorgan.
The evidence does not support the existence of a colorable claim that the
September Agreements are invalid for lack of consideration because (i) the
September Amendment to the Clearance Agreement was a modification of
anexistingcontractand,therefore,requirednoadditionalconsideration,and
1072

(ii) the September Security Agreement and Guaranty were supported by

JPMorganscontinuedextensionofcredittoLehman.3952
There may be a technical claim that the September Agreements are invalid
for lack of authority, but there are substantial defenses to such a claim,
including that Lehman ratified the agreements when it posted collateral on
September12.Accordingly,theExaminerconcludesthattheevidencedoes
notsupporttheexistenceofacolorableclaim.
The evidence does not support the existence of a colorable claim that
JPMorgan fraudulently induced the September Agreements even if
JPMorgan counsel told Lehman counsel that an agreement in principle had
already been reached by Lehmans and JPMorgans senior management.
Thereisconflictingevidenceastowhether therewassuchanagreementin
principle. Nonetheless, regardless of the outcome of that disputed issue of
fact, it does not appear that Lehman counsel in fact relied on the
representationorreasonablycouldhaverelieduponit.
The Examiner also concludes that the evidence does not support the
existence of a colorable claim that JPMorgan breached the September
Agreements by refusing to return collateral to Lehman. JPMorgan was not
legally required to do so principally because Lehman failed to provide
JPMorgan with written notice for return of collateral as required under the
SeptemberAgreements.
Finally,theExaminerconcludesthattheevidencemaysupporttheexistence
of a colorable claim but not a strong claim that JPMorgan breached the
implied covenant of good faith and fair dealing by making excessive
collateralrequeststoLehmaninSeptember2008.Atrieroffactwouldhave
to consider evidence that the collateral requests were reasonable and that
Lehmanwaivedanyclaimsbycomplyingwiththerequests.
(2) Citibank
Citibank was Lehmans designated settlement member on the Continuous
Linked Settlement (CLS) system, a trading platform operated by a consortium of
3952
See infra Section III.B.3.g.5.a for a discussion ofclaims to avoid the September Guaranty under
applicable fraudulent transfer law where a different standard applies for assessing reasonably
equivalentvalue.
1073

banksfortheclearanceandsettlementofforeignexchange(FX)trades.Inexecuting
trades for Lehman on the CLS system, Citi accepted Lehmans CLS trades, submitted
them to the CLS Bank, and extended intraday credit to Lehman, thereby assuming a
certain amount of intraday credit risk. Citi provided the clearing and settlement
servicesonCLSundertheaegisofaCLSSettlementServicesAgreementforCLSUser
Members, originally entered into by Lehman and Citi in December 2003, and later
amended in October 2004. Notably, this Agreement provided that any extension of
creditbyCitiwaswithinCitissolediscretion.
Citi provided Lehman with additional financial services, such as maintaining
cashdepositandcustodialaccounts,providingcreditfacilities,andsomecustodyand
clearingservicesinemergingmarketsandintheUnitedStates.
After the markets negative reaction to Lehmans second quarter earnings
announcement and Lehmans announced personnel changes on June 12, 2008, Citi
sought to reduce its intraday risk exposure to Lehman. Consequently, on that same
day,Citiobtaineda$2billioncomfortdepositfromLehman,tobemaintainedatCiti
inanovernightcallaccount.Althoughthe$2billiondepositwasnotformallypledged,
Citi believed that it had a general right of setoff. In addition, according to Citi
personnel,hadLehmanwithdrawnthedeposit,Lehmanwouldhavehadtoprefundits
transactionsinorderforCititocontinueclearingandsettlingLehmanstrades.The$2
billiondepositwasincludedinLehmansreportedliquiditypool.
1074

Further,beginninginJuly,thepartiesnegotiatedwithoutsuccessthetermsof
aformalpledgeagreementontheunderstandingthatLehmanwouldpledgesecurities
to collateralize Citis clearing and settlement lines, in lieu of the cash deposit. Citi
proposed several versions of a collateral pledge agreement, and Lehman proposed
different portfolios of assets to post as collateral. Citi declined to accept any of the
securities proposed by Lehman as collateral; Citi had difficulty pricing the assets and
questionedwhethertherewasareadymarketforthem.
The negotiations between Citi and Lehman over the pledge agreement ceased
when,betweenSeptember9and12,LehmanandCitiamendedtwocriticalagreements
instead of executing the pledge agreement. By early September, Citi had become
acutelyconcernedaboutitsclaimonthe$2billiondeposit.Then,onSeptember9,the
reportedfailureoftheKDBdeal,coupledwithLehmansannouncementthatitwould
accelerate its third quarter earnings announcement to September 10, prompted Citi to
requestthatLehmanimmediatelyamendtheparentGuarantyAmendmenttoexpand
thescopeoftheholdingcompanyGuaranty(toincludeobligationsowedtoCitiunder
any custodial agreement with Citi in addition to extensions of credit by Citi) and
ultimatelyadded10additionalLehmansubsidiariestotheguaranty(Citihadoriginally
requested that 17 be added). On September 12, the parties also amended the Direct
CustodialServicesAgreement(DCSA),whichprovidedCitiwithabroadandexplicit
securityinterestovercash,securitiesorotherassetsheldbyCitionbehalfofLehman.
1075

Citi continued thereafter to provide clearing and trade settlement services for
Lehman, albeit under reduced clearing limits, until Lehman filed for bankruptcy on
September 15. Ultimately, Citi cleared for Lehman through CLS until Friday,
September19.
The Examiner has identified potential common law claims against Citi arising
outofthesetransactions,buthasnotfoundanyofthemtobecolorable.
The evidence does not support the existence of a colorable claim for
economic duress surrounding Citis demand that Lehman execute the
September 9 amendment to the Guaranty because, inter alia, there is no
evidenceofanexpressunlawfulthreatbyCititoinduceLehmantoagreeto
itsterms.Indeed,Lehmansuccessfullynegotiatedcertaintermsinitsfavor
priortosigningtheamendment.
Likewise,theevidencedoesnotsupporttheexistenceofacolorableclaimfor
failureofconsideration:CitiextendedcredittoLehmanatitssolediscretion,
and the September 9 amendment induced Citi to continue providing
intraday credit to Lehman subsidiaries. Given the rapidly deteriorating
market conditions, it was not unreasonable for Citi to seek added security
fromLehman.3953
TheevidencedoesnotsupporttheexistenceofacolorableclaimagainstCiti
for breach of the duty of good faith and fair dealing in connection with its
CLS agreementwith Lehman.TheExaminer foundno evidenceto suggest
anyobligationbyCititoprovideclearingandsettlementservicestoLehman,
and given the increased risk Citi faced visvis Lehman on September 9,
there is no colorable claim that Citi acted unreasonably, irrationally,
arbitrarily, or in bad faith by exercising or threatening to exercise its
contractual right to cease extending clearing advances and to cease serving
asLehmansCLSsettlementmemberbank.
3953
See infra Section III.B.3.g.5.b for a discussion ofclaims to avoid the Guaranty under applicable
fraudulenttransferlawwhereadifferentstandardappliesforassessingreasonablyequivalentvalue.
1076

(3) HSBC
HSBC principally provided Lehman with clearing and settlement services for
sterlingdenominated trades in CREST, a clearing and settlement system for certain
securities.SterlingdenominatedtradesinCRESTaresettledinrealtime;consequently,
as Lehmans settlement bank, HSBC extended Lehman intraday credit to facilitate the
settlementofitsCRESTtrades.ThegoverningagreementbetweenLehmanandHSBC
(the CREST agreement) provided that HSBC had absolute discretion to terminate
its responsibilities as Lehmans CREST settlement bank (which included extensions of
intraday credit associated with settling Lehmans trades). The CREST agreement
furtherprovidedthatHSBCcouldterminatethecontractwithoutnotice,onlyrequiring
30daysnoticetotheextentthatHSBCconsider[ed]itpracticableandappropriate.
HSBC provided myriad other banking services to Lehman, including acting as
Lehmans trustee for special purpose vehicles in the Cayman Islands, as Lehmans
counterpartyinderivativestradesandothertransactions,andprovidingvariousother
creditproductstoLehman.HSBCsmostsignificantcreditexposure,however,derived
fromHSBCsroleasLehmansCRESTsettlementbank.
Beginning in mid2006, HSBC took steps to reduce its credit exposure to the
financial sector generally, and, in 2007, it reduced its lines of uncommitted credit
available to the investment banks. HSBC accelerated these measures after the near
collapse of Bear Stearns in early 2008. Viewing Lehman as the next most vulnerable
1077

investment bank, HSBC further reduced various lines of credit it had extended to
Lehman. Initially, HSBC implemented these measures quietly, undetected by both
Lehmanandthemarketplace.However,onAugust18,2008,HSBCadvisedLehmanof
its intention to withdraw from its business relationship with Lehman entirely. In
addition,overthenextseveraldays,HSBCdemandedthatLehmandepositjustunder
$1billionintoaccountsintheU.K.andinHongKong,ultimatelytobesecuredbythree
cashdeeds.HSBCintendedtheU.K.deposittocoveritsexposurearisingfromCREST
clearing and settling. The smaller Hong Kong deposit was intended to collateralize
variouslinesofcreditHSBCprovidedtoLehmansubsidiariesintheAsianmarket.
Lehman understood that HSBC would cease clearing and settling trades in
CRESTforLehmanifLehmandidnotpostthiscollateral.Lehmaninitiallydeposited
theequivalentofapproximately$800millionwithHSBConAugust28.Laterthatsame
day, HSBC permitted Lehman to retrieve that deposit to assist Lehman in meeting its
third quarterbalancesheettargets.Lehmansubsequentlyredepositedthe equivalent
of approximately $800 million with HSBC on September 1. On September 2, Lehman
depositedapproximately$180millioninanHSBCHongKongaccount.
Negotiations over the terms of the cash deeds ensued, and Lehman secured
favorableconcessionsduringthatprocess.Twocashdeedswereexecutedtocoverthe
U.K.depositonSeptember9(theU.K.CashDeeds),andthepartiesexecutedathird
cash deed on September 12 related to the Hong Kong deposit (the Hong Kong Cash
1078

Deed).EnglishlawgovernedthetermsoftheU.K.CashDeeds,whileHongKonglaw
governedthetermsoftheHongKongCashDeed.Notably,thedeedslimitedLehmans
abilitytoaccessthecollateralunlesstherewerenodebtsincertain,specifiedaccounts
(andnocontingentliabilities),andHSBCretainedgeneralrightsofsetoffinallevents.
The Examiner has identified several potential claims under English law against
HSBC arising out of these transactions involving the U.K. Cash Deeds, but has not
foundanyofthemtobecolorable.
The evidence does not support the existence of a colorable claim that the
U.K.CashDeedsareinvalidforlackofconsideration.Englishlawdoesnot
require consideration to enforce an agreement contained in a deed. In any
event, because the CREST agreement gave HSBC absolute discretion in
providing Lehman with settlement and clearing services, Lehman received
consideration in HSBCs agreement to continue providing those services.
Lehman may have also received consideration in the form of the interest it
receivedonthecollateralitposted.
Likewise,theevidencedoesnotsupporttheexistenceofacolorableclaimfor
economic duress because the operative CREST agreement (and other credit
agreements) permitted HSBC to terminate its services at its discretion. In
anyevent,theExaminerfoundnoevidenceofduress,inparticulargiventhat
Lehman negotiated more favorable terms for itself in the provisions of the
deeds.
Theevidencedoesnotsupporttheexistenceofacolorableclaimforbreach
ofthedutyofgoodfaithandfairdealing.HSBCsabsolutediscretionover
offeringCRESTservicesandextensionsofcredittoLehmanisnotsubjectto
such anobligation under Englishlaw, andeven if itwas,HSBCsdemands
weregroundedinlegitimatecommercialconcernsaboutLehmansviability.
HSBCdidnotbreachthenoticeprovisionoftheCRESTagreement.HSBCs
determination not to provide more advanced notice of its decision to
terminateserviceswasnotarbitrary,capricious,unreasonableorinbadfaith;
instead,itwaslegitimatelygroundedinitscommercialinterest.
1079

TheevidencedoesnotsupporttheexistenceofacolorableclaimthattheU.K
Cash Deeds were contracts of adhesion or standard form contracts. HSBC
andLehmanweresophisticatedpartiestoagreementsthatwereextensively
negotiated(ultimatelyresultinginchangesthatfavoredLehman).
Likewise, the evidence does not support the existence of a colorable claim
that HSBC was unjustly enriched through the U.K. Cash Deeds. The
Examiner concludes that the U.K. Cash Deeds are valid contracts, under
whichLehmanhadadutytoconveyabenefittoHSBC,forwhichLehman
receivedabenefit.
TheevidencedoesnotsupporttheexistenceofacolorableclaimthatHSBC
breached a fiduciary duty to Lehman. HSBC did not owe Lehman a duty
independent of its narrowly defined role as Lehmans CREST settlement
bank,andtheCRESTagreementimposednoobligationonHSBCtocontinue
providingservicestoLehman.
Even if HSBCs collateral demands were to have factored materially in

Lehmansdecisiontofileforbankruptcy,theevidencedoesnotsupportthe
existence of a colorable claim that HSBCs demand for collateral tortiously
interferedwithLehmanscontractswithother parties.HSBCwas acting to
protectitsowncommercialinterests.
Finally,theevidencedoesnotsupporttheexistenceofacolorableclaimthat
HSBC fraudulently or negligently represented its plans to terminate its
commercialrelationshipwithLehman.Tothecontrary,HSBCwasforthright
aboutitsintentionstoreduceitsexposuretoLehmanandultimatelytocease
doingbusinesswithLehman.
(4) OtherLenders
Several banks, in addition to JPMorgan, Citi and HSBC, demanded increased
security from Lehman in the weeks preceding the petition date. While the Examiner
did not investigate whether or not there were colorable claims arising from these
transactions,theExaminersetsforthfactualfindingsastheyarerelevanttotheanalysis
ofLehmansreportedliquiditypool.
1080

Bank of America (BofA). BofA provided clearing and other financial

servicestoLehman.Inconnectionwithitsclearingservices,BofAprovided
unsecured, intraday credit to cover overdrafts. On August 14, 2008, BofA
demandedadepositfromLehmaninorderforLehmantoretainitsoverdraft
credit. In addition, BofA required Lehman to sign a Security Agreement
(executedonAugust25),inwhichLehmanagreedtomaintain$500million
incollateralwithBofA,andgrantedBofAasecurityinterestinthatcollateral.
The Security Agreement permitted Lehman to remove assets from the
depositaccountwithadvancenoticeofthreedays.
Bank of New York Mellon (BNYM). BNYM provided Lehman with

credit related to commercial paper and medium term note programs. On
August 20, BNYM requested that Lehman prefund its transactions with
BNYM. After a series of discussions, Lehman and BNYM agreed on
September8, 2008, that Lehman wouldopen a moneymarketaccountwith
BNYM and maintain a sufficient deposit there to cover BNYMs forecasted
intraday exposure to Lehman. Thereafter, on September 11, Lehman and
BNYMexecutedaCollateralDepositAgreement,requiringLehmaninitially
todeposit$125millionintradayandmaintainacollateralaccountofatleast
$50million.
Standard Bank. Standard Bank provided Lehman with clearing and

settlementservicesinSouthAfrica.OnAugust18,StandardBankrequested
that Lehman begin prefunding its trades. Discussions ensued, and on
September 4, 2008, Standard Bank demanded $200 million in collateral by
September 9, or it would cease settling Lehmans trades. Consequently,
Lehmanprovided$200millionincollateraltoStandardBankonSeptember
9, and executed a pledge agreement to cover the deposit on September 11.
The Examiners financial advisors have not been able to identify a U.S.
debtorasthesourceofthesefunds.
(5) TheFederalReserveBankofNewYork
The FRBNY was one of Lehmans major creditors, particularly in the wake of
Bear Stearns near collapse in March 2008, and in the weeks subsequent to Lehmans
bankruptcy.
1081

Duringthetimeperiodsurrounding the nearcollapseofBearStearnsinMarch
2008, the FRBNY established the Primary Dealer Credit Facility, or PDCF, through
which the FRBNY offered shortterm, collateralized loans to brokerdealers at its
discountwindow,ineffectactingasarepocounterpartyoflastresort.Additionally,
theFRBNYcreated the TermSecuritiesLending Facility,orTSLF,underwhich,every
28 days, brokerdealers could engage in a competitive auction and could swap
mortgagebackedsecuritiesandothersecuritiesforTreasuries.TheExaminerfindsthe
evidence does not support the existence of colorable claims in connection with the
lendingtransactionsbetweentheFRBNYandLehman.
(6) LehmansLiquidityPool
Lehman represented in regulatory filings and in public disclosures that it
maintained a liquidity pool that was intended to cover expected cash outflows for 12
months in a stressed liquidity environment and was available to mitigate the loss of
securedfundingcapacity.AftertheBearStearnscrisisinMarch2008,itbecameacutely
apparenttoLehmanthatanydisruptioninliquiditycouldbecatastrophic;Lehmanthus
paidcarefulattentiontoitsliquiditypoolandhowitwasdescribedtothemarket.
Lehman reported the size of its liquidity pool as $34 billion at the end of first
quarter2008,$45billionattheendofsecondquarter,and$42billionattheendofthe
third quarter.Lehmanrepresentedthat itsliquiditypoolwas unencumberedthat it
1082

was composed of assets that could be monetized at short notice in all market
environments.
The Examiners investigation of Lehmans transfer of collateral to its lenders in
thesummerof2008revealedacriticalconnectionbetweenthebillionsofdollarsincash
and assets provided as collateral and Lehmans reported liquidity. At first, Lehman
carefullystructuredcertainofitscollateralpledgessothattheassetswouldcontinueto
appear to be readily available (i.e., the Overnight Account at JPMorgan, the $2 billion
comfort deposit to Citi, and the threeday notice provision with BofA). Witness
interviewsanddocumentsconfirmthatLehmansclearingbanksrequiredthiscollateral
and without it would have ceased providing clearing and settlement services to
Lehmanor,attheveryleast,wouldhaverequiredLehmantoprefunditstrades.The
market impact of either of those outcomes could have been catastrophic for Lehman.
Lehman also included formally encumbered collateral in its liquidity pool. Lehman
includedthealmost$1billionpostedtoHSBCandsecuredbytheU.K.CashDeedsin
its liquidity pool; Lehman included the $500 million in collateral formally pledged to
BofA; Lehman included an additional $8 billion in collateral posted to JPMorgan and
securedbytheSeptemberAgreements;andLehmancontinuedtoincludethe$2billion
atCiti,evenaftertheGuarantyandDCSAamendments.
BythesecondweekofSeptember2008,Lehmanfounditselfinaliquiditycrisis;
it no longer had sufficient liquidity to fund its survival. Thus, an understanding of
1083

Lehmanscollateraltransfers,andLehmansattendantlossofreadilyavailableliquidity,
isessentialtoacompleteunderstandingofwhyLehmanultimatelyfailed.
b) LehmansDealingsWithJPMorgan
ThisSectionoftheReportdiscussescollateralpostedbyLehmanentitiesduring
2008 in response to requests made by JPMorgan Chase (JPMorgan) and agreements
between Lehman and JPMorgan relating to clearing operations, credit, and collateral.
Inadditiontothemanywitnessinterviewsconductedanddocumentsreviewedbythe
Examiner,theExaminerhasinformallysoughtandobtainedinformationfromAlvarez
&Marsal,counselfortheDebtors,counselforJPMorganandcounselfortheCreditors
CommitteerelatingtotheissuesdiscussedinthisSectionoftheReport.
(1) Facts
(a) OverviewofJPMorganLehmanRelationship
JPMorgan acted as LBIs (LBHIs U.S. brokerdealer subsidiary) principal
clearingbankforsecuritiestradingandtripartyrepurchase(repo)agreements.3954In
thatrole,JPMorganassistedintheclearanceandsettlementofsecuritiestradedbyLBI
and LBI funding through triparty repos. Clearing banks facilitate security trades
between buyers and sellers and secured loans between borrowers and lenders by
3954JPMorganengagedinotherroleswithLehman,includingasacounterpartytoderivativetransactions,
counterpartytopurchasesandsalesofsecuritiesandotherfinancialinstruments,lenderonbothsecured
and unsecured terms, investment banker to assist with the issuance of loans, bonds and equity, and
counterpartytosecuritieslendingtransactions.TonuccidescribedLehmansdealingswithJPMorganas
Lehmansmostimportantrelationship.ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atp.
4.
1084

providing services such as valuing the collateral posted by borrowers, applying and
enforcing specific rules regarding collateralization and moving cash and collateral
between accounts.3955 JPMorgan was one of only two banks in the United States that
providedthevastmajorityofclearingservicestobrokerdealerentitiessuchasLBI;the
otherwasTheBankofNewYork.3956
JPMorgansclearingservicesforbrokerdealerssuchasLBIconsistedprincipally
oftripartyrepoclearingandclearingforothertypesofsecuritiestransactions.Triparty
reposareaprincipalsourceoffundingforbrokerdealers3957andrepresentedthelargest
intraday risk to JPMorgan of the clearing activities it carried out for Lehman.3958 As
implied by its name, triparty repo involves three parties: an investor (typically a
pension fund, money market mutual fund or bank), a borrower (such as a broker
dealer) and a clearing bank.3959 In a triparty repo, a triparty clearing bank such as
3955See, e.g., Tobias Adrian, et al., The Federal Reserves Primary Dealer Credit Facility, CURRENT ISSUES IN
ECON. & FIN., Aug. 2009, at p. 6, available at http://www.newyorkfed.org/research/current_issues/ci15

4.pdf [hereinafter Current Issues: PDCF]; Lehman, Repo Manual (Nov. 8, 2005), at p. 11 [LBEXLL
1175483][hereinafterRepoManual].
3956Current Issues: PDCF, at p. 6; Working Group on Government Securities Clearance and Settlement,
ReporttotheFederalReserveBoard(Dec.2003),atp.10,availableathttp://www.federalreserve.gov/
boarddocs/press/Other/2004/20040107/attachment.pdf[hereinafterWorkingGroupReport].
3957CounterpartyRiskManagementPolicyGroupIII,ContainingSystemicRisk:TheRoadtoReform(Aug.6,
2008),atp.113,availableathttp://www.crmpolicygroup.org/docs/CRMPGIII.pdf[hereinafterCRMPGIII
Report].AdocumentdraftedbyJPMorgan,BestPracticesIntradayandOvernightTripartyDealer
Financing,formedabasisforwhatwasultimatelypublishedbytheCRMPG.ExaminersInterviewof
RicardoS.Chiavenato,Sept.21,2009,atp.7;JPMorgan,BestPracticesIntradayandOvernightTriParty
DealerFinancing[JPMEXAMINER00006026];ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,at
p.4(explainingthatLehmanwasveryreliantontripartyrepoandthattripartyrepoisthelifebloodof
aninvestmentbank).
3958ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atp.5.
3959CurrentIssues:PDCF,atpp.2,6.
1085

JPMorgan acts as an agent, facilitating cash transactions from investors to broker
dealers,which,inturn,postsecuritiesascollateral.3960Thebrokerdealersandinvestors
negotiatetheirownterms;JPMorganactsonlyasanagent.3961Tripartyrepostypically
mature overnight, although investors and brokerdealers can also enter into term
repos(reposthatmatureatalatertime)oropenrepos(reposwithoutasetmaturity
datethatpermittheagreementtobeterminatedonanyday).3962
Each night collateral is allocated to investors (into designations called triparty
shells),eithermanuallybythebrokerdealeror,moretypically,throughanautomated
process inJPMorgans Broker Dealer Automation System (BDAS).3963 The investors,
inturn,provideovernightorlongertermfundingtothebrokerdealer.Thefollowing
morning, JPMorgan unwinds the triparty repos, returning cash to the triparty
investors and retrieving the securities posted the night before by the brokerdealer.
3960CRMPGIIIReport,atp.114;RepoManual,atp.7[LBEXLL1175483].Tripartyreposaresimilarto
loans in which collateral is posted to secure the loan. See Current Issues: PDCF, at p. 2 (In a repo
transaction, the holder of a security obtains funds by selling that security to another financial market
participant under an agreement to repurchase the security at a fixed price on a predetermined future
date.Inessence,thesellerisborrowingfundsagainstthesecurity,typicallyasameansoffinancingthe
originalpurchaseofthesecurity.).
3961E.g.,ExaminersInterviewofBarryL.Zubrow,Sept.16,2009,atp.3.
3962SeeCRMPGIIIReport,atpp.11415;CommitteeonPaymentandSettlementSystemsoftheCentral
BanksoftheGroupofTenCountries,CrossBorderSecuritiesSettlements(Mar.1995),atp.42,availableat
http://www.bis.org/publ/cpss12.pdf.
3963JPMorgans Responses to Examiners First Set of Questions re Lehman/JPM Accounts & Collateral
dated September 3, 2009 (Oct. 23, 2009), at pp. 1, 19 [hereinafter JPMorgan First Written Responses];
Examiners Interview of John N. Palchynsky, May 11, 2009, at p. 4. BDAS is a mainframe system that
JPMorganusestomanageitsclearanceactivities.ExaminersInterviewofRicardoS.Chiavenato,Sept.
21, 2009, at p. 12; JPMorgan, U.S. Clearance, http://www.jpm.com/tss/General/U_S_Clearance/
1114735376505 (last visited Dec. 17, 2009). BDAS handles tens of thousands of trade settlements daily.
JPMorgan, U.S. Clearance, http://www.jpm.com/tss/General/U_S_Clearance/1114735376505 (last visited
Dec.17,2009).
1086

These securities then serve as collateral against the risk created by JPMorgans cash
advance to investors.3964 During the business day, brokerdealers arrange the funding
thattheywillneedatthecloseofbusinessthroughnewtripartyrepoagreements.This
newfundingmustrepaythecashthatJPMorganadvancedduringthebusinessday,as
wellasanyothernonJPMorgancashneeds.Thus,throughouttheday,brokerdealers
send instructions into JPMorgans system to indicate the details of new triparty repos
(e.g., collateral amount and type) that will close at the end of the day.3965 The process
thenrepeatsitself.
JPMorgan also facilitates the settlement of brokerdealer sales and purchases of
securities.3966Forexample,abrokerdealerclientmaywishtopurchaseabondfor$10
million. At time of settlement, the deliveryversuspayment (DVP) convention
entails the simultaneous exchange of cash for the security. JPMorgan would advance
the$10millioncashforthebenefitofthebrokerdealer.Thecashwouldgooutwhile
thesecuritycameintoanaccountoverwhichJPMorganheldasecurityinterest.The
brokerdealerwouldeffectivelyreceivea$10millionloanfromJPMorgancollateralized
bythesecurity.Thebrokerdealerwillinmostcasesrepaythisloanatendofdayby
borrowing the $10million from a tripartyrepo investor. The risks to JPMorgan after
advancingthecashandpriortorepaymentarethatthejustpurchasedsecuritywillfall
3964SeeCRMPGIIIReport,atpp.11415.
3965ExaminersInterview of John N. Palchynsky, May 11, 2009, at pp. 34; JPMorgan First Written
Responses,atp.19.
3966SeeCRMPGIIIReport,atp.113;ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atp.4.
1087

in value below the $10 million cash advance or the brokerdealer will default on its
repaymentobligation.
The JPMorganLBI clearing relationship was governed by a Clearance
Agreement between LBI and JPMorgans predecessor, The Chase Manhattan Bank,
executed in June 2000.3967 JPMorgan agreed to act as LBIs nonexclusive clearance
agentforsecuritiestransactionsandtoopenandmaintainaclearanceaccount.3968
The Clearance Agreement also provided for the extension of credit to LBI by
JPMorgan,butatJPMorganssolediscretion.JPMorgancouldsolelyat[its]discretion,
permit [LBI] to use funds credited to the Account prior to final payment . . . or
otherwise advance funds to [LBI] prior to final payment.3969 Further,
[n]otwithstanding the fact that [JPMorgan] may from time totime makeadvances or
loans . . . or otherwise extend credit to [LBI], whether or not as a regular pattern,
[JPMorgan] may at any time decline to extend such credit at [JPMorgans] discretion,
withnotice.3970
InconsiderationofanyadvancesorloansJPMorganextendedtoLBIpursuantto
theClearanceAgreement,LBIgrantedJPMorganacontinuingsecurityinterestin,lien
upon and right of setoff as to certain LBI assets (explicitly excluding certain
3967ClearanceAgreement(June15,2000),atp.20[JPM20040031786].Foreaseofreference,TheChase
ManhattanBankisreferredtohereinafteraspartofJPMorgan.
3968Id.atp.1.Theclearanceaccountisactuallyasetofaccounts:ClearingAccounts,CustodyAccounts
andSegregatedAccounts.Id.
3969Id.atp.4.
3970Id.
1088

segregatedcustomeraccounts).3971Inotherwords,dailycreditextendedbyJPMorgan
wassecuredbyalienoncertainLBIaccountsmaintainedatJPMorgan.
Initially, the Clearance Agreement was to expire on October 7, 2002, at which
time if the parties had not entered into a written extension, the agreement would
automaticallyrenewforaoneyearperiod.3972TheExaminerisunawareofanywritten
extension of the agreement during that time. The parties, however, continued to
operate pursuant to the terms of the Clearance Agreement, as evidenced by their
amendingtheagreementonMay30,2008.3973
(b) TripartyRepoPriorto2008
TheSeptember11,2001terroristattackssignificantlydisruptedtheoperationsof
the clearing banks (in particular the Bank of New York, due to its proximity to the
WorldTradeCenter),exacerbatingpolicyconcernsabouttheconcentrationofclearing
banks and risk of disruptions to financial markets.3974 In the attacks aftermath, the
Federal Reserve, the SEC and the Treasury Department initiated discussions with
3971Id. at pp. 1213. In the Clearance Agreement, this provision was in tension with the definition of
ClearingAccountsandCustodyAccounts,whichJPMorganagreedtoholdas[LBIs]custodian,free
of[JPMorgans]lien,claimorinterest.Id.atp.1.InMay2008,theClearanceAgreementwasamended
to delete this lienfree language in the definition of Clearing Accounts and Custody Accounts.
AmendmenttoClearanceAgreement(May30,2008),atp.1[JPM20040085662].
3972ClearanceAgreement(June15,2000),atp.17[JPM20040031786].
3973TheMayAmendmenttotheClearanceAgreementaddedLehmanCommercialPaperInc.(LCPI)as
apartytotheClearanceAgreement.AmendmenttoClearanceAgreement(May30,2008),atp.1[JPM
2004 0085662]. Furthermore, JPMorgan and Lehman entered into agreements after the Clearance
Agreement that secured Lehmans obligations arising from JPMorgans provision of specific clearing
servicestoLehman.See,e.g.,CashCollateralAgreement(Oct.3,2005)[JPM20040085509].
3974WorkingGroupReport,atp.11;ExaminersInterviewofChristopherJ.McCurdy,Aug.26,2009,atp.
2.
1089

market participants to explore the risks of having only two clearing banks.3975 The
Federal Reserve considered the option of creating its own clearing bank of last resort
called NewBank. It looked at ways to transfer positions quickly from one clearing
banktoNewBankintheeventthatcustomerslostconfidenceinaclearingbankorin
the event that a clearing bank was incapacitated by some catastrophic event.
Ultimately,therewasnoeasysolutiontotheseproblems,andtheNewBankproject
was held in abeyance.3976 The Federal Reserve and the clearing banks continued,
however,todiscussabroadrangeofriskstoclearingbanks,includingrisksposedby
failureofabrokerdealer.3977
Inevaluatingtripartyrepoclearingrisksin2008,JPMorganrecognizedthatthe
tripartyrepomarkethadrecentlyexpanded,bothintermsofvolumeandthetypesof
3975WorkingGroupReport,atp.11.
3976Examiners Interview of Christopher J. McCurdy, Aug. 26, 2009, at p. 2; see also Working Group
Report, at pp. 2837; Working Group on NewBank Implementation, Report to the Federal Reserve Board
(Dec. 2005), available at
http://www.federalreserve.gov/boarddocs/Press/Other/2005/20051215/attachment.pdf [hereinafter
NewBankWorkingGroupReport].
3977See,e.g.,emailfromJanetBirney,Lehman,toDanielJ.Fleming,Lehman,etal.(Feb.26,2008)[LBEX
DOCID280175](TherecentmarketturmoilhaspromptedtheFedtoquestionJPMContheviabilityof
Tripartyfinancingintheeventofbrokerdealerdefault.);emailfromJanetBirney,Lehman,toDanielJ.
Fleming,Lehman,etal.(May5,2008)[LBEXDOCID065656];emailfromLucindaM.Brickler,FRBNY,to
TimothyF.Geithner,FRBNY,etal.(July16,2008)[FRBNYtoExam.034046](attachingtalkingpoints
theFRBNYdevelopedforaJuly17,2008meetingwithDimonandKellyregardingneartermmeasures
to enhance the stability of the triparty repo market); FRBNY, Talking Points, Nearterm Measures to
EnhancetheStabilityoftheTripartyRepoMarket[Draft](July16,2008),atp.1[FRBNYtoExam.034047]
(talkingpointsnoting,[i]ntheeventofthedefaultofalargeborrower,thepotentialforsystemicriskto
materializeco[u]ldbereduced).
1090

securities funded.3978 That is, more tripartyrepo transactions were occurring and
tripartyrepo parties were using lessliquid and often hardertoprice securities.3979
Liquidityandeaseofpricingarebothcriticalfactorsaffectingriskstotripartyinvestors
andclearingbanks.Thepremiseofatripartyrepoisthatitconstitutessecuredfunding
in which the lender (investor) has the opportunity to sell the collateral immediately
upon a brokerdealers (borrowers) failure to pay maturing principal. U.S. Treasury
securitiesaretheoptimalcollateralforU.S.dollartransactionssincelargeblockscanbe
soldreadilywithinonetradingdayandthewidelyquotedpricesofsuchsecuritiesare
highlyreliable.Stateddifferently,ifatripartyinvestorhas,forexample,avalueofpar
onits$100millionofTreasurysecuritycollateralandneedstosellitquicklybecausea
borrowerfailedtorepayitsloaninthemorning,theinvestorwouldalmostcertainlybe
abletosellthecollateralduringthesamebusinessdayatavalueveryclosetopar.
To guard against the possibility of the investor realizing less than the loan
amount in a liquidation scenario, the borrower must pledge additional margin (i.e.,
additionalcollateral)tothelender3980forexample,$100millionofTreasurysecurities
inexchangefor$98millionincash.This2percenthaircut(i.e.,discount)istypicalfor
3978ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atp.4;seealsoCurrentIssues:PDCF,at
p.2.
3979CRMPGIIIReport,atpp.11314;CurrentIssues:PDCF,atp.2.
3980RepoManual,atp.14[LBEXLL1175483].
1091

U.S.Treasurycollateral.3981Eveniftheborrowerdefaults,thelenderwillsuffernoloss
ifitcansellthe$100millionofTreasurysecuritiesfor$98millionormore.
As noted above, the risk of investor loss depends upon the investors ability to
sell collateral quickly and on the accuracy of the quoted price. Illiquid collateral
requires longer time periods for sale at more uncertain prices, with time periods and
pricesdependentonthetypeofcollateral,theamountofcollateraltosellandprevailing
marketconditions.3982
Due to the salvagevalue uncertainty associated with illiquid collateral, triparty
investorsdemandhigherhaircutsasperceivedcollateralilliquidityincreases.Equally
important,haircutsgenerallyincreaseasmarketvolatilityincreases.Forexample,some
lenders increased haircuts on assetbacked securities by 10 percent or more during
times of market turmoil.3983 Larger haircuts directly reduce the amount of funding
3981See,e.g.,NewBankWorkingGroupReport,atp.10.
3982As one example, consider a brokerdealer that owns $10million of a tripleB rated residential
mortgagebackedsecurity(RMBS).Assumetheentireissuanceofthisparticularbondis$20million,so
the brokerdealer owns half of the bond issue. Typically there would be zero or very few observable
trades of this specific bond during the preceding month. Hence, there is no way to know beforehand
howthemarketwillreactintermsofliquidationtimeandpricetoatripartyrepoinvestor(aslender
to the brokerdealer secured by the RMBS collateral) who seeks to sell $10million of the RMBS bond
quickly (upon a default of the brokerdealer). The market may treat this tripleB bond as it has other
similarlyratedRMBSbondsinthepriormonth,butassumptionsofthistypeadduncertainty.Eventhe
quoted pricein advance of anyattempt to sell the bond is anestimate based on models and the recent
performance of the prevailing residential housing market rather than a representation of recent trade
activity.Inshort,themoreilliquidthecollateral,thegreatertheuncertaintyofthesalvageablevalueof
suchcollateraltothetripartylender.
3983See, e.g., email from Laura M. Vecchio, Lehman, to Lori Bettinger, SEC, et al. (May 7, 2008) [LBEX
WGM 012803] (showing Dresdner increasing haircut on ABS from 110 to 120 during stress period); see
also email from Amberish Ratanghayra, Lehman, to John Feraca, Lehman, et al. (Mar. 24,2008) [LBEX
DOCID 046250] (Danske has requested an increase in haircut to 15%.). Craig Delany, a managing
1092

available to a brokerdealer, which may force the brokerdealer to sell collateral, find
otherfundingarrangements(suchasissuanceofunsecureddebt),oracceptareduction
inexcessliquidity.
Astripartyrepoagenttobrokerdealers,JPMorganwaseffectivelytheirintraday
tripartylender.WhenJPMorganpaidcashtothetripartyinvestorsinthemorningand
receivedcollateralintobrokerdealeraccounts(whichsecureditscashadvance),itbore
asimilarriskforthedurationofthebusinessdaythattripartylendersboreovernight.
If a brokerdealersuchasLBIdefaultedduringthe day,JPMorgan wouldhaveto sell
thesecuritiesitwasholdingascollateraltorecoupitsmorningcashadvance.
JPMorgan used a measurement for triparty and all other clearing exposure
knownasNetFreeEquity(NFE).Initssimplestform,NFEwasthemarketvalueof
Lehman securities pledged to JPMorgan plus any unsecured credit line JPMorgan
extendedtoLehmanminuscashadvancedbyJPMorgantoLehman.3984AnNFEvalue
greater than zero indicated that Lehman had not depleted its available credit with
JPMorgan. The NFE methodology also enabled JPMorgan to monitor its exposure
positionatalltimesduringthetradingdayandtherebyevaluatecollateralsubstitutions
directoratJPMorgansInvestmentBank,however,statedthat,intripartyrepos,typicallyinvestorslook
to the counterparty (i.e., brokerdealer) first and the collateral second when setting haircuts. In other
words,ahaircutmaynotbesufficientforaninvestorifithasseriousconcernsabouttheviabilityofits
counterparty.ExaminersInterviewofCraigM.Delany,Sept.9,2009,atp.13.
1093

by Lehman that might produce undesired credit exposures.3985 If a trade would put
Lehmans NFE below zero, the trade would not be permitted.3986 Through February
2008, JPMorgan gave full value to the securities pledged by Lehman in the NFE
calculation and did not require a haircut for its effective intraday triparty lending.
Consequently,throughFebruary2008,JPMorgandidnotrequirethatLehmanpostthe
marginrequiredbyinvestorsovernighttoJPMorganduringtheday.3987
DanFleming,LehmanGlobalHeadforCashandCollateralManagement,stated
thatLehmanobjectedtotheopaquenatureofJPMorgansNFEformulaandthat there
often was disagreement between Lehman and JPMorgan regarding NFE figures, with
Lehman struggling to find causal connections between drops in NFE and Lehmans
actions.3988 In February 2008, Lehman requested that JPMorgan provide a daily NFE
snapshotinordertoallowLehmantoobtainbetterestimatesofitsposition.3989
(c) JPMorganRestructuresItsApproachtoTripartyRisk
In early 2008, the Federal Reserve Bank of New York (FRBNY) urged
JPMorgan to focus on the risks associated with its intraday exposure to brokerdealer
3985Id.atp.6.
3986Id.atp.5;ExaminersInterviewofDanielJ.Fleming,Apr.22,2009,atp.3.
3988Examiners Interview of Daniel J. Fleming, Apr. 22, 2009, at p. 4; Examiners Interview of Craig L.
Jones,Sept.28,2009,atp.5.TonuccidescribedNFEasnotatransparentthing.ExaminersInterview
ofPaoloR.Tonucci,Sept.16,2009,atp.6.
3989Email from Craig L. Jones, Lehman, to Daniel J. Fleming, Lehman (Feb. 26, 2008) [LBEXDOCID
280175].
1094

clients.3990 In February 2008, JPMorgans Ricardo Chiavenato, a risk manager at
JPMorgan,wastaskedwithreviewingJPMorganstripartybusiness.3991Afteranalyzing
the market and increasing risks faced by clearing banks handling triparty repo
transactions,ChiavenatorecommendedthatJPMorganretaintripartyinvestormargin
the same margin triparty investors required.3992 JPMorgan decided to implement the
marginrequirementsgradually.3993
JPMorgan incorporated its new margin requirements into the NFE calculation.
Under its new approach, JPMorgan reduced the value it assigned to securities it held
commensuratewiththemarginrequirementsofthetripartyinvestors.3994Forexample,
ifLehmanhadborrowed$19millioninanovernighttripartyrepofromaninvestor,it
might have pledged $20 million (market value) of corporate bonds as collateral (at a
haircut of 5 percent). Before February 2008, JPMorgan required no tripartyinvestor
margin,soJPMorganspaymentof$19millioncashinthemorningtorepaythelender
(acashadvanceforthebenefitofLehman)inconcertwiththereceiptofthe$20million
3990See email from Janet Birney, Lehman, to Daniel J. Fleming, Lehman, et al. (Feb. 26, 2008) [LBEX
DOCID280175].
3991ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atpp.3,5.
3992Id.atp.5.Thisrecommendationthatclearingbanksretainmarginagainstcashadvancesisconsistent
withaDecember2005reportofaworkinggroupcommissionedbytheFederalReserveBoardtostudy
NewBank feasibility. A portion of this report dealt with prudent risk management practices and
includedtherequirementthatclientspostmargintocollateralizetheclearingbanksriskexposure.See
NewBankWorkingGroupReport,atp.17.
3993EmailfromJanetBirney,Lehman,toDanielJ.Fleming,Lehman,etal.(Feb.26,2008)[LBEXDOCID
280175].
3994Id.;ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atp.6.
1095

ofsecuritieswouldgiveLehmananimmediate$1millionsurplusofNFE.3995Lehman
could then use this surplus by withdrawing cash or securities or by executing other
tradesthatmightdrawdownthesurplus.
UponfullimplementationofJPMorgansplantoretaintripartyinvestormargin,
the change to the NFE calculation would be to treat the $20million market value of
corporate bonds as if they were worth only $19million. With this applied discount,
there would then be no NFE surplus to Lehman generated by JPMorgan paying
$19million cash in the morning and receiving $20million of bonds. Operationally,
JPMorganimplementedthischangebyadjustingNFEeachmorningbytheamountof
margin required by triparty investors the night before.3996 For example, if triparty
investors required $4.5 billion margin from LBI on Tuesday night, JPMorgan would
subtract $4.5 billion from LBIs NFE on Wednesday morning, effectively retaining the
sameamountofmarginastripartyinvestorsrequired.
Lehman and JPMorgan representatives discussed these new collateral
requirements, as well as other changes, on a February 26, 2008 conference call.
JPMorgan explained that because recent market turmoil . . . prompted the Fed to
question JPMC on the viability of [t]riparty financing in the event of broker dealer
default,JPMorganproposedthatitholdbackthemarginonthecollateralasacounter
3996See
JPMorgans Responses to Examiners Second Set of Questions re Lehman/JPM Accounts &
Collateral dated October 13, 2009 (Nov. 2, 2009), at p. 6 [hereinafter JPMorgan Second Written
Responses].
1096

debittotheNetFreeEquity(NFE)calculation,e.g.foranassetat102theywouldkeep
the2.3997JPMorganofferedtoimplementthisplanincrementally...overthenext56
weeks.3998
DespiteLehmansinitialresistancetoJPMorgansproposal,3999effectiveMarch17,
2008, JPMorgan began accounting for 20 percent of the tripartyinvestor margin in its
NFEcalculationforLehman.4000LehmanreportedinternallythatJPMorganhadbegun
implementing the intraday margin due to market conditions.4001 [M]arket
conditionswasanapparentreferencetothenearcollapseofBearStearnsandresultant
marketinstabilityoccurringatthetime.
JPMorgan continued to meet with Lehman throughout the summer to discuss
triparty risk and margin requirements. On May 2, 2008, Fleming and others from
LehmanparticipatedinaconferencecallwithEdCorral,thenJPMorgansGlobalHead
of U.S. Fixed Income Clearing, Mark Doctoroff, JPMorgans primary relationship
3997EmailfromJanetBirney,Lehman,toDanielJ.Fleming,Lehman,etal.(Feb.26,2008)[LBEXDOCID
280175].
3998Id.
3999See email fromPaolo R. Tonucci, Lehman, to Janet Birney, Lehman, et al. (Feb. 29, 2008) [LBEX
DOCID098461](describingJPMorgansproposalasablunttoolbeingusedtoaddressaverycomplex
issue). Lehman was concerned that debiting the NFE for the margin [would] be a problem,
apparentlybecauseLehmanhadhit[its]NFElimitseveraltimesoverthepriorfewweeks.Emailfrom
CraigL.Jones,Lehman,toDanielJ.Fleming,Lehman(Feb.26,2008)[LBEXDOCID280175].
4000Lehman,JPMChaseTripartyRepo,atp.4[LBEXAM001399];emailfromJackFondacaro,Lehman,
to Janet Birney, Lehman, et al. (Mar. 17, 2008) [LBEXDOCID 280168] (Chase just notified us that they
willbeginchargingusintradaymargin(20%ofthe2%).);JPMorganSecondWrittenResponses,atpp.
45.
4001Email from Jack Fondacaro, Lehman, to Janet Birney, Lehman, et al. (Mar. 17, 2008) [LBEXDOCID
280168].
1097

manager for Lehman, and others from JPMorgan.4002 JPMorgan had requested the
meetingtodiscusswheretheyareheadedandhowtheirriskdepartmentislookingat
the[tripartyproduct]business(promptedbydiscussionswiththeFED).4003According
toLehman,JPMorganwasveryclearthatthemeetingwasaproductspecificissueand
...assured[Lehman]thattheyhadnointentionofhindering[Lehmans]business.4004
The parties discussed, among other things, [c]hanges to the [i]ntra[d]ay [m]argining
process and the impact on Lehmans NFE.4005 At the meeting JPMorgan stated that
Lehman must post 100 percent tripartyinvestor margin by the end of June.4006 In
addition,ChaseagreedtoprovidearealtimecreditscreentomonitortheirNFEand
analysisonthepotentialimpactto[Lehmans]NFE.4007
4002EmailfromJanetBirney,Lehman,toDanielJ.Fleming,Lehman,etal.(May5,2008)[LBEXDOCID
065656].
4003Id.
4004Id.
4005Email from Janet Birney, Lehman, to Jack Fondacaro, Lehman, et al. (May 2, 2008) [LBEXDOCID
036292];DiscussionPoints[LBEXDOCID077455].Thepartiesalsodiscussedascheduleof[c]ollateral
andhaircutchangesforLehmanendofdayboxclearanceloans.EmailfromJanetBirney,Lehman,to
Jack Fondacaro, Lehman, et al. (May 2, 2008) [LBEXDOCID 036292]; Discussion Points [LBEXDOCID
077455]; see also JPMorgan, Fail Financing Collateral Schedule [LBEXDOCID 014193]; Lehman, JPM
ChaseTripartyRepo,atp.1[LBEXAM001399](JPMChasewantstorevisethecollateralschedulefor
overnightboxloans.Thiswouldincludetheexclusionofcertainassettypesandanoverallincreasein
haircuts.).
4006EmailfromJanetBirney,Lehman,toDanielJ.Fleming,Lehman,etal.(May5,2008)[LBEXDOCID
065656].ThereapparentlywassomeconfusionastowhetherJPMorganwouldrequirethesamemargin
amountastripartyinvestorsheldovernightorinsteadastatic2percentmargin.JPMorganclarifiedthat
itintendedtheformer.EmailfromCraigL.Jones,Lehman,toJanetBirney,Lehman,etal.(May5,2008)
[LBEXDOCID 065656]; email from Craig L. Jones, Lehman, to Janet Birney, Lehman (May 5, 2008)
[LBEXDOCID023260].
4007Email from Craig L. Jones, Lehman, to Rachel Zera, Lehman (May 2, 2008) [LBEXDOCID 031544].
Ashere,somewitnessesrefertoJPMorganasChase.ItappearsthatLehmanalso[a]greedtopledge
over to Chase excess noninvestment grade and nonrated priced collateral to assist with NFE. Id.;
ExaminersInterviewofCraigL.Jones,Sept.28,2009,atp.7(pledgingnonratedassetstoJPMorganwas
1098

Retentionof100percenttripartyinvestormargin,phasedinincrementally,was
onlyoneaspectofJPMorgansriskmitigationmeasuresforitstripartyrepobusiness.4008
JPMorgan believed that its risk was actually greater than that of individual triparty
investorsbecause,asaclearingbank,JPMorganwouldholdlargercollateralpositions
than any individual investor, and thus would face greater risks in a liquidation
scenario.4009 In addition, JPMorgan concluded that tripartyrepo investors had not
adequately assessed risks in the margins they charged.4010 Thus, in order to mitigate
liquidation and price risk, JPMorgan advised Lehman, as well as other brokerdealer
clients,thatadditionalmarginwouldberequired,basedoncollateraltype, aboveand
beyondthemarginrequiredbytheinvestors.4011JPMorgansnewriskbasedmargin
beneficialtoNFE).Despitehavingaccesstoitsowncreditscreen,Lehmanoftenstruggledtounderstand
NFEandhowdifferentfactorsaffectedit.E.g.,ExaminersInterviewofCraigL.Jones,Sept.28,2009,at
pp.2,910;ExaminersInterviewofDanielJ.Fleming,Apr.22,2009,atp.4;emailfromCraigL.Jones,
Lehman,toDanielJ.Fleming,Lehman(July7,2008)[LBEXDOCID055604].
4008As of early summer, JPMorgan was assigning a 125 percent margin to equities without regard to
tripartyinvestormargin.See,e.g.,JPMorgan,TripartyRepoDiscussionLehman(May29,2008),atp.2
[JPMEXAMINER00006028]; email from Ricardo S. Chiavenato, JPMorgan, to David A. Weisbrod,
JPMorgan(Aug.20,2008)[JPM20040006544];emailfromRicardoS.Chiavenato,JPMorgan,toDavidA.
Weisbrod,JPMorgan,etal.(Sept.8,2008)[JPM20040007292].
4009For example, a tripartyrepo investor that had loaned $19million against collateral with quoted
marketvalueof$20million(5percenthaircut)wouldneedtosellthiscollateralduringthetradingdayif
the borrower declared bankruptcy overnight. JPMorgans concentration risk to the brokerdealer
borrowerwasmuchhigherthanthatofanytripartyinvestor.Thebankfacedahigherrelativeriskthan
anyoneinvestorgiventheconcentrationofpositionsitheldagainstasinglebrokerdealer.Examiners
InterviewofRicardoS.Chiavenato,Sept.21,2009,atpp.910.
4010E.g.,id.atp.10;ExaminersInterviewofBarryL.Zubrow,Sept.16,2009,atp.4(overnightinvestors
were not concerned about liquidation pricing because they assumed clearing banks would unwind
securities).
4011See,e.g.,emailfromRicardoS.Chiavenato,JPMorgan,toThomasH.Mulligan,JPMorgan,etal.(Aug.
14, 2008) [JPM2004 0061182] (discussing riskbased margin with respect to all dealers); email from
Jane BuyersRusso, JPMorgan, to Stephen Eichenberger, JPMorgan, et al. (Sept. 11, 2008) [JPM2004
0032729] (We have taken steps this summer to improve the intraday exposures by increasing margins
1099

would take into account liquidation risk to account for oneday price volatility for
securities, and price risk, an estimate of potential vendor price overstatement for
illiquidsecurities.4012
Aswithtripartyinvestormargin,JPMorganplannedtoimplementitsnewrisk
basedmarginrequirementincrementally.JPMorganfirstcalculatedriskbasedmargin
manuallybecauseBDASdidnotyethavethecapability.4013InitiallyJPMorganwasable
to calculate only a static snapshot of riskbased margin based on a brokerdealers
collateral pool at the start of the day. Throughout the day, however, brokerdealers
couldsubstitutetripartycollateralandbuyandsellsecurities.Bothactivitieschanged
the risk profile of the collateral pool. JPMorgan planned eventually to implement the
riskbasedmargin concept and dynamic margining into BDAS, which would track
JPMorgansriskinrealtimeascollateralwassubstituted.4014
andexcludingcertaincollateralclasses....);ExaminersInterviewofRicardoS.Chiavenato,Sept.21,
2009,atp.6.
4012JPMorgan,TripartyRepoDiscussionLehman(May29,2008),atp.10[JPMEXAMINER00006028].
Chiavenato explained that vendor pricing may not be accurate for some types of securities; JPMorgan
accountedforthispriceriskinitsriskbasedmargincalculation.Thepriceriskcomponentdidnot
mitigatetheriskofdealerselfpricing.ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,at
p.11.JPMorgansviewsoftheliquidationriskandthepriceriskrolledupintoonehaircut(ormargin
amount)foreachcollateraltype.SeeJPMorgan,DetailedSummaryBreakdownbySecurityandRating
(Sept.5,2008)[JPMEXAMINER00006088].
4013Examiners Interview of Ricardo S. Chiavenato, Sept. 21, 2009, at p. 6; email from Thomas H.
Mulligan,JPMorgan,toJaneBuyersRusso,JPMorgan,etal.(Sept.11,2008)[JPM20040032729](Weare
close to having a system to calculate the risk based margin required to address the 1 day price +
liquidationrisk(Zubrowagreedtothismethodology).).
4014Examiners Interview of Ricardo S. Chiavenato, Sept. 21, 2009, at p. 6. JPMorgan had not
implementeddynamicmarginingasofSeptember15,2008,whenLBHIfileditsbankruptcypetition.E.g.,
id.
1100

(d) LehmanBeginsPostingAdditionalCollateral
On June 2, 2008, JPMorgan met with Lehman to discuss the move toward risk
basedmargin.4015Atthattime,JPMorganwasapplyingonly20percentinvestormargin
forintradayfinancing.4016JPMorganpresentedLehmanwithcalculationsshowingthat
$2.8 billion of additional collateral would be required to reach 100 percent investor
margin and an additional $3.2billion would be necessary to satisfy JPMorgans new
riskbasedmarginrequirementbasedontheprevailing(May23,2008)portfoliodata.4017
JPMorgancalculatedthat$6.1billionofadditionalcollateral(withapparentrounding)
was necessary to cover both the liquidation and price risk.4018 As a result of that
meeting,Lehmanagreedtopost$5billionofcollateraltobegintocoverthisdeficit.4019
AlthoughJPMorganscalculationsfromlateMaysuggestthatJPMorganrequiredonly
an additional $3.2 billion to cover riskbased margin (and that the $6.1 billion figure
included the adjustment to 100 percent tripartyinvestor margin as well), JPMorgan
witnesses stated that the $5 billion that Lehman agreed to post covered riskbased
4015ExaminersInterviewofBarryL.Zubrow,Sept.16,2009,atp.5;JPMorganSecondWrittenResponses,
atp.5.
4017Id.atpp.3,5,7.
4018Id.atp.5.
4019ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atpp.1011;ExaminersInterviewof
EdwardJ.Corral,Sept.30,2009,atpp.45;ExaminersInterviewofBarryL.Zubrow,Sept.16,2009,atp.
5;JPMorganSecondWrittenResponses,atp.5.JPMorganandLehmaninitiallyattemptedtodocument
thiscollateralpledgethroughaletteragreement.SeeemailfromDanielJ.Fleming,Lehman,toMarkG.
Doctoroff,JPMorgan,etal.(July16,2008)[LBEXAM001354];LetterfromJPMorgantoPaoloR.Tonucci,
Lehman,re:DeliverytoJPMorganChaseBank,N.A.of$5billionofSecurities[Draft](July2008)[LBEX
AM001356].Thatletteragreementdoesnotappeartohaveeverbeenexecuted.ExaminersInterviewof
PaoloR.Tonucci,Sept.16,2009,atp.7.
1101

margin, not tripartyinvestor margin.4020 Internally, Lehman stated in August that the
amountrequiredforJPMorgansriskbasedmarginwasestimatedat$6.2billionand
[i]n lieu of implementing the additional haircut systemically JPMorgan reduced
Lehmans intraday credit position by $5 billion, requiring [Lehman] to pledge
additionalcollateralforalikeamount.4021Althoughtheadditional$5billionwasnot
the ultimate level of collateral JPMorgan wanted, JPMorgan viewed the $5 billion
collateralasastepintherightdirection.4022
Tofulfillitsoffertopledge$5billionofcollateral,Lehmanpostedapproximately
$5.7 billion (face value) of securities at JPMorgan on June 19, 2008.4023 The collateral
consistedoflargepositionsinfourCDOscalledSASCO,Freedom,SpruceandPine
andoneassetbackedcommercialpaperposition,knownasFenway.4024Lehmanposted
4020Examiners Interview of Ricardo S. Chiavenato, Sept. 21, 2009, at p. 10; Examiners Interview of
EdwardJ.Corral,Sept.30,2009,atpp.45;ExaminersInterviewofBarryL.Zubrow,Sept.16,2009,atpp.
45;seealsoemailfromRicardoS.Chiavenato,JPMorgan,toMarkG.Doctoroff,JPMorgan,etal.(Aug.13,
2008) [JPM2004 0061165] (referencing the $5bi static margin to meet our riskbased margin); email
from Ricardo S. Chiavenato, JPMorgan, to David A. Weisbrod, JPMorgan (Aug. 20, 2008) [JPM2004
0006544] (listing $5 bi extra collateral separate from 100% of triparty investor margin); JPMorgan
SecondWrittenResponses,atp.5.
4021EmailfromJanetBirney,Lehman,toPaoloR.Tonucci,Lehman,etal.(Aug.5,2008)[LBEXDOCID
4165589];seealsoemailfromDanielJ.Fleming,Lehman,toJanetBirney,Lehman(Aug.1,2008)[LBEX
DOCID 63603]. While riskbased margin changed throughout the summer, it appears that Birney was
likelyreferencingthe$6.1billioncalculationfromlateMay.
4023JPMorganSecondWrittenResponses,atp.5.
4024Email from Craig L. Jones, Lehman, to John Feraca, Lehman, et al. (June 19, 2008) [LBEXDOCID
055575]; JPMorgan Second Written Responses, at p. 5. The SASCO 2008C2 (SASCO) bond was a
commercial real estate (CRE) CDO, although it was sometimes described less precisely as a
collateralized mortgage obligation (CMO). Freedom, Spruce and Pine were collateralized loan
obligations(CLOs)aspecialtypeofCDOthatconsistsofprimarilyhighyield(orleveraged)loans
tocorporateborrowers.TheFenwaytransactionwaswidelydescribedasassetbackedcommercialpaper
1102

thesesecuritiestoaclearanceaccountwithinJPMorgancalledLCD,whichJPMorgan
characterizes as an LBI account.4025 The securities pledged in June, however, were
ownedbyLCPI.4026
Lehman did not reach 100 percent tripartyinvestor margin by JPMorgans
original target date.4027 On July 2, 2008, Lehman posted over $1 billion additional
collateraltotheLCDaccount:Kingfisher(anAsianCLO)andHDSupply(acorporate
loan).4028 Lehman continued to post collateral to and substitute collateral in the LCD
account throughout July and August 2008, including a large position in another CDO
calledVerano.4029
(ABCP),butmostshorttermdebtobligationsofthisissuerwereextendibleCPalsoknownassecured
liquidity notes (SLNs). For purposes of this discussion we will refer to Fenway as ABCP. Lehman
createdallofthesepositionsin2008(exceptforFenway,whichwasfirstlaunchedin2007)bysecuritizing
(theCDOs)orfunding(theABCP)itsownilliquidcorporateandcommercialrealestateloans.
4025JPMorgan First Written Responses, at p. 7; JPMorgan Second Written Responses, at p. 5; see also
Spreadsheet [JPMEXAMINER00006151] (spreadsheet showing LCD as part of DG92, an LBI dealer

group).Alvarez&Marsal,however,underst[ood]JPMorganreferredtotheLCDaccountinawaythat
suggestsitwasaLCPIaccount.Alvarez&Marsal,ResponsestoQuestionsforAlvarez&Marsal/Weil,
Gotshal&Manges(Dec.7,2009),atp.1.
4026JPMorgan First Written Responses, at p. 7; see also email from Rob Rodriguez, Lehman, to Michael
Prestolino,Lehman,etal.(Aug.11,2008)[LBEXDOCID116020](emailchaindocumentingsaleofCDO
assets to LBHI from LCPI); email from Ricardo S. Chiavenato, JPMorgan, to Henry R. Yeagley,
JPMorgan,etal.(Aug.7,2008)[JPM20040008051](discussingcollateralpostedbyLCPI).
4027See email from Piers Murray, JPMorgan, to Paolo R. Tonucci, Lehman (July 1, 2008) [LBEXDOCID
036475].
4028SeeemailfromJohnN.Palchynsky,Lehman,toRichardPolicke,Lehman,etal.(July2,2008)[LBEX
DOCID077515](emailchaindocumentingpledge);JPMorganSecondWrittenResponses,atp.5.
4029JPMorgan Second Written Responses, at p. 6; see email from Ricardo S. Chiavenato, JPMorgan, to
HenryR.Yeagley,JPMorgan,etal.(Aug.7,2008)[JPM20040008051];JPMorgan,PositionPricingReport
(Aug.7,2008),atp.1[JPM2004008062](listingsecuritiesinLCDasofAugust7,2008).
1103

Securities in the LCD account contributed to LBIs NFE requirement, which, as
discussedabove,wasincrementallyadjustedtoaccountfortripartyinvestormargin.4030
By the end of July, Lehman had posted approximately $8 billion to JPMorgan (face
value),andLehmanunderstoodthatJPMorganhadtakenanofficiallienover$5bn...
above and beyond what [was] required for NFE.4031 The final adjustment to achieve
100percenttripartyinvestormarginoccurredonAugust14,2008.4032
Additionally, Lehman posted collateral in July to an LCPI clearance account
calledLCP,includingsmalleramountsinsecuritiesknownasGoldenGate(surplus
notes of a captive reinsurer SPV), Loan FNG (a Lehman loan to the R3 hedge fund),
DeltaTopco(anonpublicsecuritycomprisedofhighyieldloans),CaymanPartners(a
Lehman loan to an SPV) and Riopelle Broadway (another Lehman loan to an SPV).4033
4030SeeJPMorganSecondWrittenResponses,atp.6.JPMorganalsoadjustedLBIsNFEtoaccountforthe
$5billionofriskbasedmarginthatLehmanagreedtopost.Thisadjustmentceasedwhensecuritieswere
movedtotheLCEaccountinearlyAugust.SeeJenner&Block,MemorandumreNovember18,2009
Teleconference with JPMorgan Counsel (Nov. 19, 2009), at p. 3; see also infra at Section III.A.5.b.1.e
(discussingtransferofsecurities).
4031Email from Craig L. Jones, Lehman, to James W. Hraska, Lehman (July 31, 2008) [LBEXDOCID
077621].
4032See email from Daniel J. Fleming, Lehman, to Paolo R. Tonucci, Lehman (Sept. 3, 2008) [LBEXAM
000870];JPMorganSecondWrittenResponses,atp.7;seealsoLehman,NFETrackingSpreadsheet,atpp.
14042 [LBEXLL 385672] (spreadsheet of NFE tracking maintained by Craig Jones that shows NFE
Adjustmentincreasingfrom$10.6billiononAugust13to$11.6billiononAugust14).
4033SeeJPMorganSecondWrittenResponses,atpp.78;emailfromCraigL.Jones,Lehman,toDanielJ.
Fleming,Lehman,etal.(Aug.27,2008)[LBEXDOCID454649];Lehman,NFEData(Aug.27,2008),atp.2
[LBEXDOCID 453380] (listing these securities as pledged collateral); see also Lehman, $[450],000,000
Floating Rate Surplus Notes due 20[37], First British American Reinsurance Company II, Information
Memorandum (2006) [LBEXWGM 974136] (information concerning Golden Gate); Lehman, R3 Capital
PartnersStrategicAcquisitionReviewCommittee(May20,2008)[LBHI_SEC07940_098444](information
concerning R3 and Loan FNG); Spreadsheet [LBEXBARFID 0016221] (information concerning Delta
Topco); Spreadsheet re: Financing Trades [LBHI_SEC07940_2594028] (information concerning Riopelle
BroadwayandCaymanPartners).RiopelleBroadwaywastransferredoutofLCPonAugust27;Golden
1104

Lehman also posted Pine physicals, Spruce physicals, Verano physicals and SASCO
physicals to an LCPI physical account, Titan account G 72456.4034 Although Lehman
listed these securities on internal NFE Collateral charts,4035 according to JPMorgan,
neitherLCPnorG72456contributedtoLBIsNFE.4036Appendix18summarizessome
ofthesignificantcollateralpostingsandmovementsduringthesummerof2008.
(e) JPMorganConcernOverLehmanCollateralinAugust2008
By early August 2008, JPMorgan had learned that Lehman had pledged self
priced CDOs as collateral over the course of the summer.4037 By August 9, to meet
JPMorgans margin requirements, Lehman had pledged $9.7 billion of collateral, $5.8
GatewastransferredoutofLCPonAugust29.SeeJPMorganSecondWrittenResponses,atpp.78;e
mailfromCraigL.Jones,Lehman,toDanielJ.Fleming,Lehman(Sept.3,2008)[LBEXDOCID055415];
Lehman, NFE Data (Sept. 2, 2008), at p. 2 [LBEXDOCID 046772] (no longer listing these securities as
pledgedcollateral).
4034See email from Kristen Coletta, Lehman, to Craig L. Jones, Lehman (Sept. 3, 2008) [LBEXDOCID
055422];Lehman,NFEData(Sept.3,2008),atp.3[LBEXDOCID046675](showingnewpledgedCUSIPs
of Pine, Spruce, Verano and SASCO); email from Michael Prestolino, Lehman, to Carolyn Murillo,
Lehman, et al. (Aug. 27, 2008) [LBEXDOCID 046646] (identifying CUSIPs as physical notes); Collateral
Pledged to JPM for Intraday As of 9/12/2008 COB [LBEXAM 047008]; JPMorgan Second Written
Responses,atp.8.
4035See,e.g.,emailfromKristenColetta,Lehman,toCraigL.Jones,Lehman,etal.(Sept.11,2008)[LBEX
DOCID 055424]; Lehman, NFE Collateral Details As of 9/10/2008 COB (Sept. 11, 2008) [LBEXDOCID
046774];emailfromCraigL.Jones,Lehman,toDanielJ.Fleming,Lehman,etal.(Aug.27,2008)[LBEX
DOCID454649];Lehman,NFEData(Aug.27,2008),atp.2[LBEXDOCID453380].
4036JPMorganSecondWrittenResponses,atpp.78;JPMorganFirstWrittenResponses,atp.7.Butseee
mailfromJohnN.Palchynsky,Lehman,toCraigL.Jones,Lehman(July15,2008)[LBEXDOCID053633]
(confirming that Lehman could pledge assets to LCPIs physicals box to get...NFE benefit).
According to Alvarez & Marsal, Lehman believed that securities pledged in LCP and Titan account G
72456 impacted LBIs NFE. Alvarez & Marsal, Responses to Questions for Alvarez & Marsal/Weil,
Gotshal&Manges(Dec.7,2009),atp.1.
4037See,e.g.,emailfromRicardoS.Chiavenato,JPMorgan,toMarkG.Doctoroff,JPMorgan,etal.(Aug.9,
2008)[JPM20040006527].LehmanattemptedtopledgesomeoftheseCLOstoCitiinearlyAugustas
well,namely,Kingfisher,Freedom,SpruceandVerano.EmailfromMichaelMauerstein,Citigroup,to
YingliXie,Citigroup,etal.(Aug.4,2008)[CITILBHIEXAM00082162].UnlikeJPMorgan,Citirefusedto
accepttheCLOsascollateral.EmailfromMichaelMauerstein,Citigroup,toKatherineLukas,Citigroup,
etal.(Aug.12,2008)[CITILBHIEXAM00021175].
1105

billion of which were CDOs priced by Lehman, mostly at face value.4038 JPMorgan
expressed concern as to the quality of the assets that Lehman had pledged and,
consequently, Lehman offered to review its valuations.4039 Although JPMorgan
remainedconcernedthattheCDOswerenotacceptablecollateral,4040Lehmaninformed
JPMorganthatithadnoothercollateraltopledge.4041ThefactthatLehmandidnothave
otherassetstopledgeraisedsomeconcernsatJPMorganaboutLehmansliquidity.4042
4038EmailfromRicardoS.Chiavenato,JPMorgan,toMarkG.Doctoroff,JPMorgan,etal.(Aug.9,2008)
[JPM20040006527].
4039Email from Edward J. Corral, JPMorgan, to Ricardo S. Chiavenato, JPMorgan, et al. (Aug. 8, 2008)
[JPM20040006511];emailfromEdwardJ.Corral,JPMorgan,toRicardoS.Chiavenato,JPMorgan,etal.
(Aug. 8, 2008) [JPM2004 0006515]. Chiavenato explained that only when JPMorgan finally received
prospectuses for Lehmans CDOs did it realize that the CDOs were not the type of collateral that
JPMorganwouldtypicallytake.ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atp.11;
seealsoemailfromDanielJ.Fleming,Lehman,toMarkG.Doctoroff,JPMorgan(Sept.8,2008)[JPM2004
005807](attachingofferingmemorandaforPine,Spruce,VeranoandSASCO).Chiavenatostatedthathe
was unaware of Lehman ever having defended the quality of its collateral. Examiners Interview of
Ricardo S. Chiavenato, Sept. 21, 2009, at p. 16. At least in early August 2008, however, Tonucci
questionedwhetherJPMorganshouldbethepriceprovider.EmailfromPaoloR.Tonucci,Lehman,to
CraigL.Jones,Lehman,etal.(Aug.8,2008)[LBEXSIPA003932];seealsoemailfromMarkG.Doctoroff,
JPMorgan, to Ricardo S. Chiavenato, JPMorgan, et al. (Aug. 5, 2008) [JPM2004 0061153] (reporting that
Lehmandidnotagreewith[JPMorgans]liquidity/pricerisknumbers);emailfromPaoloR.Tonucci,
Lehman, to Mark G. Doctoroff, JPMorgan, et al. (Aug. 5, 2008) [LBHI_SEC07940_534634] (Not sure
whetheritmakessensetobecollateralisingyouonthebasis[of]yourwrong/erroneousinformation.).
CorralrecalledthatLehmanprovidedprospectusesofitssecuritiestotrytopersuadeJPMorgansthird
party pricing provider to revise its pricing, but that provider did not change its values. Examiners
InterviewofEdwardJ.Corral,Sept.30,2009,atp.9.
4040SeeemailfromDonnaDellosso,JPMorgan,toRicardoS.Chiavenato,JPMorgan(Aug.6,2008)[JPM
20040061153](I...dontwant[CDOs]ascollateralfortheintradayexposure.);emailfromRicardoS.
Chiavenato, JPMorgan, to Mark G. Doctoroff, JPMorgan, et al. (Aug. 9, 2008) [JPM2004 0006527] (We
neverintendedtohaveourmarginrequirementsmetbyCDOs....).
4041EmailfromRicardoS.Chiavenato,JPMorgan,toDonnaDellosso,JPMorgan(Aug.6,2008)[JPM2004
0061153].
1106

At the time, the market for CDOs was illiquid generally, rendering them less
desirable as collateral.4043 With regard to the specific CDOs pledged by Lehman,
JPMorgans David Weisbrod commented in an August 6 email that [e]ssentially
[Lehmanwas]packagingupsecuritiesitunderwroteandstructuredandcouldntsell.
[Lehman] put[] its own price on these securities . . . .4044 Weisbrod questioned
Lehmans intentions: [T]his strikes me as borderline insulting to think we would
accept Lehmans self structured and self priced CDOs to meet our margin
requirements.4045 Chiavenato told the Examiner that Lehman had posted the worst
type of collateral with Lehmans own prices attached.4046 Yet, at the time, at least one
person within JPMorgan, Mark Doctoroff, defended Lehmans conduct. Doctoroff
stated in a contemporaneous email that it sounds like we think [Lehman has] been
actinginbadfaith,whichIdisagreewithaswedidnotgiveclearinstructionstothem
when we asked for the $5bn . . . .4047 The Examiner has not discovered evidence
suggesting that JPMorgan told Lehman directly that Lehman could not post CDOs as
collateralthroughAugust2008.
4043Id.atp.4.
4044EmailfromDavidA.Weisbrod,JPMorgan,toEdwardJ.Corral,JPMorgan(Aug.6,2008)[JPM2004
0061153].
4045EmailfromDavidA.Weisbrod,JPMorgan,toRicardoS.Chiavenato,JPMorgan,etal.(Aug.6,2008)
[JPM20040061153].
4047EmailfromMarkG.Doctoroff,JPMorgan,toRicardoS.Chiavenato,JPMorgan,etal.(Aug.9,2008)
[JPM20040006537].
1107

In early August 2008, JPMorgan engaged Gifford Fong Associates (GFA), a
thirdparty boutique pricing vendor, to price Lehmans difficulttovalue collateral.
JPMorgansEdCorralnotedthatGFAimpressedtheheckoutofhim,4048althoughthe
managingdirectorthatoversawJPMorgansInvestmentBankstripartyrepobusiness,
Craig Delany, stated that he ignored almost any pricing from GFA.4049 Delany stated
that,inhisexperience,modelpricingismateriallyinaccurateandcouldnotbetrusted
for large, illiquid assets.4050 Nonetheless, JPMorgan used GFA to value Lehmans self
priced CDOs and continues to use GFA to price other difficulttoprice assets in its
system.4051
OnAugust8,2008,GFApricedLehmanscollateralatasignificantlylowervalue
thanthevalueassignedbyLehman.4052Chiavenatoexplainedthat,usingGFAspricing,
the $5.8 billion of pledged CDOs would be worth less than $2 billion.4053 Chiavenato
likely misstated GFAs results, however. At the time, GFA had not priced Kingfisher
4048EmailfromEdwardJ.Corral,JPMorgan,toDavidA.Weisbrod,JPMorgan(Aug.7,2008)[JPM2004
0061153].
4049ExaminersInterviewofCraigM.Delany,Sept.9,2009,atp.8.
4050Id.
4051Examiners Interview of Ricardo S. Chiavenato, Sept. 21, 2009, at pp. 7, 11; Examiners Interview of
EdwardJ.Corral,Sept.30,2009,atp.8.
4052SeeemailfromEdwardJ.Corral,JPMorgan,toRicardoS.Chiavenato,JPMorgan,etal.(Aug.8,2008)
[JPM20040008073];emailfromJessieZhang,GFA,toEdwardJ.Corral,JPMorgan,etal.(Aug.8,2008)
[LBEXGF000040].
[JPM20040006527].JPMorganalsolearnedthatLehmanhad$3.9billioninCDOsinitstripartyshells
which,usingGFAspricingofLehmansextracollateralasaproxy,wouldhavebeenworthlessthan$1.5
billion.Seeid.;seealsoemailfromRicardoS.Chiavenato,JPMorgan,toHenryR.Yeagley,JPMorgan,et
al.(Aug.7,2008)[JPM20040008051].Forthereasonsstatedintext,thevaluationappliedasaproxywas
likelytoolow.
1108

and Verano; 4054 instead of accounting for that fact, Chiavenato apparently assigned a
price of zero to Kingfisher and Verano. Excluding Kingfisher and Verano,
approximately$3.5billionofpledgedCDOswerevaluedatabout$2billionbyGFA
stillasignificantdifference.4055Laterinthesummer,whenLehmanhadfewersecurities
pledged in the relevant collateral account, GFA again assigned a significantly lower
valuetoLehmanssecuritiesthanhadLehman.4056
UponlearningthatJPMorganhadbeenacceptingdealerselfpricing,Chiavenato
undertook a general analysis of dealerpriced securities tracked in JPMorgans BDAS
system. Inlate August, Chiavenatoconcludedthat Lehman wasproviding more self
priced securities than other dealers.4057 Those securities, he explained, were also the
riskiestones.4058
In additiontoconcernsithadwith valuation,JPMorgan in early Augustraised
concerns over the fact that LCPI, rather than LBI or LBHI, was posting collateral to
[JPM20040008073];LBExcessCollateralPricedbyGF(Aug.8,2008)[JPM20040008074].
[JPM20040008073];LBExcessCollateralPricedbyGF(Aug.8,2008)[JPM20040008074].
4056EmailfromEdwardJ.Corral,JPMorgan,toDavidA.Weisbrod,JPMorgan,etal.(Sept.4,2008)[JPM
20040006562](reportingthatGFApricedthreeCDOs$1.5billionlowerthanLehmansassignedmarket
valueofapproximately$3.25billion);Spreadsheet(Sept.4,2008)[JPM20040006563].
4057Examiners Interview of Ricardo S. Chiavenato, Sept. 21, 2009, at p. 7; email from Ricardo S.
Chiavenato, JPMorgan, to Edward J. Corral, JPMorgan, et al. (Aug. 27, 2008) [JPM2004 0009300]
(Lehmanhasthehighestnumberandmarketvalueofselfpricedsecurities.).
4058ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atp.7;seealsoemailfromThomasH.
Mulligan,JPMorgan,toRicardoS.Chiavenato,JPMorgan,etal.(Aug.29,2008)[JPM20040006549](The
riskisthesizeofthelargestsecuritiesineachofthedealerspoolofsecurities.ForexampleLehmanhas4
securitiesofdealerpricedsecuritieswithatotalparvalueof$4,900MMinitsportfoliovaluedat100%.).
1109

coverintradayrisk.4059JPMorganpreferredthatadditionalcollateralsupportingLBIs
clearingexposurebeprovidedbyLBIitself,oritsparentcompany,LBHI.4060Lehman
accordingtoJPMorganwant[ed]toavoidsubstitutingothercollateralforthisblock
as it would have to come from the holdco liquidity pool directly and the way they
reportthisnumberwouldchange.4061AsofAugust5,2008,LCPIhadpledgedboth$5
billion in extra collateral for riskbased margin and $4 billion related to triparty
investor margin.4062 In order to alleviate JPMorgans concern, Lehman transferred
Spruce, Freedom, Pine, Kingfisher and Verano from LCPI to LBHI on August 8, and
JPMorgan sought and obtained a guaranty from LBHI for LBIs obligations.4063 The
securities moved concurrently from LCD to LCE, an LBHI account at JPMorgan.4064
LehmanalsotransferredFenwayfromLCPItoLBHI(andfromLCDtoLCE)onAugust
4059See,e.g.,emailfromRicardoS.Chiavenato,JPMorgan,toEdwardJ.Corral,JPMorgan,etal.(Aug.5,
2008)[JPM20040061153].
4060JPMorganFirstWrittenResponses,atp.7.
4061EmailfromPiersMurray,JPMorgan,toBarryL.Zubrow,JPMorgan,etal.(Aug.1,2008)[JPM2004
0061182].
4062Email from Ricardo S. Chiavenato, JPMorgan, to Edward J. Corral, JPMorgan, et al. (Aug. 5, 2008)
[JPM2004 0061153]. As discussed supra, these LCPI securities were posted in LCD, apparently an LBI
account,accordingtoJPMorgan.Throughcounsel,JPMorganclarifiedthatwedonotbelievethatthere
wasanagreementthattherewouldbeseparatecollateralrequirementsfortheapproximately$4billionin
investormargin.Rather,thatmarginwasimplementedbyentryofadebittoNFEeachmorninginthe
amountoftheprecedingnightsinvestormargin.JPMorganSecondWrittenResponses,atpp.56.
4063See email from MichaelPrestolino, Lehman, to Craig L. Jones,Lehman, et al. (Aug.8, 2008) [LBEX
DOCID046703];Lehman,PricesforLCDBox(Aug.8,2008)[LBEXDOCID023772].
4064JPMorganSecondWrittenResponses,atpp.67.
1110

11.4065 The guaranty from LBHI was memorialized in a new agreement, discussed
below.
JPMorgans collateral requests through the summer of 2008 were all part of
JPMorgans move toward requiring a riskbased margin.4066 Chiavenato described
Lehmans responses to JPMorgans request as Lehman dragging its feet.4067 In
Chiavenatos view, Lehman had delayed collateral pledges and pledged collateral of
questionablequality.4068
At least some of the Lehman personnel involved in discussionswith JPMorgan
believedthatJPMorganwasrequiringmoremarginthannecessary.4069PaoloTonucci,
LBHIsVicePresidentandGlobalTreasurer,statedthatJPMorganshaircutsandrelated
4065Email from Rob Rodriguez, Lehman, to Michael Prestolino, Lehman, et al. (Aug. 11, 2008) [LBEX
DOCID116020];JPMorganSecondWrittenResponses,atp.7.
4066ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atpp.1516.Theamountofriskbased
margin required increased over the course of the summer. See, e.g., email from David A. Weisbrod,
JPMorgan, to Piers Murray, JPMorgan, et al. (Aug. 3, 2008) [JPM2004 0061182] (Based on the 7/29
numbersprovidedbyRicardo,ourapproachshouldbetoget$6.7bnofmargintoachievecoveragefor
the liquidity risk and price risk.). By August 22, 2008, JPMorgan calculated riskbased margin every
morningandLehmansriskbasedmarginha[d]goneuptothe$8birangeduetomorevolume,CDOs,
andhigherriskfactorsforABSsandCPs.EmailfromRicardoS.Chiavenato,JPMorgan,toDavidA.
Weisbrod,JPMorgan(Aug.22,2008)[JPM20040061234].
4068Id.atpp.11,15.
4069E.g., Examiners Interview of Paolo R. Tonucci, Sept. 16, 2009, at p. 6. On August 5, Doctoroff
reportedthatLehmandidnotagreewith[JPMorgans]liquidity/pricerisknumbers.Seeemailfrom
Mark G. Doctoroff, JPMorgan, to Ricardo S. Chiavenato, JPMorgan, et al. (Aug. 5, 2008) [JPM2004
0061153];seealsoemailfromPaoloR.Tonucci,Lehman,toMarkG.Doctoroff,JPMorgan(Aug.5,2008)
[LBHI_SEC07940_534634] (Not sure whether it makes sense to be collateralising you on the basis [of]
yourwrong/erroneousinformation.).ChiavenatorecalledthatLehmanbelieveditsmarginwashigher
thanitshouldbe.ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atp.12.Inafollowup
email the same day, Doctoroff stated that Lehman agree[d]/underst[ood] the margin/price/liquidity
risk.EmailfromMarkG.Doctoroff,JPMorgan,RicardoS.Chiavenato,JPMorgan,etal.(Aug.5,2008)
[JPM20040061153].
1111

collateraldemandswerecompletelyinappropriateandmadepursuanttosimplistic
calculationsthatwerenotdoneonasophisticatedportfoliowidebasis.4070Lehman
believed that JPMorgan was requiring too much margin because JPMorgan
unnecessarily unwound term repos daily.4071 Term repos lasted longer than one day,
and, therefore, theoretically should not have required an extension of credit by
JPMorgan every morning to unwind. But JPMorgan unwound all repos including
termreposinthemorning,apparentlytoallowbrokerdealerstosubstituteallocated
securities during the day.4072 Chiavenato stated that termrepo investors had come to
expect to receive cash intraday.4073 JPMorgan did not alter this process prior to
Lehmansbankruptcy.4074LehmanalsoresistedtosomedegreeJPMorgansriskbased
marginimplementationbyaskingformoretimetomeetJPMorgansdemands.4075
Notably, however, Dan Fleming one of Lehmans principal contacts with
JPMorgan believed that, at least through midAugust, JPMorgan had been acting in
good faith in negotiating issues surrounding NFE and the adequacy of Lehman
4071See,e.g.,emailfromThomasH.Mulligan,JPMorgan,toRicardoS.Chiavenato,JPMorgan,etal.(Aug.
9,2008)[JPM20040006537](Lehmanfeel[s]thatthemarginwillbereduceddramaticallyoncewecan
stop the daily unwind of the term repo.); email from Mark G. Doctoroff, JPMorgan, to David A.
Weisbrod, JPMorgan, et al. (Aug. 3, 2008) [JPM2004 0061182] (Lehmans Treasurer and other seniors
therebelievethattheliquidityandpricerisksaredifferentornonexistentoncertaintypesofrepo,like
the term repo that they do not think they have to unwind, as well as some open repo.); Examiners
InterviewofBarryL.Zubrow,Sept.16,2009,atp.8;ExaminersInterviewofPaoloR.Tonucci,Sept.16,
2009,atp.6.
4073Id.
4074Id.
4075Id.atp.9.
1112

collateral.4076IanLowittalsobelievedthatuntilSeptember11(thedateofanadditional
collateral request, discussed below) JPMorgan had not acted unreasonably toward
Lehman.4077
(f) TheAugustAgreements
As discussed above, JPMorgan requested that Lehman enter into new
agreements in part because JPMorgan wanted a guaranty from LBHI. In addition,
JPMorgan requested the new agreements upon discovering that additional Lehman
subsidiaries were conducting operations through JPMorgans clearing system.4078 On
August18,2008,DoctoroffemailedFlemingthedocuments...thatwillallowforthe
lien in all the clearance accounts in Lehmans broker/dealer group, that is, a draft
AmendmenttotheClearanceAgreement,draftGuarantyanddraftSecurityAgreement
(collectively,theAugustAgreements).4079
Paul Hespel, Lehmans outside counsel at Goodwin Procter, stated that the
primary business issue animating the August Agreements was a concern by Lehman
counterparties that Lehmans clearing relationship with JPMorgan consisted of an
undocumented course of dealing.4080 Specifically, several Lehman subsidiaries were
alreadytradingusingJPMorganssystem,butwerenotformallyaddedtotheClearance
4076ExaminersInterviewofDanielJ.Fleming,Apr.22,2009,atp.5.
4077ExaminersInterviewofIanT.Lowitt,Oct.28,2009,atpp.2021.
4078ExaminersInterviewofDanielJ.Fleming,Apr.22,2009,atp.5.
4079Email
from Mark G. Doctoroff, JPMorgan, to Daniel J. Fleming, Lehman (Aug. 18, 2008) [LBEX
DOCID451527].
4080ExaminersInterviewofPaulW.Hespel,Apr.23,2009,atp.3.
1113

Agreement until the August Agreements.4081 Paolo Tonucci also explained that the
AugustAgreementsweremeanttoclosegapsinexposuremultipleLehmanentities
didbusinesswithJPMorgan,butJPMorgandidnotbelievethattheobligationsofthese
entitieswereadequatelysecured.4082TonucciemphasizedthattheAugustAgreements
were executed to manage exposures more efficiently and did not represent a
fundamentalchangeintheJPMorganLehmanclearingrelationship.4083
The August Agreements also clarified that Lehmans collateral would secure
only JPMorgans intraday risk. In the weeks leading up to the August Agreements,
JPMorganraisedtheissueofcollateralizingitsovernightexposuresaswell.4084Lehman
objected to the change.4085 JPMorgans request appeared to be the result of a
misunderstanding:internally,JPMorganhadrecognizedthatitsgoalhadalwaysbeen
toensurethatourintradayexposuretoLehman[was]properlycollateralized.4086Thus,
4081Id.
4082ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atpp.89.
4083Id.atp.9.
4084ExaminersInterviewofCraigL.Jones,Sept.28,2009,atp.13;emailfromCraigL.Jones,Lehman,to
Paolo R. Tonucci, Lehman, et al. (Aug. 8, 2008) [LBEXDOCID 457557] (relaying an urgent call from a
groupatChaseinwhichJPMorganstatedtheywant[ed]toensuretheassetshaveacontinuinglienand
notjustanintradaylien);emailfromCraigL.Jones,Lehman,toPaoloR.Tonucci,Lehman,etal.(Aug.
14, 2008) [LBEXAM 001764] (noting that Doctoroff apologized for JPMorgan requesting a continuing
ratherthanintradaylien);emailfromEdwardJ.Corral,JPMorgan,toRicardoS.Chiavenato,JPMorgan,
et al. (Aug. 8, 2008) [JPM2004 0006527] (explaining that Fleming was concerned that JPMorgan was
lookingforanovernightlienbutagreementwasforanintradaylienonly).
4085See,e.g.,emailfromEdwardJ.Corral,JPMorgan,toRicardoS.Chiavenato,JPMorgan,etal.(Aug.8,
2008)[JPM20040006519].FlemingstatedthatJPMorganwasactingunreasonablybecauseJPMorgandid
notfaceanovernightexposurewithLehman.ExaminersInterviewofDanielJ.Fleming,Apr.22,2009,at
p.5.
[JPM20040006519].
1114

DoctoroffcalledCraigJones,aSeniorVicePresidentatLehmaninchargeofcashand
collateralmanagement,onoraboutAugust15toapologizefortheissuesraisedwhen
Chaserequestedthecontinuinglienandacknowledgedthathewaswellawareitwas
onlyintendedtobeanintradaylien.4087TheAugustAgreementswereunderstoodas
documentationfortheintradaylien.4088
The August Agreements were negotiated over more than a week by legal and
business representatives of both parties, with much interaction over specific terms.4089
In the course of drafting and negotiating the August Agreements, Lehmans counsel
interacted with Lehman business personnel, who provided the big picture idea of
howthelegalagreementswouldaffectLehmansdealingswithJPMorgan.4090
The parties ultimately executed three documents on August 29, 2008 (though
dated August 26):4091 (i) an Amendment to the Clearance Agreement, (ii) a Guaranty
and (iii) a Security Agreement. The Amendment to the Clearance Agreement and
4087EmailfromCraigL.Jones,Lehman,toPaoloR.Tonucci,Lehman,etal.(Aug.15,2008)[LBEXDOCID
457560].
4088Id.
4089See, e.g., email from Mark G. Doctoroff, JPMorgan, to Daniel J. Fleming, Lehman (Aug. 18, 2008)
[LBEXDOCID 451527]; email from Daniel J. Fleming, Lehman, to Mark G. Doctoroff, JPMorgan (Aug.
21, 2008) [LBEXDOCID 310528]; email from Jeffrey Aronson, JPMorgan, to Paul W. Hespel, Goodwin
Procter, et al. (Aug. 25, 2008) [JPM2004 0003466]; email from Nikki G. Appel, JPMorgan, to Paul W.
Hespel,GoodwinProcter,etal.(Aug.28,2008)[JPM20040004408].
4090Examiners Interview of Paul W. Hespel, Apr. 23, 2009, at p. 3; Examiners Interview of Andrew
Yeung,Mar.13,2009,atp.2.
4091SeeemailfromPaulW.Hespel,GoodwinProcter,toNikkiG.Appel,JPMorgan,etal.(Aug.29,2008)
[JPM20040004629].
1115

SecurityAgreementwereexecutedbyLBHITreasurerPaoloTonucci;theGuarantywas
executedbyLBHIChiefFinancialOfficerIanLowitt.4092
The Amendment to the Clearance Agreement expanded the reach of the
Clearance Agreement in two ways. First, the parties added LBHI, Lehman Brothers
International (Europe), Lehman Brothers OTC Derivatives Inc. and Lehman Brothers
JapanInc.asCustomers,thatis,partiestotheClearanceAgreement.4093Inaddition,
pursuant to a request from Lehman,4094 the parties added language providing that the
liabilityofLehmanentitiesundertheClearanceAgreementwasseveral,notjoint(with
theexceptionofLBHIsobligationsundertheSecurityAgreementandGuaranty),and,
therefore,anysecurityinterest,lien,rightofsetofforothercollateralaccommodation
providedbyanyLehmanentitypursuanttotheClearanceAgreementwouldnotbe
available to support the obligations of any other Lehman entity under that
agreement.4095
Under the Guaranty, LBHI unconditionally and irrevocably guarantee[d] to
[JPMorgan] the punctual payment of all obligations and liabilities of the Lehman
parties to the Clearance Agreement (other than LBHI) of whatever nature, whether
4092See Security Agreement (Aug. 26, 2008), at p. 6 [JPM2004 0005867]; Amendment to Clearance
Agreement (Aug. 26, 2008), at pp. 12 [JPM2004 0005856]; Guaranty (Aug. 26. 2008), at p. 6 [JPM2004
0005879].
4093SeeAmendmenttoClearanceAgreement(Aug.26,2008),atp.1[JPM20040005856].
4094SeeemailfromPaulW.Hespel,GoodwinProcter,toJeffreyAronson,JPMorgan,etal.(Aug.25,2008)
[JPM20040003439].
4095AmendmenttoClearanceAgreement(Aug.26,2008),atp.1[JPM20040005856];seealsoemailfrom
Jeffrey Aronson, JPMorgan, to Paul W. Hespel, Goodwin Procter, et al. (Aug. 26, 2008) [JPM2004
0003482];AmendmenttoClearanceAgreement[Draft](Aug.26,2008),atp.1[JPM20040003485].
1116

nowexistingorhereinafterincurred...pursuanttotheClearanceAgreement.4096The
GuarantyfurthergaveJPMorganarightofsetoffagainstLBHI.4097
The Security Agreement secured LBHIs commitments under theGuaranty and
grantedJPMorganasecurityinterestin,andagenerallienuponand/orrightofsetoff
of certain LBHI accounts and proceeds from these accounts.4098 Although JPMorgan
initially sought a lien on essentially all LBHI accounts,4099 Lehman successfully
narrowed the lien in the Security Agreement to cover only a Securities Account
(known as LCE), a Cash Account (known as DDA# 066141605) and certain
related accounts.4100 Andrew Yeung, Lehman inhouse counsel and one of the
negotiatorsoftheAugustAgreements,describedthisasafloatinglienthatfollowed
theproceedsoftheCashAccountandtheSecuritiesAccount.4101
The Security Agreement contained a provision that allowed LBHI to transfer
collateralfromitsencumberedaccountstoagenerallylienfreeOvernightAccountat
4096Guaranty(Aug.26,2008),atp.1[JPM20040005879].
4097Seeid.atp.4.
4098SecurityAgreement (Aug. 26, 2008), at p. 2 [JPM2004 0005867]. Lehman initially questioned

JPMorgans request for a standalone Security Agreement given that the Clearance Agreement already
granted JPMorgan a lien on Lehman assets for obligations incurred under the Clearance Agreement.
ExaminersInterviewofPaulW.Hespel,Apr.23,2009,atp.3;ExaminersInterviewofAndrewYeung,
Mar.13,2009,atp.3;emailfromJamesJ.Killerlane,Lehman,toJeffreyAronson,JPMorgan,etal.(Aug.
22,2008)[JPM20040003332].Yeungexplained,however,thatJPMorganmayhavewantedtheSecurity
Agreementbecauseitofferedgreaterdetailoverthepartiesrightsandremediesintheeventofabreach
ordefault.ExaminersInterviewofAndrewYeung,Mar.13,2009,atp.3.
4099SeeemailfromMarkG.Doctoroff,JPMorgan,toDanielJ.Fleming,Lehman(Aug.18,2008)[LBEX
DOCID451527];SecurityAgreement[Draft](Aug.18,2008),atp.1[LBEXDOCID448423].
4100SecurityAgreement(Aug.26,2008),atp.1[JPM20040005867].
4101ExaminersInterviewofAndrewYeung,May14,2009,atp.4.
1117

the end of each business day if LBHI had no outstanding obligations under the
ClearanceAgreement.4102 Specifically, in the overnightaccount provision, the Security
Agreementprovided:
Except as otherwise provided herein, at the end of a business day, if

[LBHI] has determined that no [obligations under the Clearance
Agreement] remain outstanding, [LBHI] may transfer to an account (the
Overnight Account) any and all Security held in or credited to or
otherwise carried in the Accounts [(that is, the Securities Account, Cash
Account,andcertainrelatedaccounts)].Anydeterminationof[Lehman]
that no Obligations remain outstanding shall not be binding upon the
Bank.4103
UndertheSecurityAgreement,JPMorganhadagenerallienupontheSecurity,
definedas:
(i) the Accounts, together with any security entitlements relating thereto
andanyandallfinancialassets,investmentproperty,fundsand/orother
assetsfromtimetotimeheldinorcreditedtotheAccountsorotherwise
carried in the Accounts (or to be received for credit or in the process of
delivery to the Account), (ii) any interest, dividends, cash, instruments
and other property from time to time received, receivable or otherwise
distributedinrespectoforinexchangeforanyorallofthethenexisting
Securityand(iii)allproceedsofanyandalloftheforegoingSecurity.4104
Accountswasdefinedas:
(i)the...SecuritiesAccount...,(ii)...theCashAccount...and(iii)
any other account at [JPMorgan] to which [LBHI] transfer[ed] (A) cash
fromtheCashAccount,(B)anyinterest,dividends,cash,instrumentsand
other property from time to time received, receivable (including without
limitation sales proceeds) or otherwise distributed in respect of or in
4102SeeSecurityAgreement(Aug.26,2008),atp.3[JPM20040005867];ExaminersInterviewofAndrew
Yeung,May14,2009,atp.5.
4103SecurityAgreement(Aug.26,2008),atp.3[JPM20040005867].
4104Id.atpp.12.
1118

exchangeforanyorallofthecashorsecuritiesintheSecuritiesAccount
or the Cash Account or (C) any cash or securities from the Securities
Account or the Cash Account during such time as [Lehman] ha[d] an
outstanding obligation or liability to [JPMorgan] under the Guaranty or
theClearanceAgreement.4105
As relevant here, with the exception of the Cash Account and Securities Account, the
Accounts definition covered only accounts to which LBHI transferred securities
from the Securities Account . . . during such time as [Lehman] ha[d] an outstanding
obligation or liability to [JPMorgan] under the Guaranty or the Clearance
Agreement.4106Thus,wereLehmantotransfersecuritiestotheOvernightAccountata
time during which it had no outstanding obligation to JPMorgan, JPMorgan would
havenolienonthataccount.
In theory, Lehman would have only intraday liability to JPMorgan under the
ClearanceAgreementbecause,attheendoftheday,cashfromtripartyinvestorsrepaid
JPMorgansearlymorningcashadvances.4107Therefore,asageneralmatter,ifLehman
did not have any advances or loans under the Clearance Agreement outstanding
overnight (generally known as failed financing or box loans), assets in the
OvernightAccounttransferredfromtheSecuritiesAccountwouldbelienfree.4108
4105Id.atp.1.
4106Id.
4107Cf. email from DanielJ.Fleming, Lehman, to Mark G. Doctoroff, JPMorgan(Aug. 21,2008) [LBEX
DOCID 035862] (at the end of the day (after we have settled all of our obligations with JPM) we will
havethefullvalueofthecollateralintheHoldingsaccount...toapplytootherLehneeds....).
4108ExaminersInterviewofAndrewYeung,May14,2009,atp.5(explainingthattheOvernightAccount
was lienfree); Examiners Interview of Donna Dellosso, Feb. 27, 2009, at p.3 (collateral in Overnight
Accountwouldbefreeofanylienovernightbutsubjecttoalienagaininthemorning).
1119

The Security Agreement did not specifically define an Overnight Account.
AccordingtoJPMorganscounsel,theOvernightAccountwasaconstructthatLehman
neveractuallysoughttouse.4109LehmandidhaveanLBHIaccountatJPMorgancalled
LXH,whichithadopenedearlierinAugust.4110LXHwasasegaccountassociated
with the LBHI clearance account LCE (that is, the Securities Account defined in the
Security Agreement and the account into which Lehman transferred securities from
LCDinearlyAugust).4111Attheendoftheday,thecontentsofLCEwereautomatically
transferred to LXH and to a shell referred to as LHXX; after the triparty unwind,
thosesecuritiesweresweptbackintoLCEatthebeginningofeachday.4112Although,
according to JPMorgan counsel, LHXX was not technically a lienfree excess shell
(thatis,thetypeofshellintowhichabrokerdealerwouldplacesecuritiesnotslatedfor
4109Jenner & Block, Memorandum re November 18, 2009 Teleconference with JPMorgan Counsel (Nov.
19,2009),atpp.12.Alvarez&MarsaladvisedtheExaminerthatitwasnotawareofwhataccountat
JPMorgan was the Overnight Account. Alvarez & Marsal, Responses to Questions for Alvarez &
Marsal/Weil,Gotshal&Manges(Dec.7,2009),atp.1.
4110SeeLetterfromEmilyM.Critchett,Lehman,toLikaVaivao,JPMorgan(Aug.14,2008)[LBEXDOCID
462130].
4111JPMorgan First Written Responses, at p. 9; see email from Michael A. Mego, JPMorgan, to Janet
Birney,Lehman,etal.(Aug.13,2008)[JPM20040005515](identifyingLXHasasegaccount).Aseg
accountcorrespondedtoaparticularclearanceaccountandconsistedofoneormoretripartyreposhell
designationsintowhichsecuritiesfromtheclearanceaccountwouldbetransferred.Shellswereusedin
tripartyrepos,butcouldalsoholdsecuritiespledgedtoJPMorgantocollateralizeextensionsofcreditor
be nolien excess shells, which would hold securities overnight not needed for triparty repos or
overnightfinancing.JPMorganFirstWrittenResponses,atp.1.
4112JPMorgan First Written Responses, at p. 9; Jenner & Block, Memorandum re November 16, 2009
TeleconferencewithJPMorganCounsel(Nov.16,2009),atp.2.JonesstatedthatthesweepintoLBIlien
freeshellswasnotautomaticbutdonemanuallybyJohnPalchynsky.ExaminersInterviewofCraigL.
Jones,Sept.28,2009,atp.17;ExaminersInterviewofJohnN.Palchynsky,May11,2009,atp.4.
1120

triparty repo overnight), and LXH was a pledge account,4113 from August 26 to
September 9, Lehman had no outstanding overnight obligations under the Clearance
Agreement.4114 Thus, there was no obligation for LXH or the LHXX shell to secure
overnight.LHXXthereforewas,inpractice,essentiallyalienfreeexcessshellsimilarto
whatwasdescribedintheSecurityAgreementastheOvernightAccount.
According to JPMorgans counsel, Lehman could not transfer securities out of
LXHortheLHXXshellonitsown;LehmanwouldhavehadtoaskJPMorgantoissue
such an instruction.4115 Lehman could issue an instruction to transfer securities out of
LCE, but a $5 billion NFE block imposed by JPMorgan ensured that $5 billion of
19,2009),atpp.12.Lehman,however,sometimesinternallyreferredtoLHXXasalienfreeexcessshell.
See email from John N. Palchynsky, Lehman, to Jack Fondacaro, Lehman, et al. (Aug. 18,2008) [LBEX
DOCID459729].ThereissomeevidencethatJPMorganatleastafterLehmansbankruptcyreferredto
LHXXassuchaswell.SeeemailfromKarenDonahue,JPMorgan,toPaoloR.Tonucci,Lehman(Sept.21,
2008)[LBEXDOCID036183];Spreadsheet(Sept.21,2008)[LBEXDOCID014382](referringtoLHXXas
LBHI LIEN FREE EXCESS). And, although the accountopening letter referred to LXH as a pledge
account,Lehmanattemptedtoputanolienletterinplace.SeeLetterfromEmilyM.Critchett,Lehman,
to Lika Vaivao, JPMorgan (Aug. 14, 2008) [LBEXDOCID 462130]; email from Emily M. Critchett,
Lehman, to Lika Vaivao, JPMorgan, et al. (Aug. 18, 2008) [LBEXDOCID 451532] (As this account is a
segregated account we will require a nolien letter be put in place.). Yet, in his interview with the
Examiner, Richard Policke, Senior Vice President of Lehman, stated that there was a lien on LHXX.
ExaminersInterviewofRichardPolicke,May28,2009,atp.6.
19,2009),atp.1.
16,2009),atp.2.AccordingtoJPMorgan,Lehmancouldnottransferorotherwisecontrolsecuritiesin
seg accounts, and, therefore, Lehman could not control securities in LXH whether or not lienfree
overnight. JPMorgan First Written Responses, at pp. 1, 9. Tonucci confirmed that Lehman never
attemptedtoremovecollateralovernightfromitslienfreeaccountatJPMorgan.ExaminersInterviewof
PaoloR.Tonucci,Sept.16,2009,atp.10;ExaminersInterviewofCraigL.Jones,Sept.28,2009,atpp.17
18. Yeungs understanding, however, was that Lehman was able to transfer funds in the Overnight
Account, and, indeed, could transfer funds outside of JPMorgan. Examiners Interview of Andrew
1121

securities remainedinthataccountduringtheday.4116Inotherwords, anyattempt to
removesecuritiesfromLCEthatwouldreduceitsvalueunder$5billionwouldresultin
negativeNFE,and,thus,thetransactionwouldbeblocked.
Whether or not Lehman had the right, as a technical matter, to access the
securities in LXH, it could not, as a practical matter, have transferred or monetized
those securities overnight.4117 According to Chiavenato, by the time JPMorgan freed
collateral at night, it would be too late for Lehman to sell the securities because the
markets would be closed.4118 In addition, JPMorgans BDAS system was not even
accessibleovernight.4119Furthermore,JPMorganstatedthatitrequiredalmostallofthe
collateral the following morning to support the triparty unwind.4120 Thus, it is
unsurprising that Tonucci could not recall any instance in which Lehman transferred
16, 2009), at p. 2; JP Morgan First Written Responses, at p. 10; see also email from Michael A. Mego,
JPMorgan, to Ray Stancil, JPMorgan, et al. (Sept. 12, 2008) [JPM2004 0051670] (Instead of putting in a
Debit(WDDB)dailyfor$5billionontheLCEaccountandhavingitdropovernight.Wehaveaskedto
putina$5billiondebitontheLCEintradaylineofCreditsoastoalwayshaveadebitontheaccountat
alltimes.).NotethatthisNFEAdjustmentwasunrelatedtoLBIsNFE.LCEwasanLBHIaccount
and,therefore,theadjustmentwasplacedonLBHIsNFE.
4117Lehmans ability to liquidate quickly the securities in the Overnight Account is relevant to an
analysisofLehmansliquiditypool,discussedinSectionIII.A.5.iofthisReport.
19,2009),atp.3.
4120Examiners Interview of Ricardo S. Chiavenato, Sept. 21, 2009, at p. 18. JPMorgan confirmed each
morningwhetherLehmanhadsufficientcollateralpriortothetripartyunwind.ExaminersInterviewof
Edward J. Corral, Sept. 30, 2009, at p. 6. While Lehman did have sufficient collateral each morning,
CorralconfirmedthatifLehmanhadeverfailedthistest,JPMorgancouldhavedecidednottounwind
the triparty repos. Id. Corral dismissed the possibility that JPMorgan would partially unwind the
triparty repos (and await collateral for uncovered trades) in such a scenario, noting that practically
speaking,thetripartyunwindwasanallornothingproposition.Id.
1122

these securities (such as Spruce, Pine, Fenway and Verano) out of JPMorgan
overnight.4121CraigJonesofLehmanTreasuryalsoconfirmedthepracticalimpossibility
ofLehmantransferringthesecuritiesovernight,statingthatsuchamovewouldrequire
someonetoreopentheDTCcreditfacilityinthemiddleofthenight.4122Atmost,Jones
thought Lehman may have been able to transfer collateral overnight between its
accountsatJPMorganifJPMorganreopenedduringthenight,butJonesdidnotrecall
any such overnight transfer and only recalled generally the collateral movement from
LCDtoLCE.4123
According to Lehmans counsel, the overnightaccount provision formalized a
prior course of dealing between JPMorgan and Lehman.4124 At least as of August 18
(aroundthetimewhentheLXHaccountwascreated),securitiesweresweptfromLCE
eachnightintoaseparateaccountovernight.4125Lehmanunderstoodthattheovernight
accountprovisionintheAugustAgreementsconfirmedthatJPMorganslienoperated
4122ExaminersInterviewofCraigL.Jones,Sept.28,2009,atp.17.
4123Id.atpp.1718;seesupraatSectionIII.A.5.b.1.e.
4124Examiners Interview of Paul W. Hespel, Apr. 23, 2009, at p. 4; Examiners Interview of Andrew
Yeung, Mar. 13, 2009, at p. 3 (characterizing this prior course of business as using excess funds in
clearanceaccountsattheendofeachdaytofundovernightlendinganddescribingtheovernightaccount
provisionasmechanical).JPMorganscounselstated,however,thattherewasnoparticularstatement
oractionbyLehmanorJPMorganthatmadetheovernightaccountprovisionresembleacarryoverof
a structure already in place. Jenner &Block, Memorandum re November 18,2009 Teleconference with
JPMorganCounsel(Nov.19,2009),atp.2.
4125SeeJPMorganFirstWrittenResponses,atp.9.
1123

on an intraday basis only, and that Lehmans excess collateral was lienfree
overnight.4126
According to JPMorgan witnesses, however, Lehman requested the overnight
account provision because Lehman needed contractual language to justify Lehmans
inclusion of pledged collateral as part of Lehmans liquidity pool.4127 Significantly,
Lehmans counsel, Hespel, confirmed that the overnightaccount provision was
important for liquidityreporting purposes and that assets in the Overnight Account
were classified as unencumbered in Lehmans liquidity estimations.4128
Contemporaneous internal Lehman emails further confirmed that the overnight
account provision related to liquidity reporting,4129 and Lehman did, in fact, include
securitiespledgedundertheAugustAgreementsinitsliquiditypool.4130
4126E.g.,ExaminersInterviewofAndrewYeung,May14,2009,atp.8(Yeungrecalledanemailexchange
with Fleming in which Fleming instructed him that JPMorgans lien was an intraday lien and that
Lehmanhadtobeabletoclaimforliquidityreportingpurposesthecollateralwaslienfree);emailfrom
DanielJ.Fleming,Lehman,toMarkG.Doctoroff,JPMorgan(Aug.21,2008)[LBEXDOCID310528](at
theendoftheday(afterwehavesettledallofourobligationswithJPM)wewillhavethefullvalueofthe
collateralintheHoldingsaccount).
4127Examiners Interview of Mark G. Doctoroff, Apr. 29, 2009, at pp. 12, 2223 (recalling that Paolo
Tonucci represented that the purpose of the overnightaccount provision was to preserve Lehmans
ability to include in Lehmans Liquidity Pool collateral pledged to cover JPMorgans intraday risk);
Examiners Interview of Donna Dellosso, Feb. 27, 2009, at p. 3 (Lehman informed JPMorgan that it
wantedovernightaccesstothecollateral,presumablyforitsovernightliquiditypool);emailfromMark
G. Doctoroff, JPMorgan, to David A. Weisbrod, JPMorgan, et al. (Sept. 2, 2008) [JPM2004 0006556]
(acknowledgingthat$5billionpostedbyLehmanwaspartofLehmansliquiditypool).
4128ExaminersInterviewofPaulW.Hespel,Apr.23,2009,atp.4.
4129Examiners Interview of Andrew Yeung, May 14, 2009, at p. 8 (Yeung recalled an email exchange
with Fleming in which Fleming instructed him that Lehman had to be able to claim collateral pledged
withJPMorganwaslienfreeforliquidityreporting).
4130SeeinfraatSectionIII.A.5.i(discussingtheproprietyofincludingcertainassetsinLehmansliquidity
pool).Itshouldbenoted,however,thatLehmanhadtheabilityto,anddid,removesecuritiesfromthe
1124

(g) BackgroundtotheSeptember9CollateralRequestand
SeptemberAgreements
In late August and September, Lehmans deteriorating financial condition
became increasingly apparent.4131 On September 4, 2008, JPMorgan executives, led by
Chief Risk Officer Barry Zubrow, met with Lehman executives Ian Lowitt, Paolo
TonucciandChrisOMeara,todiscussLehmansupcomingthirdquarterresults,then
scheduled for release on September 18.4132 In preparation for the meeting, JPMorgan
summarizedsignificantissuesaffectingLehman:
We expect [Lehman] will have further significant asset writedowns

primarily originating from their commercial and residential real estate
relatedassets.Their3Qresultswilllikelyalsocomewithannouncements
regardingthe actionsthey willbetaking toshoreup theirbalance sheet,
bolstercapital...,andtooperatesuccessfullyinthecomingquartersin
the new market environment. Major themes in the press (i) potential
capital injection by Korea Development Bank (KDB) or other sovereign
wealth fund; (ii) sale of all or part of their Investment Management
Division(NeubergerBermanincluded)...;(iii)saleofrealestateassetsor
LCEaccountduringthedayaslongasthevalueoftheLCEaccountremainedatorabove$5billion.For
example, Lehman moved Kingfisher from LCE to LCD on September 2. See JPMorgan Second Written
Responses,atp.8;Jenner&Block,MemorandumreNovember18,2009TeleconferencewithJPMorgan
Counsel(Nov.19,2009),atp.2.
4131SeesupraatSectionIII.A.3.a.2;e.g.,AndrewRossSorkin,StrugglingLehmanPlanstoLayOff1,500,N.Y.
Times,Aug.28,2008(Lehmanshareslost73percentoftheirvaluebetweenJanuary2008andtheendof
August 2008); see also email from Ricardo S. Chiavenato, JPMorgan, to David A. Weisbrod, JPMorgan
(Aug.22,2008)[JPM20040061226](Lehmanmayfaceseriousproblemsnextweekifitisnotacquired..
.anditslossesarelarge.).
4132JPMorgan, Lehman Brothers Holdings Inc. Briefing Memorandum (Sept. 4, 2008), at p. 1 [JPM2004
0006171]; see also Lehman, JP Morgan Agenda (Sept. 4, 2008) [LBEXDOCID 445367]. Although the
JPMorganagendaindicatedthattheearningscallwasinitiallyscheduledforSeptember17,itwasinfact
scheduled for September 18. See AFP, Lehman Brothers in Freefall as Hopes Fade for New Capital (Sept. 9,
2008),availableathttp://afp.google.com/article/ALeqM5jEijYPZUGeWNO_FflIPEg_6CaQ7w.
1125

formation of a bad bank/good bank with a private equity sponsor/s may

betouchedonduringthisdiscussion.4133
Tonucci described the meeting as an opportunity for Lowitt to update JPMorgan on
LehmansthirdquarterearningsandthestatusofitsSpinCoplans.4134
IntheSeptember4meetingbetweenexecutivesfromLehmanandJPMorgan,the
partiesalsodiscussedissuesconcerningtripartyrepoandLehmanspostedcollateral,4135
although Tonucci stated that this was not the focus of the meeting.4136 At that time
Lehman had about $8 billion of collateral (as priced by Lehman) on deposit with
JPMorgan to support intraday triparty risk in the United States, and discussions were
underway to secure $2 billion in intraday risk associated with European triparty
exposures.4137LehmanbelievedthatJPMorganwasovercollateralizedagainstintraday
risk, and JPMorgan acknowledged that Lehman disagreed with JPMorgans collateral
valuations and that collateral substitutions might be necessary.4138 Notably, JPMorgan
0006171].JPMorgansBriefingMemorandumalsostated:Thereisastrongdesireat[Lehman]tohave
openandfrankdialoguewithJPMatalllevelsofourorganizations....As[Lehman]sprimaryoperating
servicesprovider,[Lehman]managementwanttoensurethatwearefullybriefedontheirstrategyand
challengesastheyneedoursupporttooperatetheirbusiness.Id.
4135SeeJPMorgan,LehmanBrothersHoldingsInc.BriefingMemorandum(Sept.4,2008),atpp.12[JPM
20040006171];Lehman,JPMorganAgenda(Sept.4,2008)[LBEXDOCID445367].
4136Examiners Interview of Paolo R. Tonucci, Sept. 16, 2009, at p. 11; Examiners Interview of Ian T.
Lowitt,Oct.28,2009,atp.18.
0006171];Lehman,JPMorganAgenda(Sept.4,2008)[LBEXDOCID445367].
0006171].
1126

also acknowledged that Lehmans collateral postings were part of [its] liquidity
pool...despitetheirlessthancashliquidityprofile.4139
JPMorganhaditsdoubtsabouttheplanthatLehmanpresentedattheSeptember
4 meeting.4140 For example, Lehman walked JPMorgan through its SpinCo proposal
(whereby Lehman planned to spin off its illiquid assets into a separate company in
ordertoremovethemfromLehmansbalancesheet),4141buttheproposaldidnotinstill
confidenceinJPMorganexecutives.ZubrowhaddifficultyunderstandinghowLehman
would infuse enough money into the SpinCo entity to cover the exposure of its real
estateloans.4142HetoldLowittthatLehmanneededtoprovidemoreclarityonSpinCo,
and relayed concern that Lehmans plan would spook the market.4143 Tonucci
confirmed to the Examiner that JPMorgan was concerned about the viability of the
SpinCoplan.4144
JPMorganofferedtoassistLehman by providing feedback on thepresentations
Lehman was planning to make to the various rating agencies in the coming days.4145
Accordingly,laterintheeveningofSeptember4,TonuccisenttoJPMorganadraftcopy
of a presentation Lehman intended to give the ratings agencies, seeking JPMorgans
4139Id.
4140ExaminersInterviewofMarkG.Doctoroff,Apr.29,2009,atp.15.
4141SeeSectionIII.A.3.c.4(discussingLehmansSpinCoproposition).
4142ExaminersInterviewofBarryL.Zubrow,Sept.16,2009,atp.7.
4143Id.
1127

comments.4146ExecutivesatJPMorganfoundthepresentationtobetoovagueandwere
concernedaboutthestrategiesLehmanoutlined.4147Zubrowviewedthepresentationas
notdetailedenoughtoprovideconfidenceinLehmansplannedcourseofactionwith
its SpinCo proposal.4148 Doctoroff consolidated the feedback from JPMorgan in an e
mailtoTonuccionSeptember5,2008.4149Amongotherconcerns,JPMorganidentified
the following: Lehman needed to be more definitive about its timeline and how its
business would be operated over that timeline; Lehman should determine whether it
could make its expense reduction more aggressive; and Lehman needed to address
additionalissuessuchasmanagementchanges.4150JPMorganexecutivesalsoexpected
more focus on liquidity, especially expected liquidity uses over the 12 to 18 months
ahead.4151 JPMorgan further suggested that Fuld participate in the rating agency
meetings.4152 This final point was the most important in JPMorgans view because
4146Email from Paolo R. Tonucci, Lehman, to Mark G. Doctoroff, JPMorgan, et al. (Sept. 4, 2008) [JPM
2004 0006300]. Lehman highlighted the sensitive nature of these documents multiple times. See id.
(There is a lot of confidential info . . . .); email from Ian T. Lowitt, Lehman, to Barry L. Zubrow,
JPMorgan (Sept. 5, 2008) [JPM2004 0006314] (The materials we sent you are obviously very sensitive
....); email from Ian T. Lowitt, Lehman, to Barry L. Zubrow, JPMorgan (Sept. 7, 2008) [JPM2004
0006317].JPMorganlimitedthecirculationofthematerials.SeeemailfromBarryL.Zubrow,JPMorgan,
toIanT.Lowitt,Lehman,etal.(Sept.8,2008)[JPM2004006317].
4147ExaminersInterviewofBarryL.Zubrow,Sept.16,2009,atp.7;seeemailfromMarkG.Doctoroff,
JPMorgan,toBarryL.Zubrow,JPMorgan,etal.(Sept.5,2008)[JPM20040006286].
4148Examiners Interview of Barry L. Zubrow, Sept. 16, 2009, at p. 7; see email from Barry L. Zubrow,
JPMorgan, to Mark G. Doctoroff, JPMorgan, et al. (Sept. 5, 2008) [JPM2004 0006286] (strategy is
presentedwithalotofequivocation).
4149See email from Mark G. Doctoroff, JPMorgan, to Paolo R. Tonucci, Lehman (Sept. 5, 2008)
[LBHI_SEC07940_556179].
4150Seeid.
4151Id.
4152Id.
1128

Lehman needed to show the rating agencies and the larger market that Lehman was
resolute about bringing its plan to completion, and that vision had to start from the
top.4153 Tonucci agreed with JPMorgans feedback and said he would push Fuld to
participateinfuturemeetingswiththeagencies.4154
While concern was growing inside JPMorgan about Lehmans condition,
Doctoroff stated that there was no serious belief within JPMorgan at the time that
Lehman would file for bankruptcy.4155 Other JPMorgan witnesses likewise stated that
they did not see the bankruptcy of Lehman as a serious possibility until the weekend
precedingLBHIsbankruptcyfiling.4156JPMorganwas,however,facingincreasingrisks
fromitsbusinesswithLehman.
Also on September 5, JPMorgans Investment Bank Risk Committee (IBRC)
met and discussed a presentation titled Overview of Debt Maturities for Major US
Broker Dealers (the IBRC Deck).4157 The discussion of the IBRC Deck was led by
4153See email from Mark G. Doctoroff, JPMorgan, to Barry L. Zubrow, JPMorgan, et al. (Sept. 5, 2008)
[JPM20040006304].
4154Id.
4155ExaminersInterviewofMarkG.Doctoroff,Apr.29,2009,atp.15.
4156E.g.,ExaminersInterviewofJamieL.Dimon,Sept.29,2009,atp.10(thefirsttimehethoughtLehman
maynotsurvivewasSaturday,September13);ExaminersInterviewofJohnJ.Hogan,Sept.17,2009,atp.
8(thefirsttimehethoughtLehmanmaynotsurvivewasSunday,September14).OnFridaymorning,
September 12, however, Lowitt anticipated problems with JPMorgan over the weekend and felt that
JPMorgan was acting as though Lehman was filing over the weekend. Email from Ian T. Lowitt,
Lehman,toPaoloR.Tonucci,Lehman(Sept.12,2008)[LBEXDOCID072153].
4157ExaminersInterviewofDonnaDellosso,Oct.6,2009,atp.6;JPMorgan,OverviewofDebtMaturities
forMajorUSBrokerDealers,IBRCPresentation(Sept.5,2008)[JPMEXAMINER00005998].Thedetails
underlying this presentation are reflected in another presentation, Lehman Brothers Exposure
Overview, which calculated exposure as of September 5 (the IBRC Deck calculated exposure as of
September 1). The second presentation was not discussed at the September 5 meeting. See JPMorgan
1129

Piers Murray, and the meeting included broad discussions about investment banks,
trading,marketsandtheskittishnessofhedgefundsregardingnovations.4158JPMorgan
was supportive of accepting novations and, thus, stepping into hedge funds shoes to
face investment banks, but discussed the risk of runs on the banks.4159 There were
particular concerns about Lehman and one other brokerdealer, but JPMorgan
reiterateditssupportofbothentities.4160TheIBRCDeckcoveredanumberofbroker
dealers, including Lehman, and revealed that JPMorgan had a primary exposure to
Lehman of $2.645 billion, the largest component of which was $1.904 billion in
derivatives exposure. The IBRC Deck showed an approved limit for settlement and
operating exposure of $10.681 billion intraday (but did not show how much exposure
JPMorgan actually had during the day).4161 The presentation addressed the exposure
only of JPMorgans Investment Bank, separate from the tripartyrepo business.4162
First Written Responses, at p. 17; JPMorgan, Lehman Brothers Exposure Overview (Sept. 2008) [JPM
EXAMINER00005966].
4158ExaminersInterviewofDonnaDellosso,Oct.6,2009,atp.6.LehmanwasawarebytheendofJuly
2008 that novation requests were increasing, and some banks were declining novation requests from
Lehman counterparties. See email from Eric Felder, Lehman, to Ian T. Lowitt, Lehman, et al. (July 28,
2008)[LBEXDOCID028924].
4160Id.
4161JPMorgan, Overview of Debt Maturities for Major US Broker Dealers, IBRC Presentation (Sept. 5,
2008),atp.6[JPMEXAMINER00005998].
4162ExaminersInterviewofDonnaDellosso,Oct.6,2009,atpp.2,67;seeJPMorgan,OverviewofDebt
Maturities for Major US Broker Dealers, IBRC Presentation (Sept. 5, 2008), at p. 6 [JPM
EXAMINER00005998]. Intraday exposure in the IBRC Deck referred to Investment Bank intraday
exposure,notintradayexposurerelatedtoclearingactivities.SeeJPMorgan,OverviewofDebtMaturities
for Major US Broker Dealers, IBRC Presentation (Sept. 5, 2008), at p. 6 [JPMEXAMINER00005998].
Notably, analyzing the September 5 tripartyrepo unwind data, Chiavenato concluded that JPMorgan
held$9.9billionincollateral(incorporatingGiffordFongspricingofcollateralintheLCEaccount)where
1130

JPMorgan subsequently shared information discussed in IBRC meetings with the
FRBNY.4163
ZubrowstatedthataftertheSeptember5IBRCmeetinghecalledLowitttorelay
thatJPMorganmightneedanadditional$5billionincollateralgivenitsconcernsabout
an adverse market reaction to Lehmans plans.4164 Zubrow characterized this as a
speculative and informal conversation to provide a place marker in case JPMorgan
followed through with a collateral request.4165 According to Zubrow, while Lowitt
hopedthatJPMorganwouldultimatelynotmaketherequest,Lowittassuredhimthat
heunderstoodthenatureofthesituation.4166LowittrecalledspeakingwithZubrowby
phone,butcouldnotbecertainofwhenthecalltookplaceorwhetherZubrowspecified
the precise amount of collateral sought by JPMorgan. The focus of the conversation,
accordingtoLowitt,wastheratingagencymeetings.4167
only$9.4billionwasneededtocoverriskbasedmargin.EmailfromRicardoS.Chiavenato,JPMorgan,
toDavidA.Weisbrod,JPMorgan,etal.(Sept.8,2008)[JPM20040007292].Yet,Chiavenatoalsopointed
out that collateral held by triparty investors overnight and securing JPMorgans exposure intraday
included $15 bi in less liquid collateral selfpriced by Lehman, with half of that priced in the 90100+
range(whichwebelieveisoverstated)usinglowervendorprices[would]reduceJPMorgansmargin.
Id.
4163ExaminersInterviewofDonnaDellosso,Oct.6,2009,atp.11;seealsoemailfromArthurG.Angulo,
FRBNY, to Timothy F. Geithner, FRBNY, et al. (Sept. 10, 2008) [FRBNY to Exam. 014605] (attaching
September7,2008JPMorganLehmanBrothersExposureOverview).
4165Id.
4166Id.
1131

JPMorgan witnesses stated that JPMorgans derivatives exposure was the
primaryimpetusforthenewcollateralrequest.4168Inaddition,DonnaDellosso,arisk
managerinJPMorgansinvestmentbank,statedthatthe$5billionfigurewasgrounded
in the IBRC Deck analysis,4169 and Steven Black, coChief Executive Officer of
JPMorgans Investment Bank, described JPMorgans arrival at the $5 billion figure as
art,notscience.4170JPMorganwitnessesstatedthatnooneatJPMorganbelieveda$5
billion request was too high; indeed, JPMorgan believed that it could have requested
more.4171Throughitscounsel,JPMorganexplainedtotheExaminerthat:
Thederivativesprimaryexposurewasaprincipalitemoffocusbecauseit
was expected to increase substantially due to novations and market
changes. . . . On the other hand, JPMorgan viewed the settlement and
operating exposures as likely to decrease over time as Lehman de
leveraged. JPMorgan also recognized that it was possible to ameliorate
the operating and settlement exposures through careful attention to the
timing of payments and deliveries. Thus, JPMorgan did not feel it
necessary to request collateral in the full amount of the identified
settlementandoperatingexposures.Takingallofthisintoconsideration,
itwasdecidedthat,inordertobeabletocontinuetosupportLehman,it
4168Examiners Interview of Barry L. Zubrow, Sept. 16, 2009, at p. 10; Examiners Interview of John J.
Hogan,Sept.17,2009,atpp.34.
4170ExaminersInterviewofStevenD.Black,Sept.23,2009,atp.6.
4171ExaminersInterviewofDonnaDellosso,Oct.6,2009,atp.8.BuyersRussorecalledthattripartyrepo
stress analyses at the time showed a shortfall approaching $20 billion. Examiners Interview of Jane
BuyersRusso, Sept. 25, 2009, at p. 5. In addition, Ed Corral stated his view that JPMorgan was
undercollateralizedthroughoutthesummerof2008andcouldhaveaskedformorecollateral,evenina
magnitude reaching $25 billion. Examiners Interview of Edward J. Corral,Sept. 30,2009,at p. 12. As
discussedinmoredetailbelow,thereissomeevidencetosuggestthatJPMorganmayhaveconsidered
itself already adequately collateralized. See, e.g., JPMorgan, TriParty Repo Margin Gap Analysis
Lehman 9/10/2008 (Sept. 10, 2008), at pp. 23 [JPM2004 0029886]. But, as discussed infra, JPMorgan
assertedthatitswrittencollateralanalysesassumedfacevaluesforcertainilliquidLehmancollateral,and
thusunderstatedJPMorgansexposure.
1132

was necessary for JPMorgan to obtain collateral of $5 billion for the

existingandanticipatedrisks.4172
In addition, JPMorgan determined that it needed a mastermaster agreement
with Lehman to cover the entire relationship across all Lehman and JPMorgan
entities.4173 Dellosso stated that she discussed such an agreement with Tonucci.4174
JPMorgan witnesses also stated that during this same time period JPMorgan sought
additionalcollateral,aswellasbroaderguarantiesandpledgeagreements,fromother
brokerdealersinadditiontoLehman.4175
By September 9, the following Tuesday, Lehmans situation had continued to
deteriorate.ReportsbegantosurfacethatTheKoreaDevelopmentBank(KDB)had
abandoned (or was likely to abandon) its acquisition talks with Lehman,4176 and
Lehmansstockhaddroppedsignificantly.4177Ultimately,anewsarticlereportingthat
4172JPMorganFirstWrittenResponses,atp.17.
4173ExaminersInterviewofDonnaDellosso,Oct.6,2009,atp.8;ExaminersInterviewofJohnJ.Hogan,
Sept.17,2009,atp.7.
4175Examiners Interview of Jane BuyersRusso, Sept. 25, 2009, at p. 6; Examiners Interview of Donna
Dellosso,Oct.6,2009,atp.8;seealsoJPMorganSecondWrittenResponses,atp.1.Althoughdiscussions
withotherbrokerdealerscouldhavebeentakingplaceatthistime,JPMorgandidnotprovideevidence
of any agreements with other brokerdealers that were actually executed in late August or September
priortothedateoftheLBHIbankruptcypetition.
4176Francesco Guerrera, et al., Equities Suffer as Lehman Shares Fall 45%, Fin. Times, Sept. 9, 2008
(LehmanssharesfellafteranewswirereportcitedanunnamedKoreangovernmentofficialassaying
thatKoreaDevelopmentBank,astaterunlender,haddecidednottoinvestinLehman.);SusanneCraig,
et al., Korean Remarks Hit Lehman, Wall St. J., Sept. 9, 2008 (A KDB official said the comments [by the
ChairmanofSouthKoreasFinancialServicesCommission]wouldlikelybestrongenoughtodeterthe
bankfrompursuingaLehmandeal....);seealsosupraatSectionIII.A.3.c.5.b.
4177Examiners Interview of Richard S. Fuld, Jr., May 6, 2009, at p. 11; Examiners Interview of Donna
Dellosso,Feb.27,2009,atp.4;SusanneCraig,etal.,LehmanFacesMountingPressures,WallSt.J.,Sept.10,
2008,atA1;SusanneCraig,etal.,KoreanRemarksHitLehman,WallSt.J.,Sept.9,2008.
1133

KDBhaddeterminednottostrikeadealwithLehmanpromptedLehmantoaccelerate
its earnings announcement; instead of releasing its earnings on September 18, as
planned,Lehmandecidedtomakeitsannouncementthenextmorning,onSeptember
10.4178Blackexplainedthattherumormillwasrampantwithclaimsthatfirmswere
nolongerdoingbusinesswithLehman.4179
As discussed in more detail below, on September 9, JPMorgan formally
requested $5 billion of additional collateral from Lehman.4180 This collateral request
intersectedwithalreadycommenceddiscussionsaboutpreparingnewagreementswith
Lehman.JPMorganinsistedthatthecollateralbepostedandthedocumentationsigned
bythefollowingmorning.4181
SeveralJPMorganwitnessesstated that in determiningthe amountofcollateral
to request, JPMorgan did not want to do anything that would harm Lehman or
destabilize financial markets.4182 For example, Jane BuyersRusso, who heads the
securitiesindustrycoveragegroupatJPMorganscorporatebank,statedthatJPMorgan
4179Examiners Interview of Steven D. Black, Sept. 23,2009,at p. 6; see also email from Pandora Setian,
JPMorgan,toJamieL.Dimon,JPMorgan,etal.(Sept.9,2008)[JPM20040006332](TodayS&Pplacedthe
ratingsofLehmanBrothersonCreditWatchwithnegativeimplications.).
4181Examiners Interview of Jane BuyersRusso, Sept. 25, 2009, at p. 6; Examiners Interview of Donna
Dellosso, Oct. 6, 2009, at p. 9; see also infra at Section III.A.5.b.1. JPMorgan was not the only bank to
request additional documentation from Lehman on September 9; Lehman also executed a Guaranty
AmendmentwithCitiandcashdeedswithHSBC.SeeinfraatSectionsIII.A.5.c.1,III.A.5.d.3.
4182E.g.,ExaminersInterviewofStevenD.Black,Sept.23,2009,atp.6.
1134

wantedtomaintainamarketneutralstancesothatoutsiderswouldobserveJPMorgan
facingLehmannormallyinitsoperatingandtradingbusinesses.4183
There were discussions within JPMorgan about JPMorgans options if Lehman
did not post the collateral or execute the additional agreements by September 10, and
how those options related to JPMorgans desire to remain a stabilizing force. One
option available to JPMorgan was to cease unwinding triparty repos in the morning,
which would result in LBI default on payment obligations (causing government
securitiesnottotradeandinvestorstolockup).ThiswasanoptionJPMorganretained,
butwasnotoneitwantedtousebecauseitwouldbehighlydisruptiveofthemarket.4184
JPMorgan also considered limiting transfers until accounts were funded, but, again,
outsiders would notice if they were not receiving payments in a timely fashion.4185
JPMorgan furtherconsideredrestrictingorreducingJPMorgansextensionofintraday
liquidity.4186JPMorgansoptionsfellalongaspectrum:ononeextreme,JPMorgancould
cancel all lines and require manual approval for all Lehman transactions and, on the
other extreme, JPMorgan could continue business as usual with Lehman. In between
4183ExaminersInterviewofJaneBuyersRusso,Sept.25,2009,atp.6.Thereissomeevidenceofconcern
about harming Lehman in contemporaneous internal JPMorgan communications. See email from
RicardoS.Chiavenato,JPMorgan,toPaulWilson,JPMorgan(Sept.9,2008)[JPM20040032609](Forthe
timebeingwearenotchanginganycreditlimitsforseclendingduetoourcollateralizationandtothefact
thatpullingoutatthisstagemightmakethingsworseandeventriggertheircollapse.).
4184ExaminersInterviewofJaneBuyersRusso,Sept.25,2009,atp.6.
4185Id.
4186Id.
1135

theseextremes,forexample,JPMorgancouldscalebacklinesandputpersonnelonalert
tomonitorLehmanaccounts.4187
Jamie Dimon, JPMorgans CEO and Chairman of the Board, asserted that in
everyconversationhehadwithFuld,DimonreiteratedthatJPMorganwantedtohelp
andthatifanythingJPMorganwasdoingwashurtingLehman,FuldshouldletDimon
know.4188 Dimon stated that JPMorgan did not want to harm Lehman and that at no
time did Lehman come to JPMorgan for relief on the amount of collateral sought.4189
DimonstatedthathadFuldcalledhim,JPMorganprobablywouldnothaveinsistedon
the collateral because JPMorgan did not want to be blamed for Lehmans demise.4190
TheChiefRisk Officer in JPMorgans InvestmentBank, John Hogan, statedthat when
hespokewithLehmansChiefRiskOfficer,ChrisOMeara,aboutcollateral,includinga
callwithOMearaabouttheSeptember9request,OMearaexpressednoacrimonyand
said he understood why JPMorgan needed the collateral.4191 Hogan added that
JPMorgan wanted to protect its own risk, but not to a point where it would cause
4187Id.atpp.67.
4189Id.atpp.2,10.Chiavenatostatedthat,althoughcollateralreturnwasnothisdecision,hewouldnot
haverecommendedthatJPMorganreturnanycollateralinAugustinresponsetoarequestfromLehman.
At that point, JPMorgan claimed it did not have enough collateral. Examiners Interview of Ricardo S.
Chiavenato,Sept.21,2009,atpp.1516;ExaminersInterviewofEdwardJ.Corral,Sept.30,2009,atp.12.
4191ExaminersInterviewofJohnJ.Hogan,Sept.17,2009,atp.4.
1136

Lehmananydistress; hestatedhehadheard from others that Fuld hadno issue with
theSeptember9collateralrequest.4192
Finally, Ed Corral, JPMorgans head of Fixed Income Clearing, stated that he
believedthatJPMorgandidnotaskfornearlyasmuchcollateralasitcouldorshould
have because it wanted to help Lehman.4193 While the Examiner gives little weight to
these statements made long after the fact and in light of pending claims between
LehmanandJPMorgan(inparticularthesuggestionthatJPMorganwouldhavebacked
down from its collateral requests if Fuld had just asked), it is significant that in
contemporaneous notes made on September 9, BuyersRusso wrote that JPMorgan
[did]nt want to push [Lehman] over edge or signal to market.4194 And, on a
conferencecallwiththeFRBNYthefollowingafternoon,whentheFRBNYquestioned
whether senior management ha[d] put forth any triggers or course of events that
would signal a desire by JPMC to stop trading, cut lines, and run from Lehman,
JPMorganriskexecutivesreiterated,asthey[had]inthepast,thatthey[did]notwant
to be the first one to make that call and [were] mindful of the implications of such a
decision. However,theydidstatethatthey[did]not wanttobethelastonetomake
4192Id.atp.5.
4193ExaminersInterviewofEdwardJ.Corral,Sept.30,2009,atpp.2,11;ExaminersInterviewofDonna
Dellosso, Feb. 27, 2009, at p. 4 (stating that the September 9 collateral request should have been higher
givenJPMorgansaggregateriskexposurestoLehman).
4194JaneBuyersRusso,JPMorgan,UnpublishedNotes(Sept.9,2008),atp.2[JPMEXAMINER00006052];
seealsoemailfromJaneBuyersRusso,JPMorgan,toKellyA.Mathieson,JPMorgan,etal.(Sept.12,2008)
[JPM20040050097](Thegoalwastoprotectjpmwithoutpushing[Lehman]overtheedge.).
1137

thatdecision....4195TheevidencesuggeststhatJPMorganexhibitedsomeflexibilityas
to the amount of collateral it would accept from Lehman,4196 but there is no
contemporaneousevidencesuggestingJPMorganwouldhaveeliminateditsSeptember
collateralrequestsinthefaceofresistancefromLehman.
(h) September9CallsBetweenStevenBlackandRichardFuld
According to JPMorgan witnesses, Black communicated the $5 billion collateral
requesttoRichardFuldbytelephoneonSeptember9.4197Blackstatedthatheexplained
thatthecollateralwasintendedtocoverJPMorgansexposuretoLehmaninitsentirety,
and was not limited to tripartyrepo exposure.4198 Ultimately, according to Black,
Lehman offered to post $3 billion immediately and post an additional $2 billion at a
latertime.4199Thereissomeevidence,however,thatLehmanagreedonlytotopupto$4
billion.4200
4195EmailfromGregoryGaare,FRBNY,toWilliamA.Rutledge,FRBNY,etal.(Sept.10,2008)[FRBNYto
Exam.014605].
4196SeeSectionIII.A.5.b.1.h.
4197Examiners Interview of Steven D. Black, Sept. 23, 2009, at p. 6; Examiners Interview of Barry L.
Zubrow, Sept. 16, 2009, at p. 10; Examiners Interview of Jane BuyersRusso, Sept. 25, 2009, at p. 7.
Decipheringacontemporaneousnote,BuyersRussorecalledthatJPMorganwouldaskfor$5billion,but
accept$3billionfromLehman.ExaminersInterviewofJaneBuyersRusso,Sept.25,2009,atp.9;Jane
BuyersRusso, JPMorgan, Unpublished Notes (Sept. 9, 2008), at p. 1 [JPMEXAMINER00006052]. In a
later contemporaneous note on September 9, BuyersRusso wrote, Black called Dick[,] asked for $3B
said ok. Examiners Interview of Jane BuyersRusso, Sept. 25, 2009, at p. 10; Jane BuyersRusso,
JPMorgan,UnpublishedNotes(Sept.9,2008),atp.3[JPMEXAMINER00006052].
4198ExaminersInterviewofStevenD.Black,Sept.23,2009,atp.7.Note,however,thatDellosso,inan
internal email, referred to the new collateral as covering intraday exposure. See email from Donna
Dellosso,JPMorgan,toStevenD.Black,JPMorgan,etal.(Sept.10,2008)[JPM20040006377]([Lehman]
willmaintaincollateralof$4blntocoverintradayexposure.).
4199Examiners Interview of Steven D. Black, Sept. 23, 2009, at pp. 6, 9; see also JPMorgan First Written
Responses,atp.17.BlackscommunicationsdidnotoccurinasingletelephonecallwithLehmanthat
1138

Black stated that he relayed to Fuld that JPMorgan was not trying to solve
JPMorgans problem by creating new problems for Lehman. He asserted that he told
Fuldthat,ifLehmanwasneartheedge,Fuldshouldsayso.AccordingtoBlack,Fuld
asked whether JPMorgan was interested in making a capital infusion, but JPMorgan
was not. Black stated that he advised Fuld that if Lehman were skating close to the
edge,LehmanshouldcalltheFederalReservesothattheFederalReservecouldherd
the cats needed to assist Lehman. According to Black, Fuld said Lehman was not
anywhereclosetothepointofneedingsuchassistance.4201
TakingadvantageofJPMorgansoffertohelpinanotherway,FuldaskedBlack
tosendaJPMorganteamtoameetingthateveningwithCitiandLehmantodiscussa
capital markets plan.4202 JPMorgan did so.4203 The JPMorgan team reported back that
Lehman had not offered a viable plan and that a preannouncement of Lehmans
day,butinmultiplecalls.ExaminersInterviewofStevenD.Black,Sept.23,2009,atpp.69.Lehmans
acceptanceofthe$3billionrequestisconsistentwiththeSeptemberGuarantywhichspecificallyinvoked
thatfigureinestablishingmaximumliability.Guaranty(Sept.9,2008),atp.2[JPM20040005813](The
GuarantorsmaximumliabilityunderthisGuarantyshallbeTHREEBILLIONDOLLARS($3,000,000,000)
orsuchgreateramountthattheBankhasrequestedfromtimetotimeasfurthersecurityinsupportof
thisGuaranty.).
4200SeeemailfromDonnaDellosso,JPMorgan,toStevenD.Black,JPMorgan,etal.(Sept.10,2008)[JPM
2004 0006377] ([Lehman] will maintain collateral of $4bln to cover intraday exposure.); email from
DanielJ.Fleming,Lehman,toMarkG.Doctoroff,JPMorgan(Sept.12,2008)[LBEXDOCID405652](JPM
nowhasatotalof4.6bn,600mmmorethenagreed.).
4201ExaminersInterviewofStevenD.Black,Sept.23,2009,atpp.67.
4202Id.atp.7.
4203See email from Jane BuyersRusso, JPMorgan, to Tim Main, JPMorgan (Sept. 9, 2008) [JPM2004
0006361].
1139

earnings without a plan in place was unwise.4204 The JPMorgan team also noted that
Lehmanhadsentjuniorexecutiveswhopitchedagoodbank/badbankproposal,but
whocouldnotanswerspecificquestionsorprovideenoughdetailforJPMorgantotake
theproposalseriously.4205
BlackalsostatedthathetoldFuldthatifJPMorganultimatelydidnotneedthe
collateralthatLehmanwaspledging,JPMorganwouldreturnit.4206Inresponsetothe
Examiners questions about issues that may have come up in JPMorgans discussions
with Lehman that evening concerning whether the collateral would be available to
Lehman overnight, Black recalled that there was a capital issue that Lehman was
attempting to solve visvis the September Agreements, but he was not involved in
specificdiscussionsaboutit.4207
Internal JPMorgan documents are consistent with the statements by JPMorgan
executives to the Examiner that on September 9, 2008, Black requested additional
4204See email from John J. Hogan, JPMorgan, to Steven D. Black, JPMorgan (Sept. 9, 2008) [JPM2004
0006362];ExaminersInterviewofStevenD.Black,Sept.23,2009,atp.7.JPMorgansInvestmentBank
Management Committee listened to Lehmans earnings call the next morning. Black stated that
JPMorgans concerns from the night before were realized. JPMorgan became concerned after the call
because,inBlackswords,itrevealedthattheemperorhadnoclothes.ExaminersInterviewofSteven
D.Black,Sept.23,2009,atp.9.
4205ExaminersInterviewofJohnJ.Hogan,Sept.17,2009,atp.8;emailfromJohnJ.Hogan,JPMorgan,to
StevenD.Black,JPMorgan(Sept.9,2008)[JPM20040006362].Thisproposalisdiscussedinmoredetail
supraatSectionIII.A.3.c.4.
4207Id.ThecapitalissuethatBlackrecalledwaslikelyLehmansrequestforathreedaynoticeperiodto
callitscollateralbacksothatLehmancouldcountthecashaspartofitsliquiditypool.
1140

collateralfromFuld,whoagreedtotherequest.4208Fuld,however,deniedhavingmade
anysuchagreement.Indeed,hestatedthathedidnotevenhavetheauthoritytoagree
tochangesincollateral.4209
Although there is a September 9 entry in Fulds call log reflecting a call with
Black,4210Fuldstatedthathehadnorecollectionofanysuchcall.4211Fuldexplainedthat
he was reminded of the call by Thomas Russo (Lehmans Chief Legal Officer) weeks
afterLBHIsbankruptcy,whosuggestedthatFuldwouldnotrecallaconversationwith
BlackbecauseFuldhadaskedRussotoreturnBlackscall.4212However,Russosaidhe
didnotrecallspeakingwithBlackspecifically,butdidrecallspeakingwithsomeoneat
JPMorgan related to an agreement that JPMorgan wanted signed quickly.4213 Fuld,
however, recalled Russo reporting to him that the topic of the call was collateral and
thatRussodidnothaveauthoritytoagreetochangesincollateral.4214
Lehmans posting of additional collateral on September 9 and 10 is consistent
withstatementsbywitnessesfromJPMorgantotheExaminerthatLehmandidagreeon
4208EmailfromJaneBuyersRusso,JPMorgan,toSusanStevens,JPMorgan,etal.(Sept.9,2008)[JPM2004
0006331](BlackspokewithFuldwhoagreedtothe$3B.);JaneBuyersRusso,JPMorgan,Unpublished
Notes(Sept.9,2008),atp.3[JPMEXAMINER00006052](BlackcalledDick[,]askedfor$3Bsaidok.)
DoctoroffwasinformedoftheconversationbyBuyersRussoandinstructedtoworkwithFlemingtoput
therequestinplace.ExaminersInterviewofMarkG.Doctoroff,Apr.29,2009,atp.11.
4210OOCClientActivityLog(03/15/200809/15/2008),atp.66[LBHI_SEC07940_016911].
4211Examiners Interview of Richard S. Fuld, Jr., May 6, 2009, at pp. 1516; Examiners Interview of
RichardS.Fuld,Jr.,Dec.9,2009,atp.4.
4214ExaminersInterviewofRichardS.Fuld,May6,2009,atp.16.
1141

September9topostupto$3billionincollateral.OnSeptember9,Lehmanpledgedto
JPMorgan$1billionincashandapproximately$1.7 billionof moneymarketfunds.4215
The next day Lehman top[ped] [JPMorgan] up to $3Bn by delivering another $300
millioncash.4216
On September 10,LehmanrequestedthatJPMorgan substitute corporate bonds
(from LBI) for a portion of the $3 billion Lehman had just posted.4217 Lehman
transferred approximately $1.6 billion of corporate bonds to JPMorgan, which were
placedintoan account subject toJPMorganslienandheldbyJPMorganovernight.4218
JPMorganendeavoredtovaluethecorporatebondsthatLehmanprovided,haircutting
them to approximately $1 billion.4219 On September 11, Lehman posted an additional
4215JPMorganSecondWrittenResponses,atp.9;Lehman,CollateralPledgedtoJPMforIntradayAsof
9/12/2008 COB [LBEXAM 047008]; see also email from Mark G. Doctoroff, JPMorgan, to Jane Buyers
Russo, JPMorgan, et al. (Sept. 9, 2008) [JPM2004 0032520]; email from Daniel J. Fleming, Lehman, to
PaoloR.Tonucci,Lehman(Sept.9,2008)[LBEXDOCID073380].
4216EmailfromMarkG.Doctoroff,JPMorgan,toDonnaDellosso,JPMorgan,etal.(Sept.10,2008)[JPM
20040032634];seealsoemailfromMarkG.Doctoroff,JPMorgan,toDonnaDellosso,JPMorgan(Sept.10,
2008) [JPM2004 0010289]; JPMorgan Second Written Responses, at p. 9; Lehman, Collateral Pledged to
JPMforIntradayAsof9/12/2008COB[LBEXAM047008].
4217See email from Mark G. Doctoroff, JPMorgan, to Donna Dellosso, JPMorgan, et al. (Sept. 10, 2008)
[JPM20040010289];emailfromJohnN.Palchynsky,Lehman,toJonCiciola,JPMorgan,etal.(Sept.10,
2008)[JPM20040002216];emailfromMarkG.Doctoroff,JPMorgan,toDonnaDellosso,JPMorgan,etal.
(Sept. 10, 2008) [JPM2004 0032634]; JPMorgan Second Written Responses, at p. 2. As described infra,
JPMorganultimatelydidnotagreetothissubstitution.
4218JPMorganSecondWrittenResponses,atpp.23;emailfromMarkG.Doctoroff,JPMorgan,toDonna
Dellosso,JPMorgan,etal.(Sept.10,2008)[JPM20040032684];emailfromMarkG.Doctoroff,JPMorgan,
toDonnaDellosso,JPMorgan,etal.(Sept.10,2008)[JPM20040032634];emailfromMarkG.Doctoroff,
JPMorgan,toDanielJ.Fleming,Lehman(Sept.10,2008)[LBEXDOCID035938].Initially,onSeptember
10, Lehman provided ABSs and CMOs to JPMorgan as well, but JPMorgan informed Lehman that it
would not consider that collateral. JPMorgan Second Written Responses, at p. 2; email from Mark G.
Doctoroff,JPMorgan,toDonnaDellosso,JPMorgan,etal.(Sept.11,2008)[JPM20040032684].
4219JPMorganSecondWrittenResponses,atpp.23;emailfromMarkG.Doctoroff,JPMorgan,toDaniel
J. Fleming, Lehman (Sept. 10, 2008) [LBEXDOCID 035938]; email from Donna Dellosso, JPMorgan, to
1142

$600 million in cash4220 and requested that $500 million of the corporate bonds be
returned.4221 JPMorgan released a portion of the bonds to Lehman, but retained
approximately$1billion(marketvalueaccordingtoLehman)ofthem.4222Theposting
of the additional $600 million in cash, as well as JPMorgans retention at least
temporarily of some of the corporate bond collateral, is consistent with Blacks
statement that Lehman had agreed to post $3 billion initially and supplement the
collateralatalaterdate.Thus,attheendofthedayonSeptember11,JPMorganheld
$1.9 billion in cash, approximately $1.7 billion in money market funds and
approximately$1billionincorporatebondsfromLehman(inadditiontothesecurities
collateralpledgedbyLehmanoverthecourseofthesummer).
(i) SeptemberAgreements
Shortly before 9:00 p.m. on September 9, JPMorgan sent draft guaranty and
security agreements to Yeung.4223 A draft amendment to the Clearance Agreement
Matthew E. Zames, JPMorgan, et al. (Sept. 10, 2008) [JPM2004 0010289]; email from Craig M. Delany,
JPMorgan,toHenryE.Steuart,JPMorgan(Sept.11,2008)[JPMEXAMINER00006219].
4220CollateralPledgedtoJPMforIntradayAsof9/12/2008COB[LBEXAM047008];ExaminersInterview
ofStevenD.Black,Sept.23,2009,atp.12;emailfromMarkG.Doctoroff,JPMorgan,toHenryE.Steuart,
JPMorgan,etal.(Sept.11,2008)[JPM20040062065];JPMorganSecondWrittenResponses,atp.9.
4221JPMorganSecondWrittenResponses,atp.3;emailfromMarkG.Doctoroff,JPMorgan,toHenryE.
Steuart,JPMorgan,etal.(Sept.11,2008)[JPM20040062065].
4222JPMorgan Second Written Responses, at p. 3; see email from Henry E. Steuart, JPMorgan, to Jane
BuyersRusso,JPMorgan,etal.(Sept.12,2008)[JPMEXAMINER00006225];emailfromRobertH.Milam,
JPMorgan,toJohnJ.Hogan,JPMorgan,etal.(Sept.11,2008)[JPMEXAMINER00006222].Theremainder
ofthesebondswasreturnedonSeptember12.SeeinfraatSectionIII.A.5.b.1.m.
4223Email from Jeffrey Aronson, JPMorgan, to Andrew Yeung, Lehman, et al. (Sept. 9, 2008) [JPM2004
0005594];ExaminersInterviewofAndrewYeung,Mar.13,2009,atp.4.
1143

arrived later that night.4224 The new agreements surprised Yeung, both because they
camesosoonaftertheAugustAgreementswerenegotiatedandexecuted,andbecause
small wording changes dramatically expanded the scope of JPMorgans lien and the
scopeofobligationsguaranteedbyLBHI.4225
Yeungstatedthatwhilereviewingthedraftdocumentsthatevening,heplaceda
call to Gail Inaba, a JPMorgan inhouse counsel.4226 According to Yeung, Inaba
explained that the changes to the agreements had already been agreed upon in a
conversationbetweenBlackandFuld.4227Shefurtherexplainedthattheagreementshad
tobeexecutedpriortoLehmansacceleratedearningsannouncementscheduledforthe
nextmorning.4228Thismessagewascommunicatedamongbusinesspersonnelaswell.
Dellosso stated that she called Tonucci on the night of September 9 and told him that
the documents needed to be signed. According to Dellosso, Tonucci replied that he
4224Email from Jeffrey Aronson, JPMorgan, to Andrew Yeung, Lehman, et al. (Sept. 9, 2008) [JPM2004
0005039].AdraftAuroraGuarantyanddraftControlAgreementweresentwiththedraftAmendmentto
theClearanceAgreementaswell.Seeid.TheSeptemberGuaranty,SecurityAgreementandAmendment
totheClearanceAgreementarereferredtohereinastheSeptemberAgreements.
4225ExaminersInterviewofAndrewYeung,Mar.13,2009,atp.3.
4226Id.atp.4.InabadidnotrecallYeungcallingherthatnight.ExaminersInterviewofGailInaba,Apr.
28,2009,atp.7.
4227Examiners Interview of Andrew Yeung, Mar. 13, 2009, at p. 4. According to Yeung, when he
expressedhisconcernovertheexpandedscopeofthecollateralpledge,Inabasaidifyouhaveconcerns
about this we will contact Dick Fuld. Id. Although she did not remember Yeung calling her, Inaba
stated to the Examiner that she told Yeung and Hespel that an agreement had been reached by very
senior management at both firms, though not necessarily that Fuld and Black had reached agreement.
ExaminersInterviewofGailInaba,Apr.28,2009,atp.7.
4228Examiners Interview of Andrew Yeung, Mar. 13, 2009, at p. 4; Examiners Interview of Gail Inaba,
Apr.28,2009,atp.8.
1144

neededtospeaktoLowitt,whowassleepingatthetime.4229Dellossofurthersaidthat
Tonucci told her that he needed Lowitts approval of the agreements, but she did not
recall any followupinformationfromTonucciastowhetherLowittwasconsulted.4230
Similarly,MarkDoctoroff,attheinstructionofDellosso,toldDanFlemingbetween10
p.m.and11p.m.thatLehmanneededtowakeLowittupbecausetheagreementshadto
becompleted.4231
Tonucci recalled an evening phone call with BuyersRusso on September 9.
According to Tonucci, BuyersRusso inquired whether Lowitt had reviewed the
agreements;hehadnot.TonuccireportedthatLowittwaslikelyasleepand,although
BuyersRusso requested that Tonucci wake him up, Tonucci decided not to do so.4232
BuyersRusso did not discuss any such call with the Examiner,4233 and it may be that
Tonucci was mistaken in saying that the call was with BuyersRusso rather than
Dellosso.4234
YeungandHespelnegotiatedtheagreementwithJPMorgan.ThecoreJPMorgan
inhouse legal team consisted of Inaba, who took the lead in the negotiations, Jeffrey
4230Id.
4231Examiners Interview of Mark G. Doctoroff, Apr. 29, 2009, at p. 19; Examiners Interview of Donna
Dellosso,Oct.6,2009,atp.9.
4233ExaminersInterviewofJaneBuyersRusso,Sept.25,2009,atpp.611.
4234ThisinterpretationissupportedbythefactthatBuyersRussosnotesfromSeptember9donotreferto
suchaconversationwithTonucci.SeeJaneBuyersRusso,JPMorgan,UnpublishedNotes(Sept.9,2008),
atpp.15[JPMEXAMINER00006052].HerSeptember11notes,bycomparison,dorecordconversations
with Tonucci. See Jane BuyersRusso, JPMorgan, Unpublished Notes (Sept. 11, 2008), at p. 5 [JPM
EXAMINER00006040].
1145

Aronson,whoworkedontheGuarantyandSecurityAgreement,andNikkiAppel,who
workedontheAmendmenttotheClearanceAgreement.4235
ThedraftagreementsraisedseveralconcernsforYeung,whichheidentifiedine
mails to Tonucci and others.4236 Thus, notwithstanding the representation from Inaba
that the agreements reflected an understanding between senior executives of Lehman
and JPMorgan, Yeung took the step of identifying his concerns to Lehman business
personnel in order to confirm their understanding. In response, Fleming instructed
YeungtoproceedasifLehmanwouldultimatelyagreetoallofJPMorgansproposed
terms.4237 According to Yeung, Fleming separately instructed Yeung to do everything
required to advance the agreements as quickly as possible, and that Tonucci would
reviewthemeventually.4238
Throughthenightandintothenextmorning,YeungandHespelnegotiatedthe
agreementswithJPMorganslegalteam.Yeungsaidhefelthewasundersignificant
4235ExaminersInterviewofGailInaba,Apr.28,2008,atp.6.Inaddition,PeterWassermanworkedona
separateLBHIGuarantyonbehalfofAuroraLoanServices,LLC.Id.
4236Examiners Interview of Andrew Yeung, Mar. 13, 2009, at p. 4; Examiners Interview of Andrew
Yeung,May14,2009,atp.9.Asdiscussedbelow,Tonuccistatedthathedidnotreviewhisemailsthat
evening.YeungstatedthatFlemingtoldhimthattheagreementshadalreadybeenagreedto,butYeung
responded that he would review them and provide comments nonetheless. Examiners Interview of
AndrewYeung,May14,2009,atp.9.
4237ExaminersInterviewofAndrewYeung,Mar.13,2009,atp.4.Flemingstatedthatheconsultedwith
TonuccibeforerespondingtoYeungsemail.ExaminersInterviewofDanielJ.Fleming,Apr.22,2009,at
p.7.Tonuccididnotreportanysuchconsultationandinsteadnotedthatafterforwardingtheoriginal
drafts of the agreements to Yeung and Fleming, he paid no attention to the issue on the evening of
September9.ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atp.13.Further,Tonucciadded
thatheturnedhisBlackberryoffthatnightandrecalledthatFlemingwaslikelytheonlybusinesscontact
workingwithcounselonthenightofSeptember9.Id.
1146

pressure and subject to a very fast timeframe. He felt the terms of the proposed
agreementsweredictatedratherthan negotiated,andthatJPMorgandidnotexpect
substantive changes or any drawnout discussion on material provisions.4239 Appel,
by contrast, described the negotiations as professional and cordial.4240 Although
JPMorgan continually emphasized that the agreements had to be in place by the next
morning,noLehmanwitnessoneitherthelegalorbusinesssidetoldtheExaminerthat
anyone at JPMorgan made any explicit threat during the negotiation to cease clearing
servicesforLehmanifLehmandidnotsignbythemorning.4241
According to Dellosso, if Lehman did not sign the agreements, it would have
been difficult for JPMorgan to extend credit to and continue being supportive of
Lehman. Dellosso recalled discussing with Tonucci JPMorgans desire to continue to
supportLehmaninthepublicdomainandJPMorgansextensionofcredittoLehman.4242
Tonucci did not recall any specific threat from Dellosso (or anyone else at JPMorgan)
4239Id. at p. 5. Hespel described the negotiations as acrimonious. Examiners Interview of Paul W.
Hespel, Apr. 23, 2009, at p. 6. While different in tone and manner from the August negotiations, the
September Agreements were not the first time Lehman had experienced difficulties negotiating with
JPMorgan.Forinstance,whenJPMorganwasnegotiatingaSubCustodialagreementwithLehmanand
oneofitstripartyinvestors,Federated,oneoftheLehmannegotiatorscommented:Inthepastyearor
so, JPMorgan has become increasingly uncooperative, reneging on previous agreements regarding
acceptable language, dictating the form of agreements that they will review . . . and taking positions
contrary to either the clear language of an agreement...or refusing to take language acceptable in the
Lehmanboilerplateformifinsertedinadifferentformprovidedbythecounterparty....Emailfrom
CharlesWitek,Lehman,toGeorgeV.VanSchaick,Lehman,etal.(Apr.23,2008)[LBEXDOCID110245].
4240ExaminersInterviewofNikkiG.Appel,Sept.11,2009,atp.4.
4241Examiners Interview of Andrew Yeung, Mar. 13, 2009, at p. 4; Examiners Interview of Paul W.
Hespel,Apr.23,2009,atp.6;ExaminersInterviewofDanielJ.Fleming,Apr.22,2009,atp.7;Examiners
4242Examiners Interview of Donna Dellosso, Oct. 6, 2009, at p. 9; see email from Donna Dellosso,
JPMorgan,toStevenD.Black,JPMorgan,etal.(Sept.10,2008)[JPM20040061485].
1147

concerningwhatwouldhappeniftheagreementswerenotsigned.4243Indeed,Tonucci
believed that JPMorgan would have continued to clear for Lehman without the
agreements in place, albeit with friction, stress, and operational difficulties for
Lehman.4244
Other than the general instructions from Fleming to proceed with the
agreements, Yeung received almost no guidance that night from Lehmans business
side regarding the crucial September Agreements.4245 Yeung believed that the
SeptemberAgreementshadalreadybeenagreedtoinprinciple,andstatedthatFleming
had specifically told him that the agreements had been agreed to; accordingly, Yeung
reportedthatFlemingwasnotexpectingtoomuchfromYeungbywayofcomments.4246
YeungsonlycommunicationfromTonuccioccurredonthemorningofSeptember10,
and was for the limited purpose of executing the final documents.4247 Tonucci
confirmed that he paid no attention to the agreements during the evening of
September 9.4248 Indeed, while the September Agreements were being negotiated,
Lehmanseniormanagementwasimmersedinallnightmeetingstoreadytheearnings
4244Id.
4245Examiners Interview of Andrew Yeung, Mar. 13, 2009, at pp. 45; Examiners Interview of Andrew
4246Examiners Interview of Andrew Yeung, May 14, 2009, at p. 9. Fleming repeatedly attempted to
distancehimselffromanyroleinprovidingbusinessguidance,statingitwasnothisjob.Hesaid:This
iswhywehavelawyers.ExaminersInterviewofDanielJ.Fleming,Apr.22,2009,atpp.2,6.
4247ExaminersInterviewofAndrewYeung,May14,2009,atp.9.
1148

report for early release on the morning of September 10.4249 According to Tonucci, he
and Lowitt were off email the entire night.4250 Thus, it appears that there was no
Lehman executivelevel review of the agreements or even an effort by Lehman
executivestoobtainasummaryofthetermsorimpactoftheproposedagreements.
Although in the course of the negotiations JPMorgan did not significantly alter
thescopeoftheSecurityAgreementandGuarantyfromJPMorgansoriginalproposal,
JPMorgan did make some changes to the proposed agreements at Lehmans request.
For example, JPMorgan agreed to change language in the Guaranty to reference
collateral request[s] rather than stronger language suggestive of an obligation or
demand.4251JPMorganalsoremovedlanguagebywhichLBHIguaranteedperformance
obligations.4252 In the Amendment to the Clearance Agreement, although initially
against the change,4253 JPMorgan ultimately removed references to affiliates in the lien
4249ExaminersInterviewofAndrewYeung,Mar.13,2009,atp.4.AccordingtoYeung,Lowittleftthe
earningsmeetingthatnightbecausehefeltill.Id.
4250ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atpp.2,13;ExaminersInterviewofIanT.
Lowitt,Oct.28,2009,atp.19.
4251CompareGuaranty[Draft](Sept.9,2008),atp.2[JPM20040005596](maximumliabilityis$3billion
orsuchgreateramountthattheBankhasnotifiedtheGuarantoritmustdelivertotheBankinsupport
ofthisGuaranty),withGuaranty(Sept.9,2008),atp.2[JPM20040005813](maximumliabilityis$3
billion or such greater amount that the Bank has requested from time to time as further security in
supportofthisGuaranty).
4252CompareGuaranty[Draft](Sept.9,2008),atp.1[JPM20040005595](guaranteeingpunctualpayment
and performance of all obligations and liabilities), with Guaranty (Sept. 9, 2008), at p. 1 [JPM2004
0005813](guaranteeingpunctualpaymentofallobligationsandliabilities).
4253See email from Nikki G. Appel, JPMorgan, to Andrew Yeung, Lehman, et al. (Sept. 10, 2008) [JPM
20040001997].
1149

provision intended to provide for crosscollateralization.4254 These changes did not
involvethemostsignificantaspectsoftheagreements,butitisclearthatatleastsome
giveandtakeoccurredduringthenegotiation.
At 6:30 a.m. on September 10, Yeung emailed JPMorgan counsel and reported
that he had sent the agreements on to our executive officers for their final approval
and signature.4255 Yeung instructed Fleming to prepare Lowitt to sign the
agreements,4256 but Tonucci signed them. Shortly after 7:00 a.m., Fleming emailed
DoctoroffandinformedhimthatAndrew[was]onhisway...topickupsigneddocs
from Paolo/Ian.4257 Yeung forwarded the signature pages to JPMorgan at
approximately 7:30 a.m.4258 Appel stated that JPMorgan did not request any type of
4254CompareAmendmenttoClearanceAgreement[Draft](Sept.9,2008),atp.1[JPM20040005055],with
AmendmenttoClearanceAgreement(Sept.9,2008),atp.1[JPM20040005861].ExaminersInterviewof
GailInaba,Apr.28,2009,atp.7.
4255Email from Andrew Yeung, Lehman, to Gail Inaba, JPMorgan, et al. (Sept. 10, 2008) [JPM2004
0002032].UnderLehmansCodeofAuthorities,otherthanforaGuaranteedSubsidiary,aHoldings
guaranty of a subsidiarys obligations for over $500 million or for an unspecified amount must be
approved by LBHIs CEO, President, COO or CFO. LBHI & LBI, Amended and Restated Code of
Authorities(July1,2004),atEx.3[LBEXAM043802].LBIoneoftheentitiescoveredbytheSeptember
Guaranty is not a Guaranteed Subsidiary, and thus this provision governs. See Alvarez & Marsal,
ResponsestoQuestionsforAlvarez&Marsal/Weil,Gotshal&Manges(Dec.7,2009),atp.1(confirming
LBIwasnotaGuaranteedSubsidiary).TheCodeofAuthoritiesalsoprovides,however,that[i]fthe
required approval is obtained, any proper officer of Holdings . . . may sign documents. LBHI & LBI,
AmendedandRestatedCodeofAuthorities(July1,2004),atEx.1[LBEXAM043802].
4257Email from Daniel J. Fleming, Lehman, to Mark G. Doctoroff, JPMorgan (Sept. 10, 2008) [LBEX
DOCID457582].
0005218].
1150

certification of Tonuccis authority; she stated that JPMorgan relied on apparent
authority.4259
Notably, Tonucci told the Examiner that he did not understand the terms of
theagreementswhenhesignedthemand,ifhehad,hewouldhavebeenreluctantto
sign.4260LowittspokewithTonucciabouttheSeptemberAgreementsaftertheearnings
call on September 10 (after the agreements were signed). Lowitt did not recall
communicating with anyone about the agreements prior to that point.4261 Tonucci
relayed to Lowitt that JPMorgan had wanted Lowitt to sign the agreements the night
before, but that Tonucci had decided not to bother Lowitt. In response to questions
fromtheExaminer,LowittrecalledhavingnoconcernaboutTonuccisauthoritytosign
theagreements,citingthefactthateventhoughJPMorganwantedLowitttosign,they
accepted Tonuccis signature.4262 In any event, neither Lowitt nor anyone else at
LehmansoughttorescindtheagreementsbasedonTonuccislackofauthority.
Asexecuted,theSeptemberAmendmenttotheClearanceAgreementexpanded
JPMorgans lien on the Lehman parties accounts, securing their existing or future
indebtedness, obligations and liabilities of any kind to JPMorgan whether arising
4261ExaminersInterview of Ian T. Lowitt, Oct. 28, 2009, at pp. 1920. Yeung did email Lowitt that
evening,butLowittdidnotrespond.ExaminersInterviewofAndrewYeung,Mar.13,2009,atp.4;see
alsoemailfromPaulW.Hespel,GoodwinProcter,toJeffreyAronson,JPMorgan(Sept.10,2008)[LBEX
AM 039572] (forwarding Lehman comments on draft Guaranty and Security Agreement to JPMorgan,
copyingLowitt).
4262ExaminersInterviewofIanT.Lowitt,Oct.28,2009,atp.19.Lowittsreasoningdoesnot,ofcourse,
addresstheissueofLehmanschainofauthorityrequirements.
1151

under the Clearance Agreement or not.4263 The September Guaranty also extended
LBHIsliability.LBHIunconditionallyandirrevocablyguarantee[d]to[JPMorgan]the
punctualpaymentofallobligationsandliabilitiesofalldirectorindirectsubsidiaries
ofLBHItoJPMorgananditsaffiliates,subsidiaries,successorsandassignsofwhatever
nature,whethernowexistingorhereinafterincurred.4264Notonlydidtheuniverseof
guaranteed Lehman entities expand, but LBHI guaranteed obligations irrespective of
whethertheyaccruedpursuanttotheClearanceAgreementandguaranteedobligations
toallJPMorganaffiliatesaswell.
Inaddition,asrequestedbyLehman,theSeptemberGuarantyimposedathree
daywrittennoticerequirement4265onLehmantotransferanysecurity:
...[LBHI]mayuponthreewrittendaysnoticeto[JPMorgan]transferany
Security...,providedthat[LBHI]shallnottransferanysuchSecurityif
[JPMorgan] has exercised or been stayed or otherwise prohibited from
exercisinganyofitsrightsunderthisGuarantyortheSecurityAgreement
orintheeventanydefault...hasoccurredandiscontinuing,inanysuch
case,priortotheendofthethreedaynoticeperiod.4266
4263Amendment to Clearance Agreement (Sept. 9, 2008), at p. 1 [JPM2004 0005861]. The September

AmendmenttotheClearanceAgreementcontainedarecitalofconsideration.Itstatedthatitwasentered
forgoodandvaluableconsideration,thereceiptandsufficiencyofwhichareherebyacknowledged.Id.
4264Guaranty(Sept.9,2008),atp.1[JPM20040005813].TheSeptemberGuarantycontainedarecitalof
consideration.Itstatedthatitwasenteredforgoodandvaluableconsiderationandinordertoinduce
theBankfromtimetotime,toextendorcontinuetoextendcredit,clearingadvances,clearingloansor
otherfinancialaccommodationsto[LBHIanditssubsidiaries]and/ortotransactbusiness,tradeorenter
intoderivativetransactionswith[LBHIanditssubsidiaries].Id.Itfurthernotedthat[t]hisGuaranty
shallbeinadditiontoanddoesnotreplacethatcertainGuarantydatedAugust26,2008.Id.Neitherthe
SeptemberGuarantynortheSeptemberSecurityAgreementdefinedthetermaffiliates.
4265The threeday provision first appeared in Bank of Americas agreement with Lehman, discussed in
moredetailinSectionIII.A.5.e,infra.
4266Guaranty(Sept.9,2008),atp.2[JPM20040005813].
1152

AlthoughYeungstatedthatthethreedaynoticeprovisioninthedraftGuaranty
originatedwithJPMorgan,4267allotherevidencesupportstheviewthatitwasLehman
that first requested the provision.4268 As reported in a contemporaneous email from
Doctoroff,LehmanwouldprovidecollateralonlyifJPMorganagreedtoa3daynotice
periodtocallthecashback.4269HeexplainedthatLehmanhadrequestedthiscondition
toallow[Lehman]tocountthecashaspartoftheirliquiditypool.4270Lehmanslogic
[was] that with a 3day notice [JPMorgan could] effectively stop doing business that
createsexposureif[Lehman]want[ed]totake[thecollateral]back.4271IfJPMorgandid
notagree,Doctoroffnotedthattherewouldbethepublicissueof[Lehmans]liquidity
pool having to drop.4272 Discussion of Lehmans request occurred among several
JPMorgan executives, including Dellosso, Corral, Hogan, BuyersRusso and Murray,
and the group decided to accede to Lehmans request.4273 BuyersRusso regarded
Lehmans proposal as giving Lehman the right to make a request for a return of
4268E.g., Examiners Interview of Jane BuyersRusso, Sept. 25, 2009, at pp. 78; Examiners Interview of
DonnaDellosso,Oct.6,2009,atp.8;ExaminersInterviewofPaulW.Hespel,Apr.23,2009,atpp.56.
4269EmailfromMarkG.Doctoroff,JPMorgan,toJaneBuyersRusso,JPMorgan,etal.(Sept.9,2008)[JPM
20040032520].
4270Id.
4271Id.
4272Id.
1153

collateral, but imposing no obligation on JPMorgan. She understood having just the
righttorequestthatcollateralbereturnedtobemeaningless.4274
In parallel, the September Security Agreement expanded the definition of
AccountsinwhichJPMorganheldasecurityinterest;insteadofjustonecashaccount,
onesecuritiesaccountandrelatedaccounts,itnowincludedallaccountsof[LBHI]at
[JPMorganoritsaffiliates]...oranysharesoraccountsheldbyorregisteredto[LBHI]
oranynomineeinanymoneymarketfundissued,managed,advisedorsubadvisedby
[JPMorgan or its affiliates], except for the Overnight Account.4275 A threeday notice
provisionwasrepeatedintheSeptemberSecurityAgreementaswell.4276
Three other Lehman entities executed clearance agreements with JPMorgan on
the morning of September 10: Lehman Brothers Bankhaus, Lehman Brothers
CommercialBankandLehmanBrothersBankFSB.4277AccordingtoNikkiAppel,those
entities maintained essentially inactive clearance boxes at the time, and JPMorgan
4275Security Agreement (Sept. 9, 2008), at p. 1 [JPM2004 0005873]. The September Security Agreement
contained a recital of consideration. It stated that it was entered [i]n consideration of [JPMorgan]
extending credit to and/or transacting business, trading or engaging in derivative transactions with
[Lehmanandsubsidiaries].Id.
4276Id.atp.3.
4277See email from Andrew Yeung, Lehman, to Gail Inaba, JPMorgan, et al. (Sept. 10, 2008) [JPM2004
0005696];emailfromAndrewYeung,Lehman,toGailInaba,JPMorgan,etal.(Sept.10,2008)[JPM2004
0002093];emailfromAndrewYeung,Lehman,toGailInaba,JPMorgan,etal.(Sept.10,2008)[JPM2004
0002133]. These agreements had been discussed earlier in the week. Email from Daniel J. Fleming,
Lehman,toMarkG.Doctoroff,JPMorgan(Sept.8,2008)[JPM2004005807](Paul,ouroutsidecounsel,
receivedacalltodayfromJPMaskingthatthethreebankingentitiesweleftofftheamendedclearance
agreementbeaddedbackon....Ithinkthepreferredrouteistoexecuteaseparateagreementforeach.).
1154

wantedtoensureclearanceagreementswereinplaceincaseLehmanmovedanyassets
intothem.4278
Consistent with the broad reach of the September Agreements,4279 once the
agreementswereexecuted,JPMorgannotifiedLBIEthatitspreviouslyunsecuredcredit
lineof$2billionwaseffectivelysecuredbytheexecutionoftheagreements.4280
4278Examiners Interview of Nikki G. Appel, Sept. 11, 2009, at p. 6. When JPMorgan initially did not
receivetheclearanceagreementforLehmanBrothersBankFSB,itinformedLehmanthatitwouldclose
itsaccountthismorning.EmailfromJeffreyAronson,JPMorgan,toAndrewYeung,Lehman(Sept.10,
2008) [JPM2004 0002124]. Lehman quickly informed JPMorgan that the document would be executed
shortly.EmailfromAndrewYeung,Lehman,toJeffreyAronson,JPMorgan(Sept.10,2008)[JPM2004
0002124].
4279TheExaminersfinancialadvisorshaveestimatedthepotentialimpactoftheSeptemberAgreements
to be as follows: First,JPMorganapplied LBHI collateral tosetoff claims totalingapproximately $10.6

millionthatLBHIhadnotguaranteedpriortoenteringtheSeptemberAgreements.Second,JPMorgan
applied LBHI collateral to set off claims totaling approximately $1.94 billion from collateral it pledged
pursuanttotheSeptemberAgreementsforobligationsthathadbeenunsecuredpriortoLBHIentering
the September Agreements. Third, JPMorgan received payments in excess of $1.1 billion (against the
newlysecuredobligations)throughsetoffofcollateralotherthantheLBHIcollateralobtainedunderthe
September Agreements(i.e., collateralheldat LBHI subsidiaries). Fourth,JPMorganasserts claims that
arenotyetpaidforapproximately$943millionrelatedtolostfeesandlossesinmanagedfunds.Duff&
Phelps,ImpactonLBHIClaimPaymentsoftheSeptember9Agreements(Jan.5,2010).Thus,assuming
arguendo the validity of the JPMorgan claims, the September Agreements may have had a $4 billion
impactonLBHI.
4280See email from Kelly A. Mathieson, JPMorgan, to Daniel J. Fleming, Lehman, et al. (Sept. 10, 2008)
[JPM2004 0032674]; Examiners Interview of Kelly A. Mathieson, Oct. 7, 2009, at pp. 11, 1314; see also
Lehman,JPMChaseTripartyRepo,atp.1[LBEXDOCID014562](JPMChaseprovidesa$2bnlineof
unsecuredcredittofacilitatetripartyrepoinEurope.JPMChasehasindicatedthattheywanttochange
thelinefromunsecuredtosecured.).LehmansU.K.executivesunderstoodevenduringthesummerof
2008 that JPMorgans discussions with Tonucci and OMeara were part of a highlevel discussion to
furthercollateralizetheclearancebusiness.EmailfromJosephIgoe,Lehman,toPhilipMorgan,Lehman,
et al. (July 31, 2008) [LBEXDOCID 075820]. While the September Agreements were being negotiated,
JPMorgansexecutivesinchargeofglobalcollateralmanagementwerepreparingforpossibleoptionsif
Lehmanrefusedtosign.SeeemailfromKellyA.Mathieson,JPMorgan,toStevenX.Taylor,JPMorgan
(Sept.10,2008)[JPM20040032521];ExaminersInterviewofKellyA.Mathieson,Oct.7,2009,atpp.14
15.At5:17a.m.LondontimeonSeptember10whentheSeptemberAgreementswerestillnotexecuted,
KellyMathiesonreportedinstructionsfromBarryZubrowandMarkDoctorofftomoveLBIEsunsecured
credit line to $1.1 billion the amount that LBIE was using at that time until the agreements were
executed.SeeemailfromKellyA.Mathieson,JPMorgan,toColleenT.Morris,JPMorgan,etal.(Sept.10,
2008)[JPM20040029858];ExaminersInterviewofKellyA.Mathieson,Oct.7,2009,atp.14.
1155

(j) DailyLiquidityPoolUpdatesFromLehmantoJPMorgan
In September, Dellosso received daily liquidity pool updates from Lehman.4281
Dellosso believed that Doctoroff and others at JPMorgan also received these updates.
After Lehman posted collateral in response to JPMorgans September 9 request,
DellossorealizedthatLehmansliquiditypoolhadnotchanged,andatthesametime
DellossorecalledthethreedaynoticeprovisionintheSeptemberAgreements.Dellosso
linkedthethreedaynoticeprovisiontotheunchangedLehmanliquiditypoolnumber.
ShemadethatobservationtoJPMorganseniormanagers,butdidnotdiscusstheissue
with anyone at Lehman. Dellosso stated to the Examiner that she would not have
counted Lehmans collateral pledge in a liquidity pool.4282 Dellosso explained that if
Lehman had requested collateral back on three days notice, JPMorgan would have
neededtoconsiderfactorssuchasJPMorgansexposurebeforeagreeingtoreturnany
collateral.4283 Thus, to Dellosso, Lehmans pledged assets seemed like encumbered
assets.4284
4281Examiners Interview of Donna Dellosso, Oct. 6, 2009, at p. 11; email from Edward A. Deleon,
JPMorgan, to Donna Dellosso, JPMorgan (Sept. 4, 2008) [JPM2004 0001065]; email from Mark G.
Doctoroff,JPMorgan,toDonnaDellosso,JPMorgan,etal.(Sept.11,2008)[JPM20040002262].
4283Id.atpp.3,8.
4284Id.atp.8.Dimonstatedthattherewerenofirmindustryrulesandtheremaybecircumstancesunder
whichonemightcountapledgedassetinaliquiditypool.However,henotedthathewouldnothave
characterized as liquid the collateral that Lehman posted with JPMorgan because it was the subject of
valuationdisputesbetweenLehmanandJPMorgan.ExaminersInterviewofJamieL.Dimon,Sept.29,
2009,atp.12.
1156

Similarly, Tonucci, while defending Lehmans decision to include collateral
posted to JPMorgan in the liquidity pool, stated that he understood Lehman would
have needed JPMorgans permission to withdraw the collateral.4285 Lowitt stated that
collateral pledged with JPMorgan was ultimately Lehmans money, although he
acknowledged that JPMorgan probably would have been reluctant to give back the
collateral.4286
When DellossoadvisedBuyersRussothat Lehmansreported liquidity had not
changed despite pledges of collateral to JPMorgan, BuyersRusso also connected the
dotsbetweenthethreedaynoticeprovisionandLehmansliquiditypool.4287Buyers
RussostatedtotheExaminerthatshealsobelieveditwasinappropriateforLehmanto
includeencumberedassetsinitsliquiditypool.4288BuyersRussodidnotunderstandthe
threedaynoticeprovisionasrenderingLehmanscollateralunencumberedbecause,in
her view, JPMorgan had no duty to return that collateral upon Lehmans request.4289
4285Examiners Interview of Paolo R. Tonucci, Sept. 16, 2009, at p. 20. Lehman outside counsel Hespel
also believed that the return of collateral to Lehman upon the end of the threeday period was not
mandatoryandthatJPMorgancouldrefusetoreturnit.ExaminersInterviewofPaulW.Hespel,Apr.23,
2009,atp.6.
4286Examiners Interview of Ian T. Lowitt, Oct. 28, 2009, at p. 22. While JPMorgans Hogan offered no
general view as to whether the assets pledged by Lehman should have been included in Lehmans
liquiditypool,hebelievedthat,hypotheticallyspeaking,Lehmancouldhavetakenbackitscollateralona
coupleofdaysnotice.ExaminersInterviewofJohnJ.Hogan,Sept.17,2009,atp.7.
4288Id.
4289Id.
1157

Even if JPMorgan did have such a duty, BuyersRusso explained, Lehman should not
havecountedpledgedcollateralinitsliquiditypooluntilthatcollateralwasreturned.4290
(k) September11CollateralRequestPursuanttothe
SeptemberAgreements
AfterSeptember9,JPMorgancontinuedtoevaluateitsexposuretoLehmanand
thevalueofLehmanscollateral.OnSeptember10,Chiavenatopreparedapresentation
titled,TriPartyRepoMarginGapAnalysisLehman9/10/2008.4291Thepresentation
analyzed the previous nights tripartyrepo portfolio.4292 Chiavenato concluded that
Lehmans total intraday margin on 9/10 was sufficient to cover JPMs riskbased
margin, which was calculated as US$9.2 billion based on the estimated oneday
liquidation risk and the price risk of thecollateral.4293Chiavenatoexplained thatthis
4290Id.
4291Examiners Interview of Ricardo S. Chiavenato, Sept. 21, 2009, at p. 17; JPMorgan, TriParty Repo
Margin Gap Analysis Lehman 9/10/2008(Sept. 10,2008), at pp. 14[JPM20040029886]. There is at

least one earlier version of this analysis, JPMorgan, TriParty Repo Margin Gap Analysis Lehman
9/9/2008 (Sept. 9, 2008) [JPMEXAMINER00006009], though it is not clear whether Chiavenato or
Weisbrod authored it, see email from Ricardo S. Chiavenato, JPMorgan, to David A. Weisbrod,
JPMorgan, et al. (Sept. 10, 2008) [JPM2004 0029885] (sending Weisbrod the September 10 analysis and
stating,[h]ereisthe3pagedeckyousentforLehmanwiththismorningsnumbers).
4292Examiners Interview of Ricardo S. Chiavenato, Sept. 21, 2009, at p. 17; JPMorgan, TriParty Repo
MarginGapAnalysisLehman9/10/2008(Sept.10,2008),atp.2[JPM20040029886].
4293JPMorgan,TriPartyRepoMarginGapAnalysisLehman9/10/2008(Sept.10,2008),atp.2[JPM
20040029886];ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atp.17.Chiavenatofurther
analyzedaworstcasescenariothatwouldoccurifnotripartyinvestorrolledandLehmanhadtorely
onthePDCFforovernightfinancing.Inthatsituation,ChiavenatoconcludedthatJPMorganwouldbe
116percentcollateralized.JPMorgan,TriPartyRepoMarginGapAnalysisLehman9/10/2008(Sept.
10,2008),atp.3[JPM20040029886].ChiavenatorepeatedthisanalysisonSeptember12andconcluded
thatJPMorganwouldbe117percentcollateralizedinatripartyworstcasescenario.JPMorgan,TriParty
Reposand Collateral Lehman 9/11/08(Sept.12, 2008), at p. 3 [JPMEXAMINER00006022]. Notably,
this analysis did not account for the $3 billion posted on September 910 or the $5 billion posted on
September 12. Id. Chiavenato performed this analysis again on September 13 and concluded that
JPMorgan would be 125 percent collateralized during a September 15 unwind in a tripartyworstcase
1158

conclusion did not mean that JPMorgan was overcollateralized, however, because
JPMorgan was still valuing the extra collateral (i.e., collateral in the LCE account)
Lehmanhadpostedat$4.5billion.EventhoughthatnumberreflectedGFAspricing,
Chiavenato explained that there was a problem with the Fenway commercial paper
(valuedat$3billion)thathadnotyetbeenresolved.Inaddition,Chiavenatostatedthat
hisanalysisdidnotaccountfordealerpricingofcollateralinthetripartyshell.4294
Althoughthere had beenconversations withinJPMorganinAugust concerning
valuation of Lehman collateral, JPMorgan witnesses stated that it was not until
September 11, during a widely attended internal meeting, that JPMorgan concluded
thatmuchofthecollateralthatLehmanhadpostedwasnotworthanythingnearwhat
Lehmanhadrepresented.4295Blackstatedthatthiscameasasurprisetomanypeopleat
the September 11 meeting.4296 JPMorgans outside counsel described the substance of
themeetingasfollows:
Questions were raised by senior management about the value of each of

the noncash items of JPMorgans additional collateral [posted by
Lehman].Specifically,therewasconsiderabledoubtexpressedaboutthe
value of the conduit CP [Fenway] and the CLOs [Spruce, Pine and
Verano], all of which had been represented by Lehman to be worth par,
scenario.JPMorgan,TriPartyReposandCollateralLehman9/12/08(Sept.13,2008),atp.3[JPM2004
0033219]. Thisanalysis, however, alsovalued the extra collateral posted byLehmanat Gifford Fong
prices of $4.5 billion. Id. at pp. 23. While the analysis recognized that JPMorgan would have the
additionalUS$5billioncashcollateralobtainedonSeptember12asacushion,theanalysisnotedthat
thatcollateralcoversallJPMscreditexposureandnotjustintradayfinancing.Id.atp.2.
4294ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atpp.1718.
4295ExaminersInterviewofBarryL.Zubrow,Oct.20,2009,atpp.45;ExaminersInterviewofStevenD.
Black,Sept.23,2009,atp.12;ExaminersInterviewofJaneBuyersRusso,Sept.25,2009,atp.14.
1159

with a total face value of $6.7 billion. . . . Craig Delany and analysts
workingwithhimwereaskedtoprovideaballparkestimateofthevalue
of these and other large securitized positions in the triparty repo
portfolio,andtheconclusionthatwasbroughtbacktoseniormanagement
wasthatthecollateralsecuritiesandsomeofthesecuritiesinthetriparty
portfolio could not be relied upon to be worth anything near par if
liquidated. As a result, JPMorgan believed it had at least a $5 billion
deficiency in its existing collateral, and informed Lehman that it had to
have$5billionincashcollateralinordertocontinuetoextendcreditand
supportLehmanthenextday.4297
Black described JPMorgans formulation of the $5 billion amount as part art, part
science,andpartcatchup.4298
4297JPMorgan First Written Responses, at p. 18. Through counsel, JPMorgan also identified one
document, Collateral Detail, prepared by a member of Dellossos team, as the only document that
constitutesaquantitativeanalysisunderlyingJPMorgansSeptember11collateralrequest.SeeJPMorgan,
Collateral Detail, at p. 1 [JPM2004 0084867]. BuyersRusso, however, did not recall any particular
document being discussed at the September 11 meeting. Examiners Interview of Jane BuyersRusso,
Sept. 25, 2009, at p. 14. Delany confirmed that the first file he received thatcontained the collateral he
wastaskedwithpricingwassenttohimaround8:00p.m.thatnight(althoughhereceivedanincorrect
file around 5:00 p.m.). Examiners Interview of Craig M. Delany, Sept. 9, 2009, at pp. 56; email from
Edward J. Corral, JPMorgan, to Craig M. Delany, JPMorgan (Sept. 11, 2008) [JPM2004 0013515]. An
analyst sentDelanya spreadsheet containinganet exposure analysisafew hours later. Emailfrom
Jonathan D. Platt, JPMorgan, to Craig M. Delany, JPMorgan (Sept. 11, 2008) [JPM2004 0017401]
(attaching spreadsheet calculating net exposure). Although Delanys written analysis was not
completed until after the meeting, JPMorgan counsel stated that Delany had conversations throughout
thedaywithMattZames,wholedtheJPMorgantradingdesk,andthatZamesmadeoralreportstothe
meeting about Lehmans collateral valuation. Jenner & Block, Memorandum re November 18, 2009
TeleconferencewithJPMorganCounsel(Nov.19,2009),atp.4.
4298Examiners Interview of Steven D. Black, Sept. 23, 2009, at p. 12 n.4. In addition, by September 11,
JPMorgan knew there were key reductions from Lehman counterparties, as well as an uptick in
novationswithLehman.ExaminersInterviewofJaneBuyersRusso,Sept.25,2009,atpp.1617;Jane
BuyersRusso,JPMorgan,UnpublishedNotes(Sept.11,2008),atpp.67[JPMEXAMINER00006040];see
alsoemailfromEricS.Rosen,JPMorgan,toStevenD.Black,JPMorgan,etal.(Sept.11,2008)[JPM2004
0006397]([M]oodyssuggestedadowngradetoBaaifassetsaleswerenotcompletedquicklywithareal
counterparty.). JPMorgan also believed that Lehman had liquidity in the order of $20 billion to $40
billionsuchthata$5billionrequestwouldnothurtLehman.ExaminersInterviewofBarryL.Zubrow,
Oct. 20, 2009, at p. 5; Examiners Interview of Donna Dellosso, Feb. 27, 2009, at pp. 78. By the early
evening, however, when the call wasmade to Lehman, JPMorgan had reason to believe that Lehmans
liquiditywasnotsorobust.EmailfromJohnJ.Hogan,JPMorgan,toBarryL.Zubrow,JPMorgan,etal.
(Sept.11,2008)[JPM20040006404](ChrisOMeara,ChiefRiskOfficeratLehman,didnotknowatthis
1160

AftertheinternalJPMorganmeeting,BlackandDimoncalledFuld,whobrought
Lowitt into the conversation.4299 Tonucci from Lehman and Zubrow from JPMorgan
recalled participating in the conversation as well.4300 On that call, Black and Dimon
requested $5 billion in collateral from Lehman, in cash, by the next morning.4301
JPMorganwitnessesstatedtotheExaminerthattheyinformedLehmanthatJPMorgan
was concerned about the value of the collateral that Lehman had previously
provided.4302AccordingtoBlack,thecollateral requestwas alsobased, in part, onthe
factthatLehmanhadprovidedonly$3.6billioninresponsetoJPMorgansSeptember9
momentwheretheliquiditystoodrelativetothe$36biotheyquotedontheearningscall....).Further,
JPMorgan was aware of the changes in Lehmans tripartyrepo book. Email from Jane BuyersRusso,
JPMorgan,toBarryL.Zubrow,JPMorgan,etal.(Sept.11,2008)[JPM20040029932](Trendanalysisshows
howthebalanceshavereducedfromapeakof$222Bto$123Blastnight.Whilemuchofthisdeclineup
tolastweekhasbeenselfimposedandtheyvebeenfairlysteadyforthepastmonthorso,therewasan
$18Bdeclinelastnight,whichIbelievewasreplacedwithfundingviatheFICCsGCFproduct.);seealso
emailfromRicardoS.Chiavenato,JPMorgan,toBarryL.Zubrow,JPMorgan,etal.(Sept.12,2008)[JPM
20040050420];emailfromJuliaA.Fox,JPMorgan,toEdwardJ.Corral,JPMorgan,etal.(Sept.12,2008)
[JPM2004 0006456] (Fidelity has requested back all the TPR overnight deals with Lehman.). At the
sametime,JPMorganwasawareoftheeffectsitsdecisionswithrespecttoLehmanstripartyrepobook
mighthaveonLehman.EmailfromJaneBuyersRusso,JPMorgan,toHeidiMiller,JPMorgan(Sept.11,
2008)[JPM20040029932](Itwillcauseanimmediateliquidityissuefor[Lehman]ifwegivethemzero
intradayvalueforthenonpdcfcollateral.).
4299Examiners Interview of Steven D. Black, Sept. 23, 2009, at p. 12; email from Jane BuyersRusso,
JPMorgan,toBrynThomas,JPMorgan,etal.(Sept.12,2008)[JPM20040050095](JamieDimonandSteve
BlackspokewithFuldandIanLowittlastnight.).
4300Examiners Interview of Paolo R. Tonucci, Sept. 16, 2009, at p. 16; Examiners Interview of Barry L.
Zubrow,Oct.20,2009,atpp.56.LowittrecalledTonuccibeingonthecall.ExaminersInterviewofIan
T.Lowitt,Oct.28,2009,atp.21.
4301ExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atp.13;ExaminersInterviewofJamieL.
Dimon, Sept. 29, 2009, at pp. 910; Examiners Interview of Steven D. Black, Sept. 23, 2009, at p. 12;
ExaminersInterviewofIanT.Lowitt,Oct.28,2009,atp.21.
4302Examiners Interview of Jamie L. Dimon, Sept. 29, 2009, at p. 10; Examiners Interview of Steven D.
Black,Sept.23,2009,atp.12;ExaminersInterviewofBarryL.Zubrow,Oct.20,2009,atp.6.Tonucci
stated that JPMorgan did not give any reason for the collateral call. Examiners Interview of Paolo R.
Tonucci,Sept.16,2009,atp.16.
1161

collateralrequestfor$5billion;BlackstatedthatLehmanunderstoodthatitstillneeded
toprovide$1.4billioninresponsetotheSeptember9request.4303
Tonuccirecalledthatduringthecall,oronaseparatecallthesameday,heasked
why JPMorgan wanted the collateral. According to Tonucci, one of the JPMorgan
participants,perhapsJamieDimon,respondednoreason.Tonuccistatedthathethen
asked:Whatistokeepyoufromaskingfor$10billiontomorrow?towhichsomeone,
perhapsDimon,responded:nothingandmaybewewill.4304Zubrowrecalledthat
when questions were raised by Lehman executives about having to send more
collateral, Lehmans Herbert Bart McDade cut off the discussion and stated that
Lehman understood what JPMorgan needed, and that Lehman would forward the
collateraltoJPMorganassoonaspossible.4305
FuldstatedtotheExaminerthatDimontoldbothhimandLowittthatJPMorgan
would give the collateral back at the end of the day.4306 Dimon, however, had no
4303ExaminersInterviewofStevenD.Black,Sept.23,2009,atpp.1213.Asdiscussed,supra,however,
Lehmandidpostcorporatebonds(atleasttemporarily)aswell,andmayhaveunderstooditsobligation
asposting$4billion.
4304ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atp.16.Dimondidnotrecallanyoneasking
thisquestiononthecall,butstatedthathecouldunderstandwhysomeonewould.ExaminersInterview
ofJamieL.Dimon,Sept.29,2009,atp.10.
4305ExaminersInterviewofBarryL.Zubrow,Oct.20,2009,atp.6.
4306ExaminersInterviewofRichardS.Fuld,Jr.,May6,2009,atp.13.TheExaminerisunawareofany
contemporaneous email documenting this understanding. In the early morning of September 12, Ian
LowittemailedPaoloTonuccitoaskDeposittojpm.Dowehaveabilitytocallitbackatendoftheday
orcouldtheyholditoverweekend?EmailfromIanT.Lowitt,Lehman,toPaoloR.Tonucci,Lehman
(Sept.12,2008)[LBEXDOCID70144].Tonucciresponded,Weshouldbebeabletocallback.Email
fromPaoloR.Tonucci,Lehman,toIanT.Lowitt,Lehman(Sept.12,2008)[LBEXDOCID70144].
1162

recollection as to whether he made that promise.4307 Lowitt also did not recall any
discussionaboutLehmanretrievingitscollateralfromJPMorgan.4308However,Tonucci
believed that the $5 billion discussed on the call was meant to collateralize only
intraday exposure, but also stated that this point was not clarified during the call.4309
According to Black, when Lehman agreed to post $5 billion cash collateral, Lehman
asked JPMorgan to return some of the detritus (Blacks description) that JPMorgan
washoldinginexchange.JPMorgandidgivesomeofitback,althoughBlackwasnot
involvedinthedetails.4310
DellossoandBuyersRussoseparatelyrelayedthe$5billioncollateralrequestto
Lehman through Tonucci. On a September 11 telephone call, they said that they
wanted to continue to be supportive of Lehman through the extension of credit and
other services.4311 BuyersRusso told Tonucci that, in order to execute the triparty
unwind, JPMorgan needed additional collateral.4312 According to BuyersRusso,
JPMorganwantedtocontinuetosupportLehmaninaspublicandasstabilizingaway
as possible; thus, BuyersRusso advised Tonucci that JPMorgan preferred to have
Lehman post collateral rather than reducing lines of credit or ceasing trading, which
4310Examiners Interview of Steven D. Black, Sept. 23, 2009, at p. 13. See Section III.A.5.b.1.m, infra
(discussingreturnofselectedcollateral).
1163

would be more visible to the market.4313 BuyersRusso stated that Tonucci responded
that JPMorgan was making things difficult for Lehman.4314 Dellosso recalled that
Tonucci said that he was not sure whether he should continue doing business with
JPMorgan.4315 According to BuyersRusso, Tonucci also defended Lehmans valuation
ofitscollateral.4316Headditionallysaid,accordingtoDellosso,thatheneededtodiscuss
the request with Lowitt.4317 BuyersRusso recalled referring to Lehmans $35 billion
liquidity pool in her conversation with Tonucci; Tonucci responded that Lehmans
liquiditypoolwasnot,infact,$35billion:$15billionoftheliquiditypoolwasalready
encumbered.4318BuyersRussorecordedthisstatementincontemporaneousnotes.4319
BuyersRusso later forwarded Tonucci written notice of the $5 billion collateral
callasdiscussedbetweenseniormanagement.4320Pursuanttothenotice,ifJPMorgan
did not receive this collateral by the opening of business on September 12, 2008,
JPMorganwouldexercise[its]righttodeclinetoextendcreditto[Lehman]underthe
4313Id.atpp.1314.
4314Id.atp.13.
4317Examiners Interview of Donna Dellosso, Oct. 6, 2009, at p. 10. During his interview with the
Examiner, Tonucci did not have a clear recollection of a call with just Dellosso and BuyersRusso, and
mayhavebeenconflatingvariouscallshehadwithJPMorgan.ExaminersInterviewofPaoloR.Tonucci,
Sept.16,2009,atp.16(recallingcallwithBuyersRusso,Dellosso,Dimon,andothersfromJPMorgan).
4319See Jane BuyersRusso, JPMorgan, Unpublished Notes (Sept. 11, 2008), at p. 12 [JPM
EXAMINER00006040](15of35isencumber[e]dintraday);ExaminersInterviewofJaneBuyersRusso,
Sept.25,2009,atp.17.
4320Email from Jane BuyersRusso, JPMorgan, to Paolo R. Tonucci, Lehman (Sept. 11, 2008) [JPM2004
0005411].
1164

[Clearance] Agreement.4321 The Notice made no mention of JPMorgan returning the
collateralatnight.
Lehmandeliveredthefull$5billioncashcollateraltoJPMorganbythefollowing
afternoon.4322MuchofthecashwasdeliveredfromLBHIscashaccountatCiti.4323
September11
Asdiscussedabove,onSeptember11,2008,CraigDelany,amanagingdirectorat
JPMorgans Investment Bank, had been asked to review the valuation of Lehmans
securities. Delany had not had any significant involvement with Lehman collateral
beforethatpoint.4324
Delanyfirstreviewedthevaluationofselectedsecurities,andstressedproblems
withthevaluationsoftwoinparticular:RACERS,whichwaspartofthetripartyshell
4321Id.atp.2(RevisedNoticereCreditExtensionattachment).Atthesametime,JPMorganrevisedcredit
lines for some Lehman entities. Email from David A. Weisbrod, JPMorgan, to Kelly A. Mathieson,
JPMorgan (Sept. 12, 2008) [JPM2004 0050026] (revised LBIE credit line from $2 billion to $1.4 billion);
ExaminersInterviewofKellyA.Mathieson,Oct.7,2009,atpp.1617.
4322Email from Christopher D. Carlin, JPMorgan, to Barry L. Zubrow, JPMorgan, et al. (Sept. 12, 2008)
[JPM2004 0033002] (At 1130 EDT current balance in the Lehman Holding Co account is 4 billion 450
million vs the target 5 billion.); email from Christopher D. Carlin, JPMorgan, to Barry L. Zubrow,
JPMorgan,etal.(Sept.12,2008)[JPM20040050902](Last550millionreceivedfromCitiat1:26PMNY
time...balanceintheLehmanHoldingcoaccountisnowat5billion....);seealsoemailfromPaoloR.
Tonucci, Lehman, to Ian T. Lowitt, Lehman (Sept. 12, 2008) [LBEXDOCID 4050567] (JP should have
their$5bn.).
4323Examiners Interview of Jane BuyersRusso, Sept. 25, 2009, at p. 14; Jane BuyersRusso, JPMorgan,
UnpublishedNotes(Sept.11,2008),atp.12[JPMEXAMINER00006040](BuyersRussosnotesindicating
3BcomingfromCiti);emailfromMarkG.Doctoroff,JPMorgan,toChristopherD.Carlin,JPMorgan,et
al.(Sept.12,2008)[JPM20040006447](emailchainshowingaccumulationandsourcesof$5billioncash
collateral);seealsoemailfromKatherineLukas,Citigroup,toTomIsaac,Citigroup,etal.(Sept.11,2008)
[CITILBHIEXAM00014488](Lehmandeposited$3.02billionwithCitiontheeveningofSeptember11
inadditiontoLehmans$2billioncashdeposit).
4324ExaminersInterviewofCraigM.Delany,Sept.9,2009,atpp.34.
1165

(and,thus,pledgedtothirdpartyinvestorsovernightandheldbyJPMorganduringthe
day),andFenway,whichwascollateralpledgedbyLehmanoutsideofthetripartyshell
(i.e., it was in the LCE account).4325 Delany concluded that the two securities were
problematic because of their structure (commercial paper and shortterm notes credit
enhancedbyLehman)andbecauseoftheilliquidityoftheunderlyingassets.4326Delany
concludedthatRACERSandFenwayshouldbeconsideredgreatlydevalued,farbelow
their$8billionassignedfacevalue.4327
Although Fenway positions had been pledged to JPMorgan since June, Delany
mayhavebeenthefirstpersontoquestionFenwaysvalueascollateral.GFAhadnot
pricedFenway,and,asofSeptember4,Corralhadindicatedwehavenoissuewithits
value.4328 On September 12, Delany wrote Corral and expressed that the real dicey
positionisFenwayandyoushouldnotacceptthiscollateral.4329
At the same time, Delany valued the other collateral posted by Lehman in the
LCEaccount,namelythePine,SpruceandVeranoCDOs.HepricedPineat70percent
4325Id.atp.6.
4326Id.atpp.68.
4327Id.atpp.7,9.
4328EmailfromEdwardJ.Corral,JPMorgan,toDavidA.Weisbrod,JPMorgan(Sept.4,2008)[JPM2004
0006562];seealsoemailfromEdwardJ.Corral,JPMorgan,toDavidA.Weisbrod,JPMorgan,etal.(Sept.3,
2008) [JPM2004 0006557] (we are OK with [Fenways] value); email from Mark G. Doctoroff,
JPMorgan,toJaneBuyersRusso,JPMorgan,etal.(Sept.3,2008)[JPM20040006558](atleastthe$3bnis
firm).
4329Email from Craig M. Delany, JPMorgan, to Edward J. Corral, JPMorgan (Sept. 12, 2008) [JPM2004
0050997]. Chiavenato explained, however, that he learned by late August that Fenway was worth
nothing.ExaminersInterviewofRicardoS.Chiavenato,Sept.21,2009,atp.16.
1166

facevalueandSpruceandVeranoat50percent.4330AlthoughGFAhadpricedVerano
similarly,itpricedPineandSpruceatalowervaluethanDelanyhad.4331
Delany also determined new margin requirements by collateral type and
produced a series of spreadsheets that calculated JPMorgans net exposure visvis
Lehmanstripartybook,factoringintheadditionalcollateralthatLehmanhadposted.
One version of Delanys spreadsheets suggests that, including the $5 billion cash
deposit that day, JPMorgan was overcollateralized by as much as $6.1 billion on
September12.4332DelanystressedinhisinterviewwiththeExaminer,however,thatthe
resultant number was not a real net exposure because, for the triparty shell, he
acceptedallmarketvaluescontainedintheBDASsystemasaccurate.4333(Delanydid,
however,incorporatehisownvaluationsforcollateralintheLCEaccount;heassigned
novaluetoFenway.)4334Delanystatedthatinretrospecthisspreadsheetsshouldhave
4330Email from Craig M. Delany, JPMorgan, to Edward J. Corral, JPMorgan (Sept. 12, 2008) [JPM2004
0050997].
4331EmailfromEdwardJ.Corral,JPMorgan,toDavidA.Weisbrod,JPMorgan(Sept.4,2008)[JPM2004
0006562].
4332SeeJPMorgan,Spreadsheet,atp.8[JPM20040029769];seealsoJPMorgan,Spreadsheet,atp.1[JPM
2004 0017402] (similar exposure analysis); JPMorgan, Spreadsheet, at p. 4 [JPM2004 0025920] (similar
exposureanalysis).
4333Examiners Interview of Craig M. Delany, Sept. 9, 2009, at p. 9; see email from Craig M. Delany,
JPMorgan,toMikeCavanagh,JPMorgan,etal.(Sept.14,2008)[JPM20040025947](notingthatanalysis
[a]ssumesalltssmarketvaluesarecorrectmidmarketvaluationsandthat[t]hismayNOTbeagood
assumptionforcollateralpricedbythecollateralprovider).
4334ExaminersInterviewofCraigM.Delany,Sept.9,2009,atp.9n.11.
1167

madeclearthatJPMorgandidnotagreewiththevaluesinBDAS,citingRACERSasan
example.4335
(m) LehmanRequestsforReturnofCollateral
Lehman sought the return of some of its collateral between September 10 and
September15.OnSeptember10,forexample,LehmanadvisedJPMorganthatLehman
would request that $1.3 billion of its cash collateral be returned in connection with
discussions about separately securing LBIEs $2 billion line of credit.4336 Lehman
believed it was overcollateralized with JPMorgan,4337 insisting that it had excess
securities in both its U.S. and U.K. clearance accounts and that the value of these
securities,coupledwiththe$3billionincashLehmanposted,exceeded$4billion(the
amountTonucciallegedlyassuredJPMorganthatLehmanwouldpost).4338Atthetime,
Lehman had the impression that JPMorgans requests for collateral (more topups)
[were]somewhatarbitraryandalsothatthecollateralvaluation[was]arbitrary,which
[caused] some confusion/mistrust.4339 JPMorgan ultimately determined that the
4335Id.atp.9.
4336JPMorgan Second Written Responses, at p. 3; email from Mark G. Doctoroff, JPMorgan, to

DonnaDellosso,JPMorgan,etal.(Sept.10,2008)[JPM20040032684].
20040032684].
4338JPMorgan Second Written Responses, at p. 3; email from Donna Dellosso, JPMorgan, to Steven D.
Black, JPMorgan, et al. (Sept. 10, 2008) [JPM2004 0006377] (After speaking with LEHs Treasurer, we
haveconfirmedthattheywillmaintaincollateralof$4blntocoverintradayexposure.).NotethatBlack
stated that Lehman agreed to post $3 billion collateral immediately on September 9 and top up to $5
billion (not $4 billion) collateral shortly thereafter. Examiners Interview of Steven D. Black, Sept. 23,
2009,atpp.89.
20040061651].
1168

collateral posted under the September Agreements was needed to cover the LBIE $2
billionline(amongotherthings).4340Thus,thatcollateralwasnotreturned.
On September 12, JPMorgan released nearly $1 billion of the Pine CLO back to
LehmanuponLehmansrequest.4341AlthoughJPMorganinitiallyagreedtoreleasePine
on the condition that Lehman replace it with cash,4342 Pine was ultimately released
withoutanyprovisionofadditionalcash.4343Throughcounsel,JPMorganexplainedthat
theconditionsforthereleaseofthatcollateralchangedonceLehmanpostedthefull$5
billion JPMorgan had requested on September 11.4344 JPMorgans counsel also stated
that Lehman operationally could have removed Pine from LCE without asking
JPMorgan first, and that Lehman likely made the request, rather than effecting the
transferitself,asamatterofrelationshipmanagement.4345
4341EmailfromEdwardJ.Corral,JPMorgan,toMichaelA.Mego,JPMorgan,etal.(Sept.12,2008)[JPM
EXAMINER00005961] (Let the CLO go.); email from Michael A. Mego, JPMorgan, to Mark G.
Doctoroff, JPMorgan, et al. (Sept.12, 2008) [JPMEXAMINER00005936] (Lehman Brothers is looking to
Release $1 billion from the $6.2 billion held on their LCE account.); email from Edward J. Corral,
JPMorgan,toJaneBuyersRusso,JPMorgan(Sept.12,2008)[JPM20040033023](JBR,myguttellsmeto
letLehmandowhattheywanthere.Wehavesoheavilydiscountedthevalueofthissecurity(oneofthe
CLOs),thatwe(JPM)isntgivingmuchup.);emailfromMichaelA.Mego,JPMorgan,toRayStancil,
JPMorgan,etal.(Sept.12,2008)[JPM20040050888](LehmanwantstoreleaseCUSIP#722490AA7for
$1,000,000,000.);JPMorganSecondWrittenResponses,atp.10.
4342Email from Henry E. Steuart, JPMorgan, to Jon Ciciola, JPMorgan, et al. (Sept. 12, 2008) [JPM
EXAMINER00005961](statingconditionsforagreementincludingJPMorganwantingtoreceivetheface
valueoftheCLO($1.025B)backincash);emailfromMarkG.Doctoroff,JPMorgan,toEdwardJ.Corral,
JPMorgan,etal.(Sept.12,2008)[JPM20040032972].
4343Examiners Interview of Edward J. Corral, Sept. 30, 2009, at p. 11 (Corral was not aware of any
conditionattachedtothereleaseofthePineCLO);JPMorganSecondWrittenResponses,atp.10.
19,2009),atp.2.
1169

In addition, on September 12, Lehman requested that JPMorgan release $600
millionoftheapproximately$1billionofcorporatebondcollateralthatJPMorganwas
still holding so that Lehman could fund part of JPMorgans $5 billion collateral
request.4346JPMorganagreedtodothisand,bytheendoftheday,allofthesecorporate
bondsthatJPMorganwasstillholdingatthetimewerereleasedbacktoLehman.4347
There is also evidence to suggest that after the close of business on Friday,
September12,Lehmansoughtthereturnofits$5billionincollateralpostedinresponse
to JPMorgans September 11 request. Tonucci reported to Lowitt at 6:10 p.m. that
Lehman may end up long in its account with JPMorgan.4348 When Lowitt asked if
JPMorganwouldreleasecashtoLehmanthatnight,Tonuccirepliedthatitwastoolate
to get cash that night, but that JPMorgan should release cash on Monday (September
15).4349
In addition, on the evening of September 12, there were conversations within
Lehman about the need to pressure JPMorgan to return collateral, including with
4346JPMorgan Second Written Responses, at p. 3; email from Mark G. Doctoroff, JPMorgan, to Jane
BuyersRusso,JPMorgan(Sept.12,2008)[JPM20040050446].
4347JPMorgansSecondWrittenResponses,atp.3;emailfromEdwardJ.Corral,JPMorgan,toMarkG.
Doctoroff, JPMorgan, et al. (Sept. 12, 2008) [JPM2004 0050913]; email from Lika Vaivao, JPMorgan, to
Karen M. Sharf, JPMorgan, et al. (Sept. 12, 2008) [JPMEXAMINER00006236]; Examiners Interview of
MarkG.Doctoroff,Apr.29,2009,atp.23;ExaminersInterviewofEdwardJ.Corral,Sept.30,2009,atp.
12;ExaminersInterviewofDonnaDellosso,Oct.6,2009,atp.9.CompareLehman,CollateralPledgedto
JPMforIntradayAsof9/10/2008COB[LBEXDOCID046681](showingcorporatebondspledged),with
Lehman,CollateralPledgedtoJPMforIntradayAsof9/12/2008COB[LBEXDOCID046684](nolonger
showingcorporatebondspledged).
4348Email from Paolo R. Tonucci, Lehman, to Ian T. Lowitt, Lehman (Sept. 12, 2008) [LBEXDOCID
3331070].
4349EmailchainbetweenPaoloR.Tonucci,Lehman,andIanT.Lowitt,Lehman(Sept.12,2008)[LBEX
DOCID3331070].
1170

assistance from the FRBNY.4350 ThenPresident of the FRBNY, Timothy Geithner, did
contact Dimon about concerns surrounding JPMorgans collateral requests. Dimon
insisted,however,thatGeithnerwasmerelyreportingwhathehadheard,ratherthan
having those concerns himself.4351 In addition, Steven Berkenfeld, Head of the Legal,
Compliance, and Audit Division at Lehman Brothers, stated that on the afternoon of
September14heparticipatedinacallbetweenDimonandseveralLehmanexecutives
inwhichDimonexpressedsympathythatLBHIwouldbefilingforbankruptcyandthat
hewishedJPMorgancouldassistfurther.BerkenfeldrepliedtoDimonthatthedecision
to file for bankruptcy was not yet made, and that JPMorgan could assistby returning
Lehmans collateral.4352 According to Berkenfeld, Dimon then left the call without
respondingtoBerkenfeld,andthecallended.4353
The Examiner is not aware of any written request or notice by Lehman to
JPMorgan for return of collateral pursuant to the September Agreements. It is clear,
however, that by the end of the weekend of September 13 to 14, Lehman had made
4350Email from Michael Gelband, Lehman, to Herbert H. (Bart) McDade III, Lehman (Sept. 12, 2008)
[LBEXAM001337].
4351ExaminersInterviewofJamieL.Dimon,Sept.29,2009,atpp.89.
4352Examiners Interview of Steven Berkenfeld, Oct. 5 & 7, 2009, at p. 21. Although Lowitt recalled
speakingtoDimonwithBerkenfeldonSeptember14,Lowittstatedthatthecallwasnotaboutcollateral.
ExaminersInterviewofIanT.Lowitt,Oct.28,2009,atp.21.
4353ExaminersInterviewofStevenBerkenfeld,Oct.5&7,2009,atp.21.At8:31p.m.onthatsameday,
September 14, Berkenfeldsent an email directly toStephen Cutler, JPMorgans General Counsel, titled
UrgentNeedtospeaktoyouassoonaspossiblethatread:Itisextremelyimportantandcouldhave
devastating consequences if we do not resolve it tonight. Email from Steven Berkenfeld, Lehman, to
StephenM.Cutler,JPMorgan(Sept.14,2008)[JPM20040047020].Theemail,however,doesnotspecify
what Berkenfeld needed to speak to Cutler about, and came at a frantic time just hours before LBHI
declaredbankruptcy.Seeid.
1171

severalcallstoJPMorganrequestingthereturnofcollateral,4354andthatJPMorganhad
notrespondedbythetimeLBHIfiledforbankruptcy.4355
(2) AnalysisofPotentialClaims
Afterreceivingsubstantialevidencefromtheinterestedparties,theExaminerhas
analyzed a number of potential commonlaw claims arising out of the facts discussed
above. The Examiner has not attempted to analyze all conceivable claims and has
excluded,forexample,potentialclaimsthatappearedparticularlyweakontheirface.
This Section of the Report focuses on several possible common law claims
relatingtoJPMorganscollateraldemands.4356TheExaminerslegalanalysisisbasedon
hisreviewofdocumentsandinterviewsofLehmanandJPMorganwitnesses.4357Formal
4354Email from Ian T. Lowitt, Lehman, to Paolo R. Tonucci, Lehman, et al. (Sept. 14, 2008) [LBEXAM
5640836] (At 5:18 p.m., Lowitt wrote, Can you press jpm to get our cash back?); email from Ian T.
Lowitt, Lehman, to Paolo R. Tonucci, Lehman, et al. (Sept. 14, 2008) [LBEXAM 5640835] (At 9:21 p.m.,
Lowitt followed up with an email titled Where do we stand getting cash from chase? and asks if
TonucciorBerkenfeldhadspokentojane,presumablyBuyersRusso).
4355SeeemailfromHeidiMiller,JPMorgan,toJamieL.Dimon,JPMorgan,etal.(Sept.15,2008)[JPM2004
0006510]([W]eneedtotalkthismorningaboutthecallsLehhasbeenmakingabouthavingusreturna
portionofourexcesscollateraltotheirholdingco.);emailfromHeidiMiller,JPMorgan,toMatthewE.
Zames, JPMorgan, et al. (Sept. 15, 2008) [JPM2004 0029748] (Miller explained that Lehman had a full
courtpressontogetustorelease);emailfromBarryL.Zubrow,JPMorgan,toHeidiMiller,JPMorgan,
etal.(Sept.15,2008)[JPM20040068975](WehavetomakesurethatwedonotallowLEHtosuckour
collateral away from us thru these different requests.); email from Jane BuyersRusso, JPMorgan, to
Heidi Miller, JPMorgan, et al. (Sept. 15, 2008) [JPM2004 0029748] (I am of the opinion we should not
giveanycollateralbacktoLehmanifwearegoingtocontinuetooperateforthem.).
4356See Section III.B below for a discussion of potential avoidance and preference actions. See Section
III.CbelowforadiscussionofpotentialclaimsagainstJPMorganarisingoutoftheBarclaystransaction.
4357InadditiontothemanywitnessinterviewsconductedanddocumentsreviewedbytheExaminer,the
ExaminersoughtandobtainedinformationfromAlvarez&Marsal,counselfortheDebtors,counselfor
JPMorgan,andcounselfortheCreditorsCommitteerelatingtotheissuesdiscussedinthisSectionofthe
Report.
1172

discovery between the parties could lead to additional evidence that could materially
affectthelegalanalysisoftheseclaims.
This Section of the Report discusses the following commonlaw theories under
which the September Agreements between Lehman and JPMorgan could be deemed
invalid: economic duress, lack of consideration, lack of authority and fraudulent
inducement. In addition, this Section discusses theories of breach of the September
Agreements and the implied covenant of good faith and fair dealing, assuming the
agreementsareenforceable.4358
(a) TheEvidenceDoesNotSupportaColorableClaim
AgainstJPMorganforEconomicDuress
Theevidenceavailableto theExaminerdoesnotsupportacolorableclaim that
theagreementsLehmanexecutedwithJPMorganinSeptember2008areinvaliddueto
economicduress.4359
(i) LegalBackground:EconomicDuress
Under New York law, [a] contract may be voided and a party may recover
damages when it establishes that it was compelled to agree to the contract terms
becauseofawrongfulthreatbytheotherpartywhichprecludedtheexerciseofitsfree
will.4360 The Examiner has analyzed the available evidence to determine if the
4358TheExaminerisnotawareofanyplausiblecommonlawclaimtoinvalidatetheAugustAgreements
betweenLehmanandJPMorganandthusdoesnotaddressthatissue.
4359ForadiscussionoftheSeptemberAgreements,seeSectionIII.A.5.b.1ofthisReport.
4360Madey v. Carman, 858 N.Y.S.2d 784, 786 (App. Div. 2008) (quoting 805 Third Ave. Co. v. M.W. Realty
Assocs.,448N.E.2d445,447(N.Y.1983)).
1173

following elements of economic duress are present: (1) a threat, (2) which was
unlawfullymade,and(3)causedinvoluntaryacceptanceofcontractterms,(4)because
thecircumstancespermittednootheralternative.4361
Theburdenonapartyseekingtoinvalidateacontractongroundsofeconomic
duress is formidable.4362 This is so regardless of evidence that one side enjoyed a
decided economic advantage over the other at the moment the agreements were
executed.4363 The burden is particularly difficult to meet where, as here, the parties
involved are sophisticated entities represented by both inhouse and outside counsel.
Significantly, to establish a claim of economic duress, a sophisticated party must do
more than merely claim that the other party knew about and used his or her poor
financialconditiontoobtainanadvantageincontractnegotiations.Rather,theplaintiff
must demonstrate that the defendants actions deprived him of his free will, and that
theordinaryremedyofanactionforbreachofcontractwouldnotbeadequate.4364
(ii) ThereIsNoAvailableEvidenceofanExpress
UnlawfulThreatMadebyJPMorganinConnection
WiththeFormationoftheSeptemberAgreements
The SeptemberAgreements were negotiated and executed by the parties under
anatmospherethatwasrushed,andJPMorganhadconsiderableleverageoverLehman.
4361Kamermanv.Steinberg,891F.2d424,431(2dCir.1989)(quotingGulf&W.Corp.v.CraftiqueProds.,Inc.,
523F.Supp.603,610(S.D.N.Y.1981)).
4362Davis&Assocs.,Inc.v.HealthMgmt.Servs.,Inc.,168F.Supp.2d109,114(S.D.N.Y.2001)(Theparty
seeking to void an agreement on grounds of economic duress shoulders a heavy burden. (internal
quotationmarksandcitationomitted)).
4363Id.(internalquotationmarksandcitationomitted).
4364Id.(internalquotationmarksandcitationomitted).
1174

Lehmansstockpricewasplummetingandreportshadsurfacedthatatleastoneofits
major survival strategies, involving KDB, had fallen through.4365 Lehman could ill
afford to challenge its primary clearing bank in the face of intense market pressures,
andanyattempttochangeclearingbanksovernight,whenLehmanwasattemptingto
restoremarketconfidence,wouldhavebeenexceedinglydifficultifnotimpossible.The
negotiation of the agreements occurred literally overnight, at a time when senior
Lehman executives were engaged in an evaluation of survival strategies and how to
approach a critical earnings call the next morning.4366 Nevertheless, JPMorgans
substantialleverageandpressureonLehmantosigntheagreementsbythemorningare
not sufficient under New York law to invalidate the agreements due to economic
duress.
Rather, evidence of an actual and wrongful threat made by JPMorgan is a
necessaryelementofanyclaimagainstJPMorganforeconomicduress.TheExaminer
hasfoundnoevidenceofanexplicitthreatbyJPMorgan,muchlessawrongfulexplicit
threat. Key Lehman witnesses each denied that any JPMorgan employee made an
express threat to them during the negotiation of the September Agreements.4367 And
Yeung, Fleming and Tonucci, as well as Lehmans outside counsel, Hespel, were each
4365SeeSectionIII.A.3.c.5.bofthisReport,whichdiscussesLehmanspotentialdealwithKDB.
4366SeesupraatSectionIII.A.5.b.1.i.
4367Examiners
Interview of Andrew Yeung, Mar. 13, 2009, at p. 4; Examiners Interview of Paul W.
Hespel,Apr.23,2009,atp.7;ExaminersInterviewofDanielJ.Fleming,Apr.22,2009,atp.7;Examiners
1175

questioned by the Examiner on the issue.4368 The Examiner finds this testimony
particularly credible given the absence of any discussion of a JPMorgan threat in any
contemporaneous internal Lehman correspondence related to the September
Agreements.Hadsuchathreatbeenmade,someoneatLehman,eitheratthetimeof
thenegotiationsorwhenquestionedbytheExaminer,wouldhaveidentifiedthethreat
anditseffectonLehmansactions.
Although the Examiner places much less weight on afterthefact statements
made when the parties were contemplating litigation, Dimon, Inaba and Doctoroff all
denied that any JPMorgan employee made any threats to Lehman in connection with
thenegotiationoftheSeptemberAgreements.However,DellossostatedthatifLehman
hadnotsignedtheSeptemberAgreements,itwouldhavebeendifficultforJPMorganto
extendcredittoandcontinuebeingsupportiveofLehman.Shestatedthatsherecalled
discussing being supportive and extending credit with Tonucci.4369 Significantly,
however, Tonucci did not recall Dellosso ever threatening him that JPMorgan would
stop advancing credit if the September Agreements were not put in place.4370 To the
contrary, Tonucci stated he believed JPMorgan would have continued to clear for
4368Yeung and Hespel were Lehmans counsel who negotiated the agreements directly with JPMorgan;
their only direct business contact at Lehman that evening was Fleming, as Lowitt and Tonucci did not
checktheiremailsthatevening.SeesupraSectionIII.A.5.b.1.i.
1176

LehmanevenifLehmanhadrefusedtoexecutetheSeptemberAgreements.4371Thereis
also no evidence that Tonucci directed others at Lehman to proceed with the
agreementsbecauseofanexpressthreatbyJPMorgan.
In addition, [t]he threatened exercise of a legal right cannot constitute
duress.4372 Even before September 9, under the agreement governing the clearance
arrangement between Lehman and JPMorgan (including the amendments made
pursuanttotheAugustAgreements),thedecisiontoadvancecreditwaswhollywithin
JPMorgansdiscretion.4373
Asnotedabove,thereislittledoubtthatLehmanwasexperiencingextraordinary
economicdifficultyandthatJPMorgansprovisionofclearingserviceswasparticularly
crucial to Lehman at the time. Economic difficulty, however, even in the exceptional
circumstances confronted by Lehman, is not sufficient by itself to establish economic
duress. Duress may take the form of unlawful restraint of property or use of
wrongful economic compulsion to force a party to yield to demands that would
otherwiseberejected,butitmaynotbefoundmerelyfromtheexistenceofadifficult
bargaining position or the pressure of financial circumstances.4374 The testimony of
4371Id.
4372MarineMidlandBankv.Stukey,427N.Y.S.2d123,123(App.Div.1980);Kamerman,891F.2dat432.
4373Clearance Agreement (June 7, 2000), at p. 4 [JPM2004 0031786] (Section 5 provides that JPMorgan
mayatanytimedeclinetoextendsuchcreditat[its]discretion,withnotice).Thisremainedsoeven
aftertheAugustAmendmentstotheClearanceAgreement.
4374Del Turco v. BRB Ceramic Tiles Marble & Stone, 03 CV 1516(JG), 2006 U.S. Dist. LEXIS 61390, at *17
(E.D.N.Y.Aug.18,2006)(quotingMcIntoshv.ConsolidatedEdisonCo.,No.963624,1999WL1511102,at*2
(S.D.N.Y.Mar.19,1999)).
1177

Lehman witnesses that there was no direct threat, and the absence of any mention of
suchathreatinLehmansinternalemailsduringthenegotiation,leadtheExaminerto
concludethereisnocolorableclaimthattheSeptemberAgreementsareinvaliddueto
economicduress.
(iii) TheAvailableEvidenceSuggestsJPMorganDidNot
HaveanImproperPurpose
Inthecontextofaclaimofeconomicduress,athreatcanbeconsideredwrongful
or unlawfully made when motivated by an improper purpose.4375 Nevertheless, the
threatened exercise of a legal right does not generally constitute an improper
purpose.4376
SomecourtsapplyingNewYorklawhavesuggestedthattoestablishaclaimof
businessoreconomicduress,improperpurposesmaybeaccomplishedthroughlawful
means...iftheyareusedtotradeuponthevictimspoorfinancialconditionwiththe
improper purpose of securing personal advantage.4377 A necessary element of [this]
type of business compulsion, however, is a showing that the victims financial straits
4375See28WillistononContracts78:13(4thed.2009).
4376MarineMidlandBank,427N.Y.S.2dat123(Thethreatenedexerciseofalegalrightcannotconstitute
duress.);Kamerman,891F.2dat432(same).
4377USWestFin.Servs.,Inc.v.Tollman,786F.Supp.333,338(S.D.N.Y.1992)(quotingNat.Am.Corp.v.Fed.
RepublicofNigeria,448F.Supp.622,644(S.D.N.Y.1978),affd,597F.2d314(2dCir.1979)).InUSWest,
Judge Mukasey found that a bank requiring a guaranty from an investor group did not cause the
financial distress of the investor group even though the bank knew of the investor groups precarious
financialconditionandthebanksactionsmayhavefurtherdestabilizedtheinvestorgroupsfinancial
condition.Id.at339340.
1178

werecausedbytheotherparty.4378Thus,evenunderthisview,Lehmanwouldhaveto
demonstratethatitsunderlyingfinancialstraitshadbeencausedbyJPMorgan.Thereis
no credible basis to conclude that prior to September 9, JPMorgan was the cause of
Lehmansfinancialstraits.
Furthermore, by September 9 Lehmans creditors had a reasonable basis for
concern as to whether Lehman would default on its obligations.4379 JPMorgan had
witnessed how rapidly Bear Stearns had declined, and JPMorgan executives had
analyzed and expressed serious concerns with Lehmans survival plans.4380 For
example, JPMorgan was concerned about the viability of Lehmans SpinCo proposal,
whichhadbeendiscussedataSeptember4meetinginvolvingJPMorganandLehman
executives.4381JPMorgansimilarlyexpressedconcernsaboutpresentationsthatLehman
prepared for the rating agencies, including Lehmans presentation of survival
strategies.4382
In addition, JPMorgans Investment Bank Risk Committee met on September 5
and reviewed the exposure of JPMorgans Investment Bank to Lehman. At that time,
JPMorganhadaprimaryexposuretoLehmanof$2.645billion,thelargestcomponent
4378Id.at338.
4379SeeSectionIII.A.3ofthisReport,whichdiscussesLehmanssurvivalstrategies,andAppendix15of
thisReport,whichdiscussestheeventsoftheweekofSeptember8,2008.
4380Seeid.
4381SeeSectionIII.A.5.b.1ofthisReport.
4382Examiners Interview of Barry L. Zubrow, Sept. 16, 2009, at p. 7; see email from Barry L. Zubrow,
JPMorgan,toMarkG.Doctoroff,JPMorgan,etal.(Sept.5,2008)[JPM20040006286].
1179

of which was a $1.904 billion derivatives exposure.4383 Several JPMorgan witnesses
focusedonJPMorgansderivativeexposureasthekeyfactormotivatingtheSeptember
9collateralrequest.4384Moreover,onSeptember9,publicreportssurfacedstating that
KDB had abandoned (or was likely to abandon) its acquisition talks with Lehman.4385
Asanapparentresult,Lehmansstockhaddroppedsignificantly.4386
Furthermore, the FRBNY had been discussing with JPMorgan for months the
need for better protection against a brokerdealer failure.4387 The fact that other banks
weredemandingmoreprotectionfromLehmanatthesametimefurtherdemonstrates
4383Examiners Interview of Donna Dellosso, Oct. 6, 2009, at pp. 67; JPMorgan, IBRC Presentation,
Overview of Debt Maturities for Major US Broker Dealers (Sept. 5, 2008), at p. 6 [JPM
EXAMINER00005998].
4384ExaminersInterviewofBarryL.Zubrow,Sept.17,2009,atpp.911;ExaminersInterviewofJohnJ.
Hogan,Sept.17,2009,atp.4.
4385FrancescoGuerrera,etal.,EquitiesSufferasLehmanSharesFall45%,FT.com,Sept.9,2008(Lehmans
shares fell after a newswire report cited an unnamed Korean government official as saying that Korea
Development Bank, a staterun lender, had decided not to invest in Lehman.); Susanne Craig, et al.,
KoreanRemarksHitLehman,WallSt.J.,Sept.9,2008;seealsosupraatSectionIII.A.3.c.5.b.
4386Examiners Interview of Richard S. Fuld, Jr., May 6, 2009, at p. 11; Examiners Interview of Donna
Dellosso,Feb.27,2009,atp.4;LehmanDrops45%;WallSt.J.,Sept.10,2008;SusanneCraig,etal.,Korean
RemarksHitLehman,WallSt.J.,Sept.9,2008.
4387See,e.g.,emailfromJanetBirney,Lehman,toDanielJ.Fleming,Lehman,etal.(Feb.26,2008)[LBEX
DOCID280175](TherecentmarketturmoilhaspromptedtheFedtoquestionJPMContheviabilityof
Tripartyfinancingintheeventofabrokerdealerdefault.);emailfromJanetBirney,Lehman,toDaniel
J.Fleming,Lehman,etal.(May5,2008)[LBEXDOCID065656](JPMorganreevaluationofriskassociated
withTripartyfinancingpromptedbydiscussionswiththeFED);emailfromLucindaBrickler,FRBNY,
toTimothyF.Geithner,FRBNY,etal.(July16,2008)[FRBNYtoExam.034046](attachingtalkingpoints
theFRBNYdevelopedforaJuly17,2008meetingwithDimonandKellyregardingneartermmeasures
to enhance the stability of the triparty repo market); Talking Points, at p. 1 [FRBNY to Exam. 034047]
(noting [i]n the event of the default of a large borrower, the potential for systemic risk to materialize
co[u]ldbereduced).
1180

that there was overall market concern with Lehmans viability, and that it was not
improperforJPMorgantoseekgreatersecurity.4388
TheExaminerconcludesthatthereisinsufficientevidencetosupportacolorable
claim that JPMorgan had an improper purpose in seeking the September
Agreements.4389
(iv) ThereWasaDegreeofNegotiationOvertheTermsof
theSeptemberAgreements
Lehman counsel Hespel and Yeung suggested that, for all practical purposes,
JPMorgan dictated the material terms of the September Agreements.4390 Even if there
had been no meaningful negotiation, there is no colorable claim of economic duress
becausetheExaminerhasfoundnoevidenceofanexplicitandwrongfulthreat.That
conclusion is further supported by the evidence of a limited negotiation between the
parties.
During the overnight negotiations of the September Agreements, JPMorgan
agreed to certain changes proposed by Yeung, including (a) changing the language
regardingadditionalcollateralfromobligationstorequests;(b)agreeingtoremove
performance obligations ofLehmansubsidiaries;and (c)agreeingtoremovereference
4388See
Sections III.A.5.c and III.A.5.d of this Report, which discuss Lehmans dealings with Citi and
HSBC,respectively.
4389Whether JPMorgan truly needed the full amount of collateral it demanded on September 9 and
September11isadifferentquestion,buttheExaminerconcludesthatJPMorganhadalegitimatebasisfor
seekingadditionalprotectionintheformoftheSeptemberAgreements.
4390Examiners Interview of Andrew Yeung, Mar. 13, 2009, at p. 5; Examiners Interview of Paul W.
Hespel,Apr.23,2009,atp.6.
1181

toLehmansaffiliatesintheAmendmenttotheClearanceAgreement.4391Thechangeto
the Amendment to the Clearance Agreement is of note because JPMorgan had
originallyrejectedthisproposedchangeat3:11a.m.onSeptember10.4392Whenasked
bytheExamineraboutthedegreeofnegotiationoftheagreements,JPMorgancounsel
Inaba pointed to the deletion of these references as one of the points of negotiation
betweentheparties.4393
The negotiation never reached the point of Lehman fully testing whether
JPMorgan might yield on the core issues, such as the expansion of the agreements to
cover all Lehman liabilities of any type. Yeung made some effort to confirm with
Lehman business managers whether Lehman had actually agreed in principle to
expand the agreements to cover all Lehman liabilities. Yeung did not, however,
recommendtoseniorexecutivesthatLehmanresisttheproposedtermsorescalateany
issuestoseniorJPMorganexecutives.WhetherornotJPMorganwouldhaveagreedto
remove terms that expanded the agreements to cover all liabilities if Lehman had
escalated the dispute, Lehmans failure to push the issue and fully test JPMorgans
4391Examiners Interview of Andrew Yeung, Mar. 13, 2009, at p. 5; Examiners Interview of Gail Inaba,
Apr.28,2009,atp.7.
4392EmailfromNikkiG.Appel,JPMorgan,toAndrewYeung,Lehman,etal.(Sept.10,2008)[JPM2004
0001997] (Appel told Yeung that JPMorgan had reviewed Lehmans proposed changes to the
AmendmenttotheClearanceAgreementandJPMorganrequestedthatthescopeoftheamendmentstay
unchanged.).
4393ExaminersInterviewofGailInaba,Apr.28,2009,atp.7.
1182

resolveknowingJPMorganhadagreedtoatleastsomechangesLehmanrequested
createsyetanothersignificanthurdletoaviableclaimofeconomicduress.4394
(b) ThereIsInsufficientEvidencetoSupportaColorable
ClaimThattheSeptemberAgreementsAreInvalidfor
LackofConsideration
claimagainstJPMorgantoinvalidateorrescindtheSeptemberAgreementsforlackof
consideration.4395Considerationiseitherabenefittothepromisororadetrimenttothe
promisee.4396 Failure of consideration gives the disappointed party the right to
rescindthecontract.4397ByNewYorkstatute,however,acontractmodificationshall
notbeinvalidbecauseoftheabsenceofconsideration,providedthatthe[modification]
agreement...shallbeinwritingandsignedbythepartyagainstwhomitissoughtto
enforcethe...modification...orbyhisagent.4398
TheSeptemberAmendmenttotheClearanceAgreementisamodificationtoan
existingcontract(thatis,the2000ClearanceAgreement),inwriting,andsignedbyboth
LehmanandJPMorgan.Itthereforerequiresnoadditionalconsideration.4399
4394SeeSectionIII.A.5.b.1ofthisReport,whichnotesthatJPMorganagreedtoatleastsomeofthechanges
thatLehmanrequestedtocurrentdrafts.
4395SeeSectionIII.B.3.gofthisReport.
4396Holtv.Feigenbaum,419N.E.2d332,336(N.Y.1981).
4397Fugelsangv.Fugelsang,517N.Y.S.2d176,177(App.Div.1987).
4398N.Y.Gen.Oblig.Law51103(2009);seealsoDeutscheBankSecs.Inc.v.Rhodes,578F.Supp.2d652,660
(S.D.N.Y.2008).
4399SeeAmendmenttoClearanceAgreement(Sept.9,2008),atpp.16[JPM2004005861].Inaddition,the
September Amendment to the Clearance Agreement states that it was entered for good and valuable
consideration,thereceiptandsufficiencyofwhichareherebyacknowledged.Id.
1183

The September Guaranty and the September Security Agreement, however, are
bestunderstoodasnewagreements.TheSeptemberGuarantyexplicitlystatesthatitis
inadditiontoanddoesnotreplacethatcertainGuarantydatedAugust26,2008made
by LBHI.4400 The September Security Agreement expressly references the September
Guaranty, and includes a reference to the Existing Security Agreement, that is, the
August Security Agreement.4401 The question thus arises whether the September
GuarantyandSecurityAgreementaresupportedbyconsideration.
Both agreements contain recitations of consideration. The September Guaranty
expresslynotes:
The Guarantor and each of the direct or indirect subsidiaries of the

Guarantor...desirestotransactbusinessand/ortradewithand/orenter
into derivative transactions with and/or to obtain credit, clearing
advances,clearingloansorotherfinancialaccommodationfromtheBank
and to continue such business, trading, derivative activity and/or such
extensions of credit, clearing advances, clearing loans or other financial
accommodation and the Bank has requested that it receive the following
guarantyoftheundersignedbeforeitwillconsiderextendingsuchcredit.4402
TheSeptemberSecurityAgreementprovides:
In consideration of JPMORGAN CHASE BANK, N.A. or any of its

affiliates, subsidiaries, successors and assigns . . . extending credit to
and/ortransactingbusiness,tradingorengaginginderivativetransactions
with the undersigned and/or its subsidiaries, the undersigned hereby
4401SecurityAgreement(Sept.9,2008),atp.1[JPM20040005873].
4402Guaranty(Sept.9,2008),atp.1[JPM20040005813](emphasisadded)(therecitationofconsideration
statesforgoodandvaluableconsiderationandinordertoinducetheBankfromtimetotime,toextend
orcontinuetoextendcredit,clearingadvances,clearingloans,orotherfinancialaccommodationstothe
Borrowersand/ortotransactbusiness,tradeorenterintoderivativetransactionswiththeBorrowers.).
1184

agree(s) that the Bank shall have the rights, remedies and benefits
hereinaftersetforth.4403
Even when a contract includes a recitation of consideration, however, a party
may use parol evidence to challenge that recitation.4404 Having reviewed all available
evidence, the Examiner concludes that there is no colorable claim that the September
Agreementswerenotsupportedbysufficientconsideration.
Although[a]promisebyonepartytodothatwhichheisalreadyunderalegal
obligation to perform is insufficient as a consideration to support a contract,4405 an
agreement to continue to act where there is no obligation to do so is proper
consideration.4406 The September Agreements are supported, inter alia, by JPMorgans
agreement to continue extending credit to Lehman. Under the Clearance Agreement,
that extension of credit was discretionary.4407 BuyersRusso confirmed that JPMorgan
consideredceasingorlimitingcreditextensionsasanoptionifLehmandidnotsignthe
4404See Diamond v. Scudder, 845 N.Y.S.2d 452, 45354 (App. Div. 2007); see also Ehrlich v. Am. Moninger
Greenhouse Mfg. Corp., 257 N.E.2d 890, 892 (N.Y. 1970) (The recitation of receipt of consideration is a
mere admission of a fact which, like all such admissions, may be explained or disputed by parol
evidence.(citationandinternalquotationmarksomitted)).
4405Carpenter v. Taylor, 58 N.E. 53, 55 (N.Y. 1900); see also Roth v. Isomed, Inc., 746 F. Supp. 316, 319
(S.D.N.Y.1990).
4406See Andre v. Gaines Berland, Inc., No. 9510524, 1996 U.S. Dist. LEXIS 9383, at *67 (S.D.N.Y. July 8,
1996) (where ongoing professional services relationship [was] terminable atwill, there was no
obligation to continue providing such services and, thus, continued services constituted valid
considerationforsubsequentagreements);seealso3WILLISTONON CONTRACTS7:41(4thed.)(Ifoneis
privilegedtoavoidacontractualdutyortorefusetoperformunderacontract,andpromisestoperform
ordoesperforminconsiderationofthepromiseofsomeadditionalpaymentbyanother...thepromise
toperformortheactualperformanceisconsideration....).
1185

SeptemberAgreements.4408Dellossoalsorecalleddiscussingtheextensionofcreditwith
Tonucci in the context of the September Agreements.4409 JPMorgans agreement to
continueextendingdiscretionarycredittoLehmanissufficientconsiderationtosupport
theSeptemberAgreements.4410
(c) ThereisSufficientEvidencetoSupporttheExistenceofa
AgreementsAreInvalidforLackofAuthority
The Examiner concludes that there is sufficient evidence to support a technical
claimthattheSeptemberAgreementsareinvalidforlackofauthoritybutthattheclaim
is not colorable because of substantial evidence supporting defenses to such a claim,
includingthatLehmanratifiedtheagreementswhenitpostedcollateralonSeptember
12.
Tonucci, Lehmans Treasurer, signed the September Agreements on LBHIs
behalf.4411 However, under Lehmans Code of Authorities, an LBHI guaranty of a
subsidiarysobligationsotherthancertainGuaranteedSubsidiariesforover$500
4408ExaminersInterviewofJaneBuyersRusso,Sept.25,2009,atpp.67.JPMorgandidinfactcontinue
extendingcredittoLehmaninthedaysaftertheSeptemberAgreementswereexecuted.Forexample,it
continuedtounwindLehmanstripartyrepos.JPMorganalsoextendeddiscretionarycreditwhen,after
the execution of the September Agreements, it restored to LBIE a $2 billion line of credit. In addition,
there is evidence that JPMorgan continued accepting novations from Lehman counterparties after
September 9, even with rumors that others were abandoning Lehman. See email from John J. Hogan,
JPMorgan, to Donna Dellosso, JPMorgan, et al. (Sept. 12, 2008) [JPM2004 0050952] (recognizing that
JPMorganwasstilltradingwithLehmaninthattheywerestillallowingLehmanderivativecredit).
4410See,e.g.,Weissv.Weiss,41N.Y.S.2d777,777(App.Div.1943)(Performancebyapromiseeofanact
whichheisnotobligatedtoperform,orthesurrenderbyhimofaprivilegewhichhehasthelegalright
toassert,issufficientconsiderationforapromise....).
4411See Security Agreement (Sept. 9, 2008), at p. 6 [JPM2004 0005873]; Guaranty (Sept. 9, 2008), at p. 6
[JPM20040005813];AmendmenttoClearanceAgreement(Sept.9,2008),atp.3[JPM20040005861].
1186

million or an unspecified amount required the approval of LBHIs CEO, President,
COOorCFO.4412LBIoneoftheentitiescoveredbytheSeptemberGuarantywasnot
aGuaranteedSubsidiary.4413Notably,[i]ftherequiredapproval[was]obtained,any
proper officer of Holdings...[could] sign documents.4414 Thus, for Tonucci to have
hadactualauthoritytosigntheSeptemberGuaranty,theagreementhadtohavebeen
approvedbyLowittorFuld.
The Code of Authorities is less clear about Tonuccis authority to sign the
September Security Agreement and Amendment to the Clearance Agreement.4415
4412LBHI&LBI,AmendedandRestatedCodeofAuthorities(July1,2004),atp.7[LBEXAM043802].
4413SeeAlvarez&Marsal,ResponsestoQuestionsforAlvarez&Marsal/Weil,Gotshal&Manges(Dec.7,
2009),atp.1.
4414LBHI&LBI,AmendedandRestatedCodeofAuthorities(July1,2004),atp.2[LBEXAM043802].
4415According to Alvarez & Marsal, the Amendment to the Clearance Agreement was governed by the
secured borrowings provision of the Code of Authorities, which provided that [a]ny secured
borrowings (excluding any collateral arrangement authorized under the Trading Lines) requires
approvaloftheCEO,President,COO,CFO,orTreasurer.LBHI&LBI,Amended&RestatedCodeof
Authorities (July 1, 2004), at Ex. 6 [LBEXAM 043802]; Alvarez & Marsal, Responses to Questions for
Alvarez&Marsal/Weil,Gotshal&Manges(Dec.7,2009),atp.2.ItthusappearsthatTonuccihadactual
authority to sign the Amendment to the Clearance Agreement. Alvarez & Marsal also stated that
Lehman personnel evidently believed that the Security Agreement was governed by the secured
borrowingsprovisionaswell,butstatednoopinionastowhetherthisbeliefwascorrect.SeeAlvarez&
Marsal,ResponsestoQuestionsforAlvarez&Marsal/Weil,Gotshal&Manges(Dec.7,2009),atp.2.The
EstatemayarguethattheSeptemberAgreementsaresointertwinedastoconstituteasingleagreement,
and,thus,ifoneoftheSeptemberAgreementsisinvalid,thentheyallmustbe.SeeTecorpEntmtLtd.v.
Heartbreakers, Inc., No. 209861, 2001 Mich. App. LEXIS 661, at *910 (Mich. Ct. App. Feb. 9, 2001) (per
curiam) (affirming trial courts holding that, where management agreement was void ab initio because
therewasnomeetingoftheminds,assetpurchaseagreementwasvoidabinitiogiventhatagreements
were interdependent). Agreements contained in separate documents are generally presumed to be
separableintheabsenceofaclearindicationthatthepartiesintendedotherwise.SeeNat.UnionFireIns.
Co.v.Clairmont,662N.Y.S.2d110,112(N.YApp.Div.1997);Ripleyv.IntlRys.ofCentralAm.,171N.E.2d
443,446(N.Y.1960).Indeterminingwhethercontractsareseparableorentire,theprimarystandardis
theintentmanifested,viewedinthesurroundingcircumstances.Rudmanv.CowlesCommcns,Inc.,280
N.E.2d867,873(N.Y.1972).AlthoughtheremaybeareasonableargumentthattheSeptemberGuaranty
andSecurityAgreementareintegratedgiventhat,forexample,bothdocumentswereexecutedbyLBHI
and the Security Agreement incorporated the Guarantys definition of Liabilities, see Security
1187

Yeung,Lehmanscounsel,didnotdifferentiateamongtheSeptemberAgreementsand
explainedthattheyallrequiredLowittsapproval.4416Yet,somewhatinconsistently,he
also noted that the August agreements were executed in a typical fashion, with
TonuccisigningtheAmendmenttotheClearanceAgreementandSecurityAgreement,
andLowittsigningtheGuaranty,perLehmansCodeofAuthorities.4417
AccordingtoJPMorgansDonnaDellosso,Tonucciinformedherontheevening
ofSeptember9thattheagreementshadtobeapprovedbyLowitt,whowassleepingat
the time. Tonucci also informed the Examiner that BuyersRusso called him on the
night of September 9 to inquire whether Lowitt had reviewed the agreements.4418
AccordingtoTonucci,LowitthadnotreviewedtheagreementshehadleftLehmans
headquartersearlierthateveningtorestinadvanceofthefollowingmorningsearnings
call,whichLowittwouldlead,andwaslikelyasleepatthetimeofBuyersRussoscall.
Agreement(Sept.9,2008),atp.1[JPM20040005873],anargumentthattheAmendmenttotheClearance
Agreement is integrated with the other September Agreements is weaker. The Amendment to the
Clearance Agreement, for example, was executed by several Lehman parties in addition to LBHI. See
AmendmenttotheClearanceAgreement(Sept.9,2008),atpp.13[JPM20040005861].Italsomodifies
analreadyexistingstandaloneagreementtheClearanceAgreementthatwasnotintertwinedwiththe
SeptemberSecurityAgreementandGuaranty.Inaddition,whileNewYorkcourtshavesuggestedthata
breach of one agreement may be a breach of another agreement with which it is interrelated, see, e.g.,
Rudman, 280 N.E.2d at 873, the Examiner is unaware of any case under New York law in which the
invalidityofoneagreementrequirestheinvalidityofanotheragreementwithwhichitisinterrelatedbut
that is not subject to the same infirmity. This issue, of course, is not relevant if JPMorgan is able to
establishthatTonucciactedwithapparentauthorityorthatLehmanratifiedtheSeptemberGuaranty.
4417Id.atp.3.
4418TonuccimayhaveconfusedaphonecallwithDellossoforonewithBuyersRusso.
1188

TonuccirecalledthatalthoughBuyersRussoaskedTonuccitowakeupLowitt,Tonucci
didnotdoso.4419
Lowitt spoke with Tonucci about the September Agreements after the earnings
callonSeptember10(andthusaftertheyweresigned).Lowittdidnotrecallwhetherhe
communicated with anyone about the agreements prior to that point.4420 Tonucci
relayed to Lowitt that JPMorgan had wanted Lowitt to sign the agreements the night
before, but that Tonucci had decided not to bother Lowitt.4421 Thus, the available
evidence suggests that Lowitt had not approved of the September Agreements before
Tonuccisignedthem.4422
LowitttoldtheExaminerthathehadnoquestionsaboutTonuccisauthorityto
signtheagreements,citingthefactthateventhoughJPMorganwantedLowitttosign,
4419DoctoroffstatedthathecalledFlemingbetween10:00and11:00p.m.onSeptember9atthedirection
ofDellossototellFlemingtowakeLowittup.ExaminersInterviewofMarkG.Doctoroff,Apr.29,2009,
atp.19.
4420Examiners Interview of Ian T. Lowitt, Oct. 28, 2009, at pp. 1920. Yeung did email Lowitt that
evening,butLowittdidnotrespond.ExaminersInterviewofAndrewYeung,Mar.13,2009,atp.4;see
alsoemailfromPaulW.Hespel,GoodwinProcter,toJeffreyAronson,JPMorgan(Sept.10,2008)[LBEX
AM 039572] (forwarding Lehman comments on draft Guaranty and Security Agreement to JPMorgan,
copyingLowitt).
4422Notably,despiteLowittslackofapprovaloftheSeptemberAgreementswithJPMorganbeforethey
wereexecuted,LowitthadapprovedanamendmenttoLehmansGuarantywithCitionSeptember9.E
mail from Paolo R. Tonucci, Lehman, to Emil R. Cornejo, Lehman (Sept. 9, 2008) [LBEXAM 008564]
(reporting that Lowitt signed Lehmans Guaranty amendment with Citi); Amendment 1 to Guaranty
(Sept. 9, 2008) [LBEXDOCID 4263143] (executed amendment with Lowitts signature). Indeed, Lowitt
wastoldthathewasrequiredtosigntheGuarantyamendmentwithCiti.EmailfromEmilF.Cornejo,
Lehman,toIanT.Lowitt,Lehman,etal.(Sept.9,2008)[LBEXAM008571].
1189

JPMorgan had accepted Tonuccis signature.4423 Fuld denied knowing about the
agreementsuntilafterLehmanfiledforbankruptcy, 4424althoughthereisevidencethat
theagreementswerebasedatleastinpartonahighlevelagreementreachedbetween
FuldandJPMorgansStevenBlack.4425
(i) TonucciMayHaveActedWithApparentAuthority
AssumingthatTonuccilackedactualauthoritytosigntheSeptemberGuaranty,
hemay haveacted withapparentauthority.Apparent authority isestablished by the
words or conduct of the principal, i.e., Lehman, visvis the third party, i.e.,
JPMorgan.4426Apparentauthorityariseswhenaprincipalplacesanagentinaposition
whereitappearsthattheagenthascertainpowerswhichhemayormaynotpossess.If
athirdpersonholdsthereasonablebeliefthattheagentwasactingwithinthescopeof
his authority and changes his position in reliance on the agents act, the principal is
estopped to deny that the agents act was not authorized.4427 Formulated slightly
differently, a principal may be estopped from denying apparent authority if (1) the
principals intentional or negligent acts, including acts of omission, created an
appearanceofauthorityintheagent,(2)onwhichathirdpartyreasonablyandingood
4423ExaminersInterviewofIanT.Lowitt,Oct.28,2009,atp.19.Thisreasoningisnotrelevanttoalegal
analysisofapparentauthority,butdoesreflectLowittspersonalviews.
4425SeesupraatSectionIII.A.5.b.1.h.
4426SeeFennellv.TLBKentCo.,865F.2d498,502(2dCir.1989).
4427Gen. Overseas Films, Ltd. v. Robin Intl, Inc., 542 F. Supp. 684, 68889 (S.D.N.Y. 1982) (citation and
internalquotationmarksomitted).
1190

faithreliedand(3)suchrelianceresultedinadetrimentalchangeinpositiononthepart
ofthethirdparty.4428
UnderNewYorklaw,intheapparentauthoritycontext,adutyofinquiryarises
when(1)thefactsandcircumstancesaresuchastoputthethirdpartyoninquiry,(2)
the transaction is extraordinary, or (3) the novelty of the transaction alerts the third
party to a danger of fraud.4429 The duty of inquiry is an alternative way of asking
whetherreliancewasreasonable.4430ThequestionwhetherJPMorganreasonablyrelied
onTonuccisapparentauthorityisessentiallyaquestionoffact.4431
Therearedisputedissuesoffactontheissueofapparentauthority.JPMorgan,
on the one hand, can point to the fact that at the conclusion of negotiations, Yeung e
mailed JPMorgan counsel and reported that he had sent the agreements on to our
executive officers for their final approval and signature.4432 Later, Fleming emailed
DoctoroffandinformedhimthatAndrew[was]onhisway...topickupsigneddocs
from Paolo/Ian.4433 As noted above, Paolo Tonucci, as LBHIs Vice President and
GlobalTreasurer,signedtheagreementsonLBHIsbehalf.ThefactthatJPMorgansent
theagreementstoLehmanscounsel,whoreturnedthemsignedbyTonuccicoupled
4428Minskoffv.Am.ExpressTravelRelatedServs.Co.,98F.3d703,708(2dCir.1996).
4429FDICv.ProvidenceColl.,115F.3d136,141(2dCir.1997).
4430ProvidenceColl.,115F.3dat142.
4431See C.E. Towers Co. v. Trinidad & Tobago (BWIA Intl) Airways Corp., 903 F. Supp. 515, 524 (S.D.N.Y.
1995).
0002032].
4433EmailfromDanielJ.Fleming,Lehman,toMarkDoctoroff,JPMorgan(Sept.10,2008)[LBEXDOCID
457582].
1191

with Tonuccis title could establish that JPMorgan reasonably relied on Tonuccis
apparentauthority.4434Inaddition,thefactthatTonuccisignedtheAugustAmendment
to the Clearance Agreement and Security Agreement further bolsters his apparent
authoritytosignanalogousagreementsinSeptember.4435Moreover,thestatementsthat
the agreements had been sent to the executive officers for their final approval and
that the signed documents were being picked up from Paolo/Ian, and not just
Paolo, could have led to a reasonable conclusion by JPMorgan that Lowitt had
approved of the agreements, even though they were signed by Tonucci. (JPMorgan
counselAppelstatedtotheExaminerthatJPMorganreliedonapparentauthorityas
totheSeptemberAgreements,buttheExaminerplaceslittleweightonthisafterthefact
statement at a time when litigation was contemplated between JPMorgan and
Lehman.4436 Appel further explained that JPMorgan generally did not require regular
customerstoprovidecertificationofauthority.)4437
TheEstateandCreditorsCommittee,ontheotherhand,canpointtothefactthat
JPMorganapparentlyknewthatLowitthadtoapprovetheagreementsbutwasasleep
on the night of September 9. Indeed, JPMorgan encouraged Tonucci to wake Lowitt,
but did not pursue the inquiry to determine if Lehman had done so and obtained
4434Cf.C.E.TowersCo.,903F.Supp.at524.
4435See Indosuez Intl Fin. B.V. v. Natl Reserve Bank, 774 N.E.2d 696, 70001 (N.Y. 2002) (thirdpartys
reliance on apparent authority was reasonable where agent executed similar agreements on behalf of
principalinpast).
4437Seeid.
1192

Lowittsapproval.JPMorganwasalsoawarethatitwasLowitt,notTonucci,whohad
signed the August Guaranty.4438 JPMorgan may therefore have been under a duty to
conductfurtherinquiriesconcerningTonuccisauthority.4439
(ii) ThereIsSubstantialEvidenceThatLehmanRatified
theSeptemberAgreements
Ratification is the express or implied adoption of acts of another by one for
whom the other assumes to be acting but without authority.4440 Consequently, a
principalmayratifyandtherebybecomeliablefortheactsofanagentevenifthoseacts
were initially unauthorized.4441 Whether express or implied, the principals intent to
ratifytheunauthorizedactmustbeclearlyestablishedandmaynotbeinferredfrom
4438TheEstateandCreditorsCommitteemayalsoarguethatYeungsstatementsconcerningapprovalof
theagreementsdonotconstituteactionsbytheprincipalbecauseYeungwasnotaseniorexecutive.
4439SeeProvidenceColl.,115F.3dat141(dutyofinquiryariseswhenthefactsandcircumstancesaresuch
astoputthethirdpartyoninquiry);HerbertConstr.Co.v.ContinentalIns.Co.,931F.2d989,996(2dCir.
1991)(Apparentauthoritycanexistonlyaslongasthethirdperson,towhomtheprincipalhasmadea
manifestation of authority, continues reasonably to believe that the agent is authorized. (citation and
internalquotation mark omitted)); Scientific Holding Co. v. Plessey Inc.,510F.2d 15,24 (2dCir.1974)(a
person with notice of a limitation which has been placed on an agents authority cannot subject the
principaltoliabilityuponatransactionwiththeagentifheknowsorshouldknowthatitisoutsidethe
scopeoftheagentsauthority).Amongotherfactorsrelevanttotheissueofinquirynoticeiswhether
theunderlyingtransactionwasextraordinary.ProvidenceColl.,115F.3dat141.Althoughcourtshave
held the guaranty of a debt of an unrelated corporation to be extraordinary and, thus, sufficient to
triggerthedutyofinquiry,see,e.g.,Gen.OverseasFilms,542F.Supp.at691,here,LBIandotherHoldings
subsidiarieswerefarfromunrelatedtoLBHI.Indeed,LBHIenteredintoaGuarantyonbehalfofseveral
subsidiaries (including LBI) just a few weeks earlier. Nevertheless, expansion of the agreements to
extend to all Lehman liabilities, as part of an overnight negotiation and at a time when Lehman was
rapidlydeteriorating,couldbeviewedasextraordinary.Cf.Gen.OverseasFilms,Ltd.v.RobinIntl,Inc.,
542 F. Supp. 684, 691 (S.D.N.Y. 1982) (extraordinary transaction where corporate treasurer executed
agreementtoguaranteedebtofunrelatedcorporation).
4440Priscov.NewYork,804F.Supp.518,523(S.D.N.Y.1992);seealsoHammv.UnitedStates,483F.3d135,
140(2dCir.2007).
4441Prisco,804F.Supp.at523.
1193

doubtfulorequivocalactsorlanguage.4442Inorderforaratificationtobeeffective,the
individual ratifying an unauthorized contract must have been able to authorize the
contractoriginally.4443Inotherwords,onlythoseindividualswhocouldhaveoriginally
authorizedacertaincontractoractonbehalfofthecorporationcanratifyitafterithas
beenmadewithoutauthorityorperformed.4444Thequestionofratificationisaquestion
offact.4445
A principal ratifies an act by manifesting assent or by conduct that justifies a
reasonable assumption that the principal consents to becoming subject to the legal
consequencesoftheact.4446LehmanreceivedanoticefromJPMorganonSeptember11
explicitly requesting funds to be held by JPMorgan as collateral under the Security
Agreement,datedSeptember9,between[LBHI]andJPMorgan.4447JPMorganinitially
sentthe noticetoTonucci,whoforwardedittoLowitt. 4448OnSeptember12,Lehman
4442Holmv.C.M.P.SheetMetal,Inc.,455N.Y.S.2d429,432(App.Div.1982).
4443N.Y.StateMed.TransportersAssn,Inc.v.Perales,566N.E.2d134,138(N.Y.1990)(citingRESTATEMENT
(SECOND)OFAGENCY84(2)(1958)).
4444Schwabv.E.G.PotterCo.,87N.E.670,673(N.Y.1909);Aronoffv.Albanese,446N.Y.S.2d368,370(App.
Div.1982);seealso11WilliamMeadeFletcheretal.,FletcherCyclopediaoftheLawofCorporations763
(rev.vol.2009)([T]hepresidentorotherlikeofficerofacorporationmayratifyacontractthatheorshe
has authority to make; but an unauthorized contract . . . cannot be binding on the corporation, even
thoughithasbeenratifiedbyboththepresidentandsecretary,iftheythemselvespossessednopowerto
entersuchacontract.).
4445SeeInreNigeriaCharterFlightsContractLitig.,520F.Supp.2d447,466(E.D.N.Y.2007).
4446RESTATEMENT(THIRD)OFAGENCY4.01(2009).
4447Email from Jane BuyersRusso, JPMorgan, to Paolo R. Tonucci, Lehman (Sept. 11, 2008) [JPM2004
0005411](September11,2008Noticeattachment).
4448Email from Paolo R. Tonucci, Lehman, to Ian T. Lowitt, Lehman (Sept. 12, 2008) [LBEXDOCID
036127].
1194

pledged $5 billion in cash collateral in response. Such affirmative conduct, in and of
itself,suggeststhatLehmanintendedtobeboundbytheSeptemberAgreements.
Ratification can also occur when the principal, upon learning of an
unauthorizedactofitsagent,acquiescesin,oraffirmsthatactthroughhisconductby
retaining any benefits of the compromise.4449 As discussed above, the September
Agreements allowed Lehman to continue to receive credit from JPMorgan. Lehman
continued to take advantage of JPMorgans extensions of credit after the agreements
were signed, and posted collateral pursuant to those agreements in order to continue
receivingsuchcredit.4450
Not only did Lehman explicitly perform under the SeptemberAgreements, but
the Examiner is aware of no instance in which Lehman sought to repudiate the
September Agreements due to concerns over Tonuccis authority to sign them. Upon
learning on September 10 that Tonucci had signed the September Agreements, Lowitt
took noactiontorepudiatethem.4451Failure torepudiateisconsideredevidencefrom
which ratification may be inferred,4452 and will often support a presumption of
4449Marnellv. Carbo, 499 F. Supp. 2d 202, 208 (N.D.N.Y. 2007) (citation and internal quotation mark
omitted).
4450The September notice stated, [i]f JPMorgan does not receive such monies by opening of business
tomorrow . . . we intend to exercise our right to decline to extend credit to you under the [Clearance
Agreement]. Emailfrom Jane BuyersRusso, JPMorgan, to Paolo R. Tonucci,Lehman (Sept. 11,2008)
[JPM20040005411](September11,2008Noticeattachment).
44522AN.Y.Jur.2dAgency197(1979);seealsoSuncoastCapitalCorp.v.GlobalIntellicom,Inc.,719N.Y.S.2d
652,652(App.Div.2001)(whereprincipalsattorneydidnotrenouncestipulationwhencopywasfaxed
1195

ratification.4453 In determining whether a principals silence demonstrates a failure to
repudiate, courts look to the relationship between the agent and the principal. The
principals silence is generally more significant where, as here, an agency relationship
existsandtheagentintheparticularcasehasexceededthedelegatedpowers.4454
The principal performing an allegedly ratifying act generally must have
knowledgeofthematerialfactsoftheunauthorizedcontract.4455WhileFuldandLowitt
arguably may not have had full knowledge of the material facts of the September
Agreements at the time of the September12 pledge,4456 they cannot avoid the effect of
ratification if they were in a position to learn those facts at that time.4457 A principal
having once ratified its agents acts, cannot afterwards avoid the effect of such
ratificationbyshowingthatitwasnotacquaintedwithallofthefactsofthetransactions
ratified, whenitwasalwaysin a position andwas in possessionofmeansoflearning
them.4458 Lowitt knew that the September Agreements had been signed as of
tohimimmediatelyuponexecution,andonlyrenounceditsixmonthslaterinresponsetoamotionto
enforce,suchsilenceconstitutedratificationofagentsauthority).
4453Agency,197(citingGoldsteinv.Tank,134N.Y.S.262,264(App.Div.1912)).
4454Id.199(1979)(citingMerrittv.Bissell,50N.E.280(N.Y.1898)).
4455SeePerales,566N.E.2dat138(1990);CooperativeAgricoleGroupementdeProducteursBovinsdeLOuestv.
BanestoBankingCorp.,No.868921,1989WL82454,at*16(S.D.N.Y.July19,1989)(Ratificationrequires
knowledgebytheprincipalofthematerialfactsofatransaction,coupledwiththeretentionofbenefits.),
affd,904F.2d35(2dCir.1990).
4456Examiners Interview of Richard S. Fuld, Jr., May 6, 2009, at p. 3; Examiners Interview of Ian T.
Lowitt,Oct.28,2009,atpp.1920;ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atpp.1314.
4457SeeOrixCreditAlliancev.PhillipsMahnen,Inc.,No.898376,1993WL183766,at*5(May26,1993)(a
principal may be deemed to have ratified the acts of an agent through silence when there is an
opportunitytospeakand,underthecircumstances,adesiretorepudiatewouldnormallybeexpressed).
4458Harvey v. J. P. Morgan & Co., 2 N.Y.S.2d 520, 531 (N.Y. Mun. Ct. 1937), revd on other grounds, 25
N.Y.S.2d636(N.Y.App.Term1938)(percuriam).
1196

September10;4459heclearlywasinapositiontoreadthe agreementshimselforconfer
withothersmorefamiliarwiththem.
Despitethisevidenceofratification,theEstatecouldarguethatLehmandidnot
have adequate time in which to knowingly ratify or repudiate the September
AgreementsgiventhatLehmanfiledforbankruptcyshortlyaftertheagreementswere
executed.4460 Although a principal does have a reasonable time4461 to repudiate,
Lehman did more than simply remain silent or tacitly acquiesce after the September
Agreements were executed; it had knowledge of the agreements and, instead of
repudiating them, affirmatively acted under them. Finally, if Lehman ratified the
agreements by posting collateral in response to the September 11 request, any later
repudiation would be ineffective; once ratified, an act is as binding as if it had been
originally authorized by the principal.4462 Accordingly, the Examiner concludes that a
claim to invalidate the September Agreements based on a lack of authority is not
colorableinlightofsubstantialevidenceofapparentauthorityand/orratification.
4460In addition,JPMorgan terminated theClearanceAgreement as to LBI on September 22,2008. Letter
fromEdwardJ.Corral,JPMorgan,toPaoloR.Tonucci,Lehman,re:terminationofClearanceAgreement
4461See,e.g.,MerexA.G.v.FairchildWestonSys.,Inc.,810F.Supp.1356,137071(S.D.N.Y.1993).
4462SeeHamm,483F.3dat140.
1197

(d) ThereIsInsufficientEvidencetoSupportaColorable
ClaimThatJPMorganFraudulentlyInducedthe
SeptemberAgreements
claimthatJPMorganfraudulentlyinducedtheSeptemberAgreementswhenInabatold
Yeunginthemidstoftheirnegotiationthatanagreementinprinciplehadalreadybeen
reachedbyseniormanagementatLehmanandJPMorgan.4463
Under New York law, a fraud claim has five elements: (1) a material
misrepresentation or omission of fact (2) made by defendant with knowledge of its
falsity(3)andintenttodefraud;(4)reasonablerelianceonthepartoftheplaintiff;and
(5)resultingdamagetotheplaintiff.4464
Asrecountedabove,ifInabasstatementwastrue,thatwouldofcoursedefeata
claim of fraud. Regardless of the outcome of that disputed issue of fact, however, it
doesnotappearthatYeunginfactreliedonInabasstatementorreasonablycouldhave.
When Inaba told Yeung about the alleged agreement, Yeung said he would confirm
Inabas understanding with Lehmans business guys.4465 Yeung emailed Lowitt,
Tonucciandothers,identifyingissuesofconcerninthedraftagreementsandseekingto
4463YeungrecalledthatInabarelayedthatthetermsoftheSeptemberAgreementshadbeenagreedupon
byStevenBlackandRichardFuld.ExaminersInterviewofAndrewYeung,Mar.13,2009,atp.4.Inaba
recalled that she advised Yeung that the September Agreements were agreed to in principle by very
senior management, but did not recallwhether she mentioned Blackand Fuld specifically. Examiners
InterviewofGailInaba,Apr.28,2009,atp.7.
4464Fierrov.Gallucci,No.065189,2008WL2039545,at*7(E.D.N.Y.May12,2008)(citationsandinternal
quotationmarksomitted).
1198

confirm their understanding.4466 It is therefore clear that Yeung did not solely rely on
JPMorgans representation as to the alleged executivelevel understanding. Fleming
respondedbyinstructingYeungtoproceedasifLehmanwouldultimatelyagreetoall
of JPMorgans proposed terms.4467 This evidence establishes that despite Inabas
representation, Yeung sought businessside approval of key terms and was instructed
byFlemingtoproceed.
Moreover,evenifYeunghadreliedonInabasstatement,thatreliancewouldnot
have been reasonable.4468 The Examiner does not believe it would be reasonable for
counselnegotiatingamajoragreementtoaccepttherepresentationofthecounterparty
thatcriticaltermshadalreadybeenagreedtobytheclient,withoutatleastconfirming
that representation with the client. This is not a case in which the critical facts
whetheralawyersownclienthadconsentedtothetermsofanagreementwereinthe
sole possession of the counterparty or otherwise inaccessible to the party claiming
fraudulentinducement.Thereisinsufficientevidencetosupportacolorableclaimfor
fraudulentinducementbecauseitwouldnothavebeenreasonableforLehmantohave
4467ExaminersInterviewofAndrewYeung,Mar.13,2009,atp.4.YeungstatedthatFlemingconfirmed
toYeungthattheSeptemberAgreementshadalreadybeenagreedto,butthatYeungrespondedthathe
would review the agreements and comment on them nonetheless. Examiners Interview of Andrew
4468See Grumman Allied Indus., Inc. v. Rohr Indus., Inc., 748 F.2d 729, 737 (2d Cir. 1984) (Where
sophisticatedbusinessmenengagedinmajortransactionsenjoyaccesstocriticalinformation,butfailto
take advantage of that access, New York courts are particularly disinclined to entertain claims of
justifiablereliance.).
1199

relied without verification on a general statement by JPMorgan that Lehman had
previously consented to theproposed terms, and because Lehmandid not in fact rely
onsucharepresentation.
***
Next, the Examiner analyzes claims arising under the September Agreements
assumingthattheyare,infact,enforceablebasedonJPMorganscollateraldemands
andfailuretoreturncollateraltoLehmaninitsfinalweek.
(e) ThereIsInsufficientEvidencetoSupportaColorable
ClaimforBreachofContractoftheSeptemberAgreements
BasedonJPMorgansRefusaltoReturnCollateral
After considering all available evidence, the Examiner concludes that there is
insufficient evidence to support a colorable claim against JPMorgan for breach of
contractforfailuretoreturncollateraltoLehman.
SeptemberAgreements
FromtheperiodofFebruary26toSeptember11,2008,JPMorganmadeanumber
of collateral requests to Lehman pursuant to the 2000 Clearance Agreement and
amendments thereto, the August and September Guaranties, and the August and
September Security Agreements. By the close of business on Friday, September 12,
1200

2008, Lehman had posted collateral totaling nearly $17 billion as a result of these
requests.4469
The three dominant collateral components were (i) JPMorgans clearingrelated
margin requirements aggregating to roughly $8billion during 2008, (ii) JPMorgans
request of $5billion on September 9, 2008, primarily relating to the exposure of its
InvestmentBanktoLehmanentitiesand(iii)JPMorgansrequestfor$5billioncashon
September11,2008.Derivativeterminationrisk(thatis,theriskthatthenondefaulting
partywillnotbeproperlycompensatedbypostedcollateral)wasthedominantfactorof
the September9 collateral request.4470 Primary elements of the September 11 request
wereaperceiveddeficitinLehmansfulfillmentoftheearlierSeptember9requestand
JPMorgans determination that collateral in the form of securities it had already
received was valued inappropriately or otherwise constituted inappropriate
collateral.4471
The Examiner has considered whether there is a colorable claim that JPMorgan
breached any of the September agreementsby refusing to return to Lehman collateral
thatJPMorganwasnotentitledtoretain.TheExaminerisnotawareofanyrequestsby
Lehman for return of allegedly excess collateral prior to the execution of the
4469Email fromEdward J. Corral,JPMorgan, to Michael A.Mego,JPMorgan (Sept. 12, 2008)[JPM2004
0050402].AsdiscussedinSectionIII.A.5.b.1above,thevalueofthecollateralisdisputed.
4470SeesupraatSectionIII.A.5.b.1.g.
4471SeesupraatSectionIII.A.5.b.1.g.
1201

September Agreements.4472 Thus, while the Examiner provides a description of the
evolvingcontractuallandscapebetweenLehmanandJPMorganduringtheperiodfrom
February2008untilSeptember15,2008,themostrelevantsetofcontractualobligations
forJPMorganarethoseestablishedbytheSeptemberAgreements.
(1)February2008toAugust26,2008.BetweenFebruary2008andtheexecution
oftheAugustAgreements,JPMorganandLehmanwereboundbythetermsofthe2000
Clearance Agreement. Under that agreement, JPMorgan agreed to act as Lehmans
nonexclusiveclearanceagentforsecuritiestransactions.4473
To accomplish this purpose, Section 3 of the Clearance Agreement authorized
JPMorgan:
(a) to receive and transfer securities for any purpose whatsoever,

including, without limitation, as a pledge of collateral; (b) to make
payments and collections of monies; (c) to permit [Lehman] to make
transfers between the Clearing Account(s), Custody Account(s) and the
SegregatedAccount(s)orotheraccounts,itbeingunderstoodthatweshall
only permit transfers from the Clearing Account(s) to the Custody
Account(s)orSegregatedAccount(s)totheextentthataftersuchtransfer
we remain fully collateralized; have been fully paid with respect to any
securities being transferred into the Segregated Account(s) or other
accounts; and (d) to transfer securities which we hold for [Lehman] as
such securities may be needed to secure loans with such entities as
[Lehman]mayspecify;(e)toreceivefromsuchentitiesas[Lehman]may
specifysecuritiesheldascollateralforloansagainstthepaymentoffunds
4472WhenaskedbytheExaminer,Alvarez&MarsalandcounselforJPMorganwerenotabletoidentify
anyevidenceofrequestsbyLehmanforreturnofallegedlyexcesscollateralpriortotheexecutionof
theSeptemberAgreements.TheExaminerisawareofcertaincollateralmovements,however,suchasthe
removal of Freedom from LCD on August 15 and the transfer of Kingfisher from LCE to LCD on
September2.
1202

requiredtoobtainthereleaseof[Lehmans]collateral;(f)toperformany
otheractincidentalornecessarytotheperformanceoftheabove.4474
This contractual provision enabled JPMorgan to clear triparty repurchase
transactions for Lehman. In doing so, JPMorgan reserved the following right: All
credits to the Account in connection with triparty repo transactions and physical
securities, regardless of how characterized, are conditioned upon the actual receipt of
finalpaymentandmaybereversedtotheextentpaymentisnotreceived.4475Further,
underthesameSection4(d),JPMorgancouldcredittheClearingAccountwithproceeds
from sales from triparty repurchase prior to actual receipt of final payment (e.g.,
immediately available or same day funds). JPMorgan had the discretion but not
theobligationtoallowLehmantouseanysuchfundspriortofinalpayment.4476
Importantly, under Section 5, while JPMorgan could solely at its discretion
advanceorloanLehmanfunds,the2000ClearanceAgreementemphasizedJPMorgans
righttodeclinecredit:Notwithstandingthefactthatwemayfromtimetotimemake
advances or loans pursuant to this paragraph or otherwise extend credit to you,
whetherornotasaregularpattern,wemayatanytimedeclinetoextendsuchcreditat
our discretion, with notice and if we are precluded from extending such credit as a
resultofanylaw,regulationorapplicableruling.4477
4474Id.atpp.12(3).
4475Id.atp.3(4(d)).
4476Seeid.
4477Id.atp.4(5).
1203

The 2000 Clearance Agreement provided several liens to JPMorgan in
considerationofanyadvancesorloans[JPMorgan]mayextendto[Lehman]pursuant
tothisAgreement.4478Specifically,Section11oftheClearanceAgreementprovided:
a continuing security interest, lien upon and right of a setoff as to all

collateral;
ifanyadvancesorloansareoutstandingattheendofabusinessday,aright
to,withnoticetoLehman,carryanycollateralinJPMorgansgeneralaccount
and to sell, transfer, assign, pledge, repledge, hypothecate and re
hypothecateanycollateral;
ifanyadvancesorloansarenotrepaid,therighttosellcollateral;
theabilitytomaintainthatallcollateral isin itspossessionandunderits

control unless and until JPMorgan receives full and final payment for
advancesorloans;
nodenialofJPMorgansstatusasabonafidepurchaserofallorpartofany
collateral;
status as securities intermediary with respect to any securities accounts

maintained with JPMorgan, which entitles JPMorgan to a priority lien over
allpropertymaintainedinsuchaccountspursuanttoSection8106(e).4479
Thus, in operation, the 2000 Clearance Agreement provided a framework for
clearanceservices,includingtripartyrepos,whichenabledJPMorgantoprovidesame
day and immediately available loans or advances to Lehman, and in return
conferredliensonLehmanaccountswithrespecttosuchadvancesorloans.
This Agreement, as amended by the parties, was the operative contractual
frameworkpriortotheexecutionoftheAugustAgreements.
4478Id.atpp.12(11).
4479Seeid.atpp.1214(11).
1204

(2) August Agreements. The operative contractual framework was modified by
thethreeAugustAgreements.
TheAugustAmendmenttotheClearanceAgreementexpandedthereachofthe
2000ClearanceAgreementby(1)addingseveralLehmanentities(LBHI,LBIE,LBOTD
DerivativesandLBJI);and(2)includingaprovisionclarifyingthatliabilitywasseveral
andnotjointforallLehmanentitiesundertheClearanceAgreement.4480
The parties also executed Guaranty and Security Agreements. The Security
Agreement included an Overnight Account provision to the effect that [e]xcept as
otherwise provided herein, at the end of a business day, if the undersigned has
determinedthatnoadvancesorloansremainoutstanding,the[undersignedLehman
entities]maytransfertoanaccount(theOvernightAccount)anyandallSecurityheld
inorcreditedtoorotherwisecarriedintheirAccounts.4481
(3) September Agreements. Shortly after execution of the August Agreements,
JPMorgan and Lehman once again executed a set of agreements that changed their
contractualobligations.
As discussed above, the September 9 Amendment to the Clearance Agreement
broadened the scope of the obligation in Section 11 of the Clearance Agreement, by
4480Amendment to Clearance Agreement (Aug. 26, 2008), at p. 1 [JPM2004 0005856]. LCPI had been
added as a Customer in May. Amendment to Clearance Agreement (May 30, 2008), at p. 1 [JPM2004
0085662].
4481SecurityAgreement(Aug.26,2008),atp.3[JPM20040005867].TheSecurityAgreementwassilentas
towhattypeofaccountLehmanhadtherightoftransfer.
1205

replacinglanguagethatlimitedSection11toclearingrelatedadvancesandloanswith
thefollowing:
In consideration of any credit, advances, loans or other financial

accommodations [JPMorgan] may extend to [Lehman] and in order to
induce [JPMorgan] from time to time, in our discretion, to extend or
continue to extend credit, clearing advances, clearing loans or other
financial accommodations to any of the Customers and/or to transact
business, trade or enter into derivative transactions with any of the
Customersandassecurityforthepaymentofallofyourexistingorfuture
indebtedness, obligations, and liabilities of any kind to [JPMorgan]
including,withoutlimitation,arisinginconnectionwithtrades,derivative
transactions, settlement of securities hereunder or any other business
(hereinaftertheObligations)youhereby:4482
TheSeptemberAmendmenttotheClearanceAgreementthusgreatlyexpanded
the scope of Obligations from being limited to loans and advances specifically in
connectionwithclearingservicestoencompassinganyindebtednessorobligationofany
kind with JPMorgan. This language significantly expanded the scope of JPMorgans
securityliens.
In addition, the parties executed a Guaranty and a Security Agreement that
likewiseexpandedthescopeofJPMorganslien.Forpurposesofevaluatingwhethera
colorablebreachofcontractclaimexists,afewprovisionsaresalient.
First, the Security Agreement states: As security for the payment of all the
Liabilities, the undersigned hereby grant(s) to the Bank a security interest in, and a
4482AmendmenttoClearanceAgreement(Sept.9,2008),atp.1[JPM20040005861](emphasisadded).
1206

general lien upon and/or right of setoff of, the Security.4483 The Security Agreement
incorporates the Guarantys broad definition of Liabilities, which includes all
obligations and liabilities of the Borrowers to the Bank of whatever nature with the
provisothat:TheGuarantorsmaximumliabilityunderthisGuarantyshallbeTHREE
BILLION DOLLARS ($3,000,000,000) or such greater amount that the Bank has
requested from time to time as further security in support of this Guaranty.4484 This
lastprovisionoftheGuarantyisalsoconsistentwithaclauseintheSecurityAgreement
thatstates:TheundersignedacknowledgesandagreesthattheBankmayfromtimeto
timerequestfurthersecurityorpaymentsonaccountofanyoftheLiabilities.4485
The practical effect of this language was that JPMorgan could, under the
September Agreements, make collateral requests to cover the broad definition of
Liabilities.
TheSeptemberAgreementsalsoalteredLehmansabilitytosecurethereturnof
collateral and JPMorgans contractual obligation to do so. The Security Agreement
includedathreedaynoticeprovisionforthereturnofaSecuritytoLehman:
Notwithstanding anything provided for herein, the undersigned may

upon three days written notice tothe Bank transfer anySecurity, provided
that the undersigned shall not transfer any Security if the Bank has
exercisedorbeenstayedorotherwiseprohibitedfromexercisinganyofits
rightsunderthisSecurityAgreementortheGuarantyorintheeventany
4483SecurityAgreement(Sept.9,2008),atpp.12[JPM20040005873].
4484Guaranty(Sept.9,2008),atpp.12[JPM200400005813].TheGuarantydefinesBorrowersasthe
directorindirectsubsidiariesofLBHI.Id.atp.1.
1207

DEFAULThasoccurredandiscontinuing,ineithercase,priortotheend
ofthethreedaynoticeperiodanduponanysuchtransferinthesecurity
interesthereundershallbereleased.4486
ThismeantthatLehmanhadtoprovidewrittennoticethreedaysinadvancebeforeit
could attempt to require JPMorgan to transfer any security under the September
Agreements.
(ii) ThereWasNoWrittenNoticeforCollateralReturn
To invoke the right to access collateral under the September 2008 Security
Agreement, Lehman would have needed, at a minimum, to provide JPMorgan with
written notice for return of collateral.4487 Lehman never provided any such written
notice.
TheExaminerisawareofaclaimbyFuldthatonaSeptember11conferencecall
between Fuld and Lowitt of Lehman and Black and Dimon of JPMorgan, there was
some type of oral promise for the return of collateral. According to Fuld, Dimon
promised that if Lehman would post $5 billion in additional collateral the next day,
4486Id.atp.3(emphasisadded).
4487The Examiner has considered whether providing notice might be regarded as futile. If a party
understands that honoring a contractual notice requirement may be futile, there are at least some
circumstancesunderwhichapartyisrelievedofthatrequirement.24/7Records,Inc.v.SonyMusicEntmt
Intl,566F.Supp.2d305,313(S.D.N.Y.2008).Thatlineofcases,however,requiresthatitbeclearthatthe
otherpartyinthiscase,JPMorganwillnotliveuptoitscontractualobligations.TheExaminerhasnot
foundanycredibleevidencetosuggestthatJPMorganmadeclearthatitwouldnothavereturnedatleast
some collateral under any circumstances on three days written notice. Indeed, there is evidence that
JPMorgan returned some of Lehmans collateral. See, e.g., email from Edward J. Corral, JPMorgan, to
Michael A. Mego, JPMorgan (September 12, 2008) [JPMEXAMINER00005961] (Let the CLO go.);
ExaminersInterviewofEdwardJ.Corral,Sept.30,2009,atp.11.
1208

JPMorganwouldreturnthatcollateralattheendofthatbusinessday.4488Dimondenied
knowledgeofanysuchpromise.4489Theexistenceofsuchapromiseisadisputedissue
offact,butanoralpromisecouldnothavemodifiedthewrittennoticerequirementof
theSeptember2008SecurityAgreement.Bytheirterms,theSeptemberGuarantyand
Security Agreement provide that all modifications to their terms be in writing.4490
Further, New York General Obligations Law 15301(1) reinforces these provisions,
providing:
A written agreement . . . which contains a provision to the effect that it

cannotbechangedorally,cannotbechangedbyanexecutoryagreement
unless such executory agreement is in writing and signed by the party
againstwhomenforcementofthechangeissoughtorbyhisagent.
Althoughtherearesomedoctrinalexceptionstothestatutewaiver,equitableestoppel
and partial performance none appears applicable here given that Lehmans actions
(i.e., pledging collateral) were consistent with the original agreements.4491 Thus, a
writtenmodificationwouldhavebeenneededtosatisfythewrittennoticerequirement
fromtheSeptemberAgreements.
4489ExaminersInterviewofJamieL.Dimon,Sept.29,2009,atpp.910.
4490Guaranty(Sept.9,2008),atp.5[JPM20040005813](Section13states:Noamendmentorwaiverof
anyprovisionofthisGuaranty...shallbeeffectiveunlessitisinwritingandsignedbytheBank,and
thenthewaiverorconsentshallbeeffectiveonlyinthespecificinstanceandforthespecificpurposefor
whichgiven.);SecurityAgreement(Sept.9,2008),atp.6[JPM20040005873](Noprovisionhereofshall
bemodifiedorlimitedexceptbyawritteninstrumentexpresslyreferredheretoandtotheprovisionso
modifiedorlimited.).
4491See22AN.Y.Jur.2dContracts486(2009).
1209

Asnotedabove,theExaminerhasnotidentifiedanysuchwrittenrequestfrom
LehmantoJPMorganforthereturnofcollateral.TheExaminer specificallyrequested
from JPMorgan, Alvarez & Marsal and the Creditors Committee any evidence of any
written requests, but none of those entities was aware of any written requests.4492
Accordingly, and assuming the validity of the September Agreements, the Examiner
concludes there is insufficient evidence to support a colorable claim that JPMorgan
breachedagreementswithLehmanbyrefusingtoreturncollateraltoLehmanfollowing
theexecutionoftheSeptemberAgreements.4493
(f) ThereIsEvidencetoSupportaColorable,ButNotStrong,
ClaimThatJPMorganBreachedtheImpliedCovenantof
GoodFaithandFairDealingbyDemandingExcessive
CollateralinSeptember2008
TheExaminerconcludesthatthereisevidencetosupportacolorableclaimthat
JPMorgan breached the implied covenant of good faith and fair dealing by making
excessivecollateralrequestsofLehmanduringSeptember2008.Theclaimisnotstrong,
4492There is some circumstantial evidence suggesting that at various times between September 11 and
September 15, Lehman executives informally inquired about the return of collateral. E.g., Examiners
InterviewofStevenBerkenfeld,Oct.5&7,2009,atp.21(Berkenfeldstatedthatonatelephonecallonthe
afternoonofSeptember14heaskedDimontoreturncollateral);emailfromMichaelGelband,Lehman,
to Herbert H. (Bart) McDade III, Lehman (Sept. 12, 2008) [LBEXAM 001337] (discussing the need to
pressureJPMorganforreturnofcollateral).TheserequestsarediscussedindetailinSectionIII.A.5.b.1.m
ofthisReport.TheExaminer,however,hasfoundnoevidencethatanyoftheseinformalrequestswere
sentinwrittenformasrequiredbytheSeptemberAgreements.
4493Notably, Lowitt told the Examiner that even if JPMorgan had agreed to return some collateral to
Lehman,thelargerissueforLehmanwasthatLehmanhadlostenormousamountsofsecuredfunding
andtheconfidenceofthemarket.ExaminersInterviewofIanT.Lowitt,Oct.28,2009,atpp.2223.
1210

however, because of evidence that the requests were reasonable and that Lehman
waivedanysuchclaimbycomplyingwiththerequests.
(i) LegalStandardsGoverningImpliedCovenantofGood
FaithandFairDealing
UnderNewYorkcommonlaw,implicitineverycontractisthecovenantofgood
faithandfairdealing.4494Tosucceedonaclaimforbreachofthecovenantofgoodfaith
and fair dealing, a plaintiff must prove 1) fraud, 2) malice, 3) bad faith, 4) other
intentionalwrongdoing,or5)recklessindifferencetotherightsofotherssuchasgross
negligence.4495 Where a contract contemplates the exercise of discretion, the duty of
goodfaithandfairdealingincludesapromisenottoactarbitrarilyorirrationally.4496
However,apartytoacontractisallowedtoactinitsownselfinterestconsistentwith
itsrightsunderthecontract.4497
Theplaintiffmustshowthatthedefendantsconductinfringedontheplaintiffs
actualrightsorbenefitsembodiedintheunderlyingcontract,4498and[n]oobligation
can be implied . . . which would be inconsistent with other terms of the contractual
relationship.4499 In addition, New York law does not recognize a separate cause of
4494ContlCas.Co.v.StateofN.Y.MortgageAgency,No.94Civ.8408,1998WL513054,at*13(S.D.N.Y.Aug.
18,1998).
4495ContlCas.,1998WL513054,at*13(internalcitationandquotationmarkomitted).
4496Citibankv.UnitedSubcontractors,Inc.,581F.Supp.2d640,645(S.D.N.Y.2008)(quotingDaltonv.Educ.
TestingServ.,663N.E.2d289,291(N.Y.1995)).
4497Id.at646.
4498Sch. Dist. of Erie v. J.P. Morgan Chase Bank, Nos. 08 CV 07688, 08 CV 07982, 2009 WL 234128, at *5
(S.D.N.Y.Jan.30,2009).
4499Murphyv.Am.HomeProds.Corp.,448N.E.2d86,91(N.Y.1983).
1211

actionforbreachoftheimpliedcovenantofgoodfaithandfairdealingwhenabreach
of contract claim, based on the same facts, is also pled.4500 A claim for breach of the
implied covenant will be dismissed as redundant where the conduct allegedly
violatingtheimpliedcovenantisalsothepredicateforbreachofcovenantofanexpress
provisionoftheunderlyingcontract.4501
New York courts have allowed claims for breach of the duty of good faith and
fair dealing to proceed where a plaintiff alleges that a bank has valued its secured
position in bad faith. For example, in CDO Plus Master Fund Ltd. v. Wachovia Bank,
N.A.,4502 the court denied Wachovias motion for judgment on the pleadings as to
plaintiffs claim that Wachovia breached the implied covenant of good faith and fair
dealing where the plaintiff alleged that Wachovia had acted arbitrarily and
irrationallyinitscapacityasValuationAgentunderISDAagreementsbetweenthe
parties.4503 When the plaintiff challenged a collateral demand made by Wachovia,
4500CDOPlusMasterFundLtd.v.WachoviaBank,N.A.,No.07Civ.11078,2009U.S.Dist.LEXIS59540,at
*19(S.D.N.Y.July13,2009)(quotingHarrisv.ProvidentLife&AccidentalIns.Co.,310F.3d73,81(2dCir.
2002)).
4501ICDHoldingsS.A.v.Frankel,976F.Supp.234,24344(S.D.N.Y.1997)(quotingHoubigant,Inc.v.ACB
Mercantile,Inc.(InreHoubigant,Inc.),914F.Supp.964,989(S.D.N.Y.1995),modifiedby914F.Supp.997
(S.D.N.Y.1996)).
4502No.07Civ.11078,2009U.S.Dist.LEXIS59540(S.D.N.Y.July13,2009).
4503Id. at *2122; see also Mallon Res. Corp. v. Midland Bank, PLC, No. 96 Civ. 7458, 1997 U.S. Dist. LEXIS
10346,at*8(S.D.N.Y.July17,1997)(denyingmotiontodismissclaimofbreachofcovenantofgoodfaith
and fair dealing where contract allowed defendant in its discretion to determine a Borrowing Base
premised upon values assigned to plaintiffs assets, where plaintiff alleged that its business was
successful and its reserves had substantially increased). Notably, however, the court held that the
plaintiff failed to state a breach of contract claim based on Wachovias collateral demands where the
contractatissueunambiguouslyprovide[d]Wachoviawiththerighttomake[collateral]demandsand
1212

Wachovia, in its capacity as Valuation Agent, was required to recalculate its
exposure.4504Wachoviaconfirmedthelegitimacyofthecollateralrequestandultimately
demandedthatplaintiffpostcollateralinexcessofthenotionalamountofthecontract
a result that the plaintiff alleged was absurd.4505 The court held these allegations
sufficienttostateaclaimforbreach.4506
Inaddition,underN.Y.U.C.C.LawSection1203,JPMorganhadanobligationof
good faith in its performance or enforcement of its various security agreements with
Lehman.4507 N.Y. U.C.C. Law Section9102, which applies to secured transactions,
defines[g]oodfaithashonestyinfactandtheobservanceofreasonablecommercial
standardsoffairdealing.4508Thesecondclauseofthisdefinitiontheobservanceof
reasonablecommercialstandardsoffairdealingestablishesanobjectivestandardfor
theplaintiffcompliedwithWachovias[collateral]demandsonfourteenoccasionswithoutexercisingits
right...tochallengethe...demands.CDOPlusMaster,2009U.S.Dist.LEXIS59540,at*1517.
4504CDOPlusMaster,2009U.S.Dist.LEXIS59540,at*56.
4505Id.at*7,*21.
4506Id.at*22.Thedeterminationofgoodfaithisgenerallyaquestionoffact.SeePernetv.PeabodyEngg
Corp.,248N.Y.S.2d132,135(App.Div.1964).
4507N.Y.U.C.C.Section1208alsoimposesanobligationtoactingoodfaithintherequestofadditional
collateral.TheannotationstoSection1208refertoitasanapplicationof[Section]1203whichimposes
ageneralobligationofgoodfaithuponthepartiesinperformingorenforcingobligations.N.Y.U.C.C.
Law1208N.Y.annotations(McKinneys2001).
4508N.Y.U.C.C.Law9102(a)(43).ThisdefinitionofgoodfaithappliesbothunderSection1203and
Section 1208. The official comment to Revised Article 9 notes that Section 9102s definition of good
faith which includes the objective consideration of the observance of reasonable commercial
standardsoffairdealingappliesforpurposesoftheobligationofgoodfaithimposedbySection1
203. Id. 9102(a)(43) official cmt. 19. Section 1208 crossreferences Section 1201, id. 1208 official
cmt., which provides an alternate definition of [g]ood faith as honesty in fact in the conduct or
transactionconcerned,id.1201(19).ThisalternatedefinitionofgoodfaithprovidedinSection1201,
however,is[s]ubjecttoadditionaldefinitionscontainedinthesubsequentArticlesofthisActwhichare
applicable to specific Articles or Parts thereof, including the definition of good faith provided in
Section9102.Seeid.1201.Thus,thedefinitionofgoodfaithprovidedinSection9102wouldalso
controltheobligationsimposedbySection1208.
1213

goodfaith,inadditiontotherequirementofhonestyinfact.4509Undertheobjective
componentofthestandard,JPMorganwasrequiredtoobservereasonablecommercial
standardsoffairdealinginthedeterminationofitscollateraldemandsfromLehman.
(ii) ThereIsSufficientEvidenceToSupportaColorable,
ButNotaStrong,ClaimThatJPMorganViolatedthe
ImpliedCovenantbyDemandingExcessiveCollateral
The September Guaranty provided that LBHIs maximum liability under this
GuarantyshallbeTHREEBILLIONDOLLARS($3,000,000,000)orsuchgreateramount
that the Bank has requested from time to time as further security in support of this
Guaranty.4510 The September Security Agreement, in turn, provided that the Bank
may from time to time request further security or payments on account of any of the
Liabilities[includingLiabilitiesasdefinedintheGuaranty].4511Asdiscussedindetail
above,4512 the definition of Liabilities in the Guaranty had been greatly expanded to
4509SeeChristiesInc.v.Davis,247F.Supp.2d414,421(S.D.N.Y.2002)(applyingSection9102definitionof
good faith to reasonableness of presale valuations and noting that the fact that of the 52 items of
collateralthathavebeenauctioned,only9soldformorethantheirhighpresaleestimate,andmostwere
well within the two estimates); see also Wawel Savings Bank v. Jersey Tractor Trailer Training, Inc. (In re
Jersey Tractor Trailer Training, Inc.), 580 F.3d 147, 156 (3d Cir. 2009) (finding that identical definition of
goodfaithunder New JerseyU.C.C.provisiongoverning secured transactions has both a subjective
pronghonestyinfactandanobjectiveprongobservanceofreasonablecommercialstandardsof
fairdealing);BankofAm.,N.A.v.PrestigeImports,917N.E.2d207,218n.25(Mass.App.Ct.2009)(noting
thatMassachusettsrevisionofU.C.C.definitionofgoodfaithtohonestyinfactandtheobservanceof
reasonable commercial standards of fair dealing adds an objective component to the previously
subjectivedefinition);Sunoco,Inc.(R&M)v.HoneywellIntlInc.,No.05CIV7984,2006WL709202,at*6
(S.D.N.Y. Mar. 21, 2006) (observing that an almostidentical definition of good faith under the
PennsylvaniaCommercialCodehasasubjectiveandobjectivecomponent).
4510Guaranty(Sept.9,2008),atp.2[JPM20040005813](emphasisadded).
4512SeesupraatSectionIII.A.5.b.2.e.i.
1214

cover any type of Lehman obligation to JPMorgan and its affiliates.4513 Thus, the
September Agreements established that JPMorgan had the discretion to make
additional collateral requests to cover any of its liabilities with Lehman, but the
September Agreements did not expressly define how JPMorgan was to calculate its
exposure. Under these circumstances, JPMorgans discretion was limited by its
commonlawdutytoavoidactinginanarbitraryorirrationalmanner,andbyitsduty
under the New York U.C.C. to exhibit honesty in fact while observing reasonable
commercialstandardsoffairdealing.4514
Itisstandardintheindustrytorequestandholdcollateralwithmarketvaluein
excessofaloanamount.4515TheExaminerisawareofnoclearcutdefinition,however,
astohowmuchcollateralcushionistoomuchforexample,atwhatpointabanks
legitimate demands for selfprotection in the face of uncertainties in exposure and
valuation of existing collateral become arbitrary or irrational. A trier of fact would
almost certainly require expert testimony as to objective standards of reasonable
conductinestimatingexposureandassessingandvaluingcollateral.4516
4514SeesupraatSectionIII.A.5.b.2.f.i(discussinglegalbackground).
4515SeeCurrentIssues:PDCF,atp.2(notingthatclearingbanksrequirecollateralwithahighermarket
valuethantheamountalendercanborrow).
4516In addition, the parties would likely seek to introduce studies or literature relevant to ascertaining
typicalindustrypracticesastocapitalization,marginandcollateralpracticesofclearingbanks.See,e.g.,
NewBankWorkingGroupReport.
1215

Based on testimony and evidence as to reasonable commercial practices in the
industry,thetrieroffactwouldthenneedtoevaluatethereasonablenessofJPMorgans
requests and whether JPMorgan had acted irrationally or arbitrarily in addition to
evaluatingwhetherJPMorgansubjectivelyexhibitedhonestyinfact.
There are sufficient competing facts for a trier of fact to resolve as to whether
JPMorgan acted reasonably,4517 and thus the Examiner concludes a colorable claim
exists.SomeofJPMorgansowndocumentssuggestthatJPMorganrecognizeditwas
overcollateralized during the days leading up to Lehmans bankruptcy. For example,
JPMorgans Ricardo Chiavenato prepared a series of analyses concerning JPMorgans
tripartyrepo exposure that suggested that JPMorgan was sufficiently collateralized at
leastasofSeptember10,2008.4518StartingonSeptember11,2008,CraigDelanydidthe
same.4519 One version of Delanys analysis suggests that JPMorgan was
overcollateralized by as much as $6.1 billion on September 12.4520 These documents
couldbeinterpretedtosuggestthatJPMorganunderstooditwasmorethanadequately
collateralizedastoclearingrisks.4521
4517The Examiner hereinafter uses the term reasonably as shorthand to encompass both the U.C.C.
standardandthecommonlawstandardofgoodfaithandfairdealing.
4518SeesupraatSectionIII.A.5.b.1.k.
4519SeesupraatSectionIII.A.5.b.1.l.
4520SeeJPMorgan,Spreadsheet,atp.8[JPM20040029769].
4521In addition, an internal JPMorgan email could be interpreted to suggest that JPMorgan believed it
was overcollateralized as of September 15. See email from Heidi Miller, JPMorgan, to Jamie Dimon,
JPMorgan,etal.(Sept.15,2008)[JPM20040006510](AllweneedtotalkthismorningaboutthecallsLeh
hasbeenmakingabouthavingusreturnaportionofourexcesscollateraltotheirholdingco.Wehave
1216

There is also substantial evidence to support a contention that JPMorgans
collateral requests were reasonable. First, both Chiavenatos and Delanys analyses
accounted only for JPMorgans tripartyrepo exposure to Lehman. The September
Agreements, however, expanded LBHIs obligations under the Guaranty and Security
Agreement to all manner of liabilities between Lehman and JPMorgan. Thus the
writtenanalysesdonotreflectJPMorgansfullrangeofexposuresundertheSeptember
Agreements.4522 As discussed above, JPMorgan stated that it based the September 9
collateralrequestonitsInvestmentBankexposurearequestthatBlackcharacterized
as art, not science.4523 Second, it was reasonable for JPMorgan to have taken into
account Lehmans rapidly deteriorating financial condition and the risk of a Lehman
failure.Thereisevidence,forexample,suggestingthatJPMorgancontinuedtoaccept
novations from Lehman counterparties, and that novation requests were increasing
over time.4524 Ultimately, because the JPMorgan September 9 request was based on
art and not science, a trier of fact will have to evaluate expert testimony and
takenthepositionthattheirisnoexcessbuttheyhavenotyetacceptedthat.Weshouldmakesureour
statementsareconsistentsinceIamsureyouwillsoongetcalledaswell).
4522Several JPMorgan witnesses stated that JPMorgan could have justified a request for more collateral
thanJPMorganultimatelydemanded.SeesupraatSectionIII.A.5.b.1.g.
4523Seeid.Note,however,thatDellosso,inaninternalemail,referredtothenewcollateralascovering
intradayexposure.SeeemailfromDonnaDellosso,JPMorgan,toStevenD.Black,JPMorgan,etal.(Sept.
10,2008)[JPM20040006377]([Lehman]willmaintaincollateralof$4blntocoverintradayexposure.).
JPMorgans largest Investment Bank exposure to Lehman was in the form of derivative transactions.
While Lehman and JPMorgan employed standard ISDA and credit support agreements to mitigate
counterparty risk, each party still faced the risk that, in the event of a default, it would not be able to
replacethedefaultedtradesatthepreviouslyunderstoodmarketvalue.AtthetimeoftheSeptember9
collateralrequest,JPMorganalsohadexposureduetoitsprovisionofa$2billioncreditlinetoLBIE.See
supraatSectionIII.A.5.b.1.i.
4524SeesupraatSectionsIII.A.5.b.1.k&III.A.5.b.2.b.
1217

determine whether the amount JPMorgan arrived at was consistent with reasonable
commercialstandards.
WithrespecttoJPMorgansSeptember11collateralrequest,JPMorganwitnesses
contend that the internal JPMorgan analyses discussed above, which imply
overcollateralization,didnotreflectJPMorgansconcernswithspecificelementsofthe
existingLehmancollateral.Chiavenatostatedthathiswrittenanalysisassumedthefull
facevalueof$3billionfortheFenwaycommercialpapereventhoughheknewthat
there was a problem with its valuation,4525 and that his analysis did not account for
dealerpricing of collateral in the triparty shell.4526 Delany similarly stressed that his
analysis accepted all valuations of tripartyshell collateral in the BDAS system as
accurate.4527 In addition, as with the September 9 request, the reasonableness of the
September 11 request must be analyzed in part based on Lehmans deteriorating
positioninthemarket.
4525Asdiscussedabove,DelanyconcludedthatRACERSandFenwaywereproblematicbecauseoftheir
structure (commercial paper and shortterm notes creditenhanced by Lehman) and because of the
illiquidityoftheunderlyingassets.DelanyconcludedthatRACERSandFenwayshouldbeconsidered
greatlydevalued,farbelowtheir$8billionassignedfacevalue.SeesupraatSectionIII.A.5.b.1.l;seealso
infra Section III.A.5.c.1.c.ii (Citigroup witness characterized CLOs offered by Lehman to Citigroup
includingFreedom,SpruceandVeranoasbottomofthebarrelandjunk).BecauseLBHIwasthe
ultimate liquidity and credit provider for the Fenway securities, Fenway was effectively equivalent to
Lehman shortterm debt that would pay principal at maturity only if Lehman remained creditworthy.
Stated differently, Fenways value would drop precipitously upon a Lehman default, and it was not
unreasonableforJPMorgantohavediscounteditsvalueascollateral.
4526SeesupraatSectionIII.A.5.b.1.k.
4527SeesupraatSectionIII.A.5.b.1.l.
1218

Furthermore, there are disputed issues of fact concerning the impact of post
petition events, if any, on an analysis of the reasonableness of JPMorgans collateral
demands in the first instance.4528 For example, according to JPMorgan, it has unpaid
claimsof$7.60billion,against$7.14billionofremainingcashandmoneymarketfunds
suggesting it was undercollateralized, or at least that its collateral demands were
reasonable.4529 In addition, JPMorgan also holds unliquidated securities collateral
separatelypledgedbyLBHI,LCPIandLBIforwhichJPMorganassertsthevalueisnot
currently determinable.4530 The Examiner understands that the Estate contends the
unvaluedcollateralisworthapproximately$6billion(andwasworththatamountin
September2008),whichwouldarguablyimplythatJPMorganwasmorethan$5billion
overcollateralized.4531 Ultimately, however, the Examiner concludes that JPMorgans
assessmentofitsexposureonSeptember9andSeptember11,andthefactorsanddata
JPMorgan considered at that time, are the most probative evidence of whether
JPMorgan acted reasonably and honestlyinmaking theSeptember collateral requests.
4528Thetrieroffactwillhavetodeterminetheprobativevalue,ifany,ofevidenceastotheeffectofpost
September 11 activity (such as liquidations and valuations) on the question whether the collateral
requestswerereasonableatthetimetheyweremade.
4529Duff&Phelps,ExPostEvaluationandClaimsofJPMCollateralization(Jan.15,2010),atp.1.Atrier
offactconsideringtheprobativevalueofthesepostpetitioneventswouldhavetoconsider,amongother
things, the underlying validity of JPMorgans postpetition claims (for example, whether JPMorgan is
attemptingtoapplycollateraltoobligationsthatfalloutsidethescopeoftheSeptemberGuaranty),and
the impact of intervening events after September 11 on the value of the collateral Lehman originally
provided.
4530Id.atp.1.
4531Id. at p.2. In addition, JPMorgan continued to extend credit to Lehman the week ofSeptember 15,
2008, supported in part by collateral received from Lehman prior to September 15. Those events,
includingtheinvolvementoftheFRBNY,arediscussedinSectionIII.A.6.
1219

Thedifferentpotentialinterpretationsofthisevidenceandthenecessityofestablishing
industry standards by expert testimony are sufficient to support the existence of a
colorable claim as to the reasonableness of JPMorgans September 2008 collateral
requests.
(iii) ATrierofFactWillLikelyHavetoResolveaWaiver
Defense
JPMorgan will likely raise a defense of waiver to any claim that JPMorgan
breacheditscontractualobligationsordutyofgoodfaithandfairdealinginmakingthe
September2008collateralrequests.UnderNewYorklaw,[i]tiswellestablishedthat
where a party to an agreement has actual knowledge of another partys breach and
continues to perform under and accepts the benefits of the contract, such continuing
performanceconstitutesawaiverofthebreach.4532JPMorganwilllikelycontendthat
Lehman not only acceded to the September requests by posting collateral, but that
Lehman also enjoyed the benefits of its actions by continuing to receive discretionary
creditfromJPMorgan.
A recent New York decision, VCG Special Opportunities Master Fund Ltd. v.
Citibank,N.A.(Citibank),4533appliedthewaiverdoctrinetobaraclaimofbreachofthe
impliedcovenantofgoodfaithandfairdealing.Inthatcase,VCGenteredintoacredit
4532VCGSpecialOpportunitiesMasterFundLtd.v.Citibank,N.A.,594F.Supp.2d334,342(S.D.N.Y.2008)
(quotingNatlWestminsterBankv.Ross,U.S.A.,130B.R.656,675(S.D.N.Y.1991),affdsubnom.Yaegerv.
Natl Westminster, 962 F.2d 1 (2d Cir. 1992)), reconsideration denied, No. 08CV01563, 2009 WL 311362
(S.D.N.Y.Jan.29,2009),affd,No.085707cv,2009WL4576542(2dCir.Dec.8,2009).
4533594F.Supp.2d334.
1220

defaultswaptransactionwithCitibank.Althoughthepartiesdisagreedastowhether
theircontractallowedCitibanktodemandadditionalcollateral(orvariationmargin)
based upon a downward movement in the daily marktomarket value of the
underlying reference obligation, Citibank demanded collateral from VCG four times
over a span of weeks.4534 While VCG delivered the collateral each time, VCG alleged
that itquestionedCitibanksevaluation ofitscreditriskunder the transactions. VCG
claimed that it delivered the sums out of fear that Citibank might use a refusal to
deliverthecollateralasareasontodeclareatechnicaldefaultundertheagreements.4535
TheCourtfoundVCGhadwaiveditsbreachofcontractclaim,concludingthat[g]iven
VCGsactualpostingofthedisputedcreditsupport,anditsreceiptofCitibanksregular
payments during this time, VCG cannot now claim that Citibank breached the CDS
Contractbywrongly demandingadditionalcollateral.4536TheCourtthenappliedthe
samereasoningtoconcludethatVCGhadalsowaiveditsclaimthatCitibankbreached
theimpliedcovenantofgoodfaithandfairdealing.4537
JPMorgancouldarguethatLehmansimilarlywaivedanybreachoftheimplied
covenantofgoodfaithandfairdealingbypostingcollateralinresponsetoJPMorgans
4534Id.at338.TheCourtlaterstatedthatitdisagreedwithVCGscontractinterpretationandnotedthat
[t]heCreditSupportAnnexallowedCitibanktorequestadditionalcollateralfromVCG.Id.at342.
4535Id.at338.
4536Id. at 34243. The Court also noted that VCG was barred from challenging Citibanks request for
additional collateral because the Credit Support Annex to the contracts in question had a Dispute
ResolutionprovisionwithwhichVCGfailedtocomply.Seeid.at343.
4537Id. at 344 (With regard to VCGs allegation of a breach of the implied covenant on the basis of
variationmargin,...thisclaimiswaivedinlightofVCGscontinuedpostingofthedemandedcollateral
andacceptanceofthebenefitsoftheCDSContract.).
1221

demands. The September Security Agreement and September Guaranty specifically
allowedJPMorgantomakecollateralrequeststosecureabroadrangeofobligations.4538
Furthermore,like VCGs actions inCitibank,even though Lehmanattimesquestioned
JPMorgans valuation of Lehmans collateral or the size of JPMorgans requests,4539
Lehman ultimately posted additional collateral in response to the September 9 and
September11requests.
There is also evidence available to Lehman to contest a defense of waiver.
Lehman did not provide the full $5 billion requested on September 9 by JPMorgan,
suggesting that Lehman did not entirely cede to JPMorgans demands.4540 Also, there
are reports that Lehman did resist the collateral requests, especially on September 11,
when they were first communicated by JPMorgan.4541 For example, there is evidence
thatFlemingandTonuccicommunicatedtoDoctoroffonSeptember10Lehmansview
that JPMorgans requests for collateral were somewhat arbitrary as was JPMorgans
valuationofcollateral.4542TheEstatecouldarguethatsuchresistancewassufficientto
4538See Security Agreement (Sept. 9, 2008), at p. 5 [JPM2004 0084865]; Guaranty (Sept. 9, 2008), at p. 2
[JPM20040005813].
4539SeesupraatSectionIII.A.5.b.1.
4540See id., supra. Lehmans objections to the full amount of the demand may not, however, excuse a
waiverastotheamountsitdidprovide.
4541Seeid.,supra.
4542See email from Mark G. Doctoroff, JPMorgan, to Donna Dellosso, JPMorgan, et al. (Sept. 11, 2008)
[JPM2004 0061651] (reporting the impression of Fleming and Tonucci); see also email from Donna
Dellosso, JPMorgan, to Steven D. Black, JPMorgan, et al. (Sept. 10, 2008) [JPM2004 0061485] (reporting
that while Tonucci confirmed that Lehman will maintain collateral of $4bln to cover intraday
exposure, Tonucci believed JPMorgan had excess collateral in [Lehmans] UK and US boxes that in
additiontothecashandmoneymarketfundslikelyexceedsour$4blnrequest).
1222

constituteanoticetoJPMorganofitsbreachoftheimpliedcovenantofgoodfaithand
fair dealing.4543 Finally, there are reports of requests from Lehman for return of its
collateral,includingevidenceto supportthecontentionthatLehmanbelievedthatthe
$5billionpostedinresponsetotheSeptember11requestwouldbereturnedattheend
ofthedayonSeptember12.4544ThisevidencecouldsupportthepositionthatLehmans
postingofcollateralwasnotawaiverbecauseitwasnotanintentionalandvoluntary
relinquishment of a known right.4545 Thus, there are credible disputed issues of
material fact concerning whether JPMorgan would ultimately succeed on a defense of
waiver.
The Examiner concludes that there is sufficient evidence to determine that a
colorableclaimexistsforbreachoftheimpliedcovenantofgoodfaithandfairdealing,
but that the claim is not strong because of substantial evidence that JPMorgan was
neither arbitrary nor irrational in its requests for collateral pursuant to its broad
discretion under the September Agreements, and because of evidence that Lehman
4543[A]partytoanagreementwhobelievesithasbeenbreachedmayelecttocontinuetoperformthe
agreementratherthanterminateit,andlatersueforbreach;thisistrue,however,onlywherenoticeof
the breach has been given to the other side. Natl Westminster Bank, U.S.A. v. Ross, 130 B.R. 656, 675
(S.D.N.Y.1991),affdsubnom.Yaegerv.NatlWestminster,962F.2d1(2dCir.1992).Butcf.Citibank,No.08
CV01563, 2009 WL 311362, at *2 (S.D.N.Y. Jan. 29, 2009) (denying motion for reconsideration; VCGs
hindsightexplanationsforwhyitfailedtoobjecttothecollateraldemandsdonotconstitutenoticeofa
breachtoCitibank.NeitherdoVCGsattemptstointroduceexpertdiscoverytodemonstratethatISDA
documentshavenotcaughtupwiththesubstanceofthetransactionatissue.).
4544SeesupraatIII.A.5.b.1.
4545Citibank,2009WL311362,at*2.
1223

waived the right to assert such a claim by complying with the collateral requests
withoutassertingabreach,andbyacceptingbenefitsfromJPMorgan.
c) LehmansDealingsWithCitigroup
This Section analyzes Lehmans relationship with Citigroup, Inc., another of its
clearing banks, and certain of its subsidiaries and affiliates (Citi or Citibank),
focusingpredominantlyonthepartiesinteractionin2008.
(1) Facts
(a) CitigroupProvidedContinuousLinkedSettlementService
andOtherClearingandSettlementOperationstoLehman
CitigroupprovidedawidearrayoffinancialservicestoLehman,includingthe
establishmentandmaintenanceofcashdepositandcustodialaccounts,theprovisionof
creditfacilities,tradeclearingandsettlementservices,agencyandtrustservices,foreign
exchangerelatedservices,andsecuritieslending.4546
(i) BackgroundInformationontheContinuousLinked
SettlementServiceCitiProvidedtoLehman
Citibank, N.A. (London) was the Designated Settlement Member on the CLS
system for Lehmans brokerdealer, LBI, and three other Lehman subsidiaries.4547 The
4546StatementofCitigroup,Inc.inSupportofMotionofDebtorsforOrder,PursuanttoSection105ofthe
BankruptcyCode,ConfirmingStatusofCitibankClearingAdvances,atp.2(1),DocketNo.110,Inre
Lehman Bros. Holdings, Inc., No. 0813555 (Bankr. S.D.N.Y. Sept. 18, 2008). In addition, Citi was
counterparty to some Lehman entities in connection with thousands of trading positions under
numerous financial contracts such as interestrate and foreignexchange swap agreements, securities
contracts,andrepurchaseagreements.Id.
4547MotionofDebtorsforOrder,PursuanttoSection105oftheBankruptcyCode,ConfirmingStatusof
CitibankClearingAdvances,Ex.A,DocketNo.109,InreLehmanBros.Holdings,Inc.,No.0813555(Bankr.
S.D.N.Y. Sept. 18, 2008). The LBICitibank CLS relationship was established by a CLS Settlement
1224

CLSsystemisatradingplatform,operatedbyaconsortiumofbanks,fortheclearance
and settlement of foreign exchange (FX) trades.4548 Approximately 80 percent of
LehmansFXtradeswentthroughCLS.4549
In the CLS community, Lehman was a shareholder and user member, while
Citi was Lehmans settlement member.4550 As a user member of the CLS system,
LehmanreliedonCititoexecuteFXtradesintheCLSsystembymakingpaymentsto
the CLS Bank4551 at scheduled times throughout the day.4552 Each member submitted
trades on a gross basis, and the system then determined a payment schedule setting
forth net amounts companies had to pay in at certain times and for various
currencies.4553 By executing Lehmans FX trades in the CLS system, Citi indicated its
acceptanceofthosetrades,extendedintradaycredittotheLehmanentity,andassumed
Services Agreement for CLS User Members dated December 19, 2003. Id. at p. 1. This CLS clearance
agreement was amended and restated in a Citibank CLS Settlement Services Amended and Restated
AgreementforCLSUserMembersdatedOctober28,2004.Id.ReferencestotheCLSAgreementrefer
totheAgreementasamendedandrestated.
4548SeeCLS,AboutCLS,http://www.clsgroup.com/About/Pages/default.aspx(lastvisitedDec.23,2009).
4549ExaminersInterviewofJonathanD.Williams,Aug.5,2009,atp.6.
4550Id. at p. 5. A settlement member has a single multicurrency account with CLS Bank and may
submit payment instructions relating to its own FX transactions in addition to FX transactions of its
customers.SeeCLS,OurCommunity,http://www.clsgroup.com/About/Community/Pages/default.aspx
(lastvisitedDec.30,2009).Ausermember,ontheotherhand,doesnothaveanaccountwiththeCLS
Bank and must submit its payment instructions through its settlement member. Id. The settlement
member must then authorize the user members instruction, at which point, the settlement member
becomesresponsibleforallfundingobligationsrelatedtotheusermembersinstructions.Id.
4551CLSBankisownedbytheforeignexchangecommunityandoperatesthelargestmulticurrencycash
settlement system. CLS, About CLS, http://www.clsgroup.com/About/Pages/default.aspx (last visited

Dec.23,2009).
4553Id.
1225

a corresponding amount of intraday risk in connection with that credit.4554 After Citi
authorizedLehmanspaymentinstructions,CitiwasobligatedtosettleallofLehmans
currencypaymentstotheCLSBank.4555
ThetimingforpaymentstotheCLSBankwassuchthatCitispaymentsintothe
system on Lehmans behalf preceded currency funding and payment cutoff times,
which meant that Citi often had to pay the CLS Bank monies Lehman owed before
Lehman received funds from nonCLS settlement trades.4556 For instance, Citi paid
Japanese Yen to the CLS Bank for Lehmans obligations well before Citi received U.S.
dollarsintoLehmansaccounts,thusleavingCitiatriskfortheJapaneseYenamountif
LehmansU.S.dollarfundsdidnotcomein.4557Priorto6:00p.m.NewYorktimeeach
business day, Citi had the option of not settling the CLS transactions, but, after 6:00
p.m.,CitiwasirrevocablycommittedtosettletheCLStransactions.4558Typically,Citi
4554Id.; see also Lehman, Citibank Clearing and Intraday Credit (June 17, 2008), at p. 1
[LBHI_SEC07940_745595].
4555Lehman,CitibankClearingandIntradayCredit(June17,2008),atp.1[LBHI_SEC07940_745595].
4556Id.atp.2.
4557EmailfromMichaelMauerstein,Citigroup,toThomasFontana,Citigroup,etal.(June17,2008)[CITI
LBHIEXAM00073791];seealsoemailfromJuliusSilbiger,Citigroup,toThomasObermaier,Citigroup,et
al.(Sept.9,2008)[CITILBHIEXAM00065668](explainingthatJapaneseYenhadbeenreleasedlatethat
day and all other Asian Currencies had been approved for release, creating a daylight overdraft limit
overdraft of$1.4 billion which wasscheduled to berepaid laterin the day on September10 when U.S.
dollarscamein).
4558Citigroup,OverviewofGTSClearingandSettlementLines(Sept.4,2008),atp.4[CITILBHIEXAM
00102127].
1226

receivedanoverviewofthenextdaysanticipatedCLSpaymentflowsby6:30p.m.the
previousevening.4559
AspartofitsFXbusinessontheCLSsystem,Lehmanconsolidateditscurrency
specificnostroaccountswithCiti.4560Anostroaccountisanaccountonebankholds
withabankinaforeigncountry,usuallyinthecurrencyofthatforeigncountry.4561For
instance,a LehmanJapaneseYen nostro accountwouldexist at Citi in Tokyobecause
thepaymentsandreceiptsoccurredduringTokyobusinesshours.4562Attheendofthe
day, the nostro accounts should have had a zero balance because the accounts were
usedtofacilitatepurchasesandsaleswhereLehmanwouldbuyJapaneseYenfromone
entityandselltheJapaneseYentoanotherentityinthesameday.4563
ProvidedtoLehman
Citi provided other clearing and settlement services to Lehman in addition to
CLS. Citi served as Lehmans primary cash clearer and a significant provider of
custody and clearing services in emerging markets, as well as a provider of those
services in the United States.4564 Citi Direct Custody and Clearing facilitated
4559EmailfromJanetBirney,Lehman,toRobertEby,Lehman,etal.(Sept.10,2008)[LBEXAM008560].
4561See InvestorWords.com, Nostro Account, http://www.investorwords.com/3348/nostro_account.html

(lastvisitedDec.23,2009).
4563Id.
1227

internationalclearingandsettlementofsecuritiestransactions.4565Occasionally,Citihad
to extend intraday credit to pay out cash or transfer securities in connection with
securities transactions on behalf of Lehman if insufficient funds or securities were
availableinLehmansaccountatthetimewhenpaymentswererequired.4566
As Lehmans cash clearer in emerging markets and in the United States, Citi
provideduncommittedclearinglines,whichmeantthelinescouldbecancelledatCitis
discretion.4567Generally,CitiexpectedLehmantocovertheintradaycreditextendedby
thedaysendinNewYork.4568
As of May 31, 2008, Citi provided Lehman with substantial clearing lines to
supportthebusinessLehmantransactedonCitisGlobalTransactionServicesSecurities
and Cash Clearing business.4569 Among the 26 countries in which Citi extended a
clearinglinetoLehmanwere:theUnitedKingdom($6.3billion),theUnitedStates($5.9
billion),Italy($3.1billion),Japan($1.8billion),Canada($500million)andMexico($500
million).4570AsLehmansGlobalTransactionServicesclearingagent,Citiservedasan
00102127].
4566Id.
4567Id.atp.5.
4568SeeemailfromJuliusSilbiger,Citigroup,toThomasObermaier,Citigroup,etal.(Sept.9,2008)[CITI
LBHIEXAM 00065668] (concerning intraday credit limit overdraft created by processing payments of
JapaneseYenonLehmansbehalfwouldberepaidbyU.S.dollarslaterinthedayonSeptember10).
4569Citigroup, Lehman Brother Holding Inc. (Exposure Summary) (as of May 31, 2008), at p. 1 [CITI
LBHIEXAM00110721].
4570Id.
1228

intermediary between Lehman and its trade counterparties, acting as both buyer and
sellerforthesecuritiestrades.
(iii) CitisClearingandSettlementExposuretoLehman,
Generally
AsofmidJune2008,Lehmanhadapproximately487bankaccountswithCitiin
the United States, Europe and Asia.4571 By then, Citi had pared back to $3 billion the
intradaycredit amounts provided in the aggregate for CLS and nonCLS eligible
currencies, $3 billion for U.S. dollar clearing and $1.2 billion for Asian currencies.4572
These aggregate intradaycredit allotments were divided among various Lehman
facilitiesandsubsidiaries.4573Inordertoexceedthesetcreditlimits,anexcessapproval
request had to be submitted to Citi Risk personnel in the New York office; local Citi
personnel outside of New York did not have the authority to authorize a Lehman
transactiontobepaidifitexceededtheestablishedcreditlimit.4574
4572Id.
4573See
email from Risk Systems Support Europe group, Citigroup, to CMB CRMS LatAm group,
Citigroup(Sept.9,2008)[CITILBHIEXAM00007751](LehmanBrothersIncorporatedhada$10million
settlement risk limit for its Chile unit); email from Risk Systems Support Europe group, Citigroup, to
CMB CRMS Asia group, Citigroup (Sept. 9, 2008) [CITILBHIEXAM 00006741] (Lehman Brothers
SecuritiesTaiwanhadadirectrisklimitofapproximately$10millionthroughCiti).
4574Examiners Interview of Christopher M. Foskett, Sept. 24, 2009, at p. 7; see also email from Thomas
Fontana, Citigroup, to Anna Jankowiak, Citigroup, et al. (June 26, 2008) [CITILBHIEXAM 00042270]
(Fontanaapproveda$6.2millionexcessforaLehmanBrothersRR3transaction);emailfromMelissaJ.
Torres,Citigroup,toAnnaJankowiak,Citigroup,etal.(July2,2008)[CITILBHIEXAM00042500](Torres
approveda$1.3millionexcessforaLehmanBrothersRR3transaction).
1229

AccordingtoofficialsatCiti,Lehmanrarelymadeitthroughadayinthespring
of2008withoutbeingoverdrawnatsomepoint.4575AccordingtoLehman,itexceeded
itsCLSintradaycreditlinebecauseofanimbalancebetweenCLSandnonCLStrades,
which,oncerealized,LehmanwasabletomonitorandcontrolbetterbyhavingitsFX
desktradeinoroutofCLSasnecessary.4576FollowingdiscussionswithLehmaninJune
2008,CitianalyzedLehmansusageofthedaylightoverdraftlimitduringtheweekof
June23toJune27,2008.4577BecauseCitididnothavethetechnologytosystemically
track intraday exposure, Citi created a manual process through which local Citi staff
physically noted Lehmans cash and securities overdraft positions on an hourly basis
over those five days.4578 The exercise was carried out in seven major markets that
accountedfor94percentofLehmansclearinglineswithCiti.4579However,themanual
natureoftheprocessmadeitpronetohumanerror.4580Nevertheless,Citicametothe
conclusion through this exercise that Lehmans average daily daylight overdraft limit
usage for cash and securities clearing combined ranged from $1.457 billion to $2.53
4575Email from Thomas Fontana, Citigroup, to Christopher M. Foskett, Citigroup, et al. (July 11, 2008)
[CITILBHIEXAM 00076243] (noting that that day was the first time in more than three months that
Lehmanwasnotoverdrawnatall);seealsoemailfromKatherineLukas,Citigroup,toSeamusKennedy,
Citigroup,etal.(May2,2008)[CITILBHIEXAM00023281](reportingLehmanusedthefullCLSclearing
lineof$3billionandexceededthatlimitonaregularbasis).
4577Citigroup Global Transaction Services Risk Management, Lehman: Intraday (DOL) Usage Profile
(July2,2008),atp.2[CITILBHIEXAM00107335].
4578Id.
4579Id.
4580Id.
1230

billion, while Lehmans actual minimum usage of the daylight overdraft limit was
$7.741millionandtheactualmaximumusagewas$10.354billion.4581
(iv) TheTermsofLehmansCLSAgreementwithCiti
LBI and Citibank, N.A. (London) entered into a CLS Settlement Services
Agreement for CLS User Members on December 19, 2003, and later agreed to the
Citibank CLS Settlement Services Amended and Restated Agreement for CLS User
Members(AgreementorCLSAgreement)onOctober28,2004.4582Forpurposesof
the issues analyzed by the Examiner, the October 28, 2004 version governs.4583 The
Agreement lists Lehman Brothers Commercial Corporation (LBCC) as a Permitted
Affiliate,whichmeantthatLBIcouldsubmitCLStransactioninstructionsonbehalfof
LBCCaswellasitself.4584InadditiontoLBCC,LehmanBrothersSpecialFinancingInc.
(LBSF)andLehmanBrothersInternational(Europe)(LBIE)wereaddedasaffiliates
onNovember8,2007.4585
4581Id.atp.6.Citialsomeasuredthepotentialmaximumusageforcashandsecuritiesclearingcombined
at $17.654 billion. Id.; see also email from Vivek Tyagi, Citigroup, to Thomas Fontana, Citigroup, et al.
(July2,2008)[CITILBHIEXAM00107333](statingtherewasahighdegreeofvolatilityovertheweek
thatCitiperformedthisexercise).
CitibankClearingAdvances,Ex.Aatp.1,DocketNo.109,InreLehmanBros.Holdings,Inc.,No.0813555
(Bankr.S.D.N.Y.Sept.18,2008).
4583Id.(specifyingthattheOriginalAgreementisherebyamendedandrestatedinitsentirety).
4584Id.atpp.1,1213.
4585Id.;MotionofDebtorsforOrder,PursuanttoSection105oftheBankruptcyCode,ConfirmingStatus
of Citibank Clearing Advances, Ex. B at p. 1, Docket No. 109, In re Lehman Bros. Holdings, Inc., No. 08
13555(Bankr.S.D.N.Y.Sept.18,2008).ThesefourLehmanentitiesaretheonlyentitiesthatagreedtothe
terms of the CLS Agreement. Motion of Debtors for Order, Pursuant to Section 105 of the Bankruptcy
Code,ConfirmingStatusofCitibankClearingAdvances,Ex.Aatpp.1,12,DocketNo.109,InreLehman
Bros.Holdings,Inc.,No.0813555(Bankr.S.D.N.Y.Sept.18,2008);MotionofDebtorsforOrder,Pursuant
1231

UndertheCLSAgreement,LBIcouldsubmittransactioninstructionsforitselfor
the three Lehman affiliates either directly to the CLS Bank or through Citi.4586 As
Lehmans Designated Settlement Member, Citi had to authorize the transaction
instructions that LBI submitted directly to the CLS Bank, and the decision whether to
provide such authorization was to be made in Citibanks sole discretion.4587 By
authorizing a transaction in the CLS system, Citibank necessarily assume[d] a credit
exposuretoCLSBankonLehmansbehalf.4588Further,theAgreementprovides:
Unless Citibank has expressly agreed in writing to a committed credit

facility and received a commitment fee therefore, any extension of credit
onbehalfoftheCustomeroraPermittedAffiliateiswithinCitibankssole
discretionandmaybechangedordiscontinuedatanytimewithoutprior
notice,notwithstandinganyotherprovisionofthisagreement,provided,
however, that Citibank may not without Customers consent, cancel or
rescindanyinstructionthatCitibankhaspreviouslyauthorized.4589
While the Agreement provided that Lehman could terminate the Agreement at
anytime,theAgreementrequiredthatCitibankprovide90dayswrittennoticebeforeit
could terminate the Agreement as a whole or with respect to any Permitted
toSection105oftheBankruptcyCode,ConfirmingStatusofCitibankClearingAdvances,Ex.Batp.1,
Docket No. 109, In re Lehman Bros. Holdings, Inc., No. 0813555 (Bankr. S.D.N.Y. Sept. 18, 2008); see also
LetterfromCitibank,N.A.,toLehmanBrothersInc.,etal.,re:CLSSettlementServicesAgreement(Sept.
15,2008),atp.2[LBEXDOCID462068](terminatingtheCLSAgreementwithLBI,LBCC,LBSFandLBIE
ontheafternoonofSeptember15).
CitibankClearingAdvances,Ex.Aatp.2(1),DocketNo.109,InreLehmanBros.Holdings,Inc.,No.08
13555(Bankr.S.D.N.Y.Sept.18,2008).TheCLSAgreementalsoholdsLBIresponsibleforanytransaction
submittedbyanaffiliateevenifthataffiliateisnotaPermittedAffiliate.Id.
4587Id.
4588Id.atp.3.
1232

Affiliate.4590 However, Citibank reserve[d] the right to terminate this Agreement
immediately, without notice in other instances, including in the event of: (1) a
Default;4591 (2) a bankruptcy, reorganization or receivership against any of the
Transaction Parties or parent corporation; or (3) upon the occurrence of a material
adversechangeinthefinancialorotherconditionofaTransactionParty.4592Paragraph
8oftheAgreementspecifiesthatthelawsofEnglandgoverntheAgreement.4593
(b) LehmanProvideda$2BillionCashDepositwithCition
June12,2008ToSupportitsClearingNeeds
Following the near collapse of Bear Stearns in March 2008, Lehmans second
quarter2008earningspreannouncementonJune9ofa$2.8billionloss,andLehmans
announced changes in uppermanagement on June 12, Citibank requested a comfort
depositfromLehmantohelpcoverCitisriskexposure.4594Consequently,onJune12,
4590Id.atp.6(6:Termination).
4591Asdefinedin6oftheCLSAgreementaneventofDefaultwithrespecttoaTransactionPartyshall
exist immediately upon the occurrence of any of the following events with respect to that Transaction
Party: (i) Transaction Party fails to make any payment to Citibank to fund a short balance of such
TransactionPartyinanycurrencybytheapplicablecutofftime;(ii)TransactionPartyhasbreachedany
obligation hereunder to make any payment other than a payment covered by (i) by the applicable due
date and fails to remedy such default within ten (10) days after Customers receipt of notice from
Citibank advising Transaction Party of such failure to pay; or (iii) Transaction Party has breached any
materialobligationhereundernotcoveredby(i)or(ii)andfailstoremedysuchdefaultwithinthirty(30)
daysafterCustomersreceiptofnoticefromCitibankdetailingthenatureoftheclaimedbreach.Id.A
TransactionPartyisdefinedastheCustomerorthePermittedAffiliateonwhosebehalfaninstruction
issubmittedwithrespecttoatransactiontowhichitisacounterparty.Id.atp.2(1).
4592Id.atp.6(6).
4593Id.atp.9(8).
4594Email from Brian R. Leach, Citigroup, to Vikram S. Pandit, Citigroup, et al. (June 12, 2008) [CITI
LBHIEXAM 00114115] (stating that Citi initially asked for $3 billion segregated but Lehman sent $2
billioninacallaccount).
1233

Lehmanposteda$2billiondepositinanovernightcallaccountwithCiti.4595Citiand
Lehman had discussions for the next several months regarding Lehman pledging
securitiestocoverintradayrisk,butaformalpledgeagreementwasneverexecuted.4596
Instead, on September 9, 2008, Lehman signed an amendment to its 2004 Guaranty
Agreement,4597 adding nine subsidiaries to its holding company guaranty and an
additionalsubsidiaryonSeptember11.4598Additionally,onSeptember12,Lehmanand
CitiamendedtheirDSCA,4599whichgaveCitistrongerrightsovertheassetsitheldfor
Lehman.4600
4595EmailfromDanielJ.Fleming,Lehman,toIanT.Lowitt,Lehman(June12,2008)[LBEXAM008608].
4596See email from Thomas Fontana, Citigroup, to Christopher M. Foskett, Citigroup (Sept. 10, 2008)
[CITILBHIEXAM 00075863] (discussing how Citi spent two months negotiating the collateral
arrangement and should have had it completed long ago instead of the fire drill of getting the
GuarantyAmendmentonSeptember9).
4597Guaranty(Jan.7,2004)[LBEXDOCID1090071].
4598SeeAmendment1ToGuaranty(Sept.9,2008)[LBEXDOCID090568](executedversionsignedbyIan
Lowitt and adding LBCC on September 11, 2008). Even though LBCC was added to the Guaranty
Amendment on September 11, the executed document retains September 9, 2008 as the amendment
datespecifiedinthetext.Assuch,referencesinthisReporttotheSeptember9GuarantyAmendment
refertotheamendmentaseffectiveontheeveningofSeptember11withLBCCadded.
4599TheDCSAisalternativelytitledtheDirectCustodyAgreement(DCA)inthedocumentsignedon
March26,1992,andreferredtoastheDCSAintheSeptember12,2008amendment.However,theDCA
and DCSA are the same document, amended by the Deed addendum on September 12, 2008. For
consistency, the Examiner refers to the 1992 version as the DCSA, or original DCSA, and the 2008
version as the DCSA Amendment. See Direct Custodial Services Agreement Deed (Sept. 12, 2008)
[LBEXDOCID 4263617] (referring to the DCSA entered into by LBI, then known as Shearson Lehman
Brothers Inc., and Citibank on March 26, 1992), and Direct Custody Agreement for Citibank, N.A.,
SubsidiariesandAffiliatesandShearsonLehmanBrothersInc.(Mar.26,1992)[LBEXDOCID1091570].
4600DirectCustodialServicesAgreementDeed(Sept.12,2008),atp.2[LBEXDOCID4263617].
1234

DepositonJune12
InMarch2008,afterthenearcollapseofBearStearns,counterpartiesandclearing
banks turned their attention to those brokerdealers regarded as the nextmost
vulnerable.LBI,asthenextsmallest,withitslargeleverageratiosandrealestateheavy
balance sheet at the parent company level, was widely viewed as particularly
vulnerable.4601
In addition, in a June 5, 2008 meeting with Citi, Lehman previewed its second
quarter earnings announcement, disclosing an anticipated $2.6 billion loss.4602
Subsequently, Lehmans thenCFO Callan formally delivered the earnings
announcementonJune9duringapreannouncementcall,whereshereportedanofficial
lossamountof$2.8billion.4603Themarketreactednegatively,andLehmanlostfurther
credibilityinthemarketwhenitalsoannounceda$6billionequitycapitalraiseonJune
94604eventhoughCallanhadstatednumeroustimes,includingonFebruary6,2008,that
4601JennyAnderson,AtLehman,AllayingFearsAboutBeingtheNexttoFall,N.Y.Times,Mar.18,2008.
4602Lehman, Q2 2008 Update (June 4, 2008), at p. 2 [CITILBHIEXAM 00078768]; email from Michael
Mauerstein, Citigroup, to Christopher M. Foskett, Citigroup, et al. (June 4, 2008) [CITILBHIEXAM

00081461](describingtheagendafortheJune5meetingasincludingalookatLehmanssecondquarter
results).
4603Preliminary 2008 Lehman Brothers Holdings Inc. Earnings Conference Call Final, Fair Disclosure Wire,
June9,2008.
4604Id. The $6 billion capital raise was comprised of $4 billion of common equity and $2 billion of
mandatorilyconvertiblepreferredstock.Id.
1235

Lehmanhadnointerestinraisingnewcommonequitycapital.4605Lehmanannounced
onJune12thatCallanandGregoryhadbeendismissedfromtheirpositions,although
CallanremainedatLehmaninaninvestmentbankingposition4606untilsheresignedin
midJuly2008.4607
Thus,asaresultofLehmansrapidlydecliningstockprice,andnegativemarket
reactionstoLehmansearningspreannouncementandchangesinuppermanagement,
Citi experienced a threefold increase in novation requests on June 124608 for a total of
approximately 26 novation requests to trade out of Lehman that week.4609 Typically,
when a novation would occur, Citi would step in to face Lehman in place of one of
4605Lehman Brothers Holdings Inc. at Credit Suisse Group Financial Services Forum Final, Fair Disclosure
Wire, Feb. 6, 2008 (We have no interest and someone may ask me this question at some point, in
raising new common equity capital.); see also Citigroup, Initial Classification Memorandum (June 13,
2008), at p. 1 [CITILBHIEXAM 00051049] (noting that Lehmans management teams credibility
howeverhascomeunderfirewith3additionalcapitalraisessinceJanuaryafterthecompanyindicatedit
didnotneedanymoreafterthefirstonewhenCallansaidinMarch2008thatLehmanwouldnotneed
to raise additional capital after raising $1.9 billion in February, but had since raised an additional $10
billioninfreshcapital).
4606AlistairBarr,etal.,LehmanCFOCallan,COOGregoryoustedfromposts,MarketWatch,June12,2008.
4607JennyAnderson,DemotedLehmanOfficerLeavesforCreditSuisse,N.Y.Times,July16,2008,availableat
http://www.nytimes.com/2008/07/16/business/16lehman.html(lastvisitedDec.23,2009).
4608Lehman,CITIGROUPCallReport(June17,2008),atp.1[LBEXAM008578](summarizingremarks
madebyCitiCROBrianLeachinaJune17,2008meetingwithLehmanthatCitibeganreceivingthree
times the number of novation requests (on average 6) starting in Asia on June 12) (attached to email
fromEmilF.Cornejo,Lehman,toJulieM.Boyle,Lehman,etal.(June20,2008)[LBEXAM008577].
4609Email from Thomas Fontana, Citigroup, to Brian R. Leach, Citigroup, et al. (June 16, 2008) [CITI
LBHIEXAM00115773].Fontanaidentifiedthecounterpartieswhorequestednovationsduringtheweek
ofMondayJune9:Putnam(15trades),GSAM(4),BOA(2),KingStreet(2),Elliot(2)andCitadel(1).Id.
Additionally,FontanastatedthatBracebridgenovatedninetradestoCitiduringtheweekofJune2,and
otherLehmancounterpartieswhosoughtnovationsoutofLehmanintheprecedingfewweeksincluded
MetWest,PIMCOandING.Id.;seealsoemailfromPaoloR.Tonucci,Lehman,toIanT.Lowitt,Lehman,
et al. (June 12, 2008) [LBEXDOCID 458725] (Lehman was informed that Citi Asia refused to take a
novationonanIndonesiacreditdefaultswap).
1236

Lehmanscounterpartieswhowantedoutofthetransaction.4610Inthefirsthalfof2008,
Citihadacceptedatotalofapproximately1100novationrequestsindustrywide,where
the average notional value per trade was just under $10 million4611 and the average
monthly total was $34 billion.4612 Approximately 90 percent of the novation requests
Citi received involved credit default swaps.4613 Citibank Global Financial Institutions
Risk Management Risk Officer Thomas Fontana, in an internal June 12 Citi email
exchange,stated:
Fuld oust[ed the] CFO and COO.... We have cut back clearing lines in
Asia.... This is bad news. Market is saying Lehman can not make it
alone. Loss of confidence here is huge at the moment. We are seeing
novationsandarepassingonthem!4614
Inalateremailinthesamechain,FontanawrotethatCitisinternalteamhas
lostcompleteconfidence[inLehman].Notellingwhatwillhappen.4615Citiwasloath
to reject these counterparty requests, but desired additional security for the increased
4610Anovationisdefinedasanagreementtochangeacontractbysubstitutingathirdpartyforoneof
the two original parties. See BNET Business Dictionary, Business Definition for: Novation,
http://dictionary.bnet.com/definition/novation.html.
4611Email from Thomas Fontana, Citigroup, to Paolo R. Tonucci, Lehman, et al. (June 20, 2008) [LBEX
DOCID038249].The1100novationswerenotLehmanspecific.Seeid.
4612Email from Thomas Fontana, Citigroup, to Brian R. Leach, Citigroup, et al. (June 16, 2008) [CITI
LBHIEXAM00115773].
4613Id.
4614Email from Thomas Fontana, Citigroup, to Christopher M. Foskett, Citigroup, et al. (June 12, 2008)
[CITILBHIEXAM00072923].
4615Id.;ExaminersInterviewofChristopherM.Foskett,Sept.24,2009,atp.3(explainingthatonlyafew
peopleonFontanasinternalteamhadlostconfidence,nottheentireCititeam).
1237

risk exposure it faced in novating these trades.4616 That day, Citi turned down a
numberoftradeswithclientsdesiringtonovateovertothem.4617
Laterthatday,CitirequestedthatLehmandeposit$35billiontocoverintraday
exposures or end of day shortages.4618 The documents suggest that Citi and Lehman
negotiated the deposit amount: Fontana reported internally at Citi that Citi made a
requestfor$5Binacashdeposit,4619FleminginformedLowittbyemailthatCitiwas
seeking a $3 billion cash deposit to cover intraday exposures,4620 but, later that day,
[CITILBHIEXAM00106013](Fontanawrote[a]fterspeakingwiththeCFOandTreasurer[ofLehman],
wemadearequestfor$5BinacashdepositandnotedthatCitihadturneddownanumberoftrades
with clients desiring to novate over to Citi); see also email from Jasmin Herrera, Lehman, to Emil F.
Cornejo, Lehman (June 16, 2008) [LBEXAM 008659] (attached memorandum summarizes the cash
deposit negotiations from Lehmans perspective); Jasmin Herrera, Lehman, Global Creditor Relations
HighlightsCitigroup(June16,2008),atp.1[LBEXAM008660]).Thememorandumstatesthat,[u]ntil
June 12, 2008, Citi has consistently been Lehmans strongest provider of credit. However, due to a
substantialincreaseinnovationrequestsfromcounterparties,Citirequestedthatwecollateralize$3$5B
in intraday exposure. Lehman declined, but did agree to a $2B term deposit, callable daily. Jasmin
Herrera, Lehman, Global Creditor RelationsHighlights Citigroup (June 16, 2008), at p. 1 [LBEXAM
008660];seealsoemailfromChristopherM.Foskett,Citigroup,toJohnP.Havens,Citigroup,etal.(June
12,2008)[CITILBHIEXAM00026400](Foskettwrotethathehadbeenonthephonethatmorningwith
LowittandTonucci,andthatheaskedLehmantoputupacashdeposittokeepourclearingcapabilities
atlevelstheyrequiretoefficientlyoperate).
LBHIEXAM00114272];emailfromThomasFontana,Citigroup,toBrianR.Leach,Citigroup,etal.(June
12,2008)[CITILBHIEXAM00114466].
LBHIEXAM 00114115] (stating that Citi initially asked for $3 billion segregated but Lehman sent $2
billion in a call account). But see email from Thomas Fontana, Citigroup, to Christopher M. Foskett,
Citigroup, et al. (June 12, 2008) [CITILBHIEXAM 00106013] (Fontana wrote that Lehman asked for $5
billioninacashdeposit);JasminHerrera,Lehman,GlobalCreditorRelationsHighlightsCitigroup(June
16, 2008), at p. 1 [LBEXAM 008660) (stating that Citi asked Lehman to collateralize $35 billion in
intradayexposure).
1238

LBHI agreed to deposit a $2 billion comfort deposit with Citibank.4621 Some within
Citiquestionedwhetherthiswastherightthingtodo,4622whileothersviewedLehmans
$2 billion cash deposit as necessary for Citi to continue to do business with them
thatsjustforustokeepansweringthephonesiftheycall.4623
Citi had received a similar deposit from Bear Stearns during the summer of
2007.4624 According to Michael Mauerstein, Citis Managing Director of the Financial
InstitutionsBrokerDealersGroup,Citismotivationinseekingthecomfortdeposit
from Lehman was grounded mainly in concerns aboutoperational efficiency, but also
due,toalesserextent,toconcernsaboutLehmansstability.4625WhenMauersteinmet
withLehmansEmilCornejo(SeniorVicePresidentTreasury),JulieBoyle(SeniorVice
PresidentinCommercialBankandGlobalCreditorRelations)andJanetBirney(Global
Head of Network Management) on the evening of June 12, they informed Mauerstein
thatCitiwastheonlybanktobotherthemthatday.4626
4622EmailfromVikramS.Pandit,Citigroup,toLewisKaden,Citigroup,etal.(June12,2008)[CITILBHI
EXAM00114272].
4623Email from Stephen G. Malekian, Citigroup, to Sanjay V. Reddy, Citigroup, et al. (June 14, 2008)
4624Email from Christopher M. Foskett, Citigroup, to John P. Havens, Citigroup, et al. (June 12, 2008)
4625ExaminersInterviewofMichaelMauerstein,Sept.16,2009,atpp.2,4.
4626Email from Michael Mauerstein, Citigroup, to Christopher M. Foskett, Citigroup (June 12, 2008)
1239

Initially, Citibank had asked for a pledge of cash or the right of setoff on
collateral rather than just a cash deposit,4627 but Lehman refused that request because
Lehman did not want to reduce the size of its liquidity pool, as Tonucci and Cornejo
were concerned about keeping the liquidity pool at a high reported level.4628 In
addition, Citi expressed its concern to Lehman that such a collateral pledge might
triggerarequirementthatLehmanreportthetransactionbyfilingan8Kformwiththe
SEC.4629 Cornejo asked Citi to consider higher yielding alternatives to the overnight
accountintowhichCitisFundsdesksweptLehmansdeposit,asthesweeppaidabout
20 to 30 basis points below what Lehman earned on its money market funds.4630
However, Lehman officials indicated numerous times that they would not encumber
thedeposit,evenifsuchanencumbrancewouldearnthemahigherinterestrateonthe
deposit.4631 Citi understood that Lehman wanted to keep the $2 billion deposit an
4627Lehman,CitigroupAgenda(June17,2008),atp.2[LBEXAM008597].
4628ExaminersInterviewofThomasFontana,Aug.19,2009,atp.5.
4629EmailfromMichaelMauerstein,Citigroup,toThomasFontana,Citigroup,etal.(July12,2008)[CITI
LBHIEXAM 00076243] (Mauerstein conveyed his opinion that Lehman would not agree to grant
collateralattheTreasurerlevelbecausegranting$2billionincollateralwilllikelybean8Keventand
thereforeaCEOdiscussion);emailfromEmilF.Cornejo,Lehman,toPaoloR.Tonucci,Lehman,etal.
(July 13, 2008) [LBHI_SEC07940_528212] (Cornejo stated that Mauerstein opined that a pledge of this
sizewouldprobablybeareportableevent).An8Kisthecurrentreportcompaniesmustfilewiththe
SEC to announce major events that shareholders should know about. See SEC, Form 8K, available at
http://www.sec.gov/answers/form8k.htm.
4630EmailfromMichaelMauerstein,Citigroup,toChristopherM.Foskett,Citigroup,etal.(June17,2008)
[CITILBHIEXAM00073732](reportingthatLehmanindicateditwillnotencumberthedeposit);email
fromChristopherM.Foskett,Citigroup,toThomasFontana,Citigroup,etal.(July14,2008)[CITILBHI
EXAM 00076293] (recapping conversation where Lowitt conveyed concern about not wanting to tie up
Lehmansliquidityunnecessarily);emailfromEmilF.Cornejo,Lehman,toJosephIgoe,Lehman(July4,
1240

overnightdeposittohavemaximumliquidity,4632andLowittexplainedtoChristopher
Foskett (Managing Director, Global Head of Citis Financial Institutions Group) that
LehmanwaswillingtoworkoutasolutiontoCitisintradaycreditconcerns,solongas
thesolutiondidnottieupLehmansliquidityunnecessarily.4633
Throughout the summer, after Lehman posted the $2 billion cash deposit,
Lehman proposed several alternatives to the cash deposit in an effort to, inter alia,
protect the deposit from a Citi insolvency.4634 Lehman considered the $2 billion cash
deposittobeadirectexposuretoCitibecauseLehmansexposurewasrollingintraday
and not one consistent exposure.4635 According to Mauerstein, Tonucci proposed
giving Citi a cash deposit each morning in anticipation of clearing and getting that
deposit back each evening when Lehman closed flat, i.e., without any overdrafts.4636
Cornejo proposed not leaving a deposit with Citi, which would have caused Citi to
reduceLehmansdaylightoverdraftlimitstozero,promptingLehmantouseitscashas
2008) [LBEXDOCID 1078431] (Cornejo explains that Lehman could make the cash deposit a time
deposit,butsteveneedstokeepthedepositliquid).
4632EmailfromMichaelMauerstein,Citigroup,toChristopherM.Foskett,Citigroup(July10,2008)[CITI
LBHIEXAM00076191].
4633Email from Christopher M. Foskett, Citigroup, to Thomas Fontana, Citigroup, et al. (July 14, 2008)
[CITILBHIEXAM 00076293] (summarizing conversation in which Lowitt conveyed concern about not
wantingtotieupLehmansliquidityunnecessarily).
4634EmailfromMichaelMauerstein,Citigroup,toChristopherM.Foskett,Citigroup,etal.(July21,2008)
[CITILBHIEXAM00082127].Specifically,TonuccisoughttoensurethatanysecuritiesLehmanpledged
wouldberemotefromaCitibankinsolvency.Id.
4635KatherineLukas,Citigroup,UnpublishedNotes(July10,2008),atp.36[CITILBHIEXAM00110294]
(contemporaneoushandwrittennotes).
LBHIEXAM00018024](conveyingtopicsdiscussedduringaconversationMauersteinhadwithTonucci).
1241

working capital during the day in lieu of Citi extending intraday credit to Lehman.4637
Yet another proposal from Tonucci was for Lehman to put up securities that would
applyonlytooutstandingclearingexposure,withtheunderstandingthatthesecurities
wouldonlybepledgedwhenLehmanactuallyhadoutstandingclearingexposure.4638
None of these alternatives were ever implemented, nor does it appear any of these
alternativesadvancedbeyondpreliminarydiscussions.4639
(ii) ThePartiesDidNotSharetheSameUnderstandingof
theTermsofthe$2BillionCashDeposit
Citi required the deposit in order to continue clearing and settling trades for
Lehman; if Lehman failed to maintain the deposit at Citi, Lehman likely would have
hadtoprefunditstradingactivity.4640Inaddition,CitiofficialsinformedLehmanthat
Citibelievedithadageneralrightofoffsetagainstthe$2billiondeposit.4641Finally,Citi
subjected the deposit to a number of internal controls designed to retain the funds at
Citi.4642Incontrast,Lehmanofficialsmaintainedthatthedepositwassimplyasignof
4637Id.
[CITILBHIEXAM 00082127]. According to Mauerstein, Tonucci also wanted further clarification that
the securities pledged would be remote from a Citi insolvency (which was part of Lehmans concern
aboutleavingthecashdepositwithCiti),wantedclarificationthatthecollateralamountwouldmatchthe
lowerlevelofdaylightoverdraftlimitLehmanwasusingatthetime,andwantedtodiscussthiswiththe
FederalReserve. Id. Tonucci reportedly further commented that, should Lehman not feelprotected, it
wouldtakeitsclearingbusinessawayfromCiti.Id.
4639ExaminersInterviewofChristopherM.Foskett,Sept.24,2009,atp.7.
4640Id.atp.9.
4641Lehman,CITIGROUPCallReport(Aug.7,2008),atp.1[LBEXDOCID450310].
4642Email from Katherine Lukas, Citigroup, to Ranjit Chatterji, Citigroup, et al. (Aug. 27, 2008) [CITI
LBHIEXAM00020787];ExaminersInterviewofThomasFontana,Aug.19,2009,atp.5.
1242

Lehmans good faith, and could have been retrieved by Lehman upon request.4643
Lehmanincludedthedepositinitsreportedliquiditypool.4644
a. WhatLehmanUnderstoodtheTermsofthe
DepositToBe
InaJune12emailtoLowittandTonucci,Flemingcharacterizedthetermsofthe
deposit as[n]o lienor rightofoffset, a straight overnightfedfundsdeposit.4645 The
assumptionthatthedepositwasfreelyreturnable,anddistinguishablefromapledge
of collateral, was widely held within Lehman.4646 In his interview with the Examiner,
TonuccistatedthathemadeitabundantlycleartoCitibankthatthedepositshouldbe
returnable to Lehman daily, and that there were to be no restrictions on getting the
depositback.4647Healsocharacterizedthedepositasagoodfaithdeposittomaintain
Citibanks good will.4648 Lehman was always beholden, to an extent, on the good
willofitsclearingbanks,Tonucciexplained,andLehmangavethe$2billiondepositto
Citi to maintain its positive relationship with that bank.4649 By early August, Tonucci
4643Examiners Interview of Paolo R. Tonucci, Sept. 16, 2009, at p. 20; Examiners Interview of Irina
Veksler,Sept.11,2009,atp.6.
4645Email from Daniel J. Fleming, Lehman, to Ian T. Lowitt, Lehman, et al. (June 12, 2008) [LBEXAM
008608].
4646Lehman, Citigroup Agenda (June 17, 2008), at p. 2 [LBEXAM 008597]. Lehmans Agenda stated:
LehmandidnotagreetopledgecashorgivetherightofsetoffoncollateralasCitirequested,butwe
reluctantlydidagreetodeposit$2Binacallaccount,callabledaily.Id.
4647Examiners Interview of Paolo R. Tonucci, Sept. 16, 2009, at p. 20; Examiners Interview of Irina
Veksler,Sept.11,2009,atp.6(expressingherunderstandingthatLehmancouldhavethe$2billioncash
depositatCitiatanytime).
4649Id.
1243

andCornejowereawarethatCitibelievedithadtherightunderNewYorklawtooffset
thecashdeposit.4650FlemingstatedthatwhileCitiviewedthedepositassomethingthat
couldbeoffset,LehmanvieweditasatradewhereLehmanwasearningareturnonthe
deposit.4651
TonuccifurthernotedthatLehmancouldhaveoperatedwithlessintradaycredit
from Citi.4652 In addition, Tonucci expressed confidence that Lehman could have
continuedtotradethroughCiti,albeitwithalittlemoredifficulty,evenifLehmanhad
withdrawn the $2 billion cash deposit. Tonucci, however, acknowledged that the full
impact of Lehman withdrawing its deposit was unknown because it was never
attempted.4653 Had Lehman withdrawn the $2 billion cash deposit prior to September
2008, Fleming acknowledged that this would likely have resulted in seniorlevel
discussionsatCiti,buthealsoexpresseddoubtthatCitiwouldactuallyhavereturned
the deposit if asked.4654 However, Fleming stated that, in hindsight, Lehman likely
couldnothavecontinuedtoclearthroughCitihadLehmansuccessfullywithdrawnits
cashdeposit.4655
4650Lehman,CITIGROUPCallReport(Aug.7,2008),atp.1[LBEXDOCID450310].CornejoandTonucci
participated in the call for Lehman, while Foskett and Mauerstein participated for Citigroup. Id.
AccordingtoLehmanssummary,CitiwouldnothavetherighttooffsetunpledgedsecuritiesifLehman
replacedthe$2billioncashdepositwithlessliquidcollateral.Id.
4651ExaminersInterviewofDanielJ.Fleming,Sept.24,2009,atp.8.
4653Id.
4655Id.
1244

b. WhatCitiUnderstoodtheTermsoftheDepositTo
Be
InterviewsofwitnessesfromCiticonfirmedthatthedepositwasstructuredasan
unencumbered, overnight call deposit, returnable daily upon Lehmans request.4656
However,Fontana,MauersteinandFosketteachstatedhisbeliefthat,eitherunderNew
YorkstatelawortheUniformCommercialCode,Citihadarightofsetoffagainstthe$2
billion,whichgavethebanksomemeasureofcomfort.4657
However, Citi officials recognized that Lehmans comfort deposit was not as
secure as the deposit posted with Citi by Bear Stearns in the summer of 2007.4658 The
deposit agreement Citi reached with Bear Stearns explicitly provided a right of offset,
whereas there was no clean right of offset with respect to the Lehman deposit.4659
Foskettexplainedthatthisconcernaboutthelackofacleanrightofoffsettothedeposit
4656Examiners Interview of Thomas Fontana, Aug. 19, 2009, at p. 2. Fontana stated that the $2 billion
deposit was structured as a lienfree, overnight call deposit, returnable daily on Lehmans request. Id.
Mauerstein stated that the deposit was structured as an unencumbered call deposit with Citis Federal
Funds desk, which was returnable on Lehmans request. Examiners Interview of Michael Mauerstein,
Sept.16,2009,atp.5;seealsoemailfromMichaelMauerstein,Citigroup,toKatherineLukas,Citigroup,
etal.(Aug.29,2008)[CITILBHIEXAM00076678](describingthedepositasanovernightdepositthat
Lehmancanasktobereturnedatanytime).
4657Examiners Interview of Christopher M. Foskett, Sept. 24, 2009, at p. 5 (Foskett explained that
someoneinCitislegaldepartmentinformedhimthatCitihadageneralrightofoffset,thetypethatany
bankgenerallyhasagainstabankdeposit);ExaminersInterviewofThomasFontana,Aug.19,2009,at
p.5;ExaminersInterviewofMichaelMauerstein,Sept.16,2009,atp.5;emailfromMichaelMauerstein,
Citigroup,toKatherineLukas,Citigroup,etal.(Aug.29,2008)[CITILBHIEXAM00076678](Mauerstein
wrotethatCitipersonnelbelievedtheyhadtherightofoffsetunderNewYorkstatelaw).
[CITILBHIEXAM00073732];seealsoemailfromPatrickRyan,Citigroup,toElenaT.Matrullo,Citigroup
(Mar.14,2008)[CITILBHIEXAM00113393](theamountofthedepositBearStearnsplacedwithCitiwas
$1.5billionasofMarch2008).
1245

arose,inpart,fromthefactthatthedepositsupportingCitisrelationshipwithLBIdid
not come from LBI, but from LBHI.4660 Additionally, unlike the Bear Stearns deposit,
Lehman was not borrowing from Citi and had not executed a promissory note with
right of offset language with Citi as Bear Stearns had done.4661 While Bear Stearns
deposit was pledged to Citi and Bear Stearns could only borrow against the deposit,
there was no similar pledge with Lehmans deposit when the deposit was made.4662
Citis Global Head of Global Transaction Services viewed overnight accounts (such as
Lehmans $2 billion cash deposit) that could be yanked at any time by the client as
countingfornothingasitrelatestocollateral/securityinterest.4663
Although the Lehman deposit with Citi was not formally pledged as collateral,
there was an understanding within Citi as to the consequences to Lehman if Lehman
weretowithdrawthedeposit.4664InresponsetoaninternalCitiemailfromMauerstein
highlightingthedistinctionbetweentreatingthe$2billionamountasapledgeversus
adeposit,CitisManagingDirectorofGlobalTransactionServicesCashManagement
stated, Mike, I am aware and understand all of this though their asking for the
4663Email from Paul S. Galant, Citigroup, to Jerry Olivo, Citigroup, et al. (Aug. 29, 2008) [CITILBHI
EXAM00076678].
4664SeeemailfromJerryOlivo,Citigroup,toMichaelMauerstein,Citigroup,etal.(Aug.29,2008)[CITI
LBHIEXAM00076678].
1246

deposit back does have distinct impacts on clearing capacity.4665 Fontana further
explained that, had Lehman withdrawn the deposit, Citi would have reassessed
whetheritwouldhavecontinueddoingbusinessasusualwithLehman,andthat,in
orderforCititocontinueclearingandsettlingtradesforLehman,Lehmanwouldhave
hadtoprefunditstransactionsthroughCiti.4666AccordingtoFontana,thatprefunding
would have been a liquidity drain for Lehman.4667 Mauerstein and Foskett each also
opined that Citi would likely have reduced Lehmans intraday credit lines if Lehman
had withdrawn the deposit.4668 Moreover, Fontana and Foskett stated that Citi would
have stopped providing credit lines to Lehman if Lehman had withdrawn its cash
depositanddidnotreplaceitby,forexample,pledgingcollateralorprefunding.4669
Notably, Citi subjected the comfort deposit to a number of internal controls
designed to keep the $2 billion within Citi.4670 Shortly after Lehman provided the
deposit,FontanastatedinaninternalCitiemailexchange:
Myconcernsaretwofold:keepingtheliquidity[ofthedeposit]withinCiti
andbeingabletocontrolthereleaseofthedeposit.Idontwanttolearn
the deposit was not renewed a week after Lehman has the funds. The
standing order to Eddie [Hewett, Jr.] is as soon as he gets the call [from
4665Id.
4667Id.
4668Examiners Interview of Michael Mauerstein, Sept. 16, 2009, at p. 9; Examiners Interview of

ChristopherM.Foskett,Sept.24,2009,atp.9.
4669Examiners Interview of Christopher M. Foskett, Sept. 24, 2009, at p. 9; Examiners Interview of
ThomasFontana,Aug.19,2009,atp.5.
4670SeeemailfromKatherineLukas,Citigroup,toRanjitChatterji,Citigroup,etal.(Aug.27,2008)[CITI
LBHIEXAM00020787].
1247

Lehmanaskingforreleaseofthedeposit]heistocallmetoadvisemeof
[Lehmans]intentions.4671
CitisRiskTreasurydeskwaschargedwithnotifyingFontanapriortothereleaseofany
portion of the deposit.4672 Further, in discussions concerning the most applicable
interest rate to provide Lehman on the $2 billion, and how to count the comfort
deposit internally within Citis systems, Citis Managing Director of Global
TransactionServicesCashManagementcharacterizedthedepositasessentiallycaptive
funds.4673
In providing background to others at Citi on the nature of the comfort
deposit,onerelationshipmanageratCitidescribedthedepositas:
[A] $2BN Cash Deposit from [LBHI] placed with Eddies Risk Treasury
Desk....Thisisanovernightinvestmentthatgetsrolledonadailybasis.
OnceofthecaveatsfromRiskwasthatCitiRiskwouldhavecontroland
final approval prior to releasing funds should Lehman look to pull the
funds back. A process is in place for Tom Fontana to be notified for
approvalbythedeskpriortoawithdrawalbeingmade.4674
In his interview with the Examiner, Fontana confirmed that an internal
notification process, such as the one described above, governed the release of the
deposit.4675 Although Citi likely would have released the deposit if asked, before
4671EmailfromThomasFontana,Citigroup,toRobertBlackburn,Citigroup,etal.(June19,2008)[CITI
LBHIEXAM00018405].
4672Id.
4673EmailfromJerryOlivo,Citigroup,toRobertBlackburn,Citigroup,etal.(June25,2008)[CITILBHI
EXAM00020787].
4674Email from Katherine Lukas, Citigroup, to Ranjit Chatterji, Citigroup, et al. (Aug. 27, 2008) [CITI
LBHIEXAM00020787].
1248

releasingthedepositCitiwouldhavedecidedinternallyifitwouldcontinuetoconduct
businessasusualwithLehman.4676Thisinternalprocedurewasjusttocheckwith
peopleatCitibeforethedepositwasreleased.4677
Thus,whileLehmanconsideredthedeposittobelienfreeandofferedmerely
as a good faith gesture to maintain a positive working relationship, Citi officials
emphasized that Citi had a legal right of setoff against the deposit, and that
withdrawingthedepositwouldhavenegativeimplicationsonCitiswillingnesstoclear
for Lehman. Further, Citi subjected the deposit to an internal procedure, whereby
releaseofthedepositwassubjecttoitsriskdesksnotificationandapproval.4678
At least once during the summer of 2008, Lehman used $210 million of the $2
billiondeposittocoveraDemandDepositAccountoverdraft,andpromisedtoreplace
the used funds the next business morning.4679 Neither Fontana nor Foskett recalled
anotherinstancewhereLehmanaskedforanyportionofitscashdepositback.4680
4676Id.
4677ExaminersInterviewofMichaelMauerstein,Sept.16,2009,atp.5.
4678Examiners Interview of Thomas Fontana, Aug. 19, 2009, at p. 5; Examiners Interview of Michael
Mauerstein,Sept.16,2009,atp.5.
4679Email from Michael Mauerstein, Citigroup, to Christopher M. Foskett, Citigroup (June 30, 2008)
[CITILBHIEXAM 00074989]; see also email from Thomas Fontana, Citigroup, to Brian R. Leach,
Citigroup, et al. (July 1, 2008) [CITILBHIEXAM 00111749] (reporting that Lehman had a fail from
anotherbankonJune30,2008,whichwouldhaveresultedina$268millionoverdraft,butCitipermitted
thecompanytousepartofitsdeposittocovertheOD[andthis]avoidedapotentialassetwhichtheOD
would have created over monthend); email from Emil F. Cornejo, Lehman, to Joseph Igoe, Lehman
(July4,2008) [LBEXDOCID 1078431](Cornejo explained that Lehman withdrew $210 million from the
depositatCititocoverafailinLehmansaccountwithCiti);Citigroup,Spreadsheet(asofSept.18,2008)
[CITILBHIEXAM00115772](showinga$210millionwithdrawalonJune30,2008).
4680ExaminersInterviewofThomasFontana,Aug.19,2009,atp.5;ExaminersInterviewofChristopher
M.Foskett,Sept.24,2009,atp.6.
1249

UnknownBecausetheTermsWereNotReducedto
Writing
ThetermscontrollingLehmans$2billioncomfortdepositwerenotreducedto
writing.4681 Foskett said that, after the near collapse of Bear Stearns, it became
standardpracticeforclientstoleaveadepositwithCititofacilitateclearingwithout
the parties necessarily formalizing the arrangement in writing.4682 Specifically, during
the summer of 2008, at least one other large investment bank in addition to Lehman
maintained a cash deposit at Citi for clearing purposes, and Citi was in talks with
another investment bank to do the same until market conditions in September 2008
madethatdepositunnecessary.4683
(iii) CitiKnewtheComfortDepositwasIncludedin
LehmansLiquidityPool
Lehman included the $2 billion comfort deposit in its liquidity pool.4684
FontanaunderstoodthatLehmanincludedthe$2billiondepositinitsliquiditypool.4685
In preparation for a June 17, 2008 meeting with Lehman, Mauersteins list of talking
points included conveying to Lehman that Lehman has over $40 billion liquidity

MichaelMauerstein,Sept.16,2009,atp.5.
4683Id.
4685Examiners Interview of Thomas Fontana, Aug. 19, 2009, at p. 6. Fontana was not aware, however,
that Lehmans deposits or collateral pledges with other clearing banks were included in the liquidity
pool.Id.WhenpresentedwiththispossibilitybytheExaminer,Fontanastated:Thewholething[pool]
couldhavebeenpledgedout!Id.
1250

pool,and[Citi]feltthatitwouldhelpusifLehmankeptsomeofthatondepositwith
us.4686 Likewise, Foskett recalled that Lehman insisted the deposit be liquid so that
Lehmancouldincludethe$2billionintheliquiditypoolinreportssenttoanalystsand
regulators(and,presumably,filingswiththeSECforpublicinvestorsaswell).4687From
Mauersteins perspective, Lehmans decisionaboutwhattoreportin itsliquiditypool
wasamatterbetweenLehmananditsregulators.4688Foskett,MauersteinandFontana
each acknowledged that they did not consider the June 12 cash deposit officially
encumbered.4689
BeganinJune2008andContinuedUntilSeptember2008
(i) TheUnexecutedPledgeAgreement:theParties
AgreedtoNegotiatetheTermsbutNotExecutethe
AgreementUntilItWasNeeded
SeveralweeksafterLehmanplacedthe$2billioncomfortdepositwithCition
June12,2008,CitiandLehmanbegantodiscussexecutingacollateralpledgeagreement
LBHIEXAM 00073791]; see also email from Michael Mauerstein, Citigroup, to Christopher M. Foskett,
Citigroup,etal.(July2,2008)[CITILBHIEXAM00073015](Mauersteinwrotethat[w]eshouldremind
propleinourorganizationthatLehmanhas$50billionofholdingcompanycash/liquidity(includingthe
$2Bwithus)andaccesstotheFeddiscountwindow).
Michael Mauerstein, Sept. 16, 2009, at p. 6; Examiners Interview of Thomas Fontana, Aug. 19, 2009, at
p.5.
1251

to replace the cash deposit.4690 Citi and Lehman met in late June and agreed that Citi
wouldcollectdataondaylightoverdrafts,whichCitiwouldthenusetoperformitsrisk
analysis,andfromthat,thepartieswouldbeabletodeterminehowmuchcollateralCiti
wouldrequest.4691
InmidJuly,thepartiesplannedtoagreeonthetermsofthepledgeagreement,
but to leave it unexecuted with the idea that the parties could execute the agreement
later if the market deteriorated further.4692 The rationale was that, should market
conditions deteriorate such that the agreement would become necessary from Citis
perspective, the firms respective legal departments would have already reviewed the
agreement and the companies could execute the agreement immediately.4693 Some at
Citi questioned the logic of this, and queried whether the parties would actually be
willing to execute the agreement at a time when it was needed because market
conditions or company circumstances would likely have changed significantly.4694
Nevertheless,thepartiesproceededwiththisarrangementandMauersteinsentthefirst
4690EmailfromChristopherM.Foskett,Citigroup,toMichaelMauerstein,Citigroup,etal.(July2,2008)
[CITILBHIEXAM 00073015] (discussing whether Citi should take some collateral from Lehman since
Lehmanoffered).
4692Email from Emil F. Cornejo, Lehman, to Paolo R. Tonucci, Lehman, et al. (July 13, 2008)
[LBHI_SEC07940_528212].
4693ExaminersInterviewofMichaelMauerstein,Sept.16,2009,atp.7;emailfromRichardC.S.Evans,
Citigroup, to Gregory Frenzel, Citigroup, et al. (July 16, 2008) [CITILBHIEXAM 00082047] (What we
need is theiragreement to agree the documentationnow so that it can be signed at a moments notice,
andnotrequireanother2448hoursoflegalreviewatalaterstagewhenwedonthavethattime.).
4694E.g.,ExaminersInterviewofChristopherM.Foskett,Sept.24,2009,atp.8.
1252

versionofadraftpledgeagreementtoCornejoonJuly14,2008,4695asecondversionon
July16,2008,4696andathirdversiononJuly28,2008.4697AsofJuly18,2008,acollateral
accounttitledLehmanBrothersHoldingsInc.,PledgetoCitibankhadbeenreserved
(butnotyetopened).4698
LehmanwantedtomoveawayfromacashdepositinJulytowardamorecash
capitalfriendlycollateraldepositoflessliquidsecurities.4699Specifically,Tonucciwas
agreeable to replacing the cash deposit with securities,4700 but in general Lehman was
resistanttoapledgeofanykind.4701
Some Citi officials questioned whether the comfort deposit would have been
returned upon the execution of the pledge agreement. Citis Chief Risk Officer in
GlobalTransactionServicesexpressedhispreferenceinJulytoholdthecashdepositfor
4695EmailfromMichaelMauerstein,Citigroup,toEmilF.Cornejo,Lehman,etal.(July14,2008)[LBEX
DOCID1078879].
4696EmailfromMichaelMauerstein,Citigroup,toEmilF.Cornejo,Lehman(July16,2008)[LBEXDOCID
1076467].
1076205].
4698EmailfromKenPorcaro,Citigroup,toKatherineLukas,Citigroup(July18,2008)[CITILBHIEXAM
00022307];emailfromKatherineLukas,Citigroup,toJanetBirney,Lehman,etal.(Aug.4,2008)[LBEX
DOCID459043](informingLehmanthatthecollateralaccounthadbeenreserved).
4699EmailfromRetoFaber,Citigroup,toVivekTyagi,Citigroup,etal.(July15,2008)[CITILBHIEXAM
00022615].
4700EmailfromThomasFontana,Citigroup,toMichaelMauerstein,Citigroup,etal.(July22,2008)[CITI
LBHIEXAM00075055].
[LBHI_SEC07940_528212] (Cornejo told Mauerstein that any pledge would not be acceptable to
[L]ehman).
1253

10 yearsbefore Citihadtogiveanyback.4702WhenaskedwhetherCitiwould have
returned the cash deposit to Lehman upon a pledge of securities, Foskett speculated
thatitwouldlikelyhavedependedonhowthecollateralwasstructured.4703
Finally, as set forth supra, Citi officials opined that a pledge of this size would
likely be an 8K reportable event for Lehman, which would require CEO approval.4704
The pledge agreement negotiations continued into September, but an agreement was
neverfinalizedandexecuted.4705
(ii) CitiHadDifficultyPricingtheCollateralOfferedby
LehmanasaSubstitutefortheCashDeposit
Part of the delay in agreeing to terms for the collateral pledge agreement
stemmed from the difficulties Lehman and Citi encountered in July and August in
negotiatingwhatsecuritieswouldbeplacedwithCiti.4706
4702EmailfromMichaelMauerstein,Citigroup,toThomasFontana,Citigroup(July2,2008)[CITILBHI
EXAM00081921)].
[LBHI_SEC07940_528212];emailfromMichaelMauerstein,Citigroup,toThomasFontana,Citigroup,et
al.(July12,2008)[CITILBHIEXAM00076243](Granting$2Bcollateralwilllikelybean8Keventand
thereforeaCEOdiscussion.);emailfromRichardC.S.Evans,Citigroup,toGregoryFrenzel,Citigroup,
etal.(July16,2008)[CITILBHIEXAM00082047](characterizingtheexecutionofapledgeagreementasa
regulatorydisclosureforLehman).
4705See email from Thomas Fontana, Citigroup, to Christopher M. Foskett, Citigroup (Sept. 10, 2008)
[CITILBHIEXAM00075863](discussinghowCitishouldhavehadthecollateralarrangementcompleted
longagoinsteadofthefiredrillofgettingtheGuarantyAmendmentonSeptember9).
4706See, e.g., email from Michael Mauerstein, Citigroup, to Thomas Fontana, Citigroup, et al. (Aug. 4,
2008) [CITILBHIEXAM 00074286] (noting the absence of a ready market for the collateral and the
difficulty of pricing the collateral because the referenced CLOs did not trade); email from Thomas
Fontana, Citigroup, to Christopher M. Foskett, Citigroup, et al. (Aug. 12, 2008) [CITILBHIEXAM
00077310] (questioning the reliability of Citis Global Transaction Services collateral system to provide
realpriceswhichCiticouldexecuteagainst);ExaminersInterviewofThomasFontana,Aug.19,2009,at
p.7.
1254

An overview of a contemplated transaction in April 2008 between Citi and
Lehman is helpful for an understanding of the securities valuation issue. Prior to the
collateral negotiations in connection with the pledge agreement, in April 2008, Citis
CEO Vikram Pandit and Lehmans CEO Richard Fuld discussed setting up a
commercial real estate repo.4707 While this proposed repo was not connected to the
pledge negotiations of import to the instant analysis, valuation difficulties in both
instancesweresimilarbecausebothinstancesinvolvedilliquidassets.4708Accordingto
Foskett, the repo discussions in April and May 2008 broke down in part because Citi
4707Examiners Interview of Christopher M. Foskett, Sept. 24, 2009, at p. 6; see email from Nancy Kim,
Citigroup, to Thomas Mellina, Citigroup, et al. (May 21, 2008) [CITILBHIEXAM 00034330] (attaching
CMAC Memo BVP against Lehmans Asset Backed Notes); Citigroup, Lehman Brother Holding Inc
(June 4, 2008), at p. 2 [CITILBHIEXAM 00078763] (detailing Lehmans CEO contact of Citis Pandit in
spring 2008 concerning Citi providing some liquidity against certain Lehman commercial real estate
assets).ABorrowversusPledgetransactionwasproposedwhereCitiwouldhaveborrowedasecurity(a
RACERS Trust Note that was backed by commercial real estate assets) from Lehman and pledged U.S.
Agency Mortgages to Lehman as collateral for the borrowed security. Citigroup, Lehman Brother
HoldingInc(June4,2008),atp.2[CITILBHIEXAM00078763].Lehmanthenwouldhavelentoutthe
agencysecuritiesinreturnforcash.Id.Thecommercialrealestateassetsbeingconsideredwereloans
against Hilton properties. Id. Citis Senior Risk Management was not comfortable with taking any
additional exposure to Hilton properties and declined to approve the financing transaction. Id. This
wouldhavebeenbookedasdirectexposure(notPSE)giventhatCitisabilitytoliquidatethecollateral
under a Lehman bankruptcy remained questionable. Id.; see also email from Thomas Fontana,
Citigroup, to Patrick Ryan, Citigroup, et al. (Apr. 25, 2008) [CITILBHIEXAM 00038195] (noting Pandit
andFuldhavingsomediscussionregardingcommercialrealestatefinancings);emailfromChristopher
M. Foskett, Citigroup, to Michael Mauerstein, Citigroup, et al. (Apr. 18, 2008) [CITILBHIEXAM
00080817](notinghighleveldialoguebetweenFuldandPandit);emailfromThomasMellina,Citigroup,
toThomasFontana,Citigroup,etal.(May30,2008)[CITILBHIEXAM00081443](summarizinghowthe
deal fell through because Lehman was supposed to contribute a diverse pool of commercial real estate
assets but, instead, contributed only loans against Hilton properties; also, the deal was supposed to be
structured so that it would be safe from a bankruptcy stay, but this failed); email from Michael
Mauerstein,Citigroup,toChristopherM.Foskett,Citigroup(May29,2008)[CITILBHIEXAM00081410]
(summarizing a conversation Mauerstein had with Cornejo that the dealfalling throughwas not about
Lehman risk and more because Citis risk people expected the portfolio to contain a diverse set of
commercialrealestateassetsbutthedealpresentedwasonlyagainstasingleassetHilton).
1255

was prepared to give only 50 cents on the dollar for the collateral, whereas Lehman
thoughttheassetswereworthcloserto90centsonthedollar.4709
Withthisrecentsignificantdiscrepancyinvaluation,someatCitirecognizedthat
anycollateraldepositnegotiationsweregoingtobedifficult,particularlywhenLehman
offered more illiquid assets, this time in the form of CLOs and CDOs, in July in
connectionwiththecollateralpledgeagreementnegotiations.4710Citicommunicatedto
Lehman that Citi was trying to be flexible in what collateral Citi would accept, and
suggested it would not view favorably a proposition that included emerging market
sovereign bonds.4711 Citi expanded the collateral listed in the proposed pledge
agreementtoreflectthatCitiwouldacceptmorethanjustgovernmentsecurities,which
Citihadinitiallyrequested.4712
4709Id.atp.6.Oneoftheadvantagesofusingthistypeoftradewasthatitdisguisedthesourceofthe
assets by sending it through a trust. See email from Thomas Mellina, Citigroup, to Joseph Martinelli,
Citigroup,etal.(May16,2008)[CITILBHIEXAM00082707].ThomasMellinacommentedthat,[w]hen
the market becomes concerned about a given party, the market should not be willing to lend against
assets issued by or guaranteed by that party, and the special structure of the repo would hide the
issuers identity for a while. Id.; see also email from Thomas Mellina, Citigroup, to Thomas Fontana,
Citigroup,etal.(July23,2008)[CITILBHIEXAM00115293](showingthattherepodiscussionsdidnot
terminateentirelyinMay,butthepartieshadnotmademuchprogressbytheendofJulybecauseCiti
wasstilltryingtocreateafinancingstructurethataddressedallofCitisconcerns);emailfromStephenJ.
Bujno, Citigroup, to Kenneth Quay, Citigroup (Sept. 3, 2008) [CITILBHIEXAM 00034297] (forwarding
LehmanCRERepodocument).
1078883] (relaying a message from Fontana in response to Cornejos query regarding what type of
collateral Citi would consider taking, including Fontanas comment that the collateral had to be
relatively simple from a pricing perspective and we are quite limited in our [collateral management
systems]abilities)(bracketsinoriginal).
1076205](MauersteincommentedthatCitisinhouseattorneyrevisedthePledgeAgreementtoinclude
securitiesotherthanUSGovies).
1256

In early August, Lehman offered Citi the Kingfisher, Freedom, Spruce and
Verano CLOs recently rated tranches of assetbacked securities that were backed by
corporateloansandstructuredbyLehmanascollateralinconnectionwiththepledge
agreement.4713CornejowasconcernedaboutCitisreactiontoLehmanproposingthese
assets as collateral4714 and, according to Mauerstein, Lehman was not surprised when
CitiultimatelyrejectedtheCLOsascollateral.4715CitipersonnelcharacterizedtheCLOs
offered by Lehman in connection with the pledge negotiations as bottom of the
barrel4716andjunk.4717
CitiencounteredseveralproblemswhentryingtopricethiscollateralduetoCiti
nothavingarobustplatformforvaluingthecollateral,4718theabsenceofareadymarket
4713EmailfromMichaelMauerstein,Citigroup,toYingliXie,Citigroup,etal.(Aug.4,2008)[CITILBHI
EXAM00082162];seealsoemailfromMichaelMauerstein,Citigroup,toAnthonyLieggi,Citigroup,etal.
(Aug.1,2008)[CITILBHIEXAM00022065](seekinginformationonLehmansKingfisher,Freedomand
Spruce CLOs). The CLOs Lehman offered to Citigroup were pledged to JPMorgan in response to
JPMorgansmarginrequirements.CompareemailfromJohnN.Palchynsky,Lehman,toRichardPolicke,
Lehman,etal.(July2,2008)[LBEXDOCID077515](Kingfisher),emailfromCraigL.Jones,Lehman,to
John Feraca, Lehman, et al. (June 19, 2008) [LBEXDOCID 55577] (Freedom and Spruce), and LB Excess
CollateralPricedbyGF(Aug.8,2008)[JPM20040008074](Verano),withemailfromMichaelMauerstein,
Citigroup,toYingliZie,Citigroup,etal.(Aug.4,2008)[CITILBHIEXAM00082162](listingCUSIPsfor
Kingfisher,Freedom,SpruceandVerano).JPMorganwasalsohavingdifficultypricingthesesecurities.
4714EmailfromEmilF.Cornejo,Lehman,toJulieM.Boyle,Lehman(July31,2008)[LBEXAM008649].
4716Id.
4718Email from Thomas Fontana, Citigroup, to Christopher M. Foskett, Citigroup, et al. (Aug. 12, 2008)
[CITILBHIEXAM 00077310] (questioning the reliability of Citis Global Transaction Services collateral
systemtoproviderealpricesagainstwhichCiticouldexecute);ExaminersInterviewofThomasFontana,
Aug. 19, 2009, at p. 7. Citis clearing risk division also did not have the ability to track a companys
clearingusageinrealtime.EmailfromThomasFontana,Citigroup,toBrianR.Leach,Citigroup,etal.
(July1,2008)[CITILBHIEXAM00111749].Additionally,inApril2008,LehmansCLSlinewasreduced
from$3billionto$1.8billion,andLehmansclearinglineswereremovedfromthenostroaccounts.E
1257

for the collateral and the nature of the collateral itself.4719 The CLOs were held by
Lehman and, according to Citis secondary trading desk, the CLOs proposed by
Lehmandidnottrade.4720IfCitiwantedtoselltheminthemarketunderconditionsthat
existedin August2008, Citiestimatedthatperhapsfiveinvestors wouldshow aprice
andthatCitiwouldessentiallyhavetodoaroadshow.4721OnacallwithCitisFoskett
andMauerstein,TonuccidescribedtheCLOsintheinitialcollateralportfolioastrading
onlyoccasionally.4722
InAugust2008,MauersteintoldCornejothatCitiwouldnotconsidertakingany
CLOsascollateralunlessCitiwassureitcouldvaluethemandwasconfidentitcould
sellthemforanamountthatcoveredtheadvancerate.4723However,Citibelievedithad
mail from Katherine Lukas, Citigroup, to Seamus Kennedy, Citigroup, et al. (May 2, 2008) [CITILBHI
EXAM00023281].
4719Examiners Interview of Thomas Fontana, Aug. 19, 2009, at p. 7; see also email from Michael
Mauerstein,Citigroup,toThomasFontana,Citigroup,etal.(Aug.4,2008)[CITILBHIEXAM00074286].
4720EmailfromMichaelMauerstein,Citigroup,toThomasFontana,Citigroup,etal.(Aug.4,2008)[CITI
LBHIEXAM00074286].
4721Id.
4722Lehman,CITIGROUPCallReport(Aug.7,2008),atp.1[LBEXDOCID1035842].Basedondocument
researchandwitnesstestimony,theExaminerdoesnotbelievetheseLehmanCLOsevertraded.Lehman
was occasionally able to repo them for short periods, but actual trades between arms length
counterpartiesthatwouldpermitevenlimitedpricediscoverydonotappeartohaveoccurred.Seeemail
fromMarieStewart,Lehman,toJonathanCohen,Lehman,etal.(May8,2008)[LBHI_SEC07940_1069905]
(Like Freedom CLO and Spruce CLO [SASCO transaction] is just creating securities to take to Fed
window);Lehman,SecuritizingLeveragedLoans:Freedom,Spruce,ThaliaCLOs,atp.2[LBEXWGM
835699] (Securities thereby created are not meant to be marketed with unidentified persons
handwritinginthemarginemphasizingNointentiontomarket).
LBHIEXAM00076589](relayingaconversationMauersteinhadwithCornejothepreviousday).
1258

nobasisforestablishinganyinitialpricefortheCLOs.4724Citissecondarytradingdesk
had informed Mauerstein that there were no active secondary market prices for the
CLOsLehmanofferedascollateral,andCitiwasnotgoingtopricethembasedsolely
ontheirratings.4725Fontanafounditsurprisingthat,accordingtoLehmansvaluation,a
singleAratedCLOwouldbepricedashighas96to97centsonthedollar.4726Overall,
CitiseemedmoreconcernedaboutwhethertherewasareadymarketfortheseCLOs,
asopposedtoCitisability(orinability,asitwere)toassignanexactpricetothembut
Citicouldnotgetsufficientinformationineitherrespect.4727Ultimately,Citidecidedin
midAugust that the CLOs Lehman offered were not going to work for the pledge
agreement.4728
On August 11, Emil Cornejo provided another portfolio of securities that
LehmanproposedCitiacceptascollateral;accordingtoLehman,thesesecuritieswere
assetbackedacrossthespectrumwithanotionalvalueof$3.7billion.4729Fontanastill
4724EmailfromThomasFontana,Citigroup,toMichaelMauerstein,Citigroup,etal.(Aug.4,2008)[CITI
LBHIEXAM00074286].
LBHIEXAM00076589].
4726EmailfromThomasFontana,Citigroup,toJosephA.Cuniglio,Citigroup,etal.(Aug.1,2008)[CITI
LBHIEXAM00022065].
4727EmailfromMichaelMauerstein,Citigroup,toYingliXie,Citigroup,etal.(Aug.4,2008)[CITILBHI
EXAM00082162].
4728EmailfromMichaelMauerstein,Citigroup,toKatherineLukas,Citigroup,etal.(Aug.12,2008)[CITI
LBHIEXAM 00021175] (discussing pricing the proposed portfolio of assetbacked securities for the
pledgeagreement).
LBHIEXAM00077310];seealsoLehman,CITIGROUPCallReport(Aug.7,2008),atp.1[LBEXDOCID
450310](describingthesecondportfolioofcollateralas$3billionofinvestmentgradeprivatelabelABS,
CMOs).
1259

doubtedwhetherCitisdeskwouldbeabletoprovidepricinginformationonmanyof
thesenewlyproposedassets,andnotedthatmostofthesecuritieshadlimitedliquidity
inthemarketatthetime.4730BylateAugust,someatCitiwantedanagreementinplace
as soon as possible detailing which securities Lehman would pledge as collateral in
placeofthecashdeposit.4731
Contributing to the difficulty of finding collateral that was agreeable to both
parties was the fact that Fleming told Citi that Lehman repoed out for cash all of the
marketable securities in its liquidity pool.4732 On July 31, 2008, Cornejo stated,
[a]pparently,theonlywaytofindacceptablecollateralforCiti,istorepoincollateral
which then can be pledged.4733 In contrast, if Citi had accepted the CLOs, Lehman
wouldnothavehadtoreverserepoinanysecurities.4734Thus,ifCitirefusedtoaccept
theCLOs,andrequestedthatLehmanpledgemarketablesecuritiestoCitiinconnection
withthepledgeagreement,Lehmanwouldhavehadtoreverseinsecuritiestodeliver
to us, and absorb the funding cost (what they would avoid doing if they pledge
CLOs).4735
4730Email from Thomas Fontana, Citigroup, to Christopher M. Foskett, Citigroup, et al. (Aug. 12, 2008)
4731Email from Paul S. Galant, Citigroup, to Jerry Olivo, Citigroup, et al. (Aug. 29, 2008) [CITILBHI
EXAM00076678].
LBHIEXAM00076589](recountingaconversationhehadwithFlemingthepreviousweek).
4733EmailfromEmilF.Cornejo,Lehman,toJulieM.Boyle,Lehman(July31,2008)[LBEXAM008649].
LBHIEXAM00076589].
4735Id.
1260

(iii) TheGuarantyAmendmentWasSignedinaFire
DrillonSeptember9,2008
TheoriginalGuarantybetweenCitiandLehman,wherebyLBHIguaranteedthe
credit obligations of certain subsidiaries, was signed on January 7, 2004, and listed
seven Lehman entities as Borrowers which LBHI guaranteed.4736 This was
subsequently amended between September 9 and 11, 2008 by adding ten Lehman
subsidiariesandextendingthescopeoftheGuaranty.4737
In the January 7, 2004 Guaranty, the consideration provision stated that LBHI
entered into the Guaranty [f]or good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, and to induce Citigroup to extend
and/ormaintaincredittoorfortheaccountof[LBHIs]subsidiarieslistedonSchedule
A.4738Section1oftheGuarantyprovidedthatLBHIunconditionallyguaranteedthe
punctual payment when due... of all obligations... of each Borrower to Citigroup
underanyandallextensionsofcreditextendedand/ormaintainedbyCitigroup.4739
The September 9, 2008 Amendment 1 to Guaranty (September 9 Guaranty
Amendment)containedanidenticalconsiderationprovision,asitprovidedthatLBHI
entered into the Amendment [f]or good and valuable consideration, the receipt and
4736Guaranty(Jan.7,2004),atpp.1,6[LBEXDOCID1090071].ScheduleAliststhesevenBorrowers:
Lehman Brothers Holdings PLC, Lehman Brothers Securities Asia Limited, Lehman Brothers Special
Financing Inc., Lehman Brothers Japan Inc., Lehman Brothers International (Europe), Lehman Brothers
CommercialCorporationAsiaLimitedandLehmanBrothersBankhausAG.Id.atp.6.
4737SeeAmendment1ToGuaranty(Sept.9,2008)[LBEXDOCID090568](executedversionsignedbyIan
LowittonSeptember11,2008).
4738Guaranty(Jan.7,2004),atp.1[LBEXDOCID1090071].
4739Id.(1).
1261

sufficiency of which are hereby acknowledged, and to induce Citigroup to extend
and/ormaintaincredittoorfortheaccountof[LBHIs]subsidiarieslistedonSchedule
A.4740 The September 9 Guaranty Amendment altered Section 1 of the original
GuarantysothatLBHInowunconditionallyguaranteedthepunctualpaymentwhen
due...ofallobligations...ofeachBorrower(i)underanyagreementswithCitigroup
or any Citigroup Entity pursuant to which any Citigroup Entity opens and maintain
accounts for the custody of cash, securities, and/or other assets of such Borrower or
providescustodialandrelatedservicesforsuchBorrower...and(ii)toanyCitigroup
Entityunderanyandallextensionsofcredit....4741
Fontana characterized the September 9 Guaranty Amendment as adding the
clearing side which was not previously expressly covered in our existing guarantees
and confirmed that the $2 billion deposit was thereby completely secure[d] for [Citi]
and any exposures.4742 Thus, the Amendment (1) increased the number of entities
covered by LBHIs Guaranty by adding ten Lehman subsidiaries, including LBI, and
(2)expanded the category of obligations covered by the Guaranty by including
4740Amendment1ToGuaranty(Sept.9,2008),atp.1[LBEXDOCID090568].
4741Id.(1).
4742EmailfromThomasFontana,Citigroup,toChristopherM.Foskett,Citigroup(Sept.10,2008)[CITI
LBHIEXAM00075863].ButseeemailfromEmilF.Cornejo,Lehman,toHuwRees,Lehman,etal.(Sept.
13,2008)[LBEXDOCID1078385](Cornejostatedthereisnoagreement,andthedepositisstillacallable
one);emailfromEmilF.Cornejo,Lehman,toHuwRees,Lehman,etal.(Sept.13,2008)[LBEXDOCID
1078385] (Cornejo stated that, because Citi had a right of offset under New York law, if there was a
negativebalancethecashwouldnotbereleased).
1262

obligations owed to Citigroup under any custodial agreement with Citi in addition to
extensionsofcreditprovidedbyCiti.4743
GuarantyAmendmentfromCitisPerspective
BySeptember2008,Citihadbecomeincreasinglyconcernedaboutthelackofan
ironclad claim to Lehmans $2 billion comfort deposit, and had worked on the
collateral pledge arrangement with Lehman for approximately two months.4744 On
September9,thefailureoftheKDBdealwaswidelyreported,Lehmanacceleratedits
thirdquarter2008earningsannouncementtoSeptember10,andLehmansstockprice
plummeted. These events led Citi to seek the September 9 Guaranty Amendment.4745
Specifically, on the morning of September 9, the Head of Citis Institutional Clients
Group requested that the comfort deposit be officially taken into collateral.4746 In
response to this request, Citi sought an amendment to the 2004 Guaranty that would
allowCititooffsetthe$2billiondepositagainstobligationsthatLBIandseveralother
4743Amendment1ToGuaranty(Sept.9,2008)[LBEXDOCID090568].
4744EmailfromThomasFontana,Citigroup,toBrianR.Leach,Citigroup,etal.(Sept.9,2008)[CITILBHI
EXAM 00077391] (discussing attempts to improve Citis claim on the $2 billion deposit); see also email
fromThomasFontana,Citigroup,toChristopherM.Foskett,Citigroup(Sept.10,2008)[CITILBHIEXAM
00075863](statingthatCitishouldhavehadthecollateralarrangementcompletedlongagoinsteadofthe
firedrillofgettingtheGuarantyAmendmentonSeptember9).
4746Email from Thomas Fontana, Citigroup, to Christopher M. Foskett, Citigroup, et al. (Sept. 9, 2008)
1263

LehmanentitiesowedtoCiti.4747Additionally,onSeptember9,CitireducedLehmans
clearinglinessignificantly,sometozero.4748Worldwide,LehmansclearinglinesatCiti
that were not reduced to zero were reduced to the level of the deposit Lehman had
postedwithCiti,whichremainedat$2billion.4749
Citisetadeadlineof6:00p.m.Easterntime4750onSeptember9bywhichLehman
had to execute the amendment.4751 According to Foskett, Citi did not present the
amendmentonatakeitorleaveitbasis,4752andLehmansaidithadnoproblemwith
providingaguarantyforLBI.4753Infact,FoskettstatedthatLehmanquicklyfaxedthe
signedamendmentbacktoCiti4754afterIanLowittsigneditshortlybeforethe6:00p.m.
deadline.4755
After LBI was added to the Guaranty prior to the 6:00 p.m. deadline, the
negotiationscontinuedinaneffortbyCititogetadditionalLehmansubsidiariesadded,
4747Amendment1ToGuaranty(Sept.9,2008)[LBEXDOCID4263143](addingLBItotheJanuary7,2004
LBHI Guaranty and expanding the scope of the Guaranty to include Custody Agreements as well as
CreditAgreements).
4748EmailfromThomasFontana,Citigroup,toBrianR.Leach,Citigroup,etal.(Sept.9,2008)[CITILBHI
EXAM00076776].
4749EmailfromGregoryFrenzel,Citigroup,toJohnDorans,Citigroup,etal.(Sept.9,2008)[CITILBHI
EXAM00076798].
4750AlltimereferencesinthissectionregardingtheSeptember9GuarantyAmendmentrefertoEastern
Time.
4751Email from Emil F. Cornejo, Lehman, to Ian T. Lowitt, Lehman, et al. (Sept. 9, 2008) [LBEXAM
008564].
4753Email from Christopher M. Foskett, Citigroup, to Thomas Fontana, Citigroup, et al. (Sept. 9, 2008)
[CITILBHIEXAM00077391](notingCitisendingoveranamendmenttotheexistingagreementtoreflect
LehmansagreementtoguaranteeLBI).
4755EmailfromPaoloR.Tonucci,Lehman,toEmilF.Cornejo,Lehman(Sept.9,2008)[LBEXAM008564].
1264

specificallythoseinAsia.4756Indeed,CitiadvisedLehmanthatCitiwouldnotopenfor
Lehman in Asia under the existing Guaranty.4757 This meant that Citi would reduce
Lehmans intraday credit lines to zero for the entities not covered by the Guaranty if
Lehman did not sign the amendment in time; it did not mean that Citi would cease
clearingforLehmanentirely.4758CitilikelywouldhavecontinuedclearingforLehman
even without a signed amendment, but Lehman would have had to prefund its
trades.4759 In order to prefund its trades, Lehman would have had to estimate its
exposureandprovidefundstocoverthatexposure,ratherthanrelyingonCititocover
the exposure while being able to pay Citi back later in the day. Citi was concerned
aboutitsownbusinessatthistimeandhadtobalancetheseissuescarefullysothatit
didnotexposeitselftosomuchLehmanriskthatCitisbusinessbecameendangered.4760
GuarantyAmendmentfromLehmansPerspective
At12:47p.m.onSeptember9,CornejowrotetoTonucciandBoylestatingthathe
had just received a call from Foskett, during which Foskett told Cornejo that Citi was
requesting a guaranty with LBI [in fact, an amendment of the existing 2004 LBHI
CitibankGuaranty]withtherighttosetoffthe$2billioncomfortdepositthathadbeen
4756Email from Thomas Fontana, Citigroup, to Emil F. Cornejo, Lehman, et al. (Sept. 9, 2008) [LBEX
DOCID1079016].
4757Id.
4760Examiners
Interview of Christopher M. Foskett, Sept. 24, 2009, at p. 8; see also Thomas Fontana,
Citigroup,UnpublishedNotes(Sept.12,2008),atp.193[CITILBHIEXAM00099649](contemporaneous
handwrittennotesnotingtheneedtoprotectshareholders).
1265

placed by Lehman in a call account with Citi on June 12.4761 Cornejo wrote that this
request was coming in response to Lehmans stock price decline, and that Lehman
hada$3.4billionintradayoverdraftwithCitiwhenhespokewithFoskett.4762Cornejo
was initially resistant to the idea and said he would get back to Foskett.4763 Tonucci
suggested Cornejo speak to Andrew Yeung, inhouse counsel at Lehman, because
LehmandidsomethingsimilarforJP[Morgan]sohopefully[itwillnotbe]anissueto
havelegalreviewandagree.4764
Cornejo sent the draft agreement to James Jim Killerlane in Lehmans legal
department for review.4765 Killerlane expressed some concern about how the setoff
provision in the original Guaranty would interact with Lehmans Custody
Agreements.4766 Despite this concern, Killerlane stated he would be comfortable with
executingtheamendmentifLowittandTreasurypersonnelwerecomfortablewithit.4767
While Killerlane was expressing his concern about the proposed amendment, Craig
Jones emailed Fleming, writing: Citibank still has not released our $2bn. They say
4761EmailfromEmilF.Cornejo,Lehman,toPaoloR.Tonucci,Lehman,etal.(Sept.9,2008)[LBEXAM
008563].
4762Id.
4763Id.
4764EmailfromPaoloR.Tonucci,Lehman,toEmilF.Cornejo,Lehman,etal.(Sept.9,2008)[LBEXAM
008690].
4765Email from Emil F. Cornejo, Lehman, to James J. Killerlane, Lehman (Sept. 9, 2008) [LBEXDOCID
1079080].
4766Email from James J. Killerlane, Lehman, to Emil F. Cornejo, Lehman (Sept. 9, 2008) [LBEXAM
008571](statingthathewasnotsureifwecanlogistically[signtheamendmenttotheguaranty]with
ourCustodyAgreementsorifwearecomfortablewiththis).
4767Id.
1266

they are working on it. We have over funded the account4768 such that it appears
Lehmanbelieved it had more moneyin the accountthanwas necessarytorelease the
payment.
At 5:45 p.m., Cornejo forwarded Lowitt and Tonucci an execution draft of the
Guaranty Amendment, stating in the email: Citi is holding payments unless we
execute by 6pm tonight. Jim [Killerlane] has reviewed.... Ian, you are required to
sign.... I will deliver to Citi tonight.4769 In fact, at approximately 4:14 p.m. on the
afternoonofSeptember9,Citihadordereda$2.088billionCLSpaymenttobeheld4770
because Lehmans account balance was only $37 million with no daylight overdraft
limit.4771 When Lehmans account balance reached $2.085 billion, Fontana provided
verbal approval shortly after 5:30 p.m. to release the CLS payment even though the
accountwas$3millionshort.4772
At approximately 5:56 p.m., Cornejo transmitted the executed document to
Citi4773 after Lowitt signed the September 9 Guaranty Amendment.4774 In the first
4768EmailfromCraigL.Jones,Lehman,toDanielJ.Fleming,Lehman(Sept.9,2008)[LBEXAM008562].
008571].
4770EmailfromWilliamR.Maher,Citigroup,toKatieEvans,Citigroup,etal.(Sept.9,2008)[CITILBHI
EXAM00032799].
4771EmailfromKatieEvans,Citigroup,toWilliamR.Maher,Citigroup,etal.(Sept.9,2008)[CITILBHI
EXAM00032799].
4772Email from Chris Deukmedjian, Citigroup, to Peter Dehaan, Citigroup, et al. (Sept. 9, 2008) [CITI
LBHIEXAM00032799].
4773EmailfromEmilF.Cornejo,Lehman,toMichaelMauerstein,Citigroup(Sept.9,2008)[LBEXDOCID
4043703].
4774EmailfromPaoloR.Tonucci,Lehman,toEmilF.Cornejo,Lehman(Sept.9,2008)[LBEXAM008564].
1267

executed version of the amendment, LBI was the only entity listed on Schedule 1,
whichspecifiestheLehmansubsidiariesaddedtotheparentGuaranty.4775
c. NegotiationsBetweenLehmanandCitiPersonnel
RegardingWhichLehmanEntitiesWereToBe
AddedtotheParentGuarantybytheSeptember9
GuarantyAmendment
At 12:54 p.m. on September 9, Mauerstein emailed the draft parent Guaranty
Amendment to Cornejo, which proposed an additional 17 subsidiaries to the LBHI
guaranty.4776MauersteintoldtheExaminerthatCitihadnotsoughtaguarantyofLBI
priortoSeptember9becausetheU.S.brokerdealerwasusuallythemostcreditworthy
Lehmanentity.4777Nevertheless,becausemostofCitisexposurewasthroughLBI,Citi
determinedthat,givenmarketevents,itneededitsexposuretoLBIcovered.4778Inthe
initialamendmentdraft,Citisproposedlistof17Lehmansubsidiariestobeaddedto
theparentguarantyincludedLBI.4779
4775Amendment1ToGuaranty(Sept.9,2008)[LBEXDOCID4263143].
4776EmailfromMichaelMauerstein,Citigroup,toEmilF.Cornejo,Lehman(Sept.9,2008)[LBEXDOCID
1079048].
4778Id.
4779Amendment1ToGuaranty[Draft](Sept.9,2008),atp.3[LBEXDOCID1032313](thisproposeddraft
wasattachedtoMauersteinsSeptember9,2008email(LBEXDOCID1079048)at12:54p.m.toCornejo).
The subsidiaries that Citi proposed be added were: Caistor Trading BV, Lehman Brothers Australia
SecuritiesPtyLimited,LehmanBrothersFinanceAG,LehmanBrothersFinancialProductsIncorporated,
LehmanBrothersIncorporated,LehmanBrothers(Taiwan)Limited,LehmanBrothersSecuritiesPrivate
Limited, Libertus Jutaku Loan K.K., Neuberger Berman LLC, Lehman Brothers Commodity Services
Incorporated, Lehman Brothers Equity Finance (Cayman) Limited, Lehman Brothers Finance Japan
Incorporated, Lehman Brothers GCS Financing, Lehman Brothers Securities Taiwan Limited, Lehman
ScottishFinanceLP,MarcyLimitedandPropertyAssetManagementInc.Id.
1268

However,thesignedamendmentthatwasreturnedtoCitishortlybeforethe6:00
p.m.deadlineonlyextendedtheGuarantytoLBI.4780WhenCitireceivedtheSeptember
9GuarantyAmendmentshortlybefore6:00p.m.onSeptember9withonlyLBIadded,
Citiviewed the absenceofLehmansAsiansubsidiariesasproblematic foropening in
Asia the next day.4781 Lehman officials explained to Citi that it intended to provide
guarantees for the Asian subsidiaries, but that Lehman needed to check with its
overseas offices to ensure that no regulatory issues would prevent LBHI from doing
so.4782Nevertheless,CitistillneededLehmantoaddthesubsidiariesinitiallylistedon
theamendmentsscheduleofparties,andstateditwouldwithholdcreditinAsiauntil
Lehmandidso.4783
Specifically, at 6:34 p.m., Fontana emailed Cornejo to request that Lehman
guaranteealloftheentitiesCitibankhadincludedinitsinitialproposal,includingthe
international subs which are critical for us to clear for you in Asia.4784 Cornejo
4780EmailfromEmilF.Cornejo,Lehman,toMichaelMauerstein,Citigroup(Sept.9,2008)[LBEXDOCID
4043703]; see also Amendment 1 To Guaranty (Sept. 9, 2008) [LBEXDOCID 4263143] (first executed
version remitted to Citigroup shortly before 6:00 p.m. on September 9, 2008 and adding only LBI as a
guaranteedsubsidiary).
4781Email from Thomas Fontana, Citigroup, to Gregory Frenzel, Citigroup (Sept. 9, 2008) [CITILBHI
EXAM00108845];emailfromChristopherM.Foskett,Citigroup,toThomasFontana,Citigroup(Sept.9,
2008) [CITILBHIEXAM 00073290] (relaying Michael Mauersteins statement that Lehman had
guaranteedtheU.S.brokerdealer).
4782Email from Emil F. Cornejo, Lehman, to Thomas Fontana, Citigroup (Sept. 9, 2008) [LBEXDOCID
1079021].
DOCID1079021](specifically,FontanawrotethatCitiwillnotopenyouinAsiawiththeagreementwe
haveinplace).
4784Id.
1269

responded that Lehman intended to include those subsidiaries in the Guaranty, but
needed more time to ensure there were no regulatory obstacles.4785 Shortly after 7:00
p.m., Cornejo forwarded the September 9 Guaranty Amendment to others within
Lehman to make sure there were no local legal or regulatory issues that prevented
Lehmanfromaddinganytheremaining16subsidiariesthatCitihadrequested.4786
At 7:11 p.m., Fontana emailed Cornejo, [w]e have a problem as we will not
openyouinAsiawiththeagreementwehaveinplace.Callme.4787Inanemailfrom
Cornejo to Lehman personnel at 7:36 p.m., Cornejo wrote that Citi wants LBHI to
guarantyeachoftheselegalentities....Iamnotsureeachoftheentitiesis100%owned
by Lehman or that we have lines in Asia. Citi will reduce all limits to 0, unless we
sign.... We signed off on [a] guaranty today in NY for LBI.4788 Citi explained to the
ExaminerthatLehmaneitherneededtoagreetoaparentalguarantyforthoseLehman
entities or prefund its trades in order for Citi to clear for Lehman in Asia the next
day.4789
1079021].
4786EmailfromEmilF.Cornejo,Lehman,toAireenPhang,Lehman,etal.(Sept.9,2008)[LBEXDOCID
1079057].
DOCID1079021].
4788Email from Emil F. Cornejo, Lehman, to Janet Birney, Lehman, et al. (Sept. 9, 2008) [LBEXAM
008669].
4789Examiners Interview of Thomas Fontana, Aug. 19, 2009, at p. 9 (Citi counsel Claudia Hammerman
clarifiedthispointtotheExaminer).
1270

During the evening of September 9, Lehman rejected eight of the original 17
entitiesthatCitihadproposedincludingintheamendedguaranty,andthefinalversion
that night contained nine Lehman subsidiaries that were ultimately added to the
Guaranty.4790 Specifically, Cornejo noted in an email that evening that Lehman
personnel had deleted five of the 17 additional subsidiaries Citi had proposed.4791
Following that modification, Lehman removed three more entities because: (i) two of
thesubsidiarieshadnoaccountswithCiti,and(ii)anothersubsidiarywasadivision
SARL.4792Lehmanpersonnelalsoconfirmedthat oneofthesubsidiariesCornejohad
removed earlier was appropriately removed because it was a Special Purpose
Vehicle.4793 Thus, the Guaranty was amended on September 9 to add nine Lehman
subsidiaries,4794 while a tenth, LBCC, was added late on September 11, 20084795 after
4790SeeemailfromEmilF.Cornejo,Lehman,toThomasFontana,Citigroup,etal.(Sept.10,2008)[LBEX
DOCID 458344)]; Schedule 1 (To Amendment 1) (Sept. 9, 2008) [LBEXDOCID 443684] (attached to
Cornejoemail).
4791EmailfromEmilF.Cornejo,Lehman,toJanetBirney,Lehman(Sept.9,2008)[LBEXDOCID1075546].
(sentat8:59p.m.Easterntime).Cornejonotedthat[w]ehavedeletedthefollowingnamesbutdidnot
explain why the subsidiaries were deleted. Id. The deleted names were: Lehman Brothers Financial
ProductsIncorporated,PropertyAssetManagementInc.,LibertusJutakuLoanK.K.,MarcyLimited,and
CaistorTradingBV.Id.
4792Email from Emily Critchett, Lehman, to Janet Birney, Lehman, et al. (Sept. 9, 2008) [LBEXDOCID
1009802](sentat9:08p.m.Easterntime).SARListheabbreviationforsocitresponsibilitlimite,
and typically appears after the name of a French private limited company. Encyclopedia.com, SARL
definition(lastaccessedJan.27,2010).
4793Email from Emily Critchett, Lehman, to Janet Birney, Lehman, et al. (Sept. 9, 2008) [LBEXDOCID
1009802]ThesubsidiarywasLehmanBrothersFinancialProductsIncorporated.Id.
4794SeeSchedule1(ToAmendment1)(Sept.9,2008),atp.1[LBEXDOCID443684].Thosenineentities
addedonSeptember9,2008were:LehmanBrothersAustraliaSecuritiesPtyLimited,LehmanBrothers
Incorporated, Lehman Brothers (Taiwan) Limited, Lehman Brothers Securities Private Limited,
NeubergerBermanLLC,LehmanBrothersCommodityServicesIncorporated,LehmanBrothersFinance
1271

MauersteintoldCornejothatLBCCsCLOobligationswouldhavetobeprefundedthat
nightifLehmandidnotsigntheScheduletotheGuarantywithLBCCincluded.4796
WiththeexceptionoftheLehmansubsidiariesthatwereinitiallyproposed,the
termsoftheexecutedGuarantyAmendmentremainedunchangedfromwhatwassent
viaemailtoCornejobyMauersteinat12:54p.m.onSeptember9.4797Thedocumentsdo
notshowwhetherLehmanadvisedCitiastothereasonsforitsremovalofsomeofthe
proposed subsidiaries from the list, nor do they establish whether Citi resisted
LehmansremovalofeightofthesubsidiariesinitiallyproposedbyCiti.4798
Japan Incorporated, Lehman Brothers GCS Financing and Lehman Brothers Securities Taiwan Limited.
Id.
4795Email fromRosa Garcia,Lehman, to Emil F. Cornejo, Lehman, et al. (Sept.12, 2008)[LBEXDOCID
065565](notingthattheattachedsignedGuarantywassenttoMauersteinatCiti;thisemailwassentat
8:55 p.m. Eastern time); see also Amendment 1 To Guaranty (Sept. 9, 2008) [LBEXDOCID 090568]
(executedversionsignedbyIanLowittonSeptember11,2008).
4796Email from Michael Mauerstein, Citigroup, to Emil F. Cornejo, Lehman (Sept. 11, 2008) [LBEX
DOCID1078857].
4797CompareAmendment1ToGuaranty[Draft](Sept.9,2008)[LBEXDOCID1032313](draftversionsent
byMauersteintoCornejoat12:54p.m.onSeptember9,2008),withAmendment1ToGuaranty(Sept.9,
2008) [LBEXDOCID 4263143] (executed version from September 9 which added only LBI to the
Guaranty),andAmendment1ToGuaranty(Sept.9,2008)[LBEXDOCID090568](finalexecutedversion
signedbyIanLowittonSeptember11,2008,listing10Lehmansubsidiariesthatwereultimatelyaddedto
theparentGuaranty).
4798SeegenerallyemailfromPaoloR.Tonucci,Lehman,toEmilF.Cornejo,Lehman,etal.(Sept.9,2008)
[LBEXAM 008690] (suggesting that, because Lehman had executed a similar guaranty with JPMorgan,
thisguarantyamendmentwouldnot,hehoped,beanissueforLehmanslegaldepartment).
1272

(iv) September12,2008:ALehmanCollateralAccountat
CitiwasActivatedAfterTwoMonthsofDiscussion,
andLehmanSignedanAmendmenttotheDirect
CustodialServicesAgreement
AcollateralaccounttitledLehmanBrothersHoldingsInc.,PledgetoCitibank
at Citi was reserved by July 18,4799 opened on September 11, and became active on
September12,4800butnocollateralwasevertransferredintoit.Theaccountwasopened
inconjunctionwiththeproposedpledgeofsecuritiesbyLBHIbecauseLehmanneeded
tohaveaUSsecuritiescustodyaccountandcashaccountatCiti.4801
Unlike JPMorgan, which discussed a guaranty amendment with Lehman on
September9thatwassubsequentlysignedonSeptember10andfollowedbyaSecurity
AgreementfromLehmanonSeptember10,4802CitididnotobtainaSecurityAgreement.
However, Citi did obtain an amendment on September 12, 2008 to its DCSA with
Lehman.4803 Specifically, on the afternoon of September 12, Citibanks Lukas and
Lehmans Birney and Boyle signed the DCSA amendment which gave Citi stronger
4799EmailfromKenPorcaro,Citigroup,toKatherineLukas,Citigroup(July18,2008)[CITILBHIEXAM
00022307];emailfromKatherineLukas,Citigroup,toJanetBirney,Lehman,etal.(Aug.4,2008)[LBEX
DOCID459043](informingLehmanthatthecollateralaccounthadbeenreserved).
4800Email fromRobsonR. Morri, Citigroup, to Thomas Fontana, Citigroup, et al.(Sept.11,2008) [CITI
LBHIEXAM00012865].
4801Email from Deborah MercerMiller, Citigroup, to Craig S. Dudsak, Citigroup, et al. (Sept. 11, 2008)
[CITILBHIEXAM00012697].Thecollateralaccountnumberwas203489.EmailfromDeborahMercer
Miller,Citigroup,toRachelV.Cole,Citigroup,etal.(Sept.11,2008)[CITILBHIEXAM00012697];email
fromRobsonR.Morri,Citigroup,toThomasFontana,Citigroup,etal.(Sept.11,2008)[CITILBHIEXAM
00012865].
4802SeeSectionIII.A.5.bofthisReport,whichdiscussestheJPMorganagreementamendments.
4803Direct Custodial Services Agreement Deed (Sept. 12, 2008) [LBEXDOCID 4263617]; see also Direct
CustodialServicesAgreementDeed(Sept.12,2008)[CITILBHIEXAM00005903](withKatherineLukas
signature).
1273

rights over the custody assets and included a carveout for customer accounts that
Lehmanrequestedbeadded.4804
Lehman had initially approached Citi in February 2008 about updating the
originalDCSA.4805Whilethepartiesnegotiatedthis,Citisoughttoreintroducelienand
setoff language into the agreements (Fontana noted in July that most major broker
dealershadnegotiatedthelienlanguageoutoftheDCSA).4806
IntheoriginalDCSAsignedonMarch26,1992,LBIauthorizedCititoestablish
Custody Accounts4807 and Client Deposit Accounts4808 in LBIs name.4809 The original
DCSAgrantedCitiagenerallienonpropertysolongasitwasnotheldforthebenefit
4804DirectCustodialServicesAgreementDeed(Sept.12,2008),atp.1(1.3)[LBEXDOCID4263617].The
carveoutprovisionspecifiesthatthesecurityinterestandrightofsetoffprovidedinthisDeedshallnot
applytoanyaccountandcashorSecuritiesheldthereiniftheaccountisidentifiedasforthebenefitof
LBIs customers, except to the extent that the client assets are needed to be used to cover fees,
administrative expenses and irrevocable transactions yet to settle. Id.; see also email from Katherine
Lukas,Citigroup,toEmilyCritchett,Lehman,etal.(Sept.12,2008)[LBEXDOCID4026355](notingthat
theupdatedDeedattachedincludesthelanguagerelatingtocustomeraccountsunder[section]1.3);e
mailfromKatherineLukas,Citigroup,toTomIsaac,Citigroup,etal.(Sept.12,2008)[CITILBHIEXAM
00011569] (explaining that the Deed includes a carveout paragraph for customer accounts except Citi
retains a lien over the client assets for fees and admin expenses as well as being covered for those
irrevocabletransactionsyettobesettled).
4805EmailfromRetoFaber,Citigroup,toKathyElOng,Citigroup,etal.(Aug.1,2008)[CITILBHIEXAM
00022171]; see also email from Emily Critchett, Lehman, to Katherine Lukas, Citigroup, et al. (Feb. 29,
2008)[LBEXDOCID1010232].
4806EmailfromThomasFontana,Citigroup,toBrianR.Leach,Citigroup(July1,2008)[CITILBHIEXAM
00111749].
4807Direct Custody Agreement for Citibank, N.A., Subsidiaries and Affiliates and Shearson Lehman
BrothersInc.(Mar.26,1992),atp.1[LBEXDOCID1091570].CustodyAccountswereforthedepositof
anySecurities,PreciousMetalsandotherproperty(apartfromcash)fromtimetotimereceivedbyCiti
fortheaccountofLBI.Id.atp.4(2).
4808Id. Client Deposit Accounts were for the deposit of funds in any currency from time to time
receivedbyCitifortheaccountofLBI.Id.
4809Id.
1274

ofLehmanscustomers.4810ThegenerallienintheoriginalDCSAextendedtoProperty
held by [Citi] under this Agreement until the satisfaction of all liabilities and
obligationsof[LBI](whetheractualorcontingent)ownedto[Citi]hereunder,provided,
that such lien shall secure only [LBIs] obligations to [Citi] for the safe custody and
administrationoftheProperty.4811
InSection4.1oftheSeptember12DCSAamendment,thelienwasstrengthened
andexpandedasLehmangrantedCitiafirstfixedsecurityinterest...overallrightsit
hasormayhavenoworinthefutureinrespectoftheCollateralwhereCollateralwas
definedtoincludecash,securitiesorotherassetsheldbyCiti.4812Citiwasonlyobliged
to release Collateral to [LBI] if there are no outstanding or contingent Secured
Obligations.4813 The Deed defines Secured Obligations as (i) all obligations of the
Client to reimburse the Custodian in respect of Irrevocable Commitments; and (ii) all
otherpresentandfutureobligationsoftheClienttorepaytheCustodianincluding,but
not limited to, daylight and overnight overdraft lines and reversals of provisional
4810Id.atp.19(17).
4811Id. Section 1 contains the definitions, including defining Property as any Securities, Precious
Metals,cashoranyotherpropertyheldbyCitiunderthetermsoftheAgreement.Id.atp.4(1).
4812DirectCustodialServicesAgreementDeed(Sept.12,2008),atp.2(4.1)[LBEXDOCID4263617].The
amendmentdefinesCollateralinsection1.1as(i)cashheldinanycashaccountwithanyCustodian;(ii)
SecuritiesorotherassetsheldbyanyCustodian;and(iii)rightsinrespectoftransactionsinSecuritiesin
conjunction[with]servicesprovidedbyanyCustodian.Id.TheCustodianisdefinedasCITIBANK,
N.A.onbehalfofeachbranchoraffiliateoftheBankfromtimetotimeselectedandappointedby[LBI]as
custodianorclearingagent.Id.
4813Id.atp.2(4.2).
1275

credits.4814 Additionally, Section 5 of the DCSA amendment provides Citi with the
right to set off any payment obligation owed by Lehman against any such obligation
owedbyCititoLehman,andspecifiesthatCitimaysetoffanamountestimatedbyit
in good faith to be the amount of that obligation if the obligation is unliquidated or
unascertained.4815
(d) LehmansClearingEnvironmentatCitiDuringtheWeek
ofSeptember8,2008
DaylightOverdraftLimits
DuringthecollateralpledgenegotiationsinJuly2008,someCitipersonnelwere
baffledastowhyLehmanneededsuchlargedaylightoverdraftlimitswithCiti,asCiti
understood Lehman to have almost $50 billion in its liquidity pool.4816 Citi did not
understand whyLehman couldnot put to usesomeofitsliquidity, sothatCiti could
significantlyreducethedaylightoverdraftlimits,asthisdoesntcreateanydisclosure
issues and [Lehman has] the liquidity.4817 Moreover, in Citis view, because Lehman
4814Id.atp.1(1.1).
4815Id.atp.2(5).
4816EmailfromGregoryFrenzel,Citigroup,toThomasObermaier,Citigroup,etal.(July16,2008)[CITI
LBHIEXAM 00082047] (concerning the Lehman Pledge Agreement, Frenzel suggested Citi insist on a
largerpledgeamountandsettheintradaylinestothatamount,orreduceLehmansintradaylinestozero
andletLehmanuseitsliquiditytoprefunditstransactions).
4817Email from John Dorans, Citigroup, to Brian R. Leach, Citigroup, et al. (July 16, 2008) [CITILBHI
EXAM00108067].
1276

representedthatithadsuchalargeliquiditypool,itwouldhavebeenhelpfultoCitiif
LehmankeptsomeofthatdepositwithCiti.4818
On Friday, September 5, 2008, Citi decided to downgrade its internal
classificationofLehmanscreditworthiness.4819CititookthisstepbecauseLehmanhad
clearly defined problems,4820 whereas Lehmans prior creditworthiness classification
at Citi only indicated potential weakness.4821 When Citi internally downgraded
Lehmans creditworthiness on September 5, the credit [system] automatically
suspendedalltradinglines,whichmeantnotthatCiticutthelines,butthatCitimore
carefully, manually monitored Lehmans trading activities.4822 In addition to carefully
monitoringLehmanstradingactivities,Citirequiredinternalapprovalsforanytrades
that were larger, longer in tenor, or riskier than usual.4823 On September 10, Citi
personnelmistakenlyinformedLehmanthatCitihadcutthetradinglines,whichwas
LBHIEXAM00073791].
4819EmailfromMelissaJ.Torres,Citigroup,toJohnJ.Foley,Citigroup,etal.(Sept.6,2008)[CITILBHI
EXAM 00088683] (noting this change was made on Friday, September 5, 2008); see also email from
Gregory Frenzel, Citigroup, to NA IRM Weekly Updates group, Citigroup (Sept. 7, 2008) [CITILBHI
EXAM00107376](weeklyupdatefromSeptember5,2008);emailfromMichaelMauerstein,Citigroup,to
Katherine Lukas, Citigroup, et al. (Sept. 8, 2008) [CITILBHIEXAM 00051890] (noting that the
classificationisstrictlyaninternalCitimatter,CitihadnotcommunicatedanythingtoLehmanabout
thechangeinitsinternalclassificationofLehman,norhadCitichangeditsoperationswithLehmandue
totheclassificationchange).
4820ThomasFontana,Citigroup,UnpublishedNotes(Sept.5,2008),atp.168[CITILBHIEXAM00099649]
(contemporaneoushandwrittennotes).
4821Thomas Fontana, Citigroup, Unpublished Notes (Sept. 12, 2008), at p. 191 [CITILBHIEXAM
00099649](contemporaneoushandwrittennotes).
4822Email from Kathy El Ong, Citigroup, to Ajaypal S. Banga, Citigroup, et al. (Sept. 11, 2008) [CITI
LBHIEXAM00012823].
4823Id.
1277

not the case, and Citi thereafter reminded its employees to be extra vigilant so that
misinformationwouldnotbecommunicatedtoLehmanortothemarketplace.4824
OnSeptember8,LehmanpresentedtoCitisMauerstein,FontanaandFoskettits
expectedthirdquarter2008resultsandgameplanforLehmangoingforward.4825Citis
impression of the presentation was that the plan made sense, but that executing the
plan was going to be key.4826 Foskett commented that Lehman was the most open
amongst the brokers about [third quarter 2008] results and [its] plans to address the
stressandstrainofthecurrentenvironment.4827
Midday on September 9, Citis Silbiger requested that Lehmans daylight
overdraftlimitbereducedfrom$3billiontozerowhileCiti,instead,usedLehmans$2
billiondeposit(plusanyovernightfundsthatLehmanhadplacedwithCitistreasury
desk) to clear transactions for Lehman.4828 Citis Chief Risk Officerrequested that Citi
pare back the Global Transaction Services clearing lines in order to monitor flows
whilekeepingFXtradingavailable.4829CitihadfrequentlyrequestedthatLehmanleave
a larger deposit, and had difficulty manually managing Lehmans clearing and
4824Id.
4825EmailfromChristopherM.Foskett,Citigroup,toIanT.Lowitt,Lehman(Sept.8,2008)[LBEXDOCID
070422].
4826Id.
4827Id.
4828Email from Joseph Chesakis, Citigroup, to Katherine Lukas, Citigroup, et al. (Sept. 9, 2008) [CITI
LBHIEXAM 00014706]. Citigroups Responses to Examiners First Set of Questions re PreBankruptcy

SetoffdatedNovember16,2009(Dec.18,2009),atp.4[hereinafterCitigroupFirstWrittenResponses].
4829EmailfromPaulEgan, Citigroup, toAjaypal S. Banga, Citigroup, et al.(Sept. 10, 2008)[CITILBHI
EXAM00075863].
1278

settlementactivitiesusingjustthe$2billiondepositafterthelineshadbeenreducedto
zero.4830Despitethereduceddaylightoverdraftlimit,CititolditsFXtraderstocontinue
trading with Lehman, so long as Citis net exposure to Lehman did not exceed the $2
billiondeposit.4831
In an interview with the Examiner, Foskett stated that, prior to Lehman
Weekend,severalsmaller multinationalcompanies had toprefund their activity with
Citi,suggestingthatsuchprefundingwaspossible.4832Additionally,Foskettstatedthat
overLehmanWeekend,twolargecompanieshadtoprefundtheirtransactionsthrough
Citi.4833
(ii) LehmanDepositedAmountsinExcessofthe$2Billion
DepositatVariousTimesin2008WithCiti
Atvarioustimesduringthesummerof2008,Lehmandepositedexcesscashwith
Citi overnight, including: $343 million on June 13,4834 $900 million on July 10,4835 $1
4830EmailfromThomasFontana,Citigroup,toMichaelMauerstein,Citigroup,etal.(Sept.9,2008)[CITI
LBHIEXAM00065673].
4831EmailfromChristopherM.Foskett,Citigroup,toPaulEgan,Citigroup,etal.(Sept.10,2008)[CITI
LBHIEXAM00076841].
4832ExaminersInterviewofChristopherM.Foskett,Sept.24,2009,atp.8.Twobrokerdealers,eachwith
approximately$1billionindailyclearingexposure,prefundedtheircashclearingthroughCitiafterthe
collapseofBearStearns.Inaddition,alargerbrokerdealermayhavealsoprefundedafterCitilimited
itsclearingexposurefacingit.CitigroupFirstWrittenResponses,atp.6.
4834Email from Edward A. Hewett, Jr., Citigroup, to Scott Bere, Citigroup, et al. (June 13, 2008) [CITI
LBHIEXAM00115260].
4835Email from Edward A. Hewett, Jr., Citigroup, to Scott Bere, Citigroup, et al. (July 10, 2008) [CITI
LBHIEXAM00114179].
1279

billiononJuly11,4836$1.25billiononJuly14,4837$1.4billiononJuly154838and$1.1billion
on August 6.4839 Citi viewed these excess cash deposits as Lehmans attempts to
demonstrate to us that they [did] not have a liquidity issue.4840 These funds would
typicallybereturnedtoLehmanthefollowingbusinessday,alongwithinterestearned
onthedepositovernight.4841DuringtheweekofSeptember8,2008,Lehmancontinued
to deposit additional funds with Citi overnight: $680 million on the evening of
September9,4842$3.3billiononSeptember104843and$3.02billiononSeptember11.4844On
themorningofSeptember12,LehmanrequestedCitireturn$1.8billion,thelastofthe
4836EmailfromMichaelMauerstein,Citigroup,toThomasFontana,Citigroup,etal.(July12,2008)[CITI
LBHIEXAM00076243].
LBHIEXAM00018024](conveyingtopicsdiscussedduringaconversationMauersteinhadwithTonucci).
4838Email from Edward A. Hewett, Jr., Citigroup, to Scott Bere, Citigroup, et al. (July 15, 2008) [CITI
LBHIEXAM00115664].
4839EmailfromMichaelMauerstein,Citigroup,toChristopherM.Foskett,Citigroup,etal.(Aug.7,2008)
4840Email from Thomas Fontana, Citigroup, to Christopher M. Foskett, Citigroup, et al. (July 11, 2008)
[CITILBHIEXAM 00082020]; email from Michael Mauerstein, Citigroup, to Christopher M. Foskett,

Citigroup, et al. (Aug. 7, 2008) [CITILBHIEXAM 00074313] (commenting that the $1.1 billion excess
deposit on August 6, 2008, was possibly a demonstration of liquidity); Examiners Interview of
ChristopherM.Foskett,Sept.24,2009,atp.7.
4841Email from Thomas Fontana, Citigroup, to Brian R. Leach, Citigroup, et al. (Sept. 10, 2008) [CITI
LBHIEXAM 00054016] (noting that, while Lehmans deposit was $2.68 billion that morning, the $680
millioninexcessofthe$2billioncashdepositwastobereturnedthatmorning);CitigroupFirstWritten
Responses,atp.4.
4842Email from Emil F. Cornejo, Lehman, to Michael Mauerstein, Citigroup (Sept. 10, 2008) [LBEX
DOCID1078918];seealsoCitigroupFirstWrittenResponses,atp.4(identifyingtheamountsoldas$679
million).
LBHIEXAM00054016].
4844Email from Katherine Lukas, Citigroup, to Tom Isaac, Citigroup, et al. (Sept. 11, 2008) [CITILBHI
EXAM00014488].
1280

additional funds Lehman had placed with Citis desk the previous night.4845 Citi
complied approximately three hours later at 12:52 p.m.4846 Citi tried to hold on to the
additionalfundsaslongasitcouldonSeptember12becauseCitisaw$4billionofline
utilization,includingFXsettlementsfromAsia,tradesettlementsandclearingusagein
Europe,4847 but Fontana later authorized the release of the funds in excess of the $2
billion cash deposit because Lehman [was] in dire need of the money.4848 When
tradingendedonSeptember12,Lehmandidnotaskforits$2billiondepositback.4849
(iii) CitiEndeavoredToHelpLehmaninSeptember2008,
PriortotheBankruptcyFiling
CitiendeavoredtoassistLehmanonnumerousoccasionsinthedaysleadingup
to Lehmans bankruptcy filing. For example, on September 10, Citi approved a $500
million extension of credit in excess of the aggregate deposit held so that a CLS
paymentcouldbemade.4850ThatbroughtallofLehmansclearinglinesuptocapacity,
4845See email from Michael Mauerstein,Citigroup, to Thomas Fontana, Citigroup, et al. (Sept. 12, 2008)
[CITILBHIEXAM00101294](reportingthatFlemingmadetherequestpriorto10:00a.m.thatday).
4846EmailfromKatherineLukas,Citigroup,toChrisDeukmedjian,Citigroup,etal.(Sept.12,2008)[CITI
LBHIEXAM00032758](fundswerereleasedbacktoLehmanshortlybefore1:00p.m.).
4847EmailfromThomasFontana,Citigroup,toThomasSchwartz,Citigroup,etal.(Sept.12,2008)[CITI
LBHIEXAM00048225].
4848EmailfromThomasFontana,Citigroup,toRichardC.S.Evans,Citigroup,etal.(Sept.12,2008)[CITI
LBHIEXAM00048225].
4849Email from Thomas Fontana, Citigroup, to Karen Kirchen, Citigroup (Sept. 12, 2008) [CITILBHI
EXAM 00054412]. But see email fromDaniel J. Fleming, Lehman, to David Forsyth, Lehman (Sept. 12,
2008)[LBEXDOCID083098](FlemingconfirmedthatmorningthathewantedtoaskCitiforthemoney
back,butitisnotclearwhetherhewasreferringtothe$2billioncashdepositorthe$3billioninextra
funds deposited with Citi the evening of September 11; also, there is no indication from this email or
othersthatLehmanrenewedthisrequestattheendofthedayonSeptember12).
LBHIEXAM00108863].
1281

and Citi advised Lehman that Lehman needed to get more money into its accounts
beforeanyfurtherpaymentscouldbemade.4851Additionally,lateonSeptember14,Citi
transferred $500 million from LBHIs account at Citi to LBIs account at Citi to fund
Lehmans CLS obligations after Fleming made the request on the afternoon of
September14.4852
CitisoughtotherwaystohelpLehmaninSeptember.4853Forexample,Citiwas
engaged by Hellman and Friedman regarding a potential acquisition of Neuberger
Berman.4854CitialsoapproachedLehmaninearlySeptembertoseeifCiticouldassist
withcapitalraises.4855Lehmanalsodiscussedspinningoffmostofitsilliquidrealestate
assetsintoaseparatepubliclytradedcompany,thebadbank,tomovethoseassetsoff
4851Id.
4852Email from Daniel J. Fleming, Lehman, to Paolo R. Tonucci, Lehman, et al. (Sept. 14, 2008) [LBEX
DOCID 457630]; see also email from Julius Silbiger, Citigroup, to Thomas Obermaier, Citigroup, et al.
(Sept.14,2008)[CITILBHIEXAM00104189](statingthatthe$500millionhadmovedby9:42p.m.that
evening); email from Roger Barnes, Citigroup, to Naresh N. Kumar, Citigroup, et al. (Sept. 14, 2008)
[CITILBHIEXAM00104189](explainingthatCiticheckingopenedat9p.m.thateveningsothetransfer
couldbemadethen);emailfromThomasFontana,Citigroup,toChristopherM.Foskett,Citigroup,etal.
(Sept. 14, 2008) [CITILBHIEXAM 00101129] (approving the transfer); Lehman Brothers Inc. Account
Report (Oct. 1, 2008), at p. 1033 [CITILBI 00024142] (account statement confirming that the transaction
transferred $500 million from Lehman Brothers Holdings Main Open Account 40615202 to Lehman
BrothersInc.account30544658).
4853Email from John P. Havens, Citigroup, to Herbert H. (Bart) McDade III, Lehman (Sept. 9, 2008)
[LBEXDOCID4191451].
4854EmailfromGaryShedlin,Citigroup,toChristopherM.Foskett,Citigroup,etal.(Sept.9,2008)[CITI
LBHIEXAM00075818].
4855Examiners Interview of Christopher M. Foskett, Sept. 24, 2009, at p. 9; email from Christopher M.
Foskett,Citigroup,toGaryShedlin,Citigroup,etal.(Sept.9,2008)[CITILBHIEXAM00075818](asking
whether Shedlin and David Head have any interest in getting involved to help Lehman as it is
obvious they need capital); email from Christopher M. Foskett, Citigroup, to Peter Heidinger,
Citigroup, et al. (Sept. 10, 2008) [CITILBHIEXAM 00076841] (Citi in discussions with Lehman on a
capitalraisetransaction).
1282

Lehmans balance sheet.4856 Under this plan, Lehman would provide a cash infusion,
but then seek more funds from shareholders or other investors to enable the spinoff
companytooperate.4857AlthoughLehmandidnotaskCititofundtherealestateassets
in the bad bank part of the good bank/bad bank alternative,4858 Citi dispatched
personnel from its equity capital markets business to speak with Lehman about
alternativesforraisingmoneytosupportthoseassets.4859Inaddition,Citiwasinvolved
in discussions over Lehman Weekend with other banks (as part of a proposed loan
facilityforLehmanbyabankconsortium)tofundthe$33billioninassetsthatLehman
contemplatedspinningoffintoabadbank.4860
ThroughoutLehmansdifficulties,Citiseemedtomaintainconfidenceinthefirm
almostuntilthepetitiondate.4861OnSeptember12,Foskettwrotethat[m]arketforces
areirrational,andheandFontanalamentedhowthemarketwastreatingLehman.4862
ThisexchangeissimilartoCitisviewofLehmaninJune2008when,eventhoughCiti
personnelreferredtoalossofconfidenceinLehmanonJune12,Foskettclarifiedthat
4856SeeSectionIII.A.3ofthisReport,whichdiscussesSpinCo.
4857Seeid.
4858Seeid.
4860EmailfromThomasFontana,Citigroup,toWilliamMandaro,Citigroup,etal.(Sept.14,2008)[CITI
LBHIEXAM00073424].CitigroupFirstWrittenResponses,atp.4.
4861SeeemailfromGeoffRichards,Citigroup,toJohnTrohan,Citigroup,etal.(May29,2008)[CITILBHI
EXAM 00082821] (the No Smoking Guns research paper assessed Lehmans liquidity as good and
thoughtconcernsaboutanotherBearStearnstypefundingproblemwereoverblown);emailfromJohn
P. Havens, Citigroup, to Herbert H. (Bart) McDade III, Lehman (Sept. 9, 2008) [LBEXDOCID 4191451]
(CitisteamwasverypositiveaboutLehmansSeptember8,2008gameplanpresentation).
4862EmailfromChristopherM.Foskett,Citigroup,toThomasFontana,Citigroup(Sept.12,2008)[CITI
LBHIEXAM00073399].
1283

the loss of confidence referred to a couple of people on Fontanas team, not a Citi
widelossofconfidenceinLehman.4863
(iv) LehmansAccountsatCitiClosedonFridaySeptember
12WithFundsinExcessofthe$2BillionDeposit
On September 12, Citi was aware of approximately $1.5 billion in anticipated
payments that Citi would have had to make on Lehmans behalf on September 15.4864
Thus, in preparation for trading on September 15, Citi held on to the full $2 billion
depositonSeptember12.4865AccordingtocontemporaneousCitiemails,inadditionto
the $2 billion deposit, Lehman ended Friday with approximately $970 million in
additional funds in its accounts at Citi because Citi did not make four Lehman
payments worth just over $2.4 billion.4866 Two of the transactions failed because there
LBHIEXAM00054412].
4865Id.
4866Email from Julius Silbiger, Citigroup, to Naresh N. Kumar, Citigroup, et al. (Sept. 14, 2008) [CITI
LBHIEXAM00068053](breakingdownthefailedtransactionamountsasaffectingLBHI($616million),
LBI ($335 million) and LBSA ($19 million)); email from Paul S. Galant, Citigroup, to John P. Havens,
Citigroup (Sept. 12, 2008) [CITILBHIEXAM 00114766] (listing the failed payments as $883MM to
Chase; $850MM to Chase; $670MM to Chase; and 224MM (USD eqv) C$ to RBC); but see email from
Thomas Fontana, Citigroup, to Richard C.S. Evans, Citigroup (Sept. 13, 2008) [CITILBHIEXAM
00052719] (stating the amount in excess of the deposit was $996 million). It appears that most of the
money in the LBHI account was transferred on September 14 to LBIs account at Citi to support CLS
service.SeeemailfromJuliusSilbiger,Citigroup,toThomasObermaier,Citigroup,etal.(Sept.14,2008)
[CITILBHIEXAM00104189](statingthatthe$500millionhadmovedby9:42p.m.thatevening);email
fromRoger Barnes, Citigroup, toNaresh N. Kumar,Citigroup, etal. (Sept.14,2008) [CITILBHIEXAM
00104189] (explaining that Citichecking opened at 9 p.m. that evening so the transfer could be made
then);emailfromThomasFontana,Citigroup,toChristopherM.Foskett,Citigroup,etal.(Sept.14,2008)
[CITILBHIEXAM 00101129] (approving the transfer); Lehman Brothers Inc. Account Report (Oct. 1,
2008),atp.1033[CITILBI00024142](accountstatementconfirmingthatthetransactiontransferred$500
millionfromLehmanBrothersHoldingsMainOpenAccount40615202toLehmanBrothersInc.account
30544658).
1284

wasnotenoughcashtocoverthem,thethirdwasreturnedbyJPMorgan,andthefourth
payment failed because Lehman did not fund its Canadian currency in time.4867
AccordingtoanemailfromFontana,LehmanranitsbalancesatCititoolateonFriday,
andCitidecidednottoaskforanextensionoftheFedwireservice4868sothatCiticould
attempttosendthosepaymentsout.4869Similarly,FlemingwrotethatdaythatLehman
did not have enough time that evening to transfer the funds.4870 One Citi officials
contemporaneouscharacterizationofthedaysactivitywasthatitlookedlikeLehman
wasclearingoutthecash.4871
(e) CitisParticipationinLehmanWeekendEvents
Over Lehman Weekend, Citi personnel worked with other banks to value
Lehmansassetsandparticipatedindiscussionswithotherbanksaboutthepossibility
of creating a loan facility for Lehman to support the winddown of certain Lehman
assets.4872
4867Email from Paul S. Galant, Citigroup, to John P. Havens, Citigroup (Sept. 12, 2008) [CITILBHI
EXAM00114766].
4868FedwireservicesareownedandoperatedbytheFederalReserveBanks,andprovideasecuremethod
of transferring largevalue, timecritical payments between participants. See Federal Reserve Bank,
FedwireServicesOfferings,availableathttp://www.frbservices.org/fedwire/index.html(lastaccessedJan.
21,2010).
4869EmailfromThomasFontana,Citigroup,toRichardC.S.Evans,Citigroup(Sept.13,2008)[CITILBHI
EXAM00052719].
4870Email from Daniel J. Fleming, Lehman, to Ian T. Lowitt, Lehman (Sept. 12, 2008) [LBEXDOCID
070225](explainingthatLehmanranoutoftimethateveningtomakecertainpaymentsbecausebythe
timeCiticonfirmedourpositionitwasafter6:30whichisthelasttimebankscantransferfundsthrough
thefed).
4871Email from John P. Havens, Citigroup, to Vikram S. Pandit, Citigroup (Sept. 12, 2008) [CITILBHI
EXAM00114766].
4872CitigroupFirstWrittenResponses,atp.4.
1285

With regard to the latter, the Examiners investigation revealed that Citi
personnel were involved in discussions regarding the creation of a loan facility by a
consortium of banks that would assist in an orderly winddown of assets that were
excluded from a sale, but these discussions ended when the proposed purchaser
withdrew.4873Inaddition,discussionaboutcreatinga$100billionequityrepobackstop
facility to fund collateral that could not be pledged at the PDCF was mooted by the
FRBNYsannouncementthatitwasexpandingthetypesofcollateralitwouldacceptat
theTSLFandPDCFwindows.4874
Inaddition,CitiwasoneofseveralbanksinvolvedwithvaluingLehmansreal
estateportfoliostogainabetterunderstandingofLehmanshiddencontingenciesand
unfundedobligations.4875AccordingtoFRBNYemails,throughthisvaluationanalysis,
thebanksreportedtotheFRBNYthattheyassignedavaluetoLehmansCREof$1720
billion in contrast to the $41 billion value Lehman had assigned.4876 In addition,
4873Id.
4874Examiners Interview of Michael Mauerstein, Sept. 16, 2009, at p. 9; Examiners Interview of

ChristopherM.Foskett,Sept.24,2009,atp.9;emailfromChristopherM.Foskett,Citigroup,toAlbert
May,Citigroup,etal.(Sept.14,2008)[CITILBHIEXAM00075998];CitigroupFirstWrittenResponses,at
p.4.
4875EmailfromSarahBell,FRBNY,toMegMcConnell,FRBNY,etal.(Sept.14,2008)[FRBNYtoExam.
014832]; see also email from Kenneth Cohen, Lehman, to Kevin Genirs, Lehman, et al. (Sept. 13, 2008)
[LBEXDOCID1900538](statingthatCreditSuisse,GoldmanSachsandCitiwouldhaveaccessshortlyto
informationontheestimated$41billionglobalcommercialrealestatebalancesheet,andnotingthatthis
wouldnotincludecashflows).
014832]; see also email from Brian R. Leach, Citigroup, to Vikram S. Pandit, Citigroup, et al. (June 12,
2008) [CITILBHIEXAM 00114272] (expressing doubt that Lehmans balance sheet could be liquidated
within 10 percent of its marks and commenting that it would likely be worse than that unless the
governmentsteppedin).
1286

regarding Lehmans residential real estate, the banks reported an assigned value
(exclusive of derivatives) of $9 billion, compared to Lehmans assigned value of $17.2
billion.4877However,accordingtoemailsproducedbytheFRBNY,thebanks,including
Citi, did not think they had either sufficient time or information to value Lehmans
assetsthoroughly.4878Indeed,somewithinCitispecificallyrecognizedthattimeisnot
onanyonesside,4879especiallygivenLehmanscomplexbalancesheet.4880
OntheafternoonofSundaySeptember14,LehmaninformedCitithatitwould
befilingforbankruptcy.4881
BankruptcyProtection
(i) CitiContinuedtoProvideCLSServicesforLehman,
ButNotinanEntirelyUninterruptedManner
OnSeptember15,2008,CitisentalettertoLehmansCLSusermembersLBI,
LBCC,LBSFandLBIEadvisingthemthat,effectiveimmediately,weareterminating
014832].
4878Id.
4879EmailfromThomasObermaier,Citigroup,toPaulS.Galant,Citigroup(Sept.12,2008)[CITILBHI
EXAM00101309].
4880Examiners Interview of Michael Mauerstein, Sept. 16, 2009, at pp. 910; see also email from
Christopher M. Foskett, Citigroup, to David J. Spinks, Citigroup (Sept. 14, 2008) [CITILBHIEXAM
00074716] (responding to Spinks comment that Spinks hoped Henry Paulson and the Federal Reserve
knewwhattheyweredoingbynotputtingtogetheradealtosaveLehman,FoskettstatedFSAputthe
squashontheBarclaysdeal).
4881SeeemailfromChristopherM.Foskett,Citigroup,toFIGExecutiveCommittee,Citigroup(Sept.14,
2008) [CITILBHIEXAM 00074716] (Lehman will be filing for bankruptcy. There is no deal to save
them.).
1287

the CLS Settlement Services Amended and Restated Agreement.4882 Later that same
day,LowittsignedanagreementrequiringthatLehmandeposit$1billioninadeposit
accountatCitiinexchangeforCitiagreeingtomaintainCLSservicesforLBIandLBCC
onSeptember16.4883Consequently,LBIestablisheda$1billiontimedepositatCition
theafternoonofSeptember15toinduceCititocontinuetoeffectCLSpaymentsforLBI
andLBCC.4884Inrecognitionofthis,CitisentanotherlettersuspendingtheSeptember
15terminationnoticeforoneday,whichmeantthatLehmanwasauthorizedtosubmit
orders through the CLS system using Citibanks account on September 16.4885 Some
withinLehmanviewedCitischangeinpositionontheeveningofSeptember15asthe
resultofpressurefromofficialsattheFederalReserveandSEC.4886
During the evening of September 17, Citi again terminated the CLS Agreement
withLBI,which,bythatpoint,wastheonlyLehmansubsidiarystillauthorizedbyCiti
4882Letter from Citibank, N.A., to Lehman Brothers Inc., et al., re: CLS Settlement Services Agreement
(Sept.15,2008)[LBEXDOCID462068].
4883Email from Julie Barboza, Lehman, to Latoya Horton, Citigroup (Sept. 15, 2008) [LBEXDOCID
4043766]; Letter Agreement from Citibank, N.A., to Lehman Brothers Inc. and Lehman Brothers
CommercialCorporation,re:CLSAgreement(Sept.15,2008)[LBEXDOCID4043766x4264053];seealsoe
mailfromJonathanD.Williams,Lehman,toRobClose,CLSBank,etal.(Sept.15,2008)[LBEXDOCID
457922](rescindingtradesinCLSforLBIEandLBSFbecauseLBIEwasinreceivershipintheU.K.and
LBSFwasaU.S.nonregulatedentitywithveryfewFXtrades).
4884Letter Agreement from Citibank, N.A., to Lehman Brothers Inc. and Lehman Brothers Commercial
Corporation,re:CLSAgreement(Sept.15,2008)[LBEXDOCID4264053];seealsoLetterAgreementfrom
Citibank, N.A., to Lehman Brothers Inc., re: CLS Agreement (Sept. 16, 2008) [CITILBI 00024114]
(referencingtheSeptember15,2008LetterAgreement).
4885LetterfromCitibank,N.A.,toLehmanBrothersInc.,etal.,re:CLSSettlementServiceAgreementand
ourletterdated15thSeptember(theLetter)(Sept.15,2008),atp.1[LBEXDOCID462068].
4886EmailfromGregoryEickbush,Lehman,toAlastairBlackwell,Lehman,etal.(Sept.15,2008)[LBEX
DOCID026761](FEDandSECtoldCititoturnCLSbackonforus.Allfineforafewdays.).
1288

to submit orders to the CLS system.4887 This termination lasted only approximately
three hours because Barclays signed a pledge agreement with Citi on the evening of
September17intheamountof$700millionsothatCitiwouldclearforvalueforLBIon
September18.4888Afterreceivingthe$700millionpledgefromBarclaysatLBIsrequest,
Citi withdrew its termination of the CLS Agreement.4889 Citi thereafter cleared for
LehmanthroughtheCLSsystemthroughFridaySeptember19.4890
CitifeltcomfortablecontinuingtoserveasLehmansCLSagenttheweekLBHI
filedforbankruptcyprotectionbecauseBarclayshadsteppedintotheshoesofLBI,and
because Citi still held the $2 billion comfort deposit.4891 In the end, Citi served as
LehmanssettlementmemberinCLSthroughFriday,September19,bywhichtimethe
4887LetterfromCitibank,N.A.,toLehmanBrothersInc.,re:CLSSettlementServicesAgreement(Sept.17,
2008)[LBEXDOCID462072];seealsoLetterAgreementfromCitibank,N.A.,toLehmanBrothersInc.,re:
CLS Agreement (Sept.16, 2008) [CITILBI 00024114] (listing only LBI asauthorized to submit orders to
theCLSsystemonSeptember17,2008).
4888EmailfromKatherineLukas,Citigroup,toDanielJ.Fleming,Lehman,etal.(Sept.17,2008)[LBEX
DOCID 457387)] (with letter attached concerning Citi withdrawing the termination of the CLS
AgreementastoLBI);seealsoemailfromJohnP.Emert,Citigroup,toStephenW.Stites,PaulWeiss,et
al.(Sept.17,2008)[BCIEX00077688](theproposedpledgeagreementforBarclaystosignisreferencedas
attachedtotheemail).Fortheentirepledgeagreement,seePledgeAgreement(Sept.17,2008)[BCIEX
00077694](unexecutedversion),andSignaturePage(Sept.17,2008)[BCIEX00077639](signaturepageof
the pledge agreement contains Gerard LaRoccas signature, Managing Director at Barclays, but the
Citibanksignatureblockisblank).
4889LetterfromCitibank,N.A.,toLehmanBrothersInc.,re:CLSSettlementServicesAgreement(Sept.17,
2008) [LBEXDOCID 457387x462072]. Citi ultimately returned the $700 million to Barclays pursuant to
the terms of the November 13, 2008 Supplement to Pledge Agreement. See Supplement to Pledge
Agreement(Nov.13,2008)[CITILBI000541].
4890Examiners Interview of Jonathan D. Williams, Aug. 5, 2009, at p. 6 (Citis clearing for Lehman
includedWednesdaySeptember17,whichwastheInternationalMonetaryMarketsquarterlysettlement
dateforCMEcurrencyfuturesandwhichWilliamsexplainedwassignificantbecauseahugevolume
oftradessettledthatdaythroughCLS);emailfromJonathanD.Williams,Lehman,toPaoloR.Tonucci,
Lehman,etal.(Sept.16,2008)[LBEXDOCID457949](commentingthathavingCLSserviceonSeptember
17wasextremelyimportantbecauseitwastheIMMsettlementdate).
1289

settlement activity was significantly less than it had been at the beginning of the
week.4892CitistoppedadvancingfundsandterminatedtheCLSagreementwhenCitis
exposurereachedapproximately$16billion.4893CitinotifiedLehmanforthelasttimeon
September 19 that, effective September 22, Citi was terminating the CLS Services
Agreement.4894
PortionoftheCashDeposit
LateonSundaynight,September14,2008,CitisJohnDoranswroteinanemail
thatCitihadsetoffcertainfundsandthebalanceofthemoneyondepositwewillbe
holding as cash collateral subject to determining what we are ow[ed] by Lehman.4895
The amount of the setoff was $512 million,4896 which was ordered to be placed in a
4893ThomasFontana,Citigroup,UnpublishedNotes(Sept.1718,2008),atpp.236,241[CITILBHIEXAM
00099649](contemporaneous handwritten notessuggesting CLSwasshort$15 billion on September 17,

2008,andshort$16billionwhentheNewYorkmarketsopenedonSeptember18,2008).
4894Letter from Tom Isaac, Citigroup, to Lehman Brothers Inc., re: CLS Settlement Services Agreement
(Sept.19,2008)[CITILBI00024117].
4895EmailfromJohnDorans,Citigroup,toJamesA.Forese,Citigroup,etal.(Sept.14,2008)[CITILBHI
EXAM00105795].
Citibank Clearing Advances, at p. 3 n.1, Docket No. 109, In re Lehman Bros. Holdings, Inc., No. 0813555
(Bankr.S.D.N.Y.Sept.18,2008).CitigroupFirstWrittenResponses,atp.1;ThomasFontana,Citigroup,
Unpublished Notes (Sept. 1415, 2008), at pp. 202, 211, 219, 223 [CITILBHIEXAM 00099649]
(contemporaneoushandwrittennotesshowingabreakdownofthe$512millionsetoffas$275millionfor
LehmanBrothersCommercialCorporationAsiaLtd.facility,$164millionforoverdraftsandplacements,
$50 million for letters of credit and $23 million for miscellaneous marktomarket. The $164 million
amount wasfurther broken downinto$56 million for Lehman Brothers Finance AG Zurich Placement,
$43millionforLBHINY,$17.3millionforLBHIU.K.and$48.3millionforLehmanBrothersSecurities
AsiaLtd.).
1290

segregated account in Citibank North Americas name,4897 but, according to Citis
counsel, was reversed (by $275 million) on September 16.4898 Thebalance of thesetoff
was reversed ($237 million) on December 18, 2008, when Citi transferred those funds
back into LBHIs cash deposit account 30778171.4899 LBHI still maintains a $2 billion
deposit with Citibank, against which Citibank asserts rights of netting, offset,
recoupment,orotherclaimsofright.4900
(2) AnalysisofPotentialColorableClaims
TheExaminersinvestigationhasnotrevealedevidencesupportingtheexistence
ofanycolorableclaimsagainstCiti.
(a) ValidityoftheSeptember9GuarantyAmendment
(i) EconomicDuress
Because the September 9 Guaranty Amendment was proposed and executed in
thesameday,andbecauseCitiofficialsstatedonSeptember9thattheywouldnotopen
4897Email fromThomas Fontana, Citigroup, to Edward A.Hewett, Jr., Citigroup(Sept.14,2008)[CITI
LBHIEXAM00068353].
4898CitigroupFirstWrittenResponses,atp.7.
4899Account30778171Statement(Jan.2,2009),atp.1[CITILBHI0005070].
4900Notice of Presentment of Stipulation and Order Authorizing (1) Transfer of Certain Prepetition
Deposits, and (2) Preservation of Citibanks Setoff Rights, if any, in Respect of Amounts Transferred,
Annex at p. 2, Docket No. 3272, In re Lehman Bros. Holdings, Inc., No. 0813555 (Bankr. S.D.N.Y. Apr. 3,
2009)(statingthatLBHImaintainsa$2billiondepositwithCitibank);StipulationandOrderAuthorizing
(1) Transfer of Certain Prepetition Deposits, and (2) Preservation of Citibanks Setoff Rights, if any, in
RespectofAmountsTransferred,atp.2(B),DocketNo.3372,InreLehmanBros.Holdings,Inc.,No.08
13555 (Bankr. S.D.N.Y. Apr. 15, 2009) (order signed by Judge James M. Peck); see also Statement of
Citigroup Inc. in Support of Motion of Debtors for Order, Pursuant to Section 105 of the Bankruptcy
Code,ConfirmingStatusofCitibankClearingAdvances,atp.2(2),DocketNo.110,InreLehmanBros.
Holdings,Inc.,No.0813555(Bankr.S.D.N.Y.Sept.18,2008)(showingthat,asofSeptember18,2008,the
amountinLBHIscashdepositaccountatCitiexcludinganypotentialamountthathadbeensetoff,was
$1.763billion.).
1291

forLehmaninAsiathenextdaywithoutanamendedagreement,thisSectionanalyzes
whethertheSeptember9GuarantyAmendmentisinvalidduetoeconomicduress.
a. LegalFramework
Section 4 of the September 9 Guaranty Amendment provides that the
Amendment is to be governed by and construed in accordance with the laws of the
StateofNewYork.4901
AsdiscussedsupraintheanalysisofpotentialcolorableclaimsagainstJPMorgan,
at Section III.A.5.b.2.a, under New York law [a] contract may be voided and a party
mayrecoverdamageswhenitestablishesthatitwascompelledtoagreetothecontract
termsbecauseofawrongfulthreatbytheotherpartywhichprecludedtheexerciseof
its free will.4902 The elements of economic duress are: (1) a threat, (2) which was
unlawfullymade,and(3)causedinvoluntaryacceptanceofcontractterms,(4)because
thecircumstancespermittednootheralternative.4903
4901Amendment1ToGuaranty(Sept.9,2008),atp.2[LBEXDOCID090568](executedversionsignedby
IanLowittandaddingLBCConSeptember11,2008).
4902Madey v. Carman, 858 N.Y.S.2d 784, 786 (App. Div. 2008) (quoting 805 Third Ave. Co. v. M.W. Realty
Assocs.,448N.E.2d445,447(N.Y.1983)).
4903Kamermanv.Steinberg,891F.2d424,431(2dCir.1989)(quotingGulf&W.Corp.v.CraftiqueProds.,Inc.,
523F.Supp.603,610(S.D.N.Y.1981)).
1292

ColorableClaimAgainstCitiforEconomicDuress
Citiimposedatight,samedaydeadlineonLehmanonSeptember9,providing
Lehman with less than six hours to review the September 9 Guaranty Amendment.4904
Internal Lehman emails suggest Citi was holding up payments until the amendment
was signed and, specifically, that Citi was not releasing a $2 billion CLS payment.4905
Moreover,whilenegotiatingtheinclusionofLehmansAsiansubsidiariesinthelater
added parties to the September 9 Guaranty Amendment, Citibank informed Lehman
thatitwouldnotopen[Lehman]inAsiawiththeagreementwehaveinplace.4906Citi
personnel stated to the Examiner that this meant Citibank would not clear trades for
LehmanentitiesunlessLBHIguaranteedtheentitiesortheyprefundedthetrades.4907
TheemailsbetweenCornejoandKillerlanesuggestthatLehmanmayhavehad
verylittletimetoverifywhetherLehmancouldsigntheamendmentwithoutinfringing
ontheirCustodyAgreements.Specifically,Killerlanewasunsureabouthowthesetoff
provision in the original Guaranty would interact with Lehmans Custody
008563](FoskettcalledCornejojustpriorto1:00p.m.requestingaguarantywithLBI);emailfromEmil
F.Cornejo,Lehman,toIanT.Lowitt,Lehman,etal.(Sept.9,2008)[LBEXAM008564](explainingthatCiti
wantedtheguarantyexecutedby6:00p.m.thatevening).
008571]; email from Craig L. Jones, Lehman, to Daniel J. Fleming, Lehman (Sept. 9, 2008) [LBEXAM
008562].
DOCID1079016].
4907ExaminersInterviewofMichaelMauerstein,Sept.16,2009,atp.8;ExaminersInterviewofThomas
Fontana,Aug.19,2009,atp.9.
1293

Agreements.4908 Nor did Killerlane seem comfortable with the September 9 Guaranty
Amendment, but stated he would not demur, so long as Lowitt and Treasury at
Lehmanwerecomfortablewithit.4909
Citi emails suggest that Lehman had little to no objection to signing the
amendment to the Guaranty,4910 and that Cornejos only hesitation was that Lehman
needed to verify that providing a guaranty for Asian entities would not create any
regulatoryissues.4911Basedondocumentaryevidence,therewasnodisagreementover
anyofthesubstantivetermsoftheamendment,andthereisnoevidencecontradicting
FoskettsstatementthatCitididnotpresenttheamendmenttoLehmanonatakeitor
leaveitbasis.4912
Moreover,CitisinitialproposalearlyintheafternoonofSeptember9 included
17Lehmanentities.Lehman,however,acceptedtheseentitiespiecemeal,firstagreeing
priorto6:00p.m.toamendtheGuarantytoincludeonlyLBI,andsubsequentlyadding
eight more Lehman entities on September 9, followed by one more subsidiary on
September11.Thus,Lehmanagreedtoaddonlyoneofthe17proposedentitiesbefore
the6:00p.m.deadlineonSeptember9beforefinallyacceptingeightadditionalentities
4908Email from James J. Killerlane, Lehman, to Emil F. Cornejo, Lehman (Sept. 9, 2008) [LBEXAM
008571](statingthathewasnotsureifwecanlogistically[signtheamendmenttotheguaranty]with
ourCustodyAgreementsorifwearecomfortablewiththis).
4909Id.
4910Email from Christopher M. Foskett, Citigroup, to Thomas Fontana, Citigroup, et al. (Sept. 9, 2008)
1079021].
1294

laterthatevening,andaddingLBCConSeptember11.EventhoughsomeofLehmans
refusalswerebasedonthefactthatthreeoftheproposedsubsidiarieshadnoaccounts
withCitiorwereSpecialPurposeVehicles,LehmansabilitytoresistCitisdemandsat
leasttosomedegreeindicatesLehmansacceptanceofthetermswasnotinvoluntary.
To the extent that the reference to Citis holding payments until execution of
the Amendment4913 refers to holding clearing advances under the CLS Agreement, the
advanceofthosefundswaslefttoCitissolediscretion,andwasapracticethatcould
beendedwithoutpriornotice.4914Thus,anystatementbyCitithatitwouldorwould
not do something that was within Citis sole discretion would not be unlawful or
improper.ThesameistrueifFontanasthreatnottoopen[Lehman]inAsia4915was
made and understood to be a threat not to advance credit to Lehman rather than a
completerefusaltoclear.CitipersonnelhaveconfirmedtotheExaminerthatFontanas
statement that it would not open for Lehman in Asia without the signed amendment
simply meant that Lehman would have had to prefund its trades in the region if the
subsidiariesinAsiawerenotaddedtotheholdingcompanyguaranty.4916Thisreading
is further supported by Fontanas approval to releaseCLS payments Citi was holding
4913See email from Emil F. Cornejo, Lehman, to Ian T. Lowitt, Lehman, et al. (Sept. 9, 2008) [LBEXAM
008564].
13555(Bankr.S.D.N.Y.Sept.18,2008).
DOCID1079021].
4916ExaminersInterviewofMichaelMauerstein,Sept.16,2009,atp.8;ExaminersInterviewofThomas
Fontana,Aug.19,2009,atp.9.
1295

on September 9; Citi waited until Lehman had prefunded the payment by providing
$2.085 billion of the $2.088 billion necessary to cover the payment.4917 The documents
suggestthatCitiwasholdingthatpayment,notbecauseCitirefusedtocleartradesfor
LehmaninordertoinduceLehmantosigntheSeptember9GuarantyAmendment,but
because Citi had reduced Lehmans daylight overdraft limit to zero and Lehmans
accountdidnothavesufficientfundstocoverthepayment.
Additionally, the 6:00 p.m. deadline imposed by Citi on September 9 must be
viewedinthecontextoftherestofthenewsofthatday,includingtheKDBdealfalling
through, the advancement of Lehmans third quarter 2008 earnings announcement to
September10andLehmansstockpricecontinuingtoplummet.The6:00p.m.deadline
was important for Citi because Citi was irrevocably committed to settle Lehmans
CLStransactionsafterthattime.4918Inthissetting,imposingasubsixhourdeadlinefor
executing the amendment was not an unreasonable effort by Citi to protect its own
businessinterests.AsFoskettexplainedtotheExaminer,Citiwasveryconcernedabout
its business at this time and had to balance its actions carefully regarding Lehman to
avoidharmingitself.4919
4917EmailfromThomasFontana,Citigroup,toChrisDeukmedjian,Citigroup,etal.(Sept.9,2008)[CITI
LBHIEXAM00032799].
00102127].
4919Examiners Interview of Christopher M. Foskett, Sept. 24, 2009, at p. 8; see also Thomas Fontana,
Citigroup,UnpublishedNotes(Sept.12,2008),atp.193[CITILBHIEXAM00099649](contemporaneous
handwrittennotesnotingtheneedtoprotectshareholders).
1296

Alternatively,LehmanmayhaveratifiedtheSeptember9GuarantyAmendment
throughacquiescingtoitsterms.ManyLehmanentities,includingthoseoperatingon
theCLSsystem,continuedtoacceptclearingadvancesfromCitiaftertheexecutionof
the Amendment. Far from repudiating the September 9 Guaranty Amendment,
Lehmansoughttoconfirm the status of Citibankclearing advances intheBankruptcy
Courtaftertheholdingcompanyfileditspetition.4920Thereisalsonoevidencethatthe
period of duress continued through that time, nor is there evidence that Lehman
desiredtorepudiatetheAmendmentatanypoint.
The Examiner concludes that the evidence does not support the existence of a
colorableclaimthattheSeptember9GuarantyAmendmentisinvalidduetoeconomic
duress.
(ii) TheFailureofConsideration
The September 9 Guaranty Amendment greatly expanded Citis protection
while, on the surface, did not provide Lehman with any clearing or custody services
beyond what Citi had previously been providing. Based on these facts, this Section
analyzes whether the September 9 Guaranty Amendment fails for lack of
consideration.4921
4920SeeMotionofDebtorsforOrder,PursuanttoSection105oftheBankruptcyCode,ConfirmingStatus
of Citibank Clearing Advances, Docket No. 109, In re Lehman Bros. Holdings, Inc., No. 0813555 (Bankr.
S.D.N.Y.Sept.18,2008).
4921 See Section III.B.3 for a discussion ofclaims to avoid the September 9 Guaranty Amendment under
applicablefraudulenttransferprincipleswheretheconsiderationneededtosupportasimplecontract
1297

a. LegalFramework
Consideration is either a benefit to the promisor or a detriment to the
promisee.4922Arecitationofconsiderationinacontractisanadmissionoffactthatcan
bedisputedorexplainedwithparolevidence.4923Notably,apromisebyonepartyto
do that which he is already under a legal obligation to perform is insufficient as a
consideration to support a contract.4924 Failure of consideration gives the
disappointedpartytherighttorescindthecontract.4925ByNewYorkstatute,however,
a contract modification shall not be invalid because of the absence of consideration,
provided that the [modification] agreement . . . shall be in writing and signed by the
partyagainstwhomitissoughttoenforcethe...modification...orbyhisagent.4926
ColorableClaimAgainstCitiforFailureof
Consideration
Even though both the original 2004 Guaranty and the September 9 Guaranty
Amendmentcontainthesameboilerplaterecitationofconsideration,andeventhough
Citi did not offer to increase the credit lines extended to Lehman in any way, the
isnotsufficienttoestablishreasonablyequivalentvalue.Rubinv.Mfrs.HanoverTrustCo.,661F.2d979,
991(2dCir.1981).
4922Holtv.Feigenbaum,419N.E.2d332,336(N.Y.1981).
4923SeeDiamondv.Scudder,45A.D.3d630,632(App.Div.2007).
4924Carpenter v. Taylor, 58 N.E. 53, 55 (N.Y. 1900); see also Roth v. Isomed, Inc., 746 F. Supp. 316, 319
(S.D.N.Y. 1990); see also supra Section III.A.5.b.2.b for further discussion of legal principles relating to
consideration.
4925Fugelsangv.Fugelsang,131A.D.2d810,812(App.Div.1987).
4926N.Y.Gen.Oblig.Law51103(McKinney2009);seealsoDeutscheBankSecs.Inc.v.Rhodes,578F.Supp.
2d652,660(S.D.N.Y.2008).
1298

September9GuarantyAmendmentisamodificationoftheJanuary7,2004Guaranty.
Paragraph1oftheSeptember9GuarantyAmendmentexplicitlystatesthat[s]ection1
of the Guarantyisamendedby replacing the first sentencethereofinitsentirety with
the following.4927 As such, under New York law, because the September 9 Guaranty
AmendmentisinwritingandsignedbyLowitt,additionalconsiderationisnotrequired
and the Amendment is valid. The September 9 Guaranty Amendment gave Citi a
guaranty for the repayment of credit obligations of various additional Lehman
subsidiaries in order to induce Citi to extend or continue extending credit to those
subsidiaries.
UndertheCLSAgreement,theauthorizationofanytransactionthroughtheCLS
systemwaslefttoCitissolediscretion,andanyextensionofcreditcouldbechanged
or terminated without prior notice.4928 Therefore, there was consideration for the
AmendmentinsofarastheSeptember9GuarantyAmendmentinducedCititoprovide
orcontinueprovidingcredittoLehmansubsidiaries,andinsofarasCitididnothavean
obligationtocontinueextendingcreditundertheCLSAgreementor,forthatmatter,
anyothercreditagreementknowntotheExaminer.Consideringthedifficulteconomic
4927Amendment 1 To Guaranty (Sept. 9, 2008) [LBEXDOCID 090568] (executed version signed by Ian
LowittandaddingLBCConSeptember11,2008).
13555(Bankr.S.D.N.Y.Sept.18,2008).
1299

situationLehmanfounditselfinonSeptember9,itdoesnotseemunreasonableforCiti
tohavesoughtadditionalsecurityfromLehmanviatheGuarantyAmendment.
Moreover, the documents suggest that Citi intended to continue to extend
clearing advances to Lehman after the execution of the September 9 Guaranty
Amendment. During negotiations over the September 9 Guaranty Amendment,
CitibankrefusedtoextendintradaycredittoLehmanentitiesthatwerenotguaranteed
byLBHI,requiringthemtoprefundtheirtrades.AfterLehmanexecutedtheSeptember
9GuarantyAmendment,CitibanksetLehmanscreditlinesforclearingatthelevelof
the deposit amount of $2 billion with the expectation that Citi personnel would
manually approve extensions of credit above the deposit amount. Thus, there was
consideration for the September 9 Guaranty Amendment because it induced Citi to
continueprovidingintradaycredittoLehman.
The Examiner has thus concluded that the evidence does not support the
existenceofacolorableclaimthattheSeptember9GuarantyAmendmentisinvaliddue
tolackofconsideration.
(b) BreachoftheDutyofGoodFaithandFairDealingin
ConnectionWiththeCLSServicesAgreement
The CLS Agreement specifies that the laws of England govern the rights and
obligationsbetweenCitibankandLehman.Generally,NewYorkcourtshonorparties
1300

choiceoflawprovisions.4929AsdiscussedinmoredetailintheHSBCSectionbelowat
Section III.A.5.d, English contract law does not recognize a generally applicable
principle of good faith and fair dealing, and English courts will allow a commercial
lender to exercise contractual, discretionary powers in what the lender genuinely
believestobeitsbestcommercialinterest.
ColorableClaimAgainstCitiforBreachoftheDutyof
GoodFaithandFairDealinginConnectionWiththe
CLSServicesAgreement
Only four Lehman subsidiaries were authorized to submit transaction
instructions to the CLS Bank through LBI: LBI, LBCC, LBSF and LBIE.4930 If an
instruction were submitted to the CLS Bank directly, Citi still had to authorize the
transactionanddidnothaveanyresponsibilityforanysuchtransactionthatithadnot
yet authorized.4931 On September 9, Citi significantly reduced the amount of credit it
4929Bossv.Am.ExpressFin.Advisors,Inc.,791N.Y.S.2d12,14(App.Div.2005).
CitibankClearingAdvances,Ex.Aatpp.1,12,DocketNo.109,InreLehmanBros.Holdings,Inc.,No.08
13555(Bankr.S.D.N.Y.Sept.18,2008)(LBIandLBCC);MotionofDebtorsforOrder,PursuanttoSection
105oftheBankruptcyCode,ConfirmingStatusofCitibankClearingAdvances,Ex.Batp.1,DocketNo.
109,InreLehmanBros.Holdings,Inc.,No.0813555(Bankr.S.D.N.Y.Sept.18,2008)(listingLBSFandLBIE
as Affiliates); see also Letter from Citibank, N.A., to Lehman Brothers Inc., et al., re: CLS Settlement
ServicesAgreement(Sept.15,2008),atp.2[LBEXDOCID462068](terminatingtheCLSAgreementwith
LBI,LBCC,LBSF,andLBIEontheafternoonofSeptember15).
13555(Bankr.S.D.N.Y.Sept.18,2008).
1301

extended to Lehman for its CLS transactions, and Citi found it difficult to manage
manuallyusingonlythe$2billiondeposit.4932
Asdiscussedinfra,Englishlawwilllikelyrecognizethatanyextensionofcredit
provided by Citi to Lehman was within Citis sole discretion unless Citi had expressly
agreedinwritingtoprovideacommittedcreditfacilityandhadreceivedacommitment
fee.TheExaminerdidnotdiscoveranythingtosuggestthatCitihadanysuchexpress
agreementorwasobligatedtoprovideacertainlevelofCLSclearingservice.Citiwas
obligatedtomakeaCLSpaymentonlyafterCitihadauthorizedthetransaction,andthat
authorization was given in Citis sole discretion. Given the increased risk Citibank
faced visvis Lehman in September 2008, it is unlikely a court would find that Citi
actedunreasonably,irrationally,arbitrarily,orinbadfaithinexercising,orthreatening
toexercise,itscontractualrighttoceaseextendingclearingadvances,andceaseserving
asLehmanssettlementmember.
Moreover, the terms of the CLS Agreement between Lehman and Citibank left
theextension ofcreditto Citibanks solediscretion,and providedCitibankwith the
right to discontinue[] such advances at any time, without prior notice so long as
Citihadnotalreadyauthorizedthetransactioninstruction.4933TheCLSAgreementalso
4932EmailfromThomasFontana,Citigroup,toMichaelMauerstein,Citigroup,etal.(Sept.9,2008)[CITI
LBHIEXAM00065673].
13555(Bankr.S.D.N.Y.Sept.18,2008).
1302

grantedCititherighttoterminatetheagreementimmediatelyandwithoutnoticeifany
one of a number of events occurred, including: a bankruptcy of a Lehman party, a
materialadversechangeinthefinancialconditionofaparty,ortheinabilityofaparty
to pay debts as they came due.4934 Under the legal framework above, it is unlikely a
court would use the implied covenant to contradict an express term of the
AgreementnamelythatitwaswithinCitissolediscretiontostopadvancingfunds
withoutnotice.
The Examiner has thus concluded that the evidence does not support the
existenceofacolorableclaimforbreachofthecovenantofgoodfaithandfairdealingin
connectionwiththeCLSAgreement.
d) LehmansDealingsWithHSBC
HSBC was a clearing bank, source of intraday credit for settling trades and
counterparty to Lehman for a variety of treasury products.4935 Approximately one
month prior to the petition date, HSBC informed Lehman that HSBC would be
completely, albeit gradually, exiting their relationship.4936 During the last week of
August and the first week of September, HSBC demanded the equivalent of
approximately $945 million and received the equivalent of approximately $947 to 992
4934Id.atp.6(6).
4935ExaminersInterviewofGuyBridge,Sept.29,2009,atp.3.
4936NicholasJ. Taylor, HSBC, Briefing Note Project Milan (Aug. 18, 2008), at pp. 12 [HBUS 90];
Examiners Interview of Nicholas J. Taylor, Oct. 15, 2009, at p. 6; Examiners Interview of Guy Bridge,
Sept.29,2009,atp.4.
1303

millioncashcollateralinordertocontinueprovidingclearingandsettlementservicesto
Lehman.4937 (HSBC returned approximately $282 million of these funds on September
11).4938
HSBCalsodemandedthatLehmanexecutetheU.K.andHongKongCashDeeds
to secure the collateral.4939 Lehman successfully negotiated with HSBC to narrow the
proposed right of setoff and expand its own access to the cash secured by the cash
4937Email from Guy Bridge, HSBC, to Carlo Pellerani, Lehman, et al. (Aug. 27, 2008) [HBUS 3]
(demanding combined deposits of $945 million in London and Hong Kong); email from Guy Bridge,
HSBC, to Nicholas J. Taylor, HSBC, et al. (Aug. 28, 2008) [HBUS 9250] (reporting receipt of GBP 435
million, or approximately $800 million); email from Martina C. W. Kung, HSBC, to Patricia Gomes,
HSBC,etal.(Sept.1,2008)[HBUS397](reportingpendingdepositofHKD1.4billion,orapproximately
$180 million); Examiners Interview of Guy Bridge, Sept. 29, 2009, at p. 5. But see email from Stirling
Fielding,Lehman,toCarloPellerani,Lehman,etal.(Sept.1,2008)[LBEXAM008963](recordinginstant
message conference stating that the Hong Kong deposit is equivalent to $192 million with unspecified
credit due to Lehman); Memorandum from Ken Coleman, HSBC counsel, to Examiner, re: Transfers in
ConnectionWiththeHongKongCashDeed(Oct.23,2009),atp.1(representingthatHSBCsHongKong
affiliate received the equivalent of approximately $148 million). As discussed below, the Examiners
financial advisors were unable to identify a Hong Kong transfer with certainty. Pellerani and Lowitt
discussed the possibility of offering securities instead of cash, although Lowitt expressed concern that
suchanoffermightsetoffalarmbells.EmailfromCarloPellerani,Lehman,toIanT.Lowitt,Lehman,
et al. (Sept. 11, 2008) [LBEXAM 008934]. The plan to use securities as collateral instead of cash never
progressedbeyondtheproposalstage.ExaminersInterviewofNicholasJ.Taylor,Oct.15,2009,atp.9.
On September 11, HSBC returned to Lehman approximately EUR 200 million, or approximately $280
million,ofthecashcollateral.SeeSectionIII.A.5.d.4,infra.
4938ExaminersInterviewofGuyBridge,Sept.29,2009,atp.7.AccordingtoLehmansDailyFundingCall
Update email for September 11: Trsy have reduced cash deposit with HSBC to GBP200m to release
liquidityinthefirm.EmailfromMariaBarrio,Lehman,toNeilUllman,Lehman,etal.(Sept.11,2008)
[LBEXDOCID 1898196]. The Examiners financial advisors analysis of Lehmans transactions during
this period shows that this report was erroneous, and that Lehman received EUR 200 million on
September11.Duff&Phelps,PreliminaryFindingsre:HSBCDeposits(Dec.2,2009),atp.1.
4939Email from Guy Bridge, HSBC, to Carlo Pellerani, Lehman, et al. (Aug. 27, 2008) [HBUS 3];
ExaminersInterviewofGuyBridge,Sept.29,2009,atpp.56;ExaminersInterviewofNicholasJ.Taylor,
Oct.15,2009,atpp.67(discussingplantorequirecollateral).
1304

deeds.4940LehmanexecutedtwocashdeedstocovertheU.K.deposit(collectively,the
U.K. Cash Deeds) on September 9,4941 and the Hong Kong Cash Deed on September
12.4942 Because Lehman executed the Hong Kong Cash Deed too late in the day for
HSBC to transfer the cash collateral to a secured account covered by the deed, and
becauseofaSeptember15publicholidayinHongKong,HSBCwasunabletotransfer
thefundsintosuchanaccountuntilSeptember16,4943andthefundsweresubsequently
returnedtoaLehmancashaccount.4944OnSeptember9,2009,HSBCandLBHIentered
into a stipulation allowing HSBC to offset GBP 100,062,061.97 (approximately $164.6
million)indebtsandinterestcoveredundertheU.K.CashDeeds.4945
(1) OverviewofHSBCsRelationshipWithLehman
HSBCs relationship with Lehman covered four broad functions: 1) facing
Lehman as a counterparty in derivatives trades and other transactions; 2) acting as a
trustee for Lehmans special purpose vehicles in the Cayman Islands; 3) performing
4940Examiners Interview of Guy Bridge, Sept. 29, 2009, at p. 6; see email from Guy Bridge, HSBC, to
NicholasJ.Taylor,HSBC,etal.(Sept.3,2008)[HBUS570](discussingLehmansrefusaltosigntheCash
Deedswithoutchangestotheterms).
4941Email from Guy Bridge, HSBC, to Nicholas J. Taylor, HSBC, et al. (Sept. 9, 2008) [HBUS 1179];
ExaminersInterviewofGuyBridge,Sept.29,2009,atp.6.
4942EmailfromPatriciaGomes,HSBC,toAgnesY.L.Lau,HSBC,etal.(Sept.12,2008)[HBUS1760].
4943Seeid.
4944MemorandumfromKenColeman,HSBCcounsel,toExaminer,re:TransfersinConnectionWiththe
HongKongCashDeed(Oct.23,2009),atp.1.
4945Stipulation, Agreement and Order, Pursuant to Sections 362 and 553 of the Bankruptcy Code,
ModifyingtheAutomaticStayfortheLimitedPurposeofPermittingHSBCBankplctoEffectSetoffand
Resolution of Certain Banking Arrangements Between Lehman Brothers Holdings Inc. andHSBC Bank
plc,atp.2,DocketNo.5089,InreLehmanBros.Holdings,Inc.,No.0813555(Bankr.S.D.N.Y.Sept.9,2009).
ThestipulationalsoallowedasetoffofGBP605,000foramisdirectedpaymentandcommittedtoreturn
EUR70,000,000toLehmanatalaterdate.Id.atpp.23.
1305

clearingandsettlementservicesforLehmanssterlingdenominatedsecuritiestradesin
theCRESTsystem;and4)providingcreditsupporttoLBHIanditssubsidiariesthrough
avarietyofcreditproducts.4946ForpurposesofthisReport,functionsthreeandfour
HSBCsexposuretoLehmanthroughcreditproducts,includingcreditadvancedaspart
ofclearingandsettlementservicesforCRESTarethemostsignificantaspectsofthe
HSBCLehmanrelationship.
(a) HSBCProvidedCRESTClearingandSettlementServices
toLehman
The CREST system is a clearing and settlement system for certain securities.4947
CREST settles securities trades denominated in U.S. dollars, Euros and Pounds
Sterling.4948SterlingdenominatedtradesarethemostrelevanttothisReport.
IntheCRESTsystem,aCRESTmemberbank,suchasLBIE,appointsoneofthe
14approvedcommercialbanks,suchasHSBC,toactasitsCRESTsettlementbank.4949
The CREST settlement bank then stands in for the CREST member bank to execute
tradesthroughCRESTscentralcomputersystem.4950
4946Examiners Interview of Guy Bridge, Sept. 29, 2009, at p. 3 (describing the first three functions);
Examiners Interview of Ken Coleman, David Esseks, and Angela Somers, July 22, 2009, at p. 2
(describing the first three functions); Lehman Global Annual Review (May 12, 2008), at pp. 12 [HBUS
10275](describingexposuretoLehmanarisingfromothercreditproducts).
4947AngelaSomers,HSBCcounsel,CRESTSystemOverview(July22,2009),atp.1.
4948Id.atp.2.
4949Id.;ExaminersInterviewofGuyBridge,Sept.29,2009,atp.3.
4950Examiners Interview of Guy Bridge, Sept. 29, 2009, at p. 3; Angela Somers, HSBC counsel, CREST
System Overview (July 22, 2009), at pp. 12 (describing in more detail the process of settlement banks
actingformemberbanks).
1306

Sterlingdenominated trades are settled in realtime.4951 Throughout the day,
CRESTmembersdirecttheirCRESTsettlementbankstoexecutetrades.4952TheCREST
settlementbanksthensendmessageswiththetradeinformationtotheCRESTcentral
computer system.4953 The CREST central computer checks the transferee members
CREST account to determine whether it holds sufficient funds and the transferor
members CREST account to determine whether it holds the relevant securities.4954 If
bothconditionsaresatisfied,theCRESTcentralcomputersystemsettlesthetransaction
initsrecordsandgeneratesamessagenotifyingthepartiesthatthetransactionhasbeen
completed.4955
UnlikeothersettlementsystemssuchasEuroclearorDTC,theCRESTsystemis
neither a custodian nor depository of the securities being traded.4956 Once the CREST
central computer system settles a trade, the settlement bank (here, HSBC) not the
member bank (here, Lehman) is directly liable for payment of the transaction.4957
Rather than require member banks to prefund every transaction with their settlement
banks, settlement banks often extend intraday credit to facilitate trades.4958 In the
4952Id.atp.1;ExaminersInterviewofGuyBridge,Sept.29,2009,atp.3.
4954Id.
4955Id.
4956Id.
4957Id.atpp.12.
4958Id.; Examiners Interview of Guy Bridge, Sept. 29, 2009, at p. 3; Examiners Interview of Nicholas J.
Taylor,Oct.15,2009,atp.7.
1307

CRESTsystem,thiscreditiscalledthedebitcap.4959Thememberbankandsettlement
banktypicallysettletheiraccountattheendofeachday.4960
A settlement bank may reduce the debit cap to zero at any time, although the
settlement bank would be obligated to clear trades that had been approved through
CRESTbeforethereduction,andtheCRESTmemberwouldstillbeabletosellsecurities
with a debit cap of zero.4961 However, HSBC personnel opined that it would be
impractical to the point of impossible to trade securities through CREST without
intradaycredit.4962AccordingtoNicholasJ.Taylor,ChiefOperatingOfficerofHSBCs
Global Financial Institutions Group and head of HSBCs Financial Institutions Group
for the Americas, relying on prefunding instead of intraday credit is not feasible
because of the difficulty of accurately modeling a member banks CREST trades each
day.4963 Inaccurate modeling could cause a member bank to post inadequate funds to
cover its trades, which would cause failed trades and send negative signals to the
marketaboutthefinancialhealthofthememberbank.4964
4960Id.; Examiners Interview of Guy Bridge, Sept. 29, 2009, at p. 3; Examiners Interview of Nicholas J.
Taylor, Oct. 15, 2009, at p. 7 (discussing impracticality of prefunding trades compared to relying on
intradaycredit).
4962ExaminersInterviewofGuyBridge,Sept.29,2009,atp.5;ExaminersInterviewofNicholasJ.Taylor,
Oct.15,2009,atp.7.
4963ExaminersInterviewofNicholasJ.Taylor,Oct.15,2009,atp.7;ExaminersInterviewofGuyBridge,
Sept.29,2009,atp.5.
4964ExaminersInterviewofNicholasJ.Taylor,Oct.15,2009,atp.7.
1308

(b) OverviewoftheOperativeAgreements
The CREST relationship between HSBC and LBIE was governed by a Facility
Letter,whichmakestheCRESTsettlementfacilityavailabletoLBIE;4965aSecurityDeed,
which grants HSBC a security interest in LBIEs property held in connection with or
derived from the CREST facility;4966 and a list of Terms and Conditions, which are
incorporated into the Facility Letter and specify the parties rights and obligations.4967
At the time of the petition, the CREST relationship between Lehman and HSBC was
governed by a facility letter HSBC sent to Lehman on July 31, 2008, which Lehman
accepted on August 19, 2008.4968 This agreement supersedes the terms Lehman
approvedwhenitexpandeditsCRESTactivitywithHSBConMay5,2007,butdoesnot
change the parties relationship in a way that would be material to the bankruptcy
proceedings.4969
4965SeeCRESTFacilityLetterbetweenLBIEandHSBC(Aug.19,2008)[HBEU138].
4966SeeSecurityDeedCreatingChargesoverCRESTStock(GiltsandEquities)andReceivablestoSecure
theLiabilitiesofaCRESTMemberorSponsoredMember(Apr.24,2002)[HBEU72].
4967SeeTermsandConditionsRelatingtoCRESTSettlementBankFacilitiesMadeAvailabletoaCREST
MemberorSponsoredMember(Aug.19,2008)[HBEU102].
4968SeeCRESTFacilityLetterbetweenLBIEandHSBC(Aug.19,2008),atp.4[HBEU138].
Member or Sponsored Member (May 5, 2007) [HBEU 142]; Letter from HSBC to LBI(E), re: CREST
SettlementBankFacilityMadeAvailableinMulticurrencyonaSecuredBasis(Apr.3,2007)[HBEU174];
CRESTFacilityLetterbetweenLBIEandHSBC(May5,2007)[HBEU174](addingadditionalparticipant
IDsforLBI(E)underexistingTermsandConditions);Jenner&Block,Memorandumre:Representations
byHSBCcounsel(Jan.11,2010),atpp.23.TheTermsandConditionsattachedtotheMay5,2007Letter
grant HSBC absolute discretion to terminate, without notice. See Terms and Conditions Relating to
CREST Settlement Bank Facilities Made Available to a CREST Member or Sponsored Member (May 5,
2007),at16.1[HBEU142].ThisclauseismateriallyidenticaltotheterminationclauseintheAugust19,
2008 Terms and Conditions. See Terms and Conditions Relating to CREST Settlement Bank Facilities
MadeAvailabletoaCRESTMemberorSponsoredMember(Aug.19,2008),at16.1[HBEU102].
1309

Further, Section 16.1 of the Terms and Conditions of the CREST facility allows
HSBCto
terminate its responsibilities as Settlement Bank for the Customer under

thisAgreementeithergenerallyorinrelationtooneormoreDesignated
Currencies[EUR,USDandGBP]atanytimeandatitsabsolutediscretion,
without notice, provided that [HSBC] shall, where it considers it
practicable and appropriate, give not less than 30 days notice to the
CustomerandEuroclearU.K.&IrelandLimitedbutshallnotinanyevent
haveanyliabilitytotheCustomerifitfailstodoso.4970
LBIEalsoacknowledgedthatHSBCdoesnotoweadutyofcaretomonitororenforce
compliance with CREST requirements and procedures.4971 LBIE further agreed to
various indemnifications of HSBC4972 and exemptions of HSBC from liability.4973 The
parties additionally agreed that the terms of the exclusions and limitations of liability
contained in the agreement are fair and reasonable,4974 and that any single waiver,
forbearance or failure to exercise rights under the contract in one instance would not
operate as waiver or forbearance in any other instance or prevent a party from
exercising its rights under the agreement.4975 Finally, the agreement grants HSBC an
irrevocable right to apply, without notice, any debts arising under the CREST
agreementagainstanycreditbalanceLBIEheldwithHSBC.4976
4970Terms and Conditions Relating to CREST Settlement Bank Facilities Made Available to a CREST
MemberorSponsoredMember(Aug.19,2008),at16.1[HBEU102].
4971Id.at9.7.
4972Idat7.
4973Id.at3.43.5,9.
4974Id.at9.11.
4975Id.at18.
4976Id.at19.
1310

As Lehmans CREST settlement bank, HSBC routinely extended between $100
millionand$1billioninintradaycreditforCRESTtransactions,andLehmantypically
repaid the balance at the end of the day.4977 Lehman was one of HSBCs 25 largest
clientsforsterlingclearingandsettlementservices.4978HSBCwasLehmansonlybank
forclearingandsettlingsterlingdenominatedsecuritiestrades.4979
(2) TheExaminersInvestigationofParticularTransactions
The most significant issues arising from the HSBCLehman relationship stem
fromHSBCsdemandthatLehmanpostcollateralandexecutecashdeedsinexchange
forcontinuedCRESTclearingandsettlementservices.Accordingly,thatdemandand
therelatedtransactionsarethefocusofthisSectionoftheReport.
TheExaminerhasalsoidentifiedothertransactionsthatdonotdirectlyaffectthe
CREST relationship but nevertheless warrant additional explanation because of their
size, timing, or divergence from the usual course of dealing between HSBC and
Lehman.Theyare:
(a) HSBCCancelleda$1BillionIntradayCreditFacility
The single largest component of HSBCs exposure to Lehman through credit
productsandservicesotherthanCRESTwasa$1billionintradaycreditfacility.HSBC
hadprovidedLehmanwitha$1billionintradaycreditfacilityforthelimitedpurpose
4977ExaminersInterviewofKenColeman,DavidEsseks,andAngelaSomers,July22,2009,atp.2.
4979Id.
1311

of financing the intraday liquidity risk Lehman incurred when marketing its clients
issuancesofnewequity.4980
Paul Lopez, HSBCs Global Relationship Manager for Financial Institutions,
stated that Lehman had not used the facility since approximately 2003.4981 Sometime
between May and July 2008, Lehman proposed repurposing the facility as a general
intradayliquidityfacilitytocovershortfallsintripartyreposwithJPMorgan.4982Lopez
stated that he decided not to proceed with repurposing the facility because Lehmans
deterioratingfinancialconditionmadeittoodifficulttojustifytakingonanunsecured
exposure to cover risks JPMorgan would not accept.4983 HSBC cancelled the unused
credit facility in July 2008 as a risk reduction measure during Project Opaque,
discussedinfra.4984However,thedecisiontocancelthefacilitymayhaveprecededthe
decisiontowithdrawfromLehman.4985
(b) LehmanMaintaineda$1BillionSegregatedDepositwith
HSBC
Documents produced by HSBC (through its American subsidiary, HSBC Bank
USA, N.A. (HBUS)) indicate that in June 2008, personnel at HSBC were concerned
4980ExaminersInterviewofPaulM.Lopez,Oct.19,2009,atpp.34(referringtocorroboratingstatements
bybothLopezandTaylortotheExaminer).
4981Id.
4982Id.
4983Id.
4984Memorandum from Nicholas J. Taylor, HSBC, to Global Financial Institutions Group, HSBC, re:
ProjectOpaque[Draft](July28,2008),atp.4[HBUS16204](describingcancellationofdayloanfacilityas
alreadyintrain).SeeSectionIII.A.5.d.3.a,below,forfurtherdiscussionofProjectOpaque.
4985ExaminersInterviewofPaulM.Lopez,Oct.19,2009,atp.3(expressinguncertaintyaboutwhenthe
facilitywascancelledbutopiningthatthecancellationprecededthedecisiontowithdrawfromLehman).
1312

thatLehmanwouldwithdrawa$1billiondepositthatwastechnicallyunencumbered
but nevertheless governed by an understanding that Lehman would not make
withdrawals.4986 Lopez confirmed that LBI kept this deposit with HSBC to satisfy the
netcapitalizationrequirementsofbrokerdealersunderRule15c3,promulgatedunder
theSecuritiesExchangeActof1934.4987LopezexplainedthatHSBCwasconcernedthat
Lehmans clients would make simultaneous withdrawals from their accounts at
LehmanandpromptLehmantowithdrawfundsfromthesegregateddepositatHSBC
to meet the demand.4988 Lopez stated that the deposit was unencumbered and that
HSBC had expressly waived its right of setoff.4989 Lopez stated that the deposit was
available to Lehman on demand, but that Lehman was required to provide notice to
HSBC before making a withdrawal.4990 Lopez also explained that sometime post
petition in September 2008, Lehman directed HSBC to deliver the deposit to Barclays
4986E.g., email from Paul M. Lopez, HSBC, to Karen von Ruffer, Lehman (June 5, 2008) [HBUS 12633]
(describingthedepositandunderstanding).
4987ExaminersInterviewofPaulM.Lopez,Oct.19,2009,atp.4.Rule15c3establishestheminimumnet
capital brokerdealers must keep on hand in order to participatein various marketactivities, including
holding funds and securities on behalf of customers. See 17 C.F.R. 240.15c31; see also Memorandum
fromRobertAzerad,Lehman,toInvestorRelationsDepartment,Lehman,re:2008Q2LiquidityPosition
(June 7, 2008), at p. 3 [LBEXDOCID 008829] (discussing customer free credit balances in LBI that are
segregatedfromtheFirmsliquidityperRule15c3),attachedtoemailfromRobertAzerad,Lehman,to
JohnFeraca,Lehman,etal.(June7,2008)[LBEXDOCID68690].
4988ExaminersInterviewofPaulM.Lopez,Oct.19,2009,atp.4.
4989Id.
4990Id.(Lopezcouldnotrecallpreciselyhowmuchnoticewasrequired).
1313

and that HSBC complied with the request.4991 According to Lehmans internal
memoranda,LBHIdidnotincludethisdepositaspartofitsliquiditypool.4992
(c) LehmanDeposited$750MillionwithHSBConJune24
OnJune24,LehmanpersonnelnotifiedLopezthatLehmanwasplacingdeposits
with HSBC totaling $750 million.4993 Lopez did not recall the specific deposits except
insofar as he recalled that they were part of the ordinary course of business between
LehmanandHSBC.4994LopezopinedthatthedepositsrepresentedLehmanselling$750
milliontoHSBCsmoneydesk,andthatthedepositswouldhavelikelybeenreturned
toLehmanthenextday.4995Lopezstatedthatthesesortsoftransactionsusuallypassed
withoutcomment,andthistransactionwasunusualonlyinthatitwasbroughttohis
attention.4996LopezopinedthatLehmanwaspublicizingthedepositsuptohislevelin
ordertoshowthestrengthofitsliquiditypoolandtobuilditsrelationshipwithHSBC
byplacingsomeofthatliquiditywithHSBC.4997
4991Id.atpp.45.
4992MemorandumfromRobertAzerad,Lehman,toInvestorRelationsDepartment,Lehman,re:2008Q2
LiquidityPosition(June7,2008),atp.3[LBEXDOCID008829](statingthatcustomerfreecreditbalances
inLBIaresegregatedfromtheFirmsliquidityperRule15c3),attachedtoemailfromRobertAzerad,
Lehman,toJohnFeraca,Lehman,etal.,(June7,2009)[LBEXDOCID68690].
4993EmailfromKarenvonRuffer,Lehman,toPaulM.Lopez,HSBC(June24,2008)[HBUS14054].
4994ExaminersInterviewofPaulM.Lopez,Oct.19,2009,atp.5.
4995Id.
4996Id.
4997Id.
1314

(d) LehmanCommitted$25MilliononAugust15toHSBCs
SyndicatedLendingFacility
AfterHSBCadvisedLehmanofitsintenttowithdrawandafterHSBCrequested
thatLehmanprovideapproximately$1billionincashcollateral,Lehmanrequestedto
bereleasedfroma$25millioncommitmenttoasyndicatedcreditrevolverforHSBC.4998
Lehman Brothers Commercial Bank had committed to this facility on August 15,
2008.4999 HSBC personnel believed Lehman was participating in the facility to secure
HSBCs continued support.5000 HSBC personnel used Lehmans need for continued
credit support as leverage to encourage Lehmans participation.5001 In a June 15, 2008
emailtoLopezandotherHSBCpersonnel,Taylorreportsthatherecentlyhadalong
callwithPellerani:[In]thecontextofreciprocityandourcontinuingsupportduring
this period, I suggested they participated in HSBC Finances current syndicated. He
waspositiveaboutthisandrequestedfulldetails.5002Atthetime,Pelleraniviewedthis
as an opportunity to cement the relationship by gaining the gratitude of HSBC
managementratherthananopportunitytosecureabindingpromisethatHSBCwould
4998EmailfromGuyBridge,HSBC,toNicholasJ.Taylor,HSBC,etal.(Aug.27,2008)[HBUS129].
4999SideLetterfromHSBCtoLBCB(Aug.15,2008)[LBEXDOCID089911](signedbyHSBC);SideLetter
fromHSBCtoLBCB(Aug.15,2008)[LBEXDOCID089916](signedbyLBCB).
5000EmailfromNicholasJ.Taylor,HSBC,toMarkStadler,HSBC,etal.(June15,2008)[HBUS9925];e
mail from Guy Bridge, HSBC, to Craig T. Thiele, HSBC, et al. (June 17, 2008) [HBUS 10046] (They are
undernoillusionitcouldbeextremelyhelpfultoshowtheirsupport...).
5001EmailfromNicholasJ.Taylor,HSBC,toMarkStadler,HSBC,etal.(June15,2008)[HBUS9925].
5002Id.
1315

continue providing credit support for CREST services or otherwise.5003 The actual
agreement governing the syndicated revolver contains a merger clause and does not
promise continued credit support.5004 For its part, the CREST agreement requires that
anychangesbemadeinwriting.5005
DocumentsfromHBUSreflectthatHSBCpersonnelinitiallysupportedreleasing
Lehmanfromtheagreement.5006TaylortoldtheExaminerthattheagentbank(Citibank,
N.A.)5007 refused the request because of the precedent that cancelling Lehmans
commitment would establish for the other banks participating in the revolver, and
because cancelling the commitment risked sending negative market signals that could
furthererodeLehmansmarketposition.5008Forhispart,PelleranibelievedthatHSBC
did not expect Lehman to meet the commitment once HSBC had demanded
collateral.5009
5003SeeemailfromCarloPellerani,Lehman,toIanT.Lowitt,Lehman,etal.(Aug.27,2008)[LBEXAM
008936] (stating that participation would cement the relationship and was extremely appreciated at
the most senior levels of HSBC, but making no mention of promises to do or refrain from doing
anything).
5004SeeThreeYearRevolvingCreditAgreement(July11,2008),at19.07[LBEXDOCID1029995];seealso
Side Letter from HSBC to LBCB (Aug. 15, 2008) [LBEXDOCID 089911] (signed by HSBC); Side Letter
5006Email from Nicholas J. Taylor, HSBC, to Guy Bridge, HSBC, et al. (Aug. 27, 2008) [HBUS 129]
(agreeingthatHSBCshouldallowLehmantoexitthefacility).
5007ThreeYearRevolvingCreditAgreement(July11,2008)[LBEXDOCID1029995].
5009ExaminersInterviewofCarloPellerani,Jan.13,2010,atpp.78.
1316

HSBCultimatelyrescindeditssupportforLehmansrequesttowithdraw.Ina
September 9, 2008 email to Taylor regarding Lehmans request to cancel the
commitment, HSBCs senior vice president of Money and Capital Markets wrote: As
wehavediscussed,wedonotplantoconsenttothisterminationrequestbecauseofthe
negative signal and precedent it would send to our other banks in the deal.5010
However,HSBCneverdrewonthe$25millioncommitment.5011
(e) LehmanPledged$6MilliontoHSBCasCollateralfor
LettersofCredit
OnAugust11,2008,Lehmanpledged$6milliontoHSBCascollateralforaletter
of credit.5012 HSBC had already issued two unsecured letters of credit of $3.6 million
and $750,000 to Lehman on or around June 27 and July 1, respectively.5013 All three
letterswereissuedpursuanttoaJune24,2008MasterLetterofCreditAgreementthat
allows HSBC to set off any of Lehmans deposits held at HSBC against any debts
incurredunderthemasterletterofcredit.5014HSBCenteredaclaimfor$116,083forfees,
interest,expensesand funds drawnagainstthelettersofcreditbythe beneficiaries.5015
5010EmailfromCraigT.Thiele,HSBC,toNicholasJ.Taylor,HSBC,etal.(Sept.9,2008)[HBUS5707].
5011ExaminersInterviewofCarloPellerani,Jan.13,2010,atpp.78.TaylorstatedthatLehmandidnot
otherwisetransferthefundstoHSBC.ExaminersInterviewofNicholasJ.Taylor,Oct.15,2009,atp.8.
5012AnnexAtoProofofClaimofHSBCBankUSA,N.A.,ClaimNo.18857,InreLehmanBros.Holdings,
Inc.,No.0813555(Bankr.S.D.N.Y.Sept.18,2009).
5013Annex B to Proof of Claim of HSBC Bank USA, N.A., Ex. 2, Claim No. 18857, In re Lehman Bros.
Holdings,Inc.,No.0813555(Bankr.S.D.N.Y.Sept.18,2009).
5014Id.(21).
1317

HSBCalsoassertedacontingentclaimforfuturedrawsagainstthelettersofcreditby
thebeneficiaries.5016
(f) OtherSignificantExposures
HSBCs remaining exposure to Lehman arises from $2,562,770.97 in payments
erroneously directed to Lehman for delivery to London Diversified Fund Limited on
September29,2008,5017andclaimsofatleast$345,276,915.79relatedtovarioussecurities
transactions.5018
5016Id.
5018SeeKenColeman,HSBCcounsel,SpreadsheetofClaimsbyHSBCandRelatedEntities(Jan.5,2010).
The claims break down as follows: HSBC Bank plc asserts a $2,910,446 claim against LBHI under an
ISDA and guaranty, and a $64,337,830.50 claim against LBHI and LBSF under an ISDA and guaranty;
HSBC Bank USA asserts a $6,320,245.45 claim against LBHI under an ISDA and guaranty, and a
$50,420,868.24 claim against LBHI and LBSF under an ISDA and guaranty; HSBC Financial Products
(France)SNCassertsa$4,652,646.23claimagainstLBHIunderanISDAandguaranty,anda$311,526.01
claimunderanOSLAandguaranty;HSBCHangSengassertsa$298,154.89claimagainstLBHIunderan
ISDA and guaranty; HSBC Private Bank (Suisse) SA asserts a $477,970 claim against LBHI for a failed
trade, a $724,723.40 claim against LBHI for another failed trade, and a $124,123.38 claim against LBHI
underanISDAandguaranty;HSBCFranceassertsa$79,998,295.50claimagainstLBHIandLBSFunder
an ISDA and guaranty; HSBC Ltd. (Hong Kong) asserts a $28,479,863.12 claim against LBHI under an
OSLAandguaranty,a$3,421,677.57claimagainstLBHIandLBSFunderanISDAandguaranty,anda
$10,095,478.51 claim under an ISDA and guaranty; Halbis US Credit Alpha Master Fund Ltd. asserts a
$1,228,570.59 claim against LBHI and LBSF under an ISDA and guaranty; Halbis France asserts a
$2,334,155claim,a$1,313,837claim,anda$1,605,357claimagainstLBHIforvariousprogramsecurities;
HSBC Assurance Vie (France) asserts an $85,206,000 claim for various program securities; HSBC PB
Franceassertsa$568,815.30claimagainstLBHIforvariousprogramsecuritiesonbehalfofaclient;HSBC
plc asserts a $368,706 claim and a $49,925.63 claim against LBHI for various program securities, and a
$27,700.47forvariousprogramsecuritiesandaguaranty.Atthetimeofdrafting,HSBCplchadnotyet
determinedthepreciseamountofitsremainingclaimsagainstLBHI,whicharethereforeexcludedfrom
thistotal.Id.AlthoughthisdebthasnotbeensetoffagainstthefundsheldpursuanttotheU.K.Cash
Deeds,HSBCreservedtherighttomakesuchsetoffsinitsstipulationwithLBHI,andLBHIhasagreedto
work in a commercially reasonable manner to address the issues surrounding HSBCs claims not
disposedofbythestipulation.Stipulation,AgreementandOrder,PursuanttoSections362and553of
theBankruptcyCode,ModifyingtheAutomaticStayfortheLimitedPurposeofPermittingHSBCBank
plctoEffectSetoffandResolutionofCertainBankingArrangementsBetweenLehmanBrothersHoldings
1318

(3) HSBCRequiredLehmantoProvideApproximately$1Billion
inCollateralWhileQuietlyEndingTheirRelationship
(a) HSBCDeterminedtoEndItsRelationshipwithLehman
Taylor stated that in mid2006, HSBC began an indepth examination of its
exposuretothefinancialsector.5019 AccordingtoTaylor,HSBCdecidedtoconductthe
examinationbecauseHSBCwasconcernedthatLehmanandotherfinancialinstitutions
hadnotadequatelydisclosedtheirexposurestorisksfromsubprimemortgages.5020
Infact,Lehmanspublicdisclosuresconcerningitssubprimemortgageexposure
fromthisperiodreliedonadefinitionofsubprimethatexcludedAltAandsocalled
AltBmortgagesevenastheperformanceofthoseproductsincreasinglyresembledthat
of subprime. 5021 Moreover, Lehman continued to increase its exposure by pursuing a
countercyclicalbusinessstrategyinwhichitcontinuedtooriginatesubprimemortgages
untilAugust2007,andAltAandAltBmortgagesuntilJanuary2008.5022
Inc.andHSBCBankplc,DocketNo.5089,InreLehmanBros.Holdings,Inc.,No.0813555(Bankr.S.D.N.Y.
Sept.9,2009).
Sept.29,2009,atp.4(describingthesameprocess).
5021See Letter from Christopher M. OMeara, Lehman, to Jeffrey Gordon, SEC (Aug. 16, 2007), at p. 2
[LBEXDOCID2703435].InresponsetoquestionsfromtheSECabouttheextentofLehmanssubprime
exposure,OMearaexplainedthatLehmansdefinitionconsideredaborrowerwithaFICOscorebelow
620asakeyfeatureofasubprimeloan.Id.However,theInteragencyGuidanceforSubprimeLending
Programs considered a borrower with a FICO score below 660 to be characteristic of a subprime loan.
FDICPressRelease,ExpandedGuidanceforSubprimeLendingPrograms(Jan.31,2001),atp.2.
5022ExaminersInterviewofLanaFranksHarber,Sept.23,2009,atp.1.
1319

AsaresultofHSBCsevaluationofitsexposuretothefinancialsector,in2007,
HSBCreducedtheamountofuncommittedcreditavailabletotheinvestmentbanks.5023
According to Taylor, other banks did the same.5024 Taylor noted that, despite this
reduction,thestresstestsconductedbytheinvestmentbanksduringthisperiodrelied
on assumptions that the credit was still available.5025 Taylor said that the cash capital
modelofcalculatingliquiditywasdiscreditedby2008preciselybecauseitreliedon
these overly optimistic assumptions about the availability of credit and unsupported
assumptionsaboutthevalueofcertainassetbackedsecurities.5026
HSBCsconcernsincreasedafterthenearcollapseofBearStearnsinMarch2008,
and HSBC viewed Lehman as the weakest remaining brokerdealer.5027 In July 2008,
HSBC increased its efforts to reduce its exposure to Lehman by further reducing the
limitsofvariouslinesofcreditithadextendedtoLehman.5028HSBCinitiallyfocusedits
efforts on lines of credit that Lehman seldom used so that the reductions would not
5024Id.
5025Id.
5026Id.atp.5.
5027Id.;ExaminersInterviewofGuyBridge,Sept.29,2009,atp.4.
5028 Memorandum from Nicholas J. Taylor, HSBC, to GlobalFinancial Institutions Group, HSBC [Draft]
(July 28, 2008), at pp. 12 [HBUS 16204]; Memorandum from HSBC Financial Institutions Group, re
ProjectMilan(Aug.2008),atpp.12[HBUS17459].Aspartofthisdecision,HSBCalsodeclinedtorenew
Lehmans letters of credit after maturity. Memorandum from Nicholas J. Taylor, HSBC, to Global
FinancialInstitutionsGroup,HSBC[Draft](July28,2008),atp.2[HBUS16204].
1320

alert Lehman or other market participants to HSBCs actions.5029 HSBC referred to its
plantomitigateexposuretothefinancialsectorasProjectOpaquebutrenamedthe
planProjectMilan,whichfocusedonLehmanspecifically.5030
As part of Projects Opaque and Milan, HSBC asked Lehman to execute credit
support annexes (CSAs) to existing swap and derivative trading agreements
(ISDAs) that were not already accompanied by CSAs.5031 Counsel for HSBC has
representedthat,asofthepetitiondate,HSBCwasanetproviderofcollateraltoLBHI
undertheCSAs.5032TheExaminersinvestigationhasnotuncoveredanyevidencethat
HSBCwithheldcollateralfromLehmanthroughtheCSAs.
On August 18, 2008, Taylor informed Tonucci that HSBC intended to end its
business relationship with Lehman entirely through an orderly withdrawal.5033
LehmanandHSBCpersonnelmetoverAugust21and22anddiscussedwaysforHSBC
5029Financial Institutions Group, HSBC, Lehman Exposure Summary (July 2008), at p. 1 [HBUS 15615]
(describing the avoidance of actions that would be transparent to the market or to Lehman under
Objectives).
5030Memorandum from Nicholas J. Taylor, HSBC, to Global Financial Institutions Group, HSBC [Draft]
(July28,2008),atp.2[HBUS16204](referringtoProjectOpaque);MemorandumfromHSBCFinancial
InstitutionsGroup,reProjectMilan(Aug.2008),atp.1[HBUS17459];ExaminersInterviewofNicholasJ.
Taylor,Oct.15,2009,atp.5.
5031EmailfromMartinJ.Holcombe,HSBC,toSidhuGurshinder,HSBC,etal.(July9,2008)[HBUS14796]
(forwarding email chain discussing HSBC project to execute CSAs for all eligible swap and derivative
trading agreements, focusing on top 25 clients and attaching files related to agreements with Lehman).
WhenonepartyholdsassetsinexcessofthevalueowedundertheISDA,theCSAgivestheotherpartya
security interest in the excess assets until they are returned. See generally, e.g., ISDA Credit Support
AnnextotheScheduletotheMasterAgreementdatedOctober5,2000betweenLehmanBrothersFinance
S.A.andHSBCBankUSA(2000),at3,13[HBUS2135].
5033NicholasJ.Taylor,HSBC,BriefingNoteProjectMilan(Aug.18,2008),atpp.12[HBUS90].
1321

tocontinuereducingitsexposuretoLehmanwithoutimpactingLehmansbusinessand
withoutalertingthemarket.5034
(b) HSBCDemandedCollateralforIntradayCredit
On August 27, 2008, Guy Bridge, a director in HSBCs Financial Institutions
Group in London, informed Pellerani that HSBC required Lehman to deposit the
equivalentof$800millionintoanaccountintheU.K.and$145millionintoanaccount
inHongKongbyAugust29.5035BridgetoldPelleranithatHSBCwouldrequireLehman
to execute cash deeds to secure the deposits.5036 Bridge explained to Pellerani in an
emailthat[t]hisisrequiredtoensurewecancontinuetoprovidethesupportforyour
clearing/settlementbusinessasprincipalBankersintheseregions.5037BothHSBCand
Lehman understood Bridges letter to mean that HSBC would cease clearing and
settlingtradesinCRESTforLehmanifLehmandidnotprovidethecollateral.5038
5034EmailfromGuyBridge,HSBC,toCarloPellerani,Lehman(Aug.23,2008)[LBEXAM008910].
5035Email from Guy Bridge, HSBC, to Carlo Pellerani, Lehman, et al. (Aug. 27, 2008) [HBUS 3];
5036Email from Carlo Pellerani, Lehman, to Guy Bridge, HSBC, et al. (Aug. 27, 2008) [HBUS 3];
ExaminersInterviewofGuyBridge,Sept.29,2009,atpp.56.
5037EmailfromGuyBridge,HSBC,toCarloPellerani,Lehman,etal.(Aug.27,2008)[HBUS3].
5038ExaminersInterviewofGuyBridge,Sept.29,2009,atp.5;ExaminersInterviewofCarloPellerani,
Jan.13,2010,atp.7;seeemailfromHuwRees,Lehman,toAndrewYeung,Lehman,etal.(Aug.28,2008)
[LBEXAM008941]([T]hereisapossibilitythat,withoutanagreement,ourUKclearingoperationswill
beimpacted.);emailfromCarloPellerani,Lehman,toPaoloR.Tonucci,Lehman(Aug.27,2008)[LBEX
AM 008916] ([W]e need to give them ~$1b of deposit by Friday with a legal right to setoff, non
negotiable, or they will not settle for us.); email from Paolo R. Tonucci, Lehman, to Ian T. Lowitt,
Lehman (Aug. 27, 2008) [LBEXAM 008918] ([T]hey want us to deposit cash by Friday if they are to
continueclearingforus.).
1322

HSBC intended the U.K. deposit to cover its exposure to Lehman arising from
CRESTclearingandsettlementactivities.5039HSBCintendedtheHongKongdepositto
cover HSBCs exposure arising from various credit lines extended to Lehman
subsidiaries in AsiaPacific markets.5040 HSBC requested collateral to cover these
exposuresintheshortterminsteadofreducingLehmanscreditlinesbecauseLehman
wouldhavehaddifficultyreplacingHSBCsservicesineitherarea.5041
Not granting HSBCs demand would have been terminal for Lehman.5042
Bridge told the Examiner that replacing HSBCs CREST services would have been
impossibleintheshorttermandverydifficultinthemediumterm.5043Taylorstated
to the Examiner that Lehman would also have had difficulty replacing HSBCs credit
servicesintheAsiaPacificregion.5044Lehmanagreedtomakethedepositsandreviewa
draftdeed.5045HSBCagreedtoassistLehmaninfindingwaystoreducethesizeofthe
requireddepositbyreducingLehmansuseofintradaycredit.5046
5039Examiners Interview of Guy Bridge, Sept. 29, 2009, at pp. 56; Examiners Interview of Nicholas J.
Taylor,Oct.15,2009,atpp.67;ExaminersInterviewofCarloPellerani,Jan.13,2010,atp.7.
5040Email from Guy Bridge, HSBC, to Carlo Pellerani, Lehman, et al. (Aug. 27, 2008) [HBUS 3]
(demanding combined deposits of $945 million in London and Hong Kong to cover clearing and
settlementactivitiesinthoseregions).
5041ExaminersInterviewofNicholasJ.Taylor,Oct.15,2009,atpp.67.
5042ExaminersInterviewofCarloPellerani,Jan.13,2010,atp.7(Basicallytheywerenotgoingtoallow
ustodobusiness....Theyputaguntoourhead.).
5044ExaminersInterviewofNicholasJ.Taylor,Oct.15,2009,atpp.67(referringtoagreementtoaccept
collateralforclearingandsettlementservicesthatwouldbedifficulttoreplace).
5045EmailfromCarloPellerani,Lehman,toGuyBridge,HSBC,etal.(Aug.27,2008)[HBUS3].
5046ExaminersInterviewofGuyBridge,Sept.29,2009,atpp.34;emailfromCarloPellerani,Lehman,to
GuyBridge,HSBC,etal.(Aug.27,2008)[HBUS3](requestingassistanceidentifyingwaystoreducethe
1323

Pellerani told Taylor he would alert government regulators the Federal
Reserve,theFinancialServicesAuthority,orbothofHSBCsdemand.5047Bridgetold
Taylor via email that the Federal Reserve was already aware of HSBCs intended
course.5048BridgetoldtheExaminerthathehadnotspokenwithanyoneattheFederal
Reserve,butthathebelievedthateitherTaylororanotherHSBCemployeeinNewYork
haddoneso.5049TaylorinformedtheExaminerthathedidnotspeakwithanyoneatthe
FederalReserve,norwasheawareofanyoneatHSBCwhodid.5050Taylorsaidthathe
assumedtheFederalReservewasawareofHSBCscashcollateraldemandandplansto
withdraw through its observation team embedded at Lehman.5051 Pellerani did not
recall directly informing the FSA of HSBCs demand, but said that the FSA had been
informed either through daily discussions with onsite evaluators or daily written
updatessenttotheFSA.5052
requireddeposit);emailfromGuyBridge,HSBC,toCarloPellerani,Lehman(Aug.23,2008)[LBEXAM
008910](suggestingcoordinationbetweenHSBCandLehman).
5047EmailfromGuyBridge,HSBC,toNicholasJ.Taylor,HSBC,etal.(Aug.28,2008)[HBUS1900];email
fromCarloPellerani,Lehman,toPaoloR.Tonucci,Lehman(Aug.27,2008)[LBEXAM008916].
5049ExaminersInterviewofGuyBridge,Sept.29,2009,atpp.56.
5051Id.
5052ExaminersInterviewofCarloPellerani,Jan.13,2010,atp.7.
1324

(c) HSBCAgreedToAccommodateLehmanatQuarterEnd
Lehman deposited the equivalent of approximately $800 million with HSBC in
the U.K. on the morning of August 28.5053 That same day, following conversations
betweenLowittandHSBCsChiefRiskOfficer,HSBCallowedLehmantoretrievethe
deposit in order to hold it over the Labor Day weekend to help with [Lehmans]
quarterendBStargets.5054
Taylor stated that HSBCs purpose in returning the deposit was to assist with
Lehmans cash management at the end of the quarter.5055 According to Taylor, cash
management issues are magnified at the end of each month, and even more so at the
endofeachquarter.5056Asaconsequence,Taylordidnotthinkthattherewasanything
wrong with a temporary return of the approximately $800 million deposit to assist
Lehman at quarter end.5057 Nevertheless, Taylor remarked that, in light of Lehmans
5053EmailfromGuyBridge,HSBC,toNicholasJ.Taylor,HSBC,etal.(Aug.28,2008)[HBUS9250].The
transfermaynothavebeencompletedbeforeHSBCnotifiedLehmanthatitwouldallowLehmantohold
thedeposituntilaftertheendofthequarter.LehmansbankrecordslistanattemptedtransferofGBP
435 million (approximately $800 million) on August 28 from LBIE to an HSBC account held by the
LondonbranchofLBHI,LBHI(U.K.).Duff&Phelps,PreliminaryFindingsre:HSBCCashTransfer(Nov.
4,2009),atp.1.Therearenowiredataorbankconfirmationsassociatedwiththisentry.Id.
5054Email from Carlo Pellerani, Lehman, to Ian T. Lowitt, Lehman, et al. (Aug. 28, 2008) [LBEXAM
008853]; see email from Ian T. Lowitt, Lehman, to Jeremy Isaacs, Lehman (Aug. 28, 2008) [LBEXAM
008940](referringtoconversationwithHSBCsCROandHSBCsaccommodationanditsconcernabout
Lehmanoverthequarterend).
5055ExaminersInterviewofNicholasJ.Taylor,Oct.15,2009,atpp.89.
5056Id.
5057Id.
1325

reported liquidity pool, he was surprised Lehman requested that HSBC temporarily
returnthefunds.5058
(d) LehmanDepositedtheCashCollateralWithHSBC
Emails from HSBC report that Lehman again deposited the equivalent of
approximately $800 million with HSBC on September 1 for value on September 2,
bringing the total U.K. deposit back up to the equivalent of approximately $800
million.5059 On September 2, Lehman deposited the equivalent of approximately $180
millioninaHongKongaccount.5060
Bridgealsosent Huw Rees,HeadofEuropeanCreditorRelationsat Lehman, a
draft cash deed on the morning of August 28.5061 Rees then sent the draft deed to
Lehmaninhousecounsel,AndrewYeung,forreview.5062
5058Id.atp.9.
5059Email from Guy Bridge, HSBC, to Nicholas J. Taylor, HSBC, et al. (Sept. 1, 2008) [HBUS 401].
Lehmans bank records show an attempted transfer on September 1. Duff & Phelps, Preliminary
Findingsre:HSBCCashTransfer(Nov.4,2009),atp.1.Therearenowiredataorbankconfirmations
associated with this record. Id. Lehmans bank records show an actual transfer of GBP 435 million,
equivalent to approximately $800 million, from LBIE into LBHI(U.K.)s HSBC account on September 2.
Id.
5060EmailfromPatriciaGomes,HSBC,toGuyBridge,HSBC,etal.(Sept.1,2008)[HBUS397](statingthat
theHongKongdepositisequivalentto$180million).ButseeemailfromStirlingFielding,Lehman,to
Carlo Pellerani, Lehman, et al. (Sept. 1, 2008) [LBEXAM 008963] (recording instant message conference
statingthattheHongKongdepositisequivalentto$192millionwithunspecifiedcreditduetoLehman).
TheExaminersinvestigationhasnotrevealedanyotherreferencestoaHongKongdepositequivalentto
$192 million. The Examiners financial advisors identified a September 1 transfer equivalent to $192
millionfromaLehmanBrothersAsiaHoldingsmoneymarketaccount,butwerenotabletodetermineif
allofthesefundswereusedforadeposit.Duff&Phelps,PreliminaryFindingsre:HSBCDeposits(Dec.
2,2009),atp.2.
5061EmailfromGuyBridge,HSBC,toHuwRees,Lehman,etal.(Aug.28,2008)[LBEXAM008941].
5062Id.
1326

OnSeptember3,PelleraniinformedBridgethatLehmanwouldnotsignthedeed
without narrowing the scope of the right of setoff, and then began negotiating its
terms.5063 Lehman sought to narrow the debts that could be set off with the collateral
andtobroadenthecircumstancesunderwhichitwouldhaveaccesstothefunds.5064
Deeds
(i) LehmanSecuredConcessionsintheU.K.CashDeeds
LehmanexecutedtheU.K.CashDeedsonSeptember9tocovertheU.K.deposit
oftheequivalentofapproximately$800million.5065Asdescribedbelow,HSBCreturned
theequivalentofapproximately$282millionofthesefundsonSeptember11.5066
One deed is between HSBC Bank plc and LBIE.5067 The second U.K. deed is
betweenHSBCBankplcandLBHI(U.K.).5068LehmansignedbothdeedsonSeptember
9.5069 HSBC split the LBHI(U.K.) deed into separate deeds to be joined by a cross
guarantybecauseHSBCbelievedadministrativehurdleswoulddelayexecutionofany
5063EmailfromGuyBridge,HSBC,toNicholasJ.Taylor,HSBC,etal.(Sept.3,2008)[HBUS570].
5064Id.PelleraniquicklydistancedhimselffromnegotiationswithHSBCtotheextentpossiblebecausehe
hadbecomesoanimatedoverHSBCscollateraldemand.ExaminersInterviewofCarloPellerani,Jan.
13,2010,atp.7.TheactualnegotiationswerehandledbyRees,whowassupervisedbyPellerani.Id.
5067CashDeedbetweenHSBCandLBIE(Sept.9,2008)[HBUS1180].
5068CashDeedbetweenHSBCandLBHI(U.K.)(Sept.9,2008)[HBUS1190].
5069Email from Guy Bridge, HSBC, to Nicholas J. Taylor, HSBC, et al. (Sept. 9, 2008) [HBUS 1179];
1327

deedthatcoveredLBHI(U.K.),andHSBC wantedtogainasmuchsecurityassoonas
possible.5070
In both of the U.K. Cash Deeds, Lehman successfully negotiated for a more
limited definition of debt for setoff purposes and greater access to the cash collateral
coveredbythedeeds.5071Theoriginaldraftcashdeeddefinesdebteligibleforsetoff
underthedeedasallmoneyandliabilitieswhatever,whenever,andhoweverincurred
whether now or in the future due or becoming due from you to [HSBC].5072 The
executed U.K. Cash Deeds limit the definition of debt to money owed on specified
accountsheldbyLBIE,LBHI(U.K.)andLehmanBrothersLtd.5073andtoLehmansdebts
forsterlingclearingandsettlementservices.5074
TheoriginaldraftcashdeedwouldhaveallowedLehmantoaccessthedeposit
onlywhenHSBCdeterminedthattherewasnooutstandingdebt(broadlydefined).5075
The executed U.K. Cash Deeds require that HSBC exercise good faith in determining
whether the deposit was adequate to cover the outstanding debt (more narrowly
defined).5076 However, Lehmans access to the deposit was still subject to HSBCs
5071Id.
5072CashDeedbetweenHSBCandLBIE[Draft](Aug.28,2008),at1(c)[LBEXDOCID4468302].
5073CashDeedbetweenHSBCandLBHI(U.K.)(Sept.9,2008),at1[HBUS1190].
5074CashDeed between HSBC and LBIE (Sept. 9, 2008), at 1(e)(1)(c), 2 [HBUS 1180]; Cash Deed
betweenHSBCandLBHI(U.K.)(Sept.9,2008),at1(e)(1)(c)[HBUS1190].
5075CashDeedbetweenHSBCandLBIE[Draft](Aug.28,2008),at4[LBEXDOCID4468302].
5076CashDeedbetweenHSBCandLBIE(Sept.9,2008),at34[HBUS1180];CashDeedbetweenHSBC
andLBHI(U.K.)(Sept.9,2008),at56[HBUS1190].
1328

approval, and the deposit was still subject to any right of setoff HSBC would have
againstanunsecureddeposit.5077
Finally,theU.K.CashDeedsspecifythattheyaregovernedbyEnglishlaw.5078
(ii) LehmanExecutedtheHongKongCashDeedLateon
September12
Lehman continued negotiating the terms of the Hong Kong Cash Deed until
Friday, September 12.5079 The parties to the executed deed are Lehman Brothers Asia
Holdings (LBAH) and HSBC Ltd.5080 Like the U.K. Cash Deeds, the executed Hong
KongCashDeedgrantsHSBCLtd.arightofsetoffagainstpaymentsmadeonbehalfof
or overdrafts on specified accounts.5081 Instead of covering HSBCs credit exposure
arising from CREST, the Hong Kong Cash Deed covers HSBCs exposure from credit
lines (both intraday and longerterm) extended to Lehman entities in the AsiaPacific
region.5082
5077See Cash Deed between HSBC and LBIE (Sept. 9, 2008), at 45 [HBUS 1180]; Cash Deed between
HSBCandLBHI(U.K.)(Sept.9,2008),at56[HBUS1190].
5079SeeemailfromPatriciaGomes,HSBC,toNicholasJ.Taylor,HSBC,etal.(Sept.12,2008)[HBUS1760]
(announcingexecutionofHongKongdeeds).
5080CashDeedbetweenLBAHandHSBCLtd(Sept.12,2008),atp.1[HBAP13].
5081Compare id. at 1(f), with Cash Deed between HSBC and LBHI(U.K.) (Sept. 9, 2008), at 1 [HBUS
1190].
5082Cash Deed between LBAH and HSBC Ltd (Sept. 12, 2008), at 1(f) [HBAP 13]; see also email from
PatriciaGomes,HSBC,toEddieC.H.Ching,HSBC(Sept.12,2008)[HBUS7642](statingthattheHong
KongdeedsecuresallCatAandPSLofHKandIndia).PSLlinesarelinesusedforcreditsettlement
activityandCatAlinesareforlongertermcreditproducts.ExaminersInterviewofNicholasJ.Taylor,
Oct. 15, 2009, at p. 6 (defining Cat S as credit lines for settlement activity and Cat A as nonsettlement
loans);NicholasJ.Taylor,HSBC,BriefingNoteProjectMilan(Aug.18,2008),atp.1[HBUS90](listing
PSLcreditlinesundertheheading,CatS).
1329

TheHongKongCashDeedalsograntsHSBCLtd.arightofsetoffagainstdebts
incurredthroughprovidingclearingandsettlementservicestocertainLehmanentities
(including LBI) designated in the Hong Kong Cash Deed.5083 As with the U.K. Cash
Deeds,Lehmanwasobligatedtomaintainasufficientbalanceinspecifiedaccountsto
covergoodfaithestimatesofHSBCsaggregateexposurecoveredbythedeed.5084
Lehman could access the collateral subject to HSBC Ltd.s approval if there
were no debts in the specified accounts (and so long as HSBC Ltd. had no actual or
contingent obligation to incur such a debt on Lehmans behalf); although HSBC Ltd.
couldnotexercisethesetoffrightscontainedinthedeedagainsttheremainingfunds,
HSBC Ltd. reserved its right to exercise any other rights of setoff it may have against
those funds.5085 The Hong Kong Cash Deed contains a choiceoflaw provision
specifyingthatthedeedistobegovernedbyHongKonglaw.5086
LBAHsignedtheHongKongCashDeedtoolateinthedayonSeptember12for
HSBC to move the Hong Kong deposit into an account secured by the deed.5087 The
banksinHongKongwereclosedonMonday,September15forapublicholiday,sothe
earliest HSBC could move the deposit into a secured account was September 16.5088
HSBCcounselhasrepresentedthatHSBCtransferredtheequivalentofapproximately
5083CashDeedbetweenLBAHandHSBCLtd(Sept.12,2008),at1,4[HBAP13].
5084Id.at5(a).
5085Id.at5(b),6(a).
5086Id.at27.
5087EmailfromPatriciaGomes,HSBC,toNicholasJ.Taylor,HSBC,etal.(Sept.12,2008)[HBUS1760].
5088Id.
1330

$148 million (on September 16) from the cash collateral deposit into an LBAH cash
accountandthenintoasecuredaccountasspecifiedbytheHongKongCashDeed.5089
HSBChaslimiteditsdocumentproductionfromoverseassubsidiaries,includingHSBC
AsiaPacific (HBAP), but HSBC counsel has represented that the deposit was
transferredoutofthesecuredaccountandbacktotheLBAHcashaccountlaterinthe
day on September 16 on instructions from Lehmans Treasurer for the AsiaPacific
region, Gregory Ito.5090 According to HSBC counsel, the Hong Kong deposit was
commingledwithotherLehmanfundsinthecashaccount.5091
HSBCcounselhasalsoadvisedthatKPMG,theprovisionalliquidatorsofLBAH,
instructed HSBC to freeze all LBAH accounts, at which point all outgoing payments
requiredpriorapprovalfromKPMG.5092Further,onOctober3,2008,KPMGinstructed
HSBC to transfer the balance of the Hong Kong deposit to an account specified by
KPMG.5093 HSBC counsel represented that HSBC Ltd. made the transfer on October 6
after receiving (with KPMGs approval) the equivalent of approximately $680,000 for
checks clearing from the account and $3 million, which was subsequently setoff
against an obligation of LBAH to [HSBC Ltd.] under a loan agreement.5094 HSBC
5090Id.
5091Id.
5092Id.
5093Id.
5094Id.
1331

counsel stated further that the $3 million setoff took place automatically pursuant to
the mandatory insolvency setoff under Section 35 of the Hong Kong Bankruptcy
Ordinance, following the making of a winding up order against LBAH by the High
CourtoftheHongKongSpecialAdministrativeRegionon19November2008.5095
(f) HSBCandLBHIStipulatedToSetOffandReturnSomeof
theFundsCoveredbytheU.K.CashDeeds
Prior to entering into a stipulation with LBHI, HSBC held the equivalent of
approximately $495 million from the U.K. Cash Deeds.5096 On September 9, 2009, the
bankruptcycourtapprovedanAugust28,2009stipulationbetweenHSBCandLBHI.5097
The stipulation allows HSBC to set off the equivalent of approximately $164 million
against these funds for overdrafts, $114,070 for interest, and unspecified amounts for
additionalaccruedinterests,costsandexpensespursuanttothetermsoftheU.K.Cash
Deeds.5098HSBCandLBHIalsostipulatedthatLBHIwillremitamisdirectedpayment
equivalent to approximately $999,516, which had been erroneously deposited in an
accountcovered by theU.K. CashDeeds.5099Additionally,HSBCagreedtoreturn the
equivalent of approximately $101 million to an account designated by LBHI once the
5095Id.
5096Stipulation, Agreement and Order, Pursuant to Sections 362 and 553 of the Bankruptcy Code,
plc,atp.2,DocketNo.5089,InreLehmanBros.Holdings,Inc.,No.0813555(Bankr.S.D.N.Y.Sept.9,2009)
(referringtoaccountbalanceofEUR343,446,459.96).
5097Id.atp.8(referringtosetoffofGBP99,992,714.37foroverdraftsandGBP69,347.60forinterest).
5098Id.atpp.23.
5099Id.
1332

setoffs were complete.5100 HSBC expressly reserved its rights to additional setoffs
againsttheremainingfunds,andLBHIagreedtoworkinacommerciallyreasonable
mannertoaddressthosesetoffs.5101Asdescribedabove,HSBCcounselhasrepresented
that HSBC claims total more than $345 million related to various securities
transactions.5102
(4) OtherIssuesStemmingfromHSBCsCollateralDemand
(a) LehmanIncludedtheDepositsCoveredbytheCashDeeds
inItsReportedLiquidityPool
Lehman reported a liquidity pool in excess of $40 billion as of September 2,
2008.5103LehmanincludedthecollateralplacedwithHSBCinconnectionwiththecash
deedsinitsreportedliquiditypool.5104BridgetoldtheExaminerthathewasnotaware
that Lehman included the collateral in its liquidity pool, but opined that the cash
LehmanpostedwithHSBCshouldnothavebeenincludedinLehmansliquiditypool
5100Id.atp.3(referringtoreturnofEUR70million).
5101Id.
5102SeeKenColeman,HSBCcounsel,SpreadsheetofClaimsbyHSBCandRelatedEntities(Jan.5,2010).
5103FRBNY,LehmanIBUpdates(Sept.12,2008)[FRBNYtoExam.007965].Earlierintheyear,HSBCs
May12GlobalAnnualReviewreportedthatLehmanhadanexcessliquiditycushionof$93billion.
HSBC, Lehman Global Annual Review (May 12, 2008), at p. 7 [HBUS 10281]. According to Taylor, the
excessliquiditycushionwascalculateddifferentlythantheliquiditypool,andtheGlobalAnnualReview
data was often months outofdate because of the preparation and review process for those reports.
Examiners Interview of Nicholas J. Taylor, Oct. 15, 2009, at pp. 45. The excess liquidity cushion was
calculated by assuming 50 percent funding of noninvestment grade commitments, then subtracting
unsecured obligations maturing within 12 months and additional collateral required for trading in the
eventofaonenotchratingsdowngradefromthesumofunencumberedassetsandglobalcashavailable.
Id.
5104Examiners Interview of Paolo R. Tonucci, Sept. 16, 2009, at p. 19; see also, e.g., Lehman, Liquidity
Update (Sept. 10, 2008), at p. 3 [LBHI_SEC07940_742574] (listing a U.K. deposit with a pledge value of
$966 million with the comment, HSBC, etc, categorizing Lehmans ability to monetize the deposit as
low);Lehman,AbilitytoMonetizeTable(Sept.12,2008)[LBEXWGM784607].
1333

becauseLehmandidnothaveimmediateaccesstothemoney.5105Bridgestatedthat,in
hislayopinion,thecashdepositwasencumberedcollateralfromthemomentLehman
posted it.5106 Bridge said that he did not believe that HSBC would have pulled the
plugifLehmanhadattemptedtowithdrawthecashitplacedwithHSBCbeforeitwas
securedbythedeeds,buthesaidthatanumberofthingswould[have]happened.5107
Bridge also noted that, given the size of the deposit with HSBC, Lehmans liquidity
wouldlikelyhavebeenimpactedandthatLehmanprobablywouldhavebeenobliged
toreporttherestrictionplacedonthefunds.5108
Taylor said that, in his view, the deposits were unencumbered before Lehman
executed the deeds, but that HSBC had implemented processes through which he
wouldbenotifiedifLehmanattemptedtowithdrawthedeposits.5109Taylorstatedthat
an email from Bridge in which Bridge said Lehman could not withdraw the deposits
without our say so referred to such processes.5110 Taylor described the deposits as
havingastrongencumbranceafterLehmanexecutedthecashdeeds.5111
PelleranisaidthathewasnotawareoftheprecisetermsoftheU.K.CashDeeds
anddidnotknowwhathappenedtothecashonceitwaspostedtoHSBC,butsaidthat
5106Id.atp.6.
5107Id.atp.7.
5108Id.
5110Id.;emailfromGuyBridge,HSBC,toNicholasJ.Taylor,HSBC,etal.(Sept.3,2008)[HBUS570].
1334

hewasnotcountingonusingthecash.PelleraniassumedthatifLehmanwithdrew
part of the deposit during the day, HSBC would have reduced its clearing and
settlement services accordingly.5112 As described in more detail in the Bank of New
YorkMellonSectionbelow,Pelleranididnotconsidersuchdepositstobeavailablefor
inclusionintheliquiditypool.5113
Analysts from rating agencies were unaware that Lehmans liquidity pool
included the deposits with HSBC (or similar deposits with other banks).5114 Fitchs
analyst opined that it would be inappropriate to include encumbered assets in the
liquiditypoolandwouldhaveconsideredtherestrictionsonthecashdepositsatHSBC
andelsewherematerial.5115AnalystsforStandard&PoorsandMoodys(interviewed
on a later date) both stated that they would have wanted to know about the
deposits.5116
HSBC returned the equivalent of approximately $282 million from the U.K.
deposit to Lehman on September 11.5117 Bridge told the Examiner that the return of
5113SeeSectionIII.A.5.f,infra;ExaminersInterviewofCarloPellerani,Jan.13,2010,atpp.34,8.
Sept.22,2009,atp.6;ExaminersInterviewofPeterE.Nerby,Oct.8,2009,atp.4.
5116ExaminersInterviewofDianeHinton,Sept.22,2009,atp.6;ExaminersInterviewofPeterE.Nerby,
Oct.8,2009,atpp.45.
5117ExaminersInterviewofGuyBridge,Sept.29,2009,atp.7.AccordingtoLehmansDailyFundingCall
Update email for September 11: Trsy have reduced cash deposit with HSBC to GBP200m to release
liquidityinthefirm.EmailfromMariaBarrio,Lehman,toNeilUllman,Lehman,etal.(Sept.11,2008)
[LBEXDOCID 1898196]. The Examiners financial advisors analysis of Lehmans transactions during
1335

funds was the result of rebalancing the account in Lehmans favor based on credit
usage.5118
(b) HSBCConsideredWithholdingPaymentsorRequiring
LehmansBankruptcy
OnSundaySeptember14,TaylorexchangedemailswithotherHSBCpersonnel
regarding orders to withhold payments and/or requiring prefunding of trades for
Lehman when the Asian markets opened on Monday.5119 Taylor instructed HSBC
personneltoleaveourselftheoptiontoclose[CRESTlinescoveredbythecashdeeds]
andeverything.5120BridgetoldtheExaminerthatHSBCopenedinAsiaonabusiness
asusualbasiswithLehmanonSeptember15.5121
(5) TheEvidenceDoesNotSupporttheExistenceofColorable
CashCollateralandExecuteCashDeedsinOrderforHSBCto
ContinueProvidingClearingandSettlementServices
(a) TheParametersoftheExaminersAnalysis
TheExaminerfocusedonthetransactionssurroundingthecashdeedsbecauseof
theamountofcollateraltheysecured,thetimingofHSBCsdemand,andthepotential
this period shows that this report was erroneous, and that Lehman received EUR 200 million on
September11.Duff&Phelps,PreliminaryFindingsre:HSBCDeposits(Dec.2,2009),atp.1.
5118ExaminersInterviewofGuyBridge,Sept.29,2009,atp.7.BridgestressedthatHSBCapprovedthe
release and that Lehman could not have directed money out of the collateral accounts without HSBCs
approval.Id.Taylorwasunawareofthetransfer.ExaminersInterviewofNicholasJ.Taylor,Oct.15,
2009,atp.3.Pelleraniwasalsounawareofthetransfer.ExaminersInterviewofCarloPellerani,Jan.13,
2010,atp.8.
5119EmailfromNicholasJ.Taylor,HSBC,toChristineCoe,HSBC,etal.(Sept.14,2008)[HBUS1987].
5120EmailfromNicholasJ.Taylor,HSBC,toMartinNicholson,HSBC,etal.(Sept.14,2008)[HBUS1999].
1336

consequences to Lehman had it refused to comply. This investigation has produced
sufficient information to analyze plausible claims. However, the Examiner has had
limited access to relevant documents held by HSBC (headquartered in the U.K.) and
some of its overseas subsidiaries. Accordingly, this analysis relies in part on
representationsmadebyHSBCscounsel.5122
TheExaminersinvestigationhasdeterminedthatthetransactionsrelatedtothe
letters of credit, syndicated credit facility, the CSA agreements and the Hong Kong
depositdonotrepresentamaterialportionoftheestate.
HSBC counsel represented that HSBC returned the Hong Kong deposit to an
LBAH cash account before transferring the funds to KPMG in their capacity as the
provisionalliquidatorsofLBAH,minusa$3millionsetoffrequiredunderHongKong
lawandtheequivalentofapproximately$680,000usedforclearingchecksonLBAHs
cashaccount.5123Asdescribedabove,HSBCcounselrepresentedthatKPMGapproved
the equivalent of approximately $680,000 for clearing checks and that the $3 million
setoff was made pursuant to an order by the High Court of the Hong Kong Special
AdministrativeRegion.5124
5122See,e.g.,MemorandumfromKenColeman,HSBCcounsel,toExaminer,re:TransfersinConnection
WiththeHongKongCashDeed(Oct.23,2009).
5123Id.atp.1.
5124Id.
1337

HSBCs present claim based on the letters of credit is only $116,083 for fees,
interest, expenses andfundsdrawn against the letters ofcredit by thebeneficiaries.5125
The remaining $6 million is contingent upon further draws by the beneficiary of the
unexpired letter of credit.5126 The Examiners investigation has not uncovered any
evidencethatLehmandidnotexchangefairvaluefortheselettersofcredit.
Lehmanagreedtocontribute$25milliontoarevolvingcreditfacilityforHSBCs
benefitonAugust15.However,Lehmanneverdeliveredthefunds.5127HSBChasnot
broughtaclaimbasedonthesidelettercommittingthe$25million.5128
Finally, the CSA agreements executed in the months preceding the bankruptcy
gaveeachpartyasecurityinterestincertainassetstransferredinexcessofthevalueof
thepartiesswapandderivativestrades;asanetproviderofcollateralasofthepetition
date, HSBC was providing Lehman with excess funds rather than the reverse.5129 The
Examiners investigation has not uncovered any evidence that HSBC withheld any
collateral from Lehman under the CSAs. These transactions are factually significant
only insofar as they relate to or provide context for HSBCs efforts to secure the U.K.
Deeds.
5125Annex A to Proof of Claim of HSBC Bank USA, N.A., at p. 3, Claim No. 18857, In re Lehman Bros.
Holdings,Inc.,No.0813555(Bankr.S.D.N.Y.Sept.18,2009).
5126Id.ExaminersInterviewofCarloPellerani,Jan.13,2010,atpp.78.
5128SeeKenColeman,HSBCcounsel,SpreadsheetofClaimsbyHSBCandRelatedEntities(Jan.5,2010);
see also Side Letter from HSBC to LBCB (Aug. 15, 2008) [LBEXDOCID 89911] (signed by HSBC); Side
LetterfromHSBCtoLBCB(Aug.15,2008)[LBEXDOCID89916](signedbyLBCB).
5129Jenner&Block,Memorandumre:RepresentationsbyHSBCcounsel(Jan.11,2010),atp.1.
1338

(b) TheFactsProvideLittletoNoSupportforInvalidatingthe
U.K.CashDeeds
(i) AnalyticalFramework
a. EnglishLawGovernsContractClaimsArising
fromtheU.K.CashDeeds
Express choiceoflaw provisions in contracts are prima facie valid under New
York law.5130 A party seeking to invalidate an express choiceoflaw provision must
establish that enforcement of the clause would be unreasonable, unjust, or would
contravene public policy, or that the clause would be invalid because of fraud or
overreaching.5131 Each of the U.K. Cash Deeds contains an identical provision
specifyingthatitistobegovernedbyandconstruedinaccordancewithEnglishlaw.5132
ThedeedsarebetweenHSBCBankplc,headquarteredinLondon,andLBIE5133andthe
U.K. branch of LBHI,5134 respectively. The relevant facts support a determination that
thechoiceoflawprovisionisvalid.
Lehman may argue the choiceoflaw provision is invalid because HSBC
overreached by demanding that Lehman either execute the deeds or confront the
alternative of HSBC ceasing CREST clearing and settlement services. The Examiners
5130Bossv.Am.ExpressFin.Advisors,Inc.,791N.Y.S.2d12,14(App.Div.2005),affd844N.E.2d1142(N.Y.
2006).
5131Id. (citing Koko Contracting v. Contl Envtl. Asbestos Removal Corp., 709 N.Y.S.2d 825, 826 (App. Div.
2000).
5133CashDeedbetweenHSBCandLBIE(Sept.9,2008),atp.1[HBUS1180].
5134CashDeedbetweenHSBCandLBHI(U.K.)(Sept.9,2008),atp.1[HBUS1190].
1339

investigationhasnotuncoveredanyevidencethatLehmancontestedthechoiceoflaw
provision, and, moreover, Lehman successfully negotiated favorable changes to other
termsofthedeeds(thisissueisdiscussedinmoredetailbelowinreferencetoeconomic
duress).Thereisnocolorableargumentthatthatthechoiceoflawprovisionisinvalid.
b. EnglishContractLawTreatsDeedsDifferently
fromOtherContracts
English law distinguishes deeds from informal contracts.5135 Deeds must (a)
effectthetransferenceofaninterest,rightorproperty;(b)createanobligationbinding
on some person or persons; [or] (c) confirm some act whereby an interest, right or
property has already passed.5136 An instrument must make clear on its face that the
partiesintendedittobeadeedanditmustbevalidlyexecutedasadeed.5137Ifthedeed
isexecutedbyacompany(organizedundertheCompaniesAct),theinstrumentmust
bedulyexecutedanddeliveredasadeedmeaningthatitmustbedoneevidencing
an intent to be bound by a deed.5138 Delivery is presumed upon execution, and
generally,acompanyorcorporationaggregatemaydulyexecutedeedsbyaffixingthe
corporationscommonsealorthroughthesignatureoftwosignatoriesauthorizedbya
director of the company, in the presence of a witness.5139 However, corporations
aggregate are required (at least in principle) to affix the company seal to execute a
5135CHITTYONCONTRACTS,56(H.G.Bealeetal.eds.,ThompsonReuters2008)(1826)[hereinafterCHITTY].
5136Id.at6061.
5137Id.at67.
5138Id.at69.
5139Id.at6869.
1340

deed.5140Thisrequirementmaybesatisfiedbyaffixinganysealandhavingtheboardof
directors or one such member and a permanent officer (or deputy of a permanent
officer)attestthatitisthecorporationssealandwasaffixedintheirpresence.5141
The U.K.Cash Deeds meet these criteria. They transfer a right to the U.K.
deposit from Lehman to HSBC and they expressly state that they are executed as
deeds.5142 Lehmans common seal is affixed to the LBIE deed,5143 and Huw Rees and
Craig Goldband signed the LBHI(U.K.) deed,5144 which is accompanied by an
authorization letter signed by Tonucci and Jeffrey Welikson (LBHIs secretary),5145 and
byasheetofauthorizedsignaturesforverification.5146
ColorableClaimThattheU.K.CashDeedsAreInvalid
forWantofConsideration
English law does not ordinarily require consideration to enforce a contract
contained in a deed, although consideration is required for other contracts.5147 The
5140Id.at69.
5141Id.
5142Cash Deed between HSBC and LBIE (Sept. 9, 2008) [HBUS 1180]; Cash Deed between HSBC and
LBHI(U.K.)(Sept.9,2008)[HBUS1190].
5143LBIEPowerofAttorney(July9,2008),atp.1[HBUS1188](attachedtoCashDeedbetweenHSBCand
LBIE).
5144CashDeedbetweenHSBCandLBHI(U.K.)(Sept.9,2008),atp.10[HBUS1190].
5145SeeLBHI(U.K.)AuthorizedSignatureList(Apr.2008),atpp.13[HBUS1200].
5146LBHI(U.K.)AuthorizedSignatureListA(Apr.2008)[HBUS1205].
5147CHITTY,72(citingMorleyv.Boothby(1825)130Eng.Rep.455,45657(C.P.)).
1341

absence of consideration to support a contract contained in a deed will, however,
preventpartiesfromobtainingequitableremediessuchasspecificperformance.5148
The evidence does not support the existence of a colorable claim for failure of
consideration of the U.K.Cash Deeds. Because the CREST agreement grants HSBC
absolute discretion to determine whether or not to continue providing CREST
clearing and settlement services,5149 Lehman received consideration in the form of
HSBCscontinuingtoprovidethoseservices,atleasttemporarily,afteritdeterminedto
withdrawfromLehman.Lehmanmayalsohavereceivedconsiderationintheformofa
higher rateofinterestonthedeposits securedby thedeeds.InternalLehman emails
refertopromisesbyBridgethatLehmanwouldreceivehigherthanmarketratesonthe
collateral deposits, although Lehman personnel complained that they did not receive
the level of interest that they had expected.5150 Even if Lehman did not receive
consideration,thefailureofconsiderationwouldnotbesufficienttorescindthedeeds
becausedeedsdonotrequireconsiderationunderEnglishlaw.
5148Id.(citingKekewichv.Manning(1851)42Eng.Rep.519,525(Ch.)).
5150EmailfromBarbaraGinet,Lehman,toHuwRees,Lehman(Sept.1,2008)[LBEXAM008968].
1342

(iii) TheEvidenceDoesNotSupporttheExistenceofa
CRESTAgreementAllowedHSBCToCeaseClearing
andSettlementatItsAbsoluteDiscretion
The evidence does not support the existence of a colorable claim for economic
duressagainstHSBCinconnectionwiththeCashDeeds.AlthoughLehmanagreedto
executethedeedsafterHSBCraisedthepossibilityofthecessationofCRESTclearing
andsettlementservices,HSBCmerelyproposedtodowhatithadacontractualrightto
do:exerciseitsabsolutediscretionovertheprovisionofCRESTclearingandsettlement
services.5151EvenwithouttheabsolutediscretionprovisionoftheCRESTagreement,
Lehmans ability to secure important concessions during negotiations over the cash
deeds provides a factual basis to support a finding that Lehmans agreement was not
theresultofeconomicduressdespitetheseverepotentialconsequencestoLehmanhad
itfailedtopostthedemandedcollateralandfailedtoexecutethecashdeeds.
a. ElementsofEconomicDuress
English law recognizes economic duress as grounds to avoid a contract. A
contractisvoidableifthedefendantappliespressure(a)whosepracticaleffectisthat
there is a compulsion on, or lack of practical choice for the victim, (b) which is
illegitimate, and (c) which is a significant cause in inducing the claimant to enter into
5151SeeCHITTY,616(citingAlecLobbLtd.v.TotalOilG.B.Ltd.[1983]1W.L.R.87,9394(Ch.)variedonother
pointsby[1985]1W.L.R.173)(A.C.);TermsandConditionsRelatingtoCRESTSettlementBankFacilities
Made Available to a CREST Member or Sponsored Member (Aug. 19, 2008), at 16.1 [HBEU 102]
(grantingHSBCabsolutediscretiontoterminateCRESTclearingandsettlementservices).
1343

thecontract.5152Aproposaldoesnotrisetothelevelofeconomicduressiftheprincipal
reasonforthecomplyingpartysagreementwasthatheorshewaspreparedtocomply
anyway, asisthecase whenthe complying partyagrees,believinghe or shewill lose
littlebygrantingtheillegitimatedemand.5153
In determining whether the defendant applied illegitimate pressure, English
courtslooktoarangeoffactors,including:
whether there has been an actual or threatened breach of contract;

whether the person allegedly exerting the pressure has acted in good or
badfaith;whetherthevictimhadanyrealisticpracticalalternativebutto
submit to the pressure; whether the victim protested at the time; and
whetherheaffirmedandsoughttorelyonthecontract.5154
Englishcourtshavealsomadeclearthat[t]hreateningtocarryoutsomethingperfectly
withinonesrightswillnotnormallyamounttoduress....5155
b. ApplicationtoLehmanFacts
BridgesaidthatHSBCwasLehmansprimaryCRESTbank,thatLehmanhadno
secondarybank,thatitwouldhavebeenimpossibleforLehmantoreplaceHSBCinthe
shorttermandverydifficultinthemediumterm,andthatbothLehmanandHSBC
understood HSBCs demand to mean that HSBC would cease to provide CREST
5152DSND Subsea Ltd. v. Petroleum GeoServs. ASA, [2000] B.L.R. 530 at [131] (Q.B.); see also Dimskal
ShippingCo.v.IntlTransp.WorkersFedn(TheEviaLuckNo.2)[1992]2AC152,165(H.L.)(appealtaken
fromEng.).
5153CHITTY,607(citingPaoOnv.LauLiuLong[1980]A.C.614,635(P.C.1979)(appealtakenfromH.K.)).
5154DSNDSubseaLtd.v.PetroleumGeoServs.ASA,[2000]B.L.R.530at[131](Q.B.).
5155CHITTY, 616 (citing Alec Lobb Ltd. v. Total Oil G.B. Ltd. [1983] 1 W.L.R. 87, 9394 (Ch.) varied on other
pointsby[1985]1W.L.R.173)(A.C.).
1344

clearingandsettlementservicesifLehmandidnotacquiesce.5156Pelleranidescribedthe
demand as put[ting] a gun to our head because HSBC acting on its threat would
havebeenterminal.5157
For its part, HSBC believed that publicity of its decision to withdraw from
Lehman would have sent negative market signals that could have precipitated
Lehmanscollapse.5158AlthoughHSBCtookcaretopreventpublicitywhilenegotiating
the cash deeds, ending the CREST relationship entirely would have been public and
broughtthesame(orgreater)riskofprecipitatingLehmanscollapse.Lehmanhadno
practicaloptionbuttocomplywithHSBCsdemandorriskthecollapseofthefirm.
Nevertheless,HSBCsconductwaslegitimateunderitsagreementwithLehman.
HSBC had absolute discretion to provide or not provide CREST services,5159 and
invokingtheabilitytoceaseclearingwouldnotamounttoduressdespitetheadverse
consequencestoLehman.5160
In addition, Lehman only agreed to the terms of the deeds after an extended
negotiation over several days that yielded more favorable terms on the points of its
5156ExaminersInterviewofGuyBridge,Sept.29,2009,atp.2;ExaminersInterviewofNicholasJ.Taylor,
Oct. 15, 2009, at pp. 67 (reporting that HSBC agreed to maintain credit lines that would have been
difficulttoreplaceifLehmanprovidedcollateraltocoverHSBCsexposure).
5158Id.
5160See CHITTY,616(citingAlecLobbLtd.v.TotalOilG.B.Ltd.[1983]1W.L.R.87,9394(Ch.)variedonother
pointsby[1985]1W.L.R.173)(A.C.).
1345

greatest concern.5161 Lehman also obtained an agreement from HSBC to return the
equivalentofapproximately$800millionsothatLehmanwouldbeabletomanageits
cashrequirementsatquarterend.5162Thesefactssupportafindingthattheagreements
werenottheresultofduress.
c. OtherTransactionsDoNotGiveRisetoEconomic
DuressClaims
HSBC cancelled or reduced other credit lines and products as part of Projects
OpaqueandMilan.5163However,HSBCdidnotmakeanydemandsuntiltheAugust18,
2008 meeting between Taylor and Tonucci. Indeed, as the name implies, Project
Opaque was designed to avoid attracting any notice,5164 and the Examiners
investigationhasnotuncoveredanydiscussionsbetweenLehmanandHSBCaboutthe
reduction in credit prior to August 18. Bridge and Taylor described the credit lines
cancelled or reduced under Projects Opaque and Milan as underused or unused, and
the documents corroborate that assertion.5165 Further, as described above, the
5162Emailfrom Carlo Pellerani, Lehman, to Ian T. Lowitt, Lehman, et al. (Aug. 28, 2008) [LBEXAM
008853];seealsoemailfromIanT.Lowitt,Lehman,toJeremyIsaacs,Lehman(Aug.28,2008)[LBEXAM
8940];ExaminersInterviewofNicholasJ.Taylor,Oct.15,2009,atpp.89.
5163 Memorandum from Nicholas J. Taylor, HSBC, to Global Financial Institutions Group, HSBC, re:
ProjectOpaque[Draft](July28,2008),atp.1[HBUS16204](describingProjectOpaque);seealsoFinancial
InstitutionsGroup,HSBC,ProjectMilan(Aug.2008)[HBUS17459](substantiallysimilarplanforProject
Milan).
5164Memorandum from Nicholas J. Taylor, HSBC, to Global Financial Institutions Group, HSBC, re:
ProjectOpaque[Draft](July28,2008),atp.1[HBUS16204](referringtocovertreductionofexposurein
whichclientandmarketassumesbusinessasusualandGTBrevenuesprotected.).
5165SeeLehman,SpreadsheetofCreditLinesSubjecttoExaminationbyHSBCandLBHI(Aug.28,2008)
[HBUS237](createdinconcertwithLehmantodetermineutilizationoflinesforfurtherreductions).
1346

cancellation of the unused day loan facility, the execution of CSAs, and the other
transactionsrelatedtothelettersofcreditdidnotimpactLehmansignificantly.
Lehman may argue that HSBCs August 27, 2008 offer to reduce the
approximately$1billiondepositifLehmanreduceditsuseofcreditlinesamountedto
an improper threat to cancel those lines unless Lehman posted sufficient collateral.
HSBC has not produced the agreements governing each of the credit lines at issue.
Counsel for HSBC has represented that HSBC provided these credit lines solely at its
discretion.5166
EvenifHSBCdidnothavethe discretiontocanceltheseotherlines,HSBC did
have absolute discretion under the CREST agreement to cease providing CREST
clearing and settlement services if Lehman did not provide sufficient collateral.5167
Instead of an improper threat, HSBC would arguably have been proposing a
modification to the agreements governing the other lines: HSBC would reduce the
collateral required for continued CREST services in exchange for Lehman agreeing to
reduce the other credit lines that HSBC (hypothetically) did not have discretion to
reduceunilaterally.
Hong Kong Cash Deed (Oct. 23, 2009), at p. 1; see also Citigroup, Overview of GTS Clearing and
Settlement Lines (Sept. 4, 2008), at p. 5 [CITILBHIEXAM 00102127] (explaining that Citi provided
uncommittedclearinglines,whichmeantthelinescouldbecancelledatCitisdiscretion).
5167SeeSectionIII.A.5.d.iii.b,supra.
1347

Further, the cancellation of the other lines was not a significant factor in
Lehmans decision to post the collateral and execute the cash deeds. The immediate
reaction within Lehman to the August 27 demand was the concern that HSBC would
cease clearing and settling CREST trades.5168 If anything, HSBCs offer to reduce the
amount of the cash collateral demanded if Lehman reduced its use of intraday credit
was viewed as an opportunity: Pelleranis response to the August 27 demand was to
askBridgeforassistanceinidentifyinglinesthatcouldbecancelled.5169Thus,thelossof
CREST clearing and settlement services dominated Lehmans concerns with regard to
thecollateraldemand.Theothercreditreductions,ontheirown,werenotasignificant
factor in Lehmans decision to execute the deeds and thus will not support a claim of
economicduress.
(iv) TheEvidenceDoesNotSupporttheExistenceofa
ColorableClaimthatHSBCViolatedaDutyofGood
FaithandFairDealingbyDemandingCashCollateral
The evidence does not support the existence of a colorable claim that HSBC
breached a duty of good faith and fair dealing under English law. HSBCs absolute
discretionoverofferingCRESTservicesisnotsubjecttoanobligationofgoodfaithand
5168SeeemailfromHuwG.Rees,Lehman,toAndrewYeung,Lehman,etal.(Aug.28,2008)[LBEXAM
008941] ([T]here is a possibility that, without an agreement, our UK clearing operations will be
impacted.);emailfromCarloPellerani, Lehman, to Paolo R. Tonucci,Lehman (Aug. 27,2008)[LBEX
AM 008916] ([W]e need to give them ~$1b of deposit by Friday with a legal right to setoff, non
negotiable, or they will not settle for us.); email from Paolo R. Tonucci, Lehman, to Ian T. Lowitt,
Lehman,etal.(Aug.27,2008)[LBEXAM008918]([T]heywantustodepositcashbyFridayiftheyareto
continueclearingforus.).
5169EmailfromCarloPellerani,Lehman,toGuyBridge,HSBC,etal.(Aug.27,2008)[HBUS3].
1348

fairdealingand,evenifitwere,HSBCsfinancialconcernssupportadeterminationthat
HSBCexerciseditsdiscretioningoodfaithwhenitdecidedtowithdrawfromLehman.
a. EnglishLawDoesNotRecognizeaPrincipleof
GoodFaithandFairDealingofGeneral
Application
[I]in English contract law, there is no principle of good faith of general
application....5170 English courts have nevertheless implied terms requiring that
parties bargain in good faith on particular kinds of contracts, such as employment
contracts.5171Englishcourtshavesometimesusedtheimplicationofatermtorestrict
the ambit of a unilateral discretionary power conferred on one of the parties by the
contract,5172 but this would not prevent a commercial lender from conducting its
business in what it genuinely believes to be its best commercial interest.5173 Express
terms requiring parties to act in good faith are enforceable, but the court interprets
those terms narrowly, such that an obligation to bargain in good faith will not be
deemedviolatedabsentindiciaoffraud.5174
HSBC would have made Lehmans situation significantly more difficult had
HSBC simply ceased providing CREST clearing and settlement services in the short
5170CHITTY,20.
5171Id.at28(citingJohnsonv.UnisysLtd[2001]UKHL13[2003]1A.C.518,536(H.L.)(appealtakenfrom
Eng.)).
5172Id.at29(citingParagonFin.plcv.Nash[2001]EWCACiv.1466[2002]1W.L.R.685,700(Eng.)).
5173Id.(quotingParagonFin.plcv.Pender[2005]EWCACiv.760[2005]1W.L.R.3412,3440(Eng.)).
5174Id.at26(citingPetromecInc.v.PetroloBrasileiroSAPetrobras(No.3)[2005]EWCACiv891,[117][121]
[2006]1LloydsRep.121,153(Eng.)).
1349

term (as opposed to the orderly withdrawal from Lehman that HSBC in fact
instituted).5175LehmanunderstoodthatitfacedthepossibilityofHSBCceasingtoclear
andsettletradesifLehmandidnotmeetHSBCsdemandthatLehmanprovidenearly
$1billionincollateralandthatLehmanreduceitsuseofothercreditproducts.5176HSBC
provided CREST services solely at its discretion under the CREST agreement.5177
AlthoughtheCRESTagreementdoesnotcontainexpresstermsimposinganobligation
of good faith on determinations of whether or not to provide CREST services,5178 the
courtmightimplyanobligationtoexercisethatdiscretionconsistentwithprinciplesof
goodfaithandfairdealing.
Evenifthecourtweretoimplysuchanobligation,Englishcourtsinterpretsuch
obligationsnarrowly(Englishcourtslikewiseinterpretexpressobligationsnarrowly).5179
ThefactssupportadeterminationthatHSBCwasmotivatedbyagenuineconcernfor
5175ExaminersInterviewofGuyBridge,Sept.29,2009,atpp.2,4(statingthatLehmancouldnotreplace
clearing services in the short term and reiterating that HSBC adopted a cautious approach when
withdrawingtoavoidbeingblamedforcausingLehmanscollapse).
5176SeeemailfromCarloPellerani,Lehman,toGuyBridge,HSBC(Aug.2,2008)[HBUS3];emailfrom
GuyBridge,HSBC,toCarloPellerani,Lehman(Aug.23,2008)[LBEXAM008910];ExaminersInterview
ofGuyBridge,Sept.29,2009,atp.5;ExaminersInterviewofNicholasJ.Taylor,Oct.15,2009,atpp.67;
ExaminersInterviewofCarloPellerani,Jan.13,2010,atp.7.
5178TheonlyexpressrequirementinthecontracttoactingoodfaithappliestoEuroclearU.K.&Irelandin
making determinations over whether a particular transaction was entered in error. Terms and
Conditions Relating to CREST Settlement Bank Facilities Made Available to a CREST Member or
SponsoredMember(Aug.19,2008),at4.5[HBEU102].Further,theagreementstatesthatanyactionby
HSBCtakeninaccordancewithitsnormalproceduresapplicabletosettlementbankswillbeconsidered
tobetakeningoodfaithandwithduecare.Id.at9.5.
5179CHITTY,25(citingPetromecInc.v.PetroloBrasileiroSAPetrobras(No.3)[2005]EWCACiv891,117121
[2006]1LloydsRep.121,153(Eng.));Id.at29(quotingParagonFin.plcv.Nash[2001]EWCACiv.1466
[2002]W.L.R.685,702(Eng.)).
1350

itsowncommercialinterests,whichwouldbeadequatetoestablishgoodfaithdespite
thepotentialnegativeeffectonLehman.
TaylorsAugust18briefingnotesummarizinghismeetingwithTonucciexplains
thatHSBCsdecisiontoreduceitscreditriskwithregardtoLehmanwasmotivatedby
commercialconcernsaboutexposuretothefinancialsectoringeneral,andLehmanin
particular.5180InterviewsofHSBCpersonnel andtheExaminersreviewofdocuments
corroborate that explanation.5181 The Examiners investigation has not revealed any
indicationofmaliceorulteriormotivesinHSBCsdeterminationtowithdraw.
TheU.K.CashDeedscontainexpresstermsimposinganobligationonHSBCto
exercise good faith in determining the amount of collateral required to cover the
exposuresthatweretobesecuredbythedeeds.5182However,thegoodfaithtermsinthe
deedswouldonlyberelevanttothequestionofwhetherHSBCexercisedgoodfaithin
determininghowmuchofHSBCsexposuretoLehmanwascoveredbythedeeds(and
therefore,howmuchofthecollateralLehmanprovidedwassecuredbythedeeds).The
Examinerhasnotdiscoveredanyevidencethatthesedeterminationsweremadeinbad
faith.
5180NicholasJ.Taylor,HSBC,BriefingNoteProjectMilan(Aug.18,2008),atp.2[HBUS90].
5181See,e.g.,MemorandumfromNicholasJ.Taylor,HSBC,toGlobalFinancialInstitutionsGroup,HSBC,
re:ProjectOpaque[Draft](July28,2008),atp.4[HBUS16204](explainingcreditriskimpetusforProject
Opaque); Examiners Interview of Nicholas J. Taylor, Oct. 15, 2009, at pp. 46 (explaining source of
concernaboutfinancialsector);ExaminersInterviewofGuyBridge,Sept.29,2009,atp.4(agreeingwith
TaylorsassessmentofwithdrawingfromLehman).
5182Cash Deed between HSBC and LBIE (Sept. 9, 2008), at 2(c), 3 [HBUS 1180]; Cash Deed between
HSBCandLBHI(U.K.)(Sept.9,2008),at4(c),5[HBUS1190].
1351

ProvisionoftheCRESTAgreement
The evidence does not support the existence of a colorable claim that HSBC
violated the notice provision of the CREST agreement. As set forth below, the
agreement states that HSBC may terminate the contract without notice, only requires
30daysnoticetotheextentthatHSBCconsidersitpracticableandappropriateand
exemptsHSBCfromanyliabilityforfailingtoprovidenotice.
a. ConstructionofTerms
Termsofacontractareunderstoodtobearthemeaningthatthepartiesusingthe
terms would reasonably have understood them to mean against the relevant
background of the transaction.5183 Courts will attempt to give effect to the entire
contract.5184Ifdifferentpartsofacontractareinconsistentwithoneanother,thecourt
mayrejectportionsthatwoulddefeatthepartiesintentionasexpressedbythecontract
as a whole.5185 Clauses that limit or qualify, but do not entirely negate, obligations
created in other clauses are not inconsistent.5186 If an agreement gives one party
5183CHITTY, 84142 (discussing Investors Comp. Scheme Ltd. v. W. Bromwich Bldg. Socy (No. 1) [1998] 1
W.L.R.896,912(H.L)(appealtakenfromEng.)).
5184Id.at 855(citing Taylor v.Rive DroiteMusic Ltd.[2005] EWCA Civ 1300,[26][2006] E.M.L.R 4, 6566
(Eng.)).
5185Id.
5186Id.at856(citingPagnanSpAv.TradaxOceanTransp.SA[1987]2LloydsRep.342,351).
1352

discretion to rescind the agreement, that party may not exercise that discretion
arbitrarily,orcapriciously,unreasonablyorinbadfaith.5187
Although HSBC had informed Lehman on August18, 2008, of its intention to
withdraw,HSBCdidnotsetadateforcancellingCRESTservicesuntilAugust27,when
BridgeinformedPelleranithatHSBCwouldceaseprovidingCRESTservicesifLehman
didnotprovidecollateralequivalenttoapproximately$945millionintwodaystime.
Section 16.1 of the Terms and Conditions to the CREST agreement gives HSBC
absolute discretion to terminate without notice, qualifies that absolute discretion
with a requirement that HSBC give 30days notice where [HSBC] considers it
practicable and appropriate, and provides that HSBC shall not have liability in any
event for failing to provide notice.5188 The second clause limits, but does not entirely
negate, HSBCs exercise of discretion by conditioning it upon a secondary exercise of
discretion. Thus, the practicable and appropriate clause suggests that termination
withoutnoticewouldbearbitrary,capricious,unreasonable,orinbadfaithifHSBChad
determinedthatnoticewouldhavebeenpracticableandappropriate,andyetfailedto
provideany.
5187Id. at 244 (quoting Selkirk v. Romar Invs., Ltd. [1963] 1 W.L.R. 1415, 1422 (P.C.) (appeal taken from
Bah.)).
5188Terms
and Conditions Relating to CREST Settlement Bank Facilities Made Available to a CREST
1353

The facts do not support a determination that HSBCs decision not to provide
more advanced notice was arbitrary, capricious, unreasonable, or in bad faith. As
describedabove,thecourtwillnotimplyrestrictionsonacommerciallendersexercise
ofdiscretionthatwouldpreventitfromconductingitsbusinessinwhatitgenuinely
believestobeitsbestcommercialinterest.5189BridgeinformedtheExaminerthatHSBC
intended to exit its relationship with Lehman as swiftly as practicable in an effort to
protectHSBCscommercialinterests,5190andLehmanhadbeenabletoprovidethebulk
of the collateral before being granted an extension on August 28.5191 Thus, the notice,
while short, would not violate the agreement.5192 Moreover, more than a week before
HSBCissueditstwodaydeadline,TaylorandTonuccihadalreadydiscussedHSBCs
intention to request collateral. Furthermore, HSBC subsequently allowed Lehman to
5189CHITTY,29(quotingParagonFin.plcv.Pender[2005]EWCACiv.760,[2005]1W.L.R.3412,3440).
5192Even if the twoday notice did violate the agreement, HSBC has a colorable defense of waiver by
estoppel.Acontractingpartythatrepresentsitwillnotenforceitsstrictlegalrightsunderacontractis
estopped from later asserting those rights against the party intended to rely upon the representation.
CHITTY,303(citingB.P.Exploration(Libya)v.Hunt(No.2)[1979]1.W.L.R.783,812(Q.B),affd[1983]2A.C.
352). The representation may be inferred from conduct. Id. (citing Bremer Handelsgesellschaft mbH v.
Vanden AvenneIzegem P.V.B.A. [1978] 2 Lloyds Rep. 109, 126 (H.L.)). Here, Lehman entered into a
stipulation allowing HSBC to set off funds under the U.K. Cash Deeds instead of challenging the
adequacyofthetwodayultimatumHSBCgavewhenitdemandedLehmanexecutethedeedsorfacethe
consequence of HSBC ceasing clearing services. See Stipulation, Agreement and Order, Pursuant to
Sections362and553oftheBankruptcyCode,ModifyingtheAutomaticStayfortheLimitedPurposeof
Permitting HSBC Bank plc to Effect Setoff and Resolution of Certain Banking Arrangements Between
Lehman Brothers Holdings Inc. and HSBC Bank plc, Docket No. 5089, In reLehman Bros.Holdings, Inc.,
No.0813555(Bankr.S.D.N.Y.Sept.9,2009).
1354

delaypostingthecollateraluntilSeptember2.5193Finally,evenifHSBChadviolatedthe
noticeprovision,theagreementexemptsHSBCfromliability.5194
(vi) TheCashDeedsWereNotContractsofAdhesionor
StandardFormContracts
The evidence does not support the existence of a colorable claim that the cash
deedswerecontractsofadhesionorstandardformcontracts.HSBCandLehmanwere
sophisticated parties to an agreement that was the product of several days worth of
negotiationsthatsecuredchangesfromtheinitialproposeddraftthatwerefavorableto
Lehman.5195
ContractsofAdhesion
Under English law, the court may modify or reject terms of a contract where
contractingpartiesareofunequalbargainingpowerandthetermsareofferedonatake
itorleaveitbasis.5196
Even though HSBC and Lehman were both sophisticated parties, HSBC held
substantially greater bargaining power. HSBC was the only bank that could provide
5193Email from Carlo Pellerani, Lehman, to Ian T. Lowitt, Lehman, et al. (Aug. 28, 2008) [LBEXAM
008853]; see email from Ian T. Lowitt, Lehman, to Jeremy Isaacs, Lehman (Aug. 28, 2008) [LBEXAM
8940](referringtoaconversationwithHSBCsCROandHSBCsaccommodationanditsconcernabout
Lehmanoverthequarterend).
5195SeeSectionIII.A.5.d.3.e,supra.
5196SeeLevisonv.PatentSteamCarpetCleaningCo.,[1978]Q.B.69,79.
1355

LehmanwithCRESTclearingandsettlementservicesintheshortterm,andlikelythe
medium term as well.5197 HSBC would have had even more leverage if, as Bridge
believed,ceasingtoclearandsettleCRESTtradeswouldhavesentnegativesignalsto
themarketthatcouldhavehastenedLehmanscollapse.5198
Nevertheless,thedeedswerenotofferedonatakeitorleaveitbasis.HSBCwas
willing to negotiate the terms of the contracts as well as the size of the required
deposit.5199Overaperiodofdays,Lehmanwasabletonegotiatemorefavorableterms,
expanding its own access to the collateral, while narrowing the scope of debts HSBC
could offset against the secured accounts.5200 Thus, the evidence does not support the
existence of a colorable claim that the U.K. Cash Deeds were contracts of adhesion or
standardformcontracts.
5197Examiners Interview of Guy Bridge, Sept. 29, 2009, at p. 2 (stating that it would not be possible to
replace HSBCs CREST services in the short term and would be very difficult to do so in the medium
term);ExaminersInterviewofNicholasJ.Taylor,Oct.15,2009,atpp.67(describingCRESTsettlement
linesasthelionsshareofthecreditthatwouldbedifficulttoreplacequickly);ExaminersInterviewof
Carlo Pellerani, Jan. 13, 2010, at p. 7 (stating that cessation of clearing would have been terminal for
Lehman).
5198ExaminersInterviewofGuyBridge,Sept.29,2009,atp.4(reiteratingthatHSBCattemptedtoexitits
relationship with Lehman as quickly as possible, but also attempted to be flexible with Lehman out of
concernthatHSBCsactionsmightbeviewedastheimpetusofaLehmancollapse).
5199SeeemailfromCarloPellerani,Lehman,toGuyBridge,HSBC(Aug.27,2008)[HBUS3];emailfrom
Guy Bridge, HSBC, to Carlo Pellerani, Lehman (Aug. 23, 2008) [LBEXAM 008910] (discussing effect of
creditusageoncollateralrequirements);ExaminersInterviewofGuyBridge,Sept.29,2009,atp.6.
5200Examiners Interview of Guy Bridge, Sept. 29, 2009, at p. 6; email from Guy Bridge, HSBC, to
NicholasJ.Taylor,HSBC,etal.(Sept.3,2008)[HBUS570].
1356

(c) OtherPotentialTheoriesofLiability
(i) EnglishLawGovernstheRemainingPotentialClaims
EvenThoughTheyAreNotCoveredbytheChoiceof
LawProvisionoftheCashDeeds
a. AnalyticalFramework
Although English law governs the potential, material claims arising from the
facts described herein, this analysis is conducted independent of the choiceoflaw
provision in the CREST agreement. New York law applies contractual choiceoflaw
clauses to claims sounding in tort only where the parties to a contract draft a
sufficientlybroadchoiceoflawclause.5201
Here,thescopeofthelanguageintheU.K.CashDeedsandCRESTagreementis
nearly identical to choiceoflaw clauses New York courts have found insufficiently
broad to cover tort claims: This Deed is governed by and shall be construed in
accordance with English law.5202 The Examiners investigation has not revealed any
negotiations over the scope of the choiceoflaw clause, or any other factual basis to
supportapplyingthechoiceoflawprovisiontotortclaims.
5201Fin. One Public Co. v. Lehman Bros. Special Fin., Inc., 414 F.3d 325, 335 (2d Cir. 2005) (applying New
Yorklaw).
5202Compare Cash Deed between HSBC and LBIE (Sept. 9, 2008), at 22 [HBUS 1180], and Cash Deed
betweenHSBCandLBHI(U.K.)(Sept.9,2008),at27[HBUS1190],andTermsandConditionsRelatingto
CRESTSettlementBankFacilitiesMadeAvailabletoaCRESTMemberorSponsoredMember(Aug.19,
2008),at24.1[HBEU102],withTwinlabCorp.v.Paulson,724N.Y.S.2d496,496(App.Div.2001)(choice
oflaw provision specifying New York law would govern validity, interpretation, construction, and
performance of contract not broad enough to govern tort claims that did not arise from contractual
obligations), and Fin. One Public Co., 414 F.3d at 335 (choiceoflaw provision inapplicable to claim for
setoffwherecontractdidnotestablishrightandonlystatedthiscontractshallbegovernedbythelaws
oftheStateofNewYork).
1357

Where the law of two or more jurisdictions may apply to a dispute, New York
courtsexaminewhetherthelawsconflict.5203Whereaconflictexists,NewYorkemploys
oneoftwomethodstodeterminewhichlawshouldapply,dependingonthenatureof
the claim. New York employs a center of gravity test for contract claims and an
interest analysis for tort claims and any other claim where no specific approach is
calledfor.5204Quasicontractclaimsaredecidedunderthecenterofgravitytest.5205
Under the center of gravity test, the court examines the place of negotiation,
place of performance, execution location and subject matter of the contract, and
domicileoftheparties,givingthelocationofthecontractsexecutionandperformance
themostweight.5206
Underaninterestanalysis,thecourtconductstwoseparateinquiries:(1)what
arethesignificantcontactsandinwhichjurisdictiontheyarelocated;and(2)whether
thepurposeofthelawistoregulateconductorallocateloss.5207Wherethepurposeof
the law is to regulate conduct, the law of the location of the tort generally governs.5208
Where the purpose of the law is to allocate loss, parties with domiciles in different
jurisdictions are generally governed by the law of the jurisdiction where the injury
occurredandpartieswithdomicilesinthesamejurisdictionaregenerallygovernedby
5203K.T.v.Dash,827N.Y.S.2d112,116(App.Div.2006).
5204Fin.OnePublicCo.,414F.3dat336.
5205GlobalFin.Corp.v.TriarcCorp.,715N.E.2d482,484(N.Y.1999).
5206BrinksLtd.v.S.AfricanAirways,93F.3d1022,103031(2dCir.1996)(applyingNewYorklaw).
5207Padulav.LilarnProps.Corp.,644N.E.2d1001,1002(N.Y.1994).
5208Id.
1358

thejurisdictionoftheshareddomicile.5209NewYorklawconsidersacorporationtobe
domiciled in the jurisdiction of its headquarters.5210 New York courts have also
considered New Yorks policy interest in maintaining its preeminent financial
positionasafinancialcapitaloftheworldbyprotectingthejustifiedexpectations
ofthepartiesto[a]contract.5211
b. ApplicationtoRemainingPotentialClaims
The potential claims arising from Lehmans relationship with HSBC are
governedbyEnglishlaw.Thefactsdonotimplicateanyconflictoflawsovertortsthat
allocatelossandtheCRESTagreementistheonlycontractthatgivesrisetoclaimsthat
maybematerialtothebankruptcyproceedings.
English Law Will Govern Claims Based on QuasiContract and Conduct
RegulatingTortClaims.TheU.K.CashDeedsweresignedinLondonandgoverned
the U.K.based CREST clearing and settlement services. HSBC is headquartered in
London.TheLehmanpartiestothedeedwereLBHI(U.K.)andLBIE.LBHI(U.K.)wasa
Londonbased branch office of LBHI, and LBIE was headquartered in the U.K. These
factssupportadeterminationthatthecenterofgravitytestrequirestheapplicationof
Englishlaw.
5209Cooneyv.OsgoodMach.,Inc.,612N.E.2d277,281(N.Y.1993).
5210Schultzv.BoyScoutsofAm.,Inc.,480N.E.2d679,682(N.Y.1985).
5211WellsFargoAsiaLtd.v.Citibank,N.A.,936F.2d723,726(2dCir.1991)(quotingJ.Zeevi&Sons,Ltd.v.
GrindlaysBank(Uganda)Ltd.,333N.E.2d168,172(N.Y.1975)).
1359

The same facts support the existence of significant contacts to the U.K. for the
analysisofintereststest.Further,anytortiousconductarisingfromthedeedswould
haveoccurredintheU.K.,asdidanyinjurytoLBIEandLBHI(U.K.).Totheextentthat
thereisaconflictoflawsovertortsthatregulateconductbetweenanypartiesorover
tortsthatallocatelossesbetweenpartieswiththesamedomicile,thesefactssupporta
determination that the analysis of interests test requires the application of English
law.
LehmansValidContractualObligations
TheevidencedoesnotsupporttheexistenceofacolorableclaimthatHSBCwas
unjustly enriched through the cash deeds. The cash deeds are likely valid contracts,
under which Lehman had a duty to convey a benefit to HSBC for which Lehman
received consideration. As described above, the Examiners investigation has not
uncoveredsufficientfactstosupportacolorableclaimtoinvalidatethecashdeeds.On
these facts, HSBC would have a defense to a claim of unjust enrichment because any
benefit conveyed by Lehman pursuant to the cash deed transactions was conveyed
pursuanttoLehmansdutytoperformitsvalidcontractualobligations.
1360

a. ElementsofUnjustEnrichment
UnjustenrichmentisaquasicontractualclaiminNewYork.5212Wherethecourt
determinesthereisaconflictbetweenEnglishandNewYorklaw,thecourtwillapply
the center of gravity test. 5213 As described above, this will likely result in the
applicationofEnglishlaw.
Englishlawdoesnotrecognizeageneralcauseofactionofunjustenrichment,
but the principle of unjust enrichment has been recognized judicially5214 and
statutorily5215asabasisforrecoveryinindividualinstanceswherethelawcreatesaright
ofrestitution,suchasanactionformoneyhadandreceived.5216
The elements of the unjust enrichment principle under English law are: (1)
enrichmentofthedefendantbyreceiptofabenefit,(2)attheexpenseoftheclaimant,
(3)wheretheretentionofthebenefitisunjustand(4)wherethereisnodefensetothe
claim.5217Amongthedefensestoclaimsbasedontheprincipleofunjustenrichmentare
that the claimant conferred the benefit to the defendant pursuant to a common law,
5212Goldmanv.Metro.LifeIns.Co.,841N.E.2d742,746(N.Y.2005).
5213Fin.OnePublicCo.,414F.3dat336.
5214CHITTY, 1843 (citing Lipkin Gorman v. Karpnale Ltd. [1991] 2 A.C. 548, 559 (H.L.) (appeal taken from
Eng.)).
5215Id.(citingtheCivilLiability(Contribution)Act,1978,c.47;theInsolvencyAct,1986c.45382(4);and
theTorts(InterferencewithGoods)Act,1977c.327(4)).
5216Id.at1845(citingMosesv.Macferlan(1760)97Eng.Rep.676,678(K.B.)).
5217Id.(citingBanqueFinancieredelaCitev.Parc(Battersea)Ltd.[1999]1A.C.221,234(H.L.)(appealtaken
fromEng.).
1361

equitable or statutory duty5218 and that the claimant is estopped from bringing a
claim.5219
HSBC received a benefit from Lehman in the form of the U.K. and Hong Kong
deposits, and an additional benefit in the form of security through the cash deeds.
HSBC acquired this benefit by causing Lehman to believe that HSBC would cease
providingCRESTsettlementandclearingservicesforLehmanifitdidnotmeetHSBCs
demands.5220 The consequences of not complying were severe: It would have been
impossible for Lehman to replace HSBCs services quickly and, therefore, HSBCs
withdrawal would have quickly and inevitably become public knowledge.5221 Such a
negative market signal could have had a significant adverse effect on Lehmans
situation.5222HSBCwas careful, however,toavoidalertingany marketparticipantsof
itsintenttowithdrawfromLehman.5223
Nevertheless, HSBC received the deposits and the additional security through
the cash deeds in exchange for continuing to provide CREST clearing and settlement
services.Asdescribedabove,therearefactssupportingthevalidityofthesecontracts
5218Id. at 1846 (citing Ocean Shipping Ltd. v. Creditcorp Ltd. [1994] 1 W.L.R. 161, 164 (H.L.) (appeal taken
fromEng.)).
5219Id.
5220SeeSectionsIII.A.5.d.3,supra.
5221Seeid.
5222Examiners Interview of Guy Bridge, Sept. 29, 2009, at pp. 2, 4; Examiners Interview of Carlo
Pellerani,Jan.13,2010,atp.7.
5223See,e.g.,MemorandumfromNicholasJ.Taylor,HSBC,toGlobalFinancialInstitutionsGroup,HSBC
[Draft](July28,2008),atp.4[HBUS16204](referringtocovertreductionofexposure).
1362

and the legitimacy of HSBCs demands. Under English law, these facts would
constitute a defense to a claim based on unjust enrichment to the extent that they
establishthatanybenefitHSBCreceivedwasnotunjust,butwasconveyedpursuantto
Lehmansdutytoperformundervalidcontracts.Further,LBHIhasalreadyagreedto
allowHSBCtosetoffthefundsundertheU.K.CashDeeds,andsoitmaybeestopped
fromclaimingthatHSBCwasunjustlyenrichedthroughthosedeeds.5224
(iii) TheEvidenceDoesNotSupportaColorableClaim
ThatHSBCBreachedaFiduciaryDutytoLehman
BecauseHSBCandLehmanWereSophisticatedParties
inaRelationshipGovernedbyanAgreementThat
LimitedHSBCsObligations
HSBC did not owe Lehman a fiduciary duty independent of HSBCs role as an
agent in the CREST system. The terms and conditions impose limited obligations on
HSBC to execute CREST trades pursuant to the contract, and those obligations were
subject to various indemnifications and exemptions from liability. Most importantly,
the agreement imposed no obligation on HSBC to continue providing clearing and
settlementservices.
5224See Stipulation, Agreement and Order, Pursuant to Sections 362 and 553 of the Bankruptcy Code,
plc,DocketNo.5089,InreLehmanBros.Holdings,Inc.,No.0813555(Bankr.S.D.N.Y.Sept.9,2009).
1363

Misappropriation
BreachoffiduciarydutyisaconductregulatingtortinNewYork.5225Wherethe
courtdeterminesthereisaconflictbetweenEnglishandNewYorklaw,thecourtwill
applyaninterestanalysistodeterminewhichtoapply.5226Asdescribedabove,thiswill
likelyresultintheapplicationofEnglishlaw.
Englishlawrecognizesafiduciaryrelationshipwhereonepartyhasundertaken
toactfororonbehalfofanotherinaparticularmatterorcircumstancewhichgivesrise
toarelationshipoftrustandconfidence.Thedistinguishingobligationofafiduciaryis
the obligation of loyalty. . . . Breach of fiduciary obligation, therefore, connotes
disloyalty or infidelity.5227 Parties to relationships governed by commercial contracts
negotiatedatarmslengtharegenerallyunderstoodtorepresenttheirowninterests.5228
Nevertheless, [t]he existence of the contract does not exclude the coexistence of
concurrent fiduciary duties (indeed the contract may well be their source); but the
contract can and does modify the extent and nature of the general duty that would
otherwisearise.5229
5225Reid v. Ernst & Young Global, Ltd., No. 604028/2005, 2006 WL 3455259, at *7 (N.Y. Sup. Ct. Nov. 15,
2006).
5226Seeid.
5227BristolandW.Bldg.Socyv.Mothew[1998]Ch.1,18.
5228ChristaBand,ConflictsofInterestsinFinancialServicesandMarkets,21 J.OF INTL BANKING L.AND REG.
677,67879(2006).
5229Hendersonv.MerrettSyndicates[1995]2A.C.145206(H.L.)(appealtakenfromEng.).
1364

HSBCactedasLehmansagentwhenexecutingLehmanssterlingdenominated
securities trades in the CREST system5230 and so may have owed Lehman a duty of
loyalty in providing those services. Additionally, HSBC used its knowledge of
LehmansneedforHSBCcreditsupportasleveragetoencourageLehmantomakean
additional commitment to HSBC through the syndicated credit facility, even though
HSBChadbeencovertlyreducingLehmanscreditthroughProjectOpaque.
However, HSBC acted as Lehmans agent in a sharply circumscribed context,
andcertainlydidnotoweLehmananyfiduciarydutiesbeyondthat.BothLehmanand
HSBC are highly sophisticated entities conducting business with one another and
dealingwitheachotherthroughnumerousarmslengthtransactions.AlthoughHSBC
acted as Lehmans agent in executing CREST trades, the Examiners investigation has
notuncoveredanyevidencethatHSBChadanyobligationtoprovidecredittosupport
thoseservices.ThesefactswouldundermineanyclaimunderEnglishlawthatHSBC
hadanybroaderfiduciaryobligation(ifithadanyobligationatall)beyondproviding
CRESTclearingandsettlementservicestoLehmanasdictatedbythelimitedtermsof
theagreementbetweentheparties.
Member or Sponsored Member (Aug. 19, 2008), at 4.1, 6 [HBEU 102]; Examiners Interview of Guy
Bridge,Sept.29,2009,atp.3(describingHSBCsroleinCRESTtradesasstandinginforLehman).
1365

TheagreementbetweenHSBCandLehmanlimitsHSBCsobligationsinseveral
ways,themostsignificantofwhichwasHSBCsabsolutediscretiontoterminateCREST
services at any time.5231 Further, the CREST agreement contains various exclusions of
HSBCs liability under the agreement,5232 agreements to indemnify HSBC,5233 and an
acknowledgement that HSBC does not owe Lehman a duty of care to monitor or
enforce compliance by any person with any obligations applicable to participation in
the CREST system.5234 These provisions limit the scope of HSBCs obligations to
Lehman, and exclude any parallel duty to ensure that Lehman complied with the
requirementsoftheCRESTsystem.ThissupportsadeterminationthatHSBCwasonly
obligedtoexecuteLehmansCRESTtrades,andowednofurtherdutytoassistLehman.
Moreover, HSBCs obligation to execute Lehmans CREST trades was itself contingent
uponHSBCsabsolutediscretionoverwhethertoterminatetheagreement.5235
Lehmans willingness to contribute $25 million to HSBCs syndicated credit
facilityinthehopeofsecuringcreditsupportfromHSBCinthefuturemayindicatethat
Lehman believed HSBC would provide assistance beyond the narrowly defined
obligations in the CREST agreement, but such belief alone would not establish a
fiduciaryduty.Further,HSBCpersonnel,atleastinitially,supportedallowingLehman
5232Id.at3.43.5.
5233Id.at7.
5234Id.at9.7.
5235Seeid.at16.1.
1366

towithdrawitscommitment.5236Althoughthereisconflictingevidenceregardingwhat
roleHSBCplayedinthefinaldecisionnottoallowLehmantowithdraw,thedecision
was based, at least in part, on considerations that Lehmans withdrawal would have
sentanegativesignaltothemarket,andtheconcomitantriskofprecipitatingLehmans
collapse.5237
Thus, HSBC does not appear to have had any relevant fiduciary obligations to
LehmanbeyondactingasitsagentwhenexecutingCRESTtrades.LehmanandHSBC
werecommercialpartiestoanarmslengthtransactiongovernedbyanagreementthat
substantially limited HSBCs obligations to Lehman and, moreover, expressly gave
HSBCabsolutediscretionovertheprovisionofcreditandsettlementservices.
(iv) TheEvidenceDoesNotSupportaColorableClaim
thatHSBCsDemandforCollateralTortiously
InterferedWithLehmansOtherBusinessorContracts
BecauseHSBCWasActingToProtectItsOwn
EconomicInterests
EvenifHSBCsactionsrelatedtothecashdeedsweretohavefactoredmaterially
into Lehmans decision to file for bankruptcy, the evidence does not support the
5236Email from Nicholas J. Taylor, HSBC, to Guy Bridge, HSBC, et al. (Aug. 27, 2008) [HBEU 129]
(agreeingthatHSBCshouldcancelLehmanscommitmenttothesyndicatedfacility).
5237CompareExaminersInterviewofNicholasJ.Taylor,Oct.15,2009,atp.8(statingthattheagentbank
administering the revolver made the ultimate decision), with email from Nicholas J. Taylor, HSBC, to
CraigT.Thiele,HSBC(Sept.9,2008)[HBUS5709](referringtodiscussionanddecisionwithinHSBCnot
toconsenttothecancellation),andemailfromPaulM.Lopez,HSBC,toGuyBridge,HSBC,etal.(Sept.2,
2008)[HBUS566]
1367

existenceofacolorableclaimoftortiousinterferenceunderEnglishlawbecauseHSBC
demandedcollateralinordertoprotectitseconomicinterests.5238
a. ElementsofTortiousInterference
Tortious interference is a conductregulating tort in New York.5239 Where the
courtdeterminesEnglishandNewYorklawconflict,itwillapplyaninterestanalysisto
determine which to apply.5240 As described above, this will likely result in the
applicationofEnglishlaw.
UnderEnglishlaw,apartycommitsthetortofinterferencewithrightswherethe
defendant procures or induces the violation of a right held by the plaintiff through
someactionablewrong.5241Injuryaloneisinsufficienttosustainatortofinterferenceif
the defendant acted lawfully and the plaintiffs legal rights were not violated.5242
Knowinglyinducingathirdpartytobreakacontractwiththeclaimant(orthreatening
todoso)isaninterferencewithcontractualrightsabsentsomereasonablejustification
orexcuse.5243Thepursuitofnormalandlegitimatebusinessinterestsisconsidereda
5238NicholasJ.Taylor,HSBC,BriefingNoteProjectMilan(Aug.18,2008),atpp.12[HBUS90].
5239See Discover Group, Inc. v. Lexmark Intl, Inc., 333 F. Supp. 2d 78, 84 (E.D.N.Y. 2004) (applying New
Yorklaw).
5240Seeid.
5241LawDebentureTrustCorp.v.UralCaspianOilCorp.[1995]Ch.152,155.
5242Id.
5243Pitman Training Ltd. and Another v. Nominet U.K. and Another [1997] F.S.R. 797, 807 (Ch.) (finding no
interference with contract where the defendant induced a domain name registrar to restore its use ofa
particularURLthatanotherdomainnameregistrarhadsubsequentlyallocatedtoanothercompany).
1368

reasonable justification even where it may have the effect of causing a third party to
breachacontract.5244
HSBCsdemandthatLehmanprovidetheequivalentof$945millionincollateral
reduced Lehmans cash on hand in the week prior to the petition date. According to
Lehmans internal postmortem analysis of its bankruptcy, the loss of liquidity to
clearing banks collateraldemands may havebeenthe causeofthe bankruptcy.5245 By
September 14, LBHIs free cash available for intraday funding had dwindled to $2
billion, while LBIEfaceda projected cash shortfallof $4.5billion.5246Accordingto the
postmortem,thispromptedLehmantoplaceLBIEintoadministration,whichcauseda
crossdefault that triggered LBHIs filing.5247 Through the bankruptcy, LBHI breached
contractswithnumerouscounterparties. HadLehman refusedto provide HSBC with
collateralandhadHSBCimmediatelyceasedprovidingCRESTservices,thesameresult
likelywouldhaveoccurred,giventhatHSBCpersonnelwereconcernedthatpublicity
oftheplantoeventuallywithdrawcouldprecipitateLehmanscollapse.5248
Evenifthepostmortemanalysiswerecorrect,HSBCwouldhaveadefensetoa
claimoftortiousinterference.HSBCactedtoprotectitseconomicinterestsbysecuring
5244Id.at809.
5245Lehman,LiquidityofLehmanBrothers(Oct.7,2008),atp.9[LBHI_SEC07940_844701].
5246Id.
5247Id.
5248ExaminersInterviewofGuyBridge,Sept.29,2009,atpp.2,4.
1369

its own credit risk against a potential default by Lehman. Taylors August 18
memorandumsummarizingthemeetingwhereheinformedTonucciofHSBCsplanfor
an orderly withdrawal states that the decision is on the basis of deteriorating risk
and business fundamentals, continuing performance/valuation uncertainty, capital
erosion,andsignificant[FinancialInstitutions]GroupexposuretoLehmaninparticular
andthesectorasawhole.5249InterviewswithHSBCpersonnelhavecorroboratedthe
claim that HSBCs demand for collateral was motivated by a desire to reduce its
unsecuredexposuretoLehmanbecauseoftheseconcerns.5250Further,itisnotclearthat
the postmortem analysis correctly identifies LBIEs default as the cause of LBHIs
bankruptcy,asthebankruptcymayhavebeeninevitablebeforethatpoint.Interviews
withmembersofLBHIsBoardofDirectorsindicatethatLehmanalreadydecidedtofile
for bankruptcy on September 14 at the prompting (though not necessarily the explicit
instruction)ofU.S.regulators.5251Regulatorsmadethesejudgmentsindependentofan
analysisofhowLBIEsenteringadministrationwouldimpactLBHIsfunding;Thomas
Baxter, the General Counsel for the FRBNY, said that the Government was taken by
Sept.29,2009,atp.4.
5251Examiners Interview of John F. Akers, Apr. 22, 2009, at pp. 1314; Examiners Interview of Roger
Berlind, May 8, 2009, at p. 11; Examiners Interview of Richard S. Fuld, Jr., Apr. 28, 2009, at pp. 1314;
ExaminersInterviewofJerryA.Grundhofer,Sept.16,2009,atp.16;seealsoLehmanBrothersHoldings
Inc., Minutes of Meeting of Board of Directors (Sept. 14, 2008), at pp. 35 [LBEXAM 003932]
(unanimouslyvotingtofileforbankruptcyprotectionfollowingaconferencecallwithThomasBaxter,Jr.,
generalcounseloftheFRBNY,andChristopherCox,thenChairmanoftheSEC).
1370

surprisebytheeffectofLBIEenteringadministration.5252Thesefactstendtoundermine
aclaimfortortiousinterferenceunderEnglishlaw.
(v) TheEvidenceDoesNotSupportaFindingthatHSBC
FraudulentlyorNegligentlyMisrepresentedItsPlanto
Withdraw
The evidence does not support the existence of a colorable claim of fraudulent
misrepresentation, fraudulent inducement, or negligent misrepresentation under
English law against HSBC in relation to the cash deeds or the prospect of continued
creditsupportinexchangeforparticipatinginthesyndicatedrevolver.
a. ElementsofFraudandMisrepresentation
FraudisaconductregulatingtortinNewYork. 5253Wherethecourtdetermines
EnglishandNewYorklawconflict,itwillapplyaninterestanalysistodeterminewhich
toapply.5254Asdescribedabove,thiswilllikelyresultintheapplicationofEnglishlaw.
TheelementsofmisrepresentationinEnglishlawarederivedfromcommonlaw,
and the relief available is governed by the Misrepresentation Act of 1967.5255 A
misrepresentationmustbe(1)afalsestatementoffact,pastorpresent,asdistinctfrom
astatementofopinion,orofintentionormerecommendatorystatements,5256(2)byor
5253ChaseManhattanBankv.N.H.Ins.Co.,749N.Y.S.2d632,63435(Sup.Ct.2002).
5254Id.
5255CHITTY,50306.
5256Id.at505(citingDimmockv.Hallett(186667)L.R.2Ch.App.21,27).
1371

knowntoapartytothecontractorapartysagent,5257(3)thattheclaimantwasintended
toactupon.5258
Toprovefraudulentmisrepresentation,theclaimantmustalsoestablishthatthe
representation was made in the absence of an honest belief.5259 A defendant who
suspects, but does not know, that a statement is inaccurate will have made the
statementintheabsenceofanhonestbelief.5260
To prove negligent misrepresentation, the claimant must show: (1) that the
representationwasmadewithoutreasonablegroundsforbelievingittobetrue;and(2)
either (a) that the defendant owed a duty to the claimant or (b) that the defendant
inducedtheclaimanttoenterintoacontractthroughthemisrepresentation.5261
The Misrepresentation Act allows damages to be awarded for fraudulent and
negligentmisrepresentations.5262Claimantsmayalsoseekrescission,buttheActgrants
the court discretion to impose damages instead of rescission for negligent
misrepresentation.5263 If the claimant seeks rescission of a contract instead of damages,
5257Id.at516(citingHasanv.Wilson[1977]1LloydsRep.431,444(Q.B.)).
5258Id.at519.
5259Id.at530(citingDerryv.Peek(1889)14App.Cas.337,379(H.L.)(appealtakenfromEng.)).
5260Id.(citingReeseRiverSilverMiningCo.v.Smith(1869)L.R.4H.L.64,7980(H.L.)(appealtakenfrom
Eng.)).
5261Id.at540541(citingHowardMarine&DredgingCo.v.A.Ogden&Sons(Excavations)Ltd.[1978]Q.B.
574,595).
5262MisrepresentationAct,1967c.72(1).
5263Id.2(2).
1372

theclaimantneedonlyshowthatthemisstatementmateriallyinfluencedthedecision
toenterintothecontract.5264
HSBCbeganreducingitsexposuretoLehmanthroughProjectOpaquebymeans
calculated to conceal its actions from Lehman.5265 Meanwhile, HSBC pursued a
$25millioncommitmentfromLehmanforHSBCssyndicatedcreditfacility,awarethat
Lehman was participating in the hope that HSBC would continue to provide credit
support.5266 Taylor encouraged this belief, suggesting that Lehman participate in the
facility in the context of reciprocity and [HSBCs] continuing support during this
period.5267LehmanformallycommittedtothefacilityonAugust15,threedaysbefore
HSBCnotifiedLehmanthatitintendedtoexittherelationship.5268
However, it is not clear that Taylor or anyone else at HSBC led Lehman to
believe that committing $25 million to the syndicated credit facility would secure
continued credit support from HSBC rather than merely securing an improved
relationship with HSBC and a favorable disposition toward continued support.
PelleraniremarkedonlythatHSBCsmanagementappreciatedLehmansparticipation,
5264CHITTY, 524 (citing Edgington v. Fitzmaurice (1885) 29 Ch. D 459, 483 (describing materiality as
activelypresentto[thehearers]mind)).
5265See Memorandum from Nicholas J. Taylor, HSBC, to Global Financial Institutions Group, HSBC
[Draft](July28,2008),atp.1[HBUS16204].
5266EmailfromNicholasJ.Taylor,HSBC,toMarkStadler,HSBC,etal.(June15,2008)[HBUS9925];e
mailfromGuyBridge,HSBC,toCraigT.Thiele,HSBC,etal.(June17,2008)[HBUS10046].
5267EmailfromNicholasJ.Taylor,HSBC,toMarkStadler,HSBC,etal.(June15,2008)[HBUS9925].
5268SideLetterfromHSBCtoLBCB(Aug.15,2008)[LBEXDOCID89911](signedbyHSBC);SideLetter
1373

andthatitwouldservetocementtherelationshipandmadenomentionofcontinued
creditsupport.5269Further,theagreementitselfcontainsamergerclauseandmakesno
promiseofcontinuedsupport.5270Inaddition,theCRESTagreementrequiresthatany
variation of its terms be made in writing.5271 Taylors initial willingness to allow
Lehman to cancel its commitment once he informed Tonucci of HSBCs plan to
withdrawalsounderminesanytheorythatTaylormadeintentionalmisrepresentations
tosecureLehmanscommitmentbeforeLehmanlearnedofthewithdrawal.5272
Finally,theExaminersinvestigationhasnotrevealedanyevidenceoffraudulent
or negligent misrepresentation in connection with the cash deeds themselves. To the
contrary, once HSBC informed Lehman of its intention to withdraw, HSBC was
forthright about its intentions to continue to reduce its exposure through the cash
deeds, and even disclosed its intentions to request additional collateral following the
execution of the deeds.5273 Although HSBC decided to withdraw from Lehman before
August 18, HSBC had no duty to inform Lehman of its plan to terminate the CREST
5269Email from Carlo Pellerani, Lehman, to Ian T. Lowitt, Lehman (Aug. 27, 2008) [LBEXAM 008936]
(summarizingeventsleadingtoHSBCsdecisiontowithdraw,includingthethenrecentcommitmentto
thecreditfacility).
5270SeeThreeYearRevolvingCreditAgreement(July11,2008),at19.07[LBEXDOCID1029995];seealso
SideLetterfromHSBCtoLBCB(Aug.15,2008)[LBEXDOCID89911](signedbyHSBC);SideLetterfrom
HSBCtoLBCB(Aug.15,2008)[LBEXDOCID89916](signedbyLBCB).
5272See email from Nicholas J. Taylor, HSBC, to Guy Bridge, HSBC, et al. (Aug. 27, 2008) [HBUS 129]
(agreeingthatHSBCshouldallowLehmantoexitthefacility).
5273EmailfromGuyBridge,HSBC,toCarloPellerani,Lehman(Aug.27,2008)[HBUS1].
1374

agreement because the CREST agreement allowed HSBC to terminate at any time.5274
Thus,theevidencedoesnotsupporttheexistenceofacolorableclaimagainstHSBCfor
fraudulentmisrepresentationornegligentmisrepresentationunderEnglishlaw.
e) LehmansDealingsWithBankofAmerica
This Section briefly summarizes Lehmans dealings with Bank of America
(BofA)in2008.Atthetimeofthiswriting,LehmanandBofAarebeforetheCourtin
anadversaryproceeding.ThependingdisputestemsfromBofAsNovember10,2008
setoffofapproximately$509millionfromvariousLBHIaccounts.5275Specifically,BofA
set off the funds against debts it claims LBSF incurred through derivative and swap
agreementswithBofA.5276
OutofdeferencetotheCourtandtoavoidinterferingwithactivelitigation,the
Examiner has limited his direct investigation of this claim and does not reach
conclusions about the relative merits of the parties arguments. However, the $500
million collateral deposit and the related negotiations in 2008 are significant to the
ExaminersinvestigationofLehmansliquiditypool,discussedinmoredetailinSection
5.i of this Report. In particular, as noted in Appendix 19, Lehmans Dealings With
Bank of America, and Section 5.i, the Security Agreement executed by Lehman and
MemberorSponsoredMember(Aug.19,2008),at16.1[HBEU102].AlthoughHSBCagreestoprovide
atleast30daysnoticewhere[HSBC]considersitpracticableandappropriate,HSBCisnotsubjectto
liabilityforfailingtodoso.Id.
5275Joint Stipulation of Undisputed Facts, at 44, Docket No. 74, Bank of Am., N.A. v. Lehman Bros.
Holdings,Inc.(InreLehmanBros.Holdings,Inc.),No.0801753(Bankr.S.D.N.Y.Dec.7,2009).
5276Id.at45.
1375

BofAonAugust25,2008containsaprovisionrequiringLehmantoprovidethreedays
writtennoticeinordertoretrieveanypartofthecollateraldeposit.Thisissignificantto
the Examiners investigation because Lehman continued to include the $500 million
collateral deposit in Lehmans liquidity pool calculations, and Lehman inserted the
threedaynoticeprovisionintotheSeptemberGuarantyandSecurityAgreementwith
JPMorgan.
A more complete summary of Lehmans interaction with BofA is contained in
Appendix19LehmansDealingswiththeBankofAmerica.
f) LehmansDealingsWithBankofNewYorkMellon
The Bank of New York Mellon (BNYM) provided, among other services,
accountsupporttoLehmanforLehmansEuropeancommercialpapertradingprogram
and account and financing support for mediumterm note issuances and
redemptions.5277 As a result, BNYM believed that it bore intraday credit risk from
Lehman,andrequestedcollateralinAugustof2008.5278
OnDecember3,2009,theCourtapprovedastipulationamongLBHI,LBSFand
BNYM that requires BNYM to return a $170 million collateral deposit to LBHI.5279
BNYMacquiredthesefundsthroughaseriesoftransfersbetweenSeptember10and12,
5277Email from Graham Kettle, Lehman, to Joseph Igoe, Lehman, et al. (Aug. 21, 2008) [LBEXDOCID
1066642](explainingsourcesofBNYMsintradayexposuretoLehman).
5278Id.
5279Stipulationand Agreed Order Between Lehman Brothers Holdings Inc., Lehman Brothers Special
Financing Inc. and Bank of New York Mellon Regarding (1) Turnover of Collateral Deposit and (2)
ReturnofMisdirectedWires,atpp.12,DocketNo.6040,InreLehmanBros.Holdings,Inc.,CaseNo.08
13555(Bankr.S.D.N.Y.Dec.3,2009).
1376

2008,5280 and held them pursuant to a collateral deposit agreement executed on
September11,2008.5281Becausethepartieshaveagreedtothereturnofthefunds,this
transactionisprimarilyrelevanttotheExaminersReportbecauseoftherelationshipof
the collateral deposit to Lehmans reported liquidity pool (as discussed infra, Section
5.i).
(1) BNYMDemandsandReceivesaCollateralDeposit
ArelationshipmanageratBNYMforLehmansaccountscontactedEmilCornejo
onAugust20,2008torequestthatLehmanprefunditsEuropeancommercialpaperand
mediumtermnoteprograms.5282Afteraseriesofmeetings,LBHIandBNYMagreedon
September 8, 2008 that LBHI New York would open a money market account with
BNYMandmaintainasufficientdeposittocoverBNYMsforecastedintradayexposure
toLehman.5283
On September 11, 2008, LBHI and BNYMs London branch executed an
agreement that required Lehman to deposit $125 million initially and thereafter
5280Email from Graham Kettle, Lehman, to Scott Alvey, Lehman, et al. (Sept. 10, 2008) [LBEXDOCID
1065130](orderingthetransferof$125millionfromLBHItoanaccountheldforthebenefitofBNYM);e
mailfromStevenJ.Engel,Lehman,toGrahamKettle,Lehman,etal.(Sept.10,2008)[LBEXDOCID65930]
(providing transaction details); email from Craig L. Jones, Lehman, to Stirling Fielding, Lehman, et al.
(Sept. 10, 2008) [LBEXDOCID 65919] (confirming outgoing payment); email from Graham Kettle,
Lehman, to Steven J. Engel, Lehman, et al. (Sept. 11, 2008) [LBEXDOCID 65879] (reporting BNYM
orderingthereturnof$75milliontoLehman);emailfromGrahamKettle,Lehman,toDanielJ.Fleming,
Lehman,etal.(Sept.12,2008)[LBEXDOCID65923](reportingdepositof$120millionwithBNYM).
5281Collateral Deposit Agreement between Lehman Brothers Holdings, Inc. and the Bank of New York
Mellon,LondonBranch(Sept.11,2008)[LBEXDOCID1031225](finalversionforexecution).
5282Email from Joseph Igoe, Lehman, to Emil F. Cornejo, Lehman, et al. (Aug. 20, 2008) [LBEXDOCID
1066675](forwardingsummaryofcallwithBNYMsGlobalRiskManager).
5283EmailfromGrahamKettle,Lehman,toCarloPellerani,Lehman,etal.(Sept.8,2008)[LBEXDOCID
65890].
1377

maintain a collateral account with at least $50 million (with more required if BNYM
forecasted greater intraday exposure).5284 The funds were transferred to BNYMs
LondonbranchbyLBHI(U.K.).5285
OnSeptember12,BNYMheld$170millionincollateralundertheSeptember11
agreement.5286Lehmanexpectedtobeabletowithdraw$120millionfromtheaccount
on Monday, September 15, leaving BNYM with the minimum $50 million collateral
required under the September 11 agreement.5287 However, because of the bankruptcy
filingonSeptember15,BNYMwasleftholdingthe$170milliondeposit.5288
5284Email from Gerry Barber, BNYM, to Carlo Pellerani, Lehman, et al. (Sept. 11, 2008) [LBEXDOCID
1065087] (attaching Final Version of collateral deposit agreement); Collateral Deposit Agreement
between Lehman Brothers Holdings, Inc. and the Bank of New York Mellon, London Branch (Sept. 11,
2008), at 1.1, 2.3 [LBEXDOCID 1031225] (setting minimum deposit at $50 million). The agreement
allowed BNYM to set off all present and future monies, obligations and liabilities LBHI or other
specifiedLehmanentitiesowedunderanylegaldocumentation...relatedtotheissuanceofsecurities.
Id. at 1.1, 4. If any of BNYMs agreements with Lehman required BNYM to make a payment on
Lehmansbehalf,LehmanhadthreebusinessdaystorepayBNYM,afterwhichBNYMcouldwithdraw
an equivalent amount from the collateral deposit. Id. at 3. Lehman was entitled to direct BNYM to
transfer any excess collateral out of the account. Id. at 3.1.5. Further, BNYM could, in its absolute
discretion,allowLehmantowithdrawfundsfromthecollateralaccounteventhoughLehmanwasnot
otherwiseentitledtodosoundertheagreement.Id.at5.3.
5285SeeemailfromGrahamKettle,Lehman,toHuwRees,Lehman,etal.(Sept.12,2008)[LBEXDOCID
65923](announcingsuccessfulpaymentof$120milliontoBNYMbyLBHI(U.K.),pertheagreement).
5286Email from Graham Kettle, Lehman, to Daniel J. Fleming, Lehman, et al. (Sept. 12, 2008) [LBEX
DOCID065923](discussing$120millionpaymenttoBNYMonSeptember12inadditionto$50million
alreadyheldbyBNYM).
5287Email from Graham Kettle, Lehman, to Daniel J. Fleming, Lehman, et al. (Sept. 12, 2008) [LBEX
DOCID065875](discussing$120millionpaymenttoBNYMonSeptember12andexpectationthatBNYM
wouldreturn$120milliontoLehmanonSeptember15).
5288SeeStipulationandAgreedOrderBetweenLehmanBrothersHoldingsInc.,LehmanBrothersSpecial
Financing Inc. and Bank of New York Mellon Regarding (1) Turnover of Collateral Deposit and (2)
Return of Misdirected Wires, at p. 1, Docket No. 6040, In re Lehman Bros. Holdings, Inc., No. 0813555
(Bankr.S.D.N.Y.Dec.3,2009).
1378

(2) TheDepositIsSignificantBecauseofInternalLehman
ConcernsAboutIncludingItinItsPool
The parties stipulation to return the collateral deposit to Lehman removes the
need for substantial analysis of the transfers described above. Moreover, at the time,
LehmanpersonnelregardedmeetingBNYMsdemandasaminorconcessioncompared
tothebenefitsagoodrelationshipwithBNYMprovided.5289
For example, on September 10, 2008, Janet Birney suggested meeting BNYMs
demands without further negotiation in light of the significant amount of business
BNYMbroughtLehman:Theeconomicsofthe$600milliondontmakesensetoargue
overasweinvest$15Bwiththem.5290StirlingFieldingagreed,stating,myviewisthat
wearetoobusyrightnowtobeworryingoverthis....However,ifSteveEngelsayshe
reall[y] needs the liquidity that might change things.5291 Nevertheless, this deposit is
5289Email from Stirling Fielding, Lehman, to Janet Birney, Lehman (Sept. 10, 2008) [LBEXDOCID
1066546].
5290Email from Janet Birney, Lehman, to Stirling Fielding, Lehman (Sept. 10, 2008) [LBEXDOCID
1066546] (misspelling in original). BNYM reduced its demand to $125 million after Lehman exited the
trades that generated most of BNYMs intraday exposure. See email from Sara Mahoney, Lehman, to
JanetBirney,Lehman(Sept.10,2008)[LBEXDOCID1065014](Lookslikewewillonlybepaying$50mil
now); email from Graham Kettle, Lehman, to Emil F. Cornejo, Lehman, et al. (Sept. 10, 2008) [LBEX
DOCID 1065036] (reporting that a delay in exiting a trade will require Lehman initially deposit $125
million). BNYM ultimately held $170 million because Lehman placed a $120 million collateral deposit
with BNYM on Friday, September 12, 2008, even though BNYM was already holding a $50 million
collateral deposit. Email from Graham Kettle, Lehman, to Daniel J. Fleming, Lehman, et al. (Sept. 12,
2008) [LBEXDOCID 065923]. Lehman expected that BNYM would return the $120 million deposit on
Monday,September15.EmailfromGrahamKettle,Lehman,toDanielJ.Fleming,Lehman,etal.(Sept.
12,2008)[LBEXDOCID065875].
5291Email from Stirling Fielding, Lehman, to Janet Birney, Lehman (Sept. 10, 2008) [LBEXDOCID
1066546].
1379

significant in light of the Examiners findings with regard to Lehmans reported
liquiditypool.
TheSeptember9,2008AbilitytoMonetizeinternalchartofLehmansliquidity
poolincludesaDreyfusentryintheLowabilitytomonetize.5292Itisnotclearthat
this is the same Dreyfus account used for the BNYM agreement because Lehman did
not designate the Dreyfus account for use with the BNYM collateral deposit until
September 10.5293 However, Lehman was already placing cash in a [BNYM] money
fundonSeptember8.5294
ItisclearthatLehmanintendedtoincludethedepositinitsliquiditypool.Ina
September8emailexchange,CarloPellerani,LehmansInternationalTreasurer,asked
Graham Kettle, Lehmans vice president of Cash and Collateral Management, why
KettlehadsaidLehmanandBNYMhadheldagoodmeetingwhenLehmanhadjust
agreedtoplace$500millionincollateralinaBNYMmoneymarketaccount.5295Kettle
responded:
5292Lehman,LiquidityPoolSummary(Sept.9,2008),atp.4[LBHI_SEC07940_557815](attachedtoemail
from Robert Azerad, Lehman, to Paolo R. Tonucci, Lehman, et al. (Sept. 9, 2008)
[LBHI_SEC07940_557814],circulatingarevisedabilitytomonetizetable).SeeSection5.iofthisReport
forfurtherdiscussionofthischart.
5293Email from Graham Kettle, Lehman, to Scott Alvey, Lehman, et al. (Sept. 10, 2008) [LBEXDOCID
1065130].
065890].
5295EmailfromCarloPellerani,Lehman,toGrahamKettle,Lehman,etal.(Sept.8,2008)[LBEXDOCID
065890].TheamountoftherequireddepositfluctuatedoverthenextfewdaysasLehmanattemptedto
reduce BNYMs intraday exposure. See email from Sara Mahoney, Lehman, to Janet Birney, Lehman
(Sept.10,2008)[LBEXDOCID1065014](Lookslikewewillonlybepaying$50milnow);emailfrom
1380

The only reason I say good is the fact we are already placing cash in a
[BNYM]moneyfund,soitsnotadditionalallthatwouldchangeisthat
it will be placed on behalf of LBHINY and [BNYM] be taking a pledge
overthis.Doesnoteffectourliquiditypool.5296
Pelleranireplied:Disagreewiththatview.Ifweneedtohavethislockedthen
thereisanargumentforthisnottobeavailableliquidity.5297Cornejothenresponded
toPellerani:Carlo,wedonthavethelegaldocsyet,butitwouldnotbeapledge.The
moneywillbeinaLehmanaccount,withsomerightofoffset.5298
Pellerani told the Examiner that he did not understand Cornejos distinction
betweenpledgeddepositsanddepositssubjecttoarightofsetoff.5299Indeed,Pellerani
was also unaware of other strategies the threeday provision and the fiveday
horizon for monetizing liquid assets Lehman relied upon to justify including
depositsatclearingbanksintheliquiditypool.5300InPelleranisview,assetsplacedat
Graham Kettle, Lehman, to Emil F. Cornejo, Lehman, et al. (Sept. 10, 2008) [LBEXDOCID 1065036]
(reportingthatadelayinexitingatraderequiredLehmantoinitiallydeposit$125million).
065890].
065890].
5298Email from Emil F. Cornejo, Lehman, to Daniel J. Fleming, Lehman, et al. (Sept. 8, 2008) [LBEX
DOCID065890].NotethatinJuly,CitibankpersonnelhadproposedtoCornejothatLehmanagreetothe
terms of but not actually execute a pledge for the $2 billion comfort deposit. Email from Paolo R.
Tonucci,Lehman,toEmilF.Cornejo,Lehman,etal.(July14,2008)[LBHI_SEC07940_528212](discussing
Citibankproposal).ThisissueisdiscussedinmoredetailinSectionIII.A.5.cofthisReport.
5300ThisiscorroboratedbyPelleranisemailexchangeswithReesduringthenegotiationsovertheHSBC
cashdeeds. Pellerani orderedRees toremove the threeday provision that had been carried overfrom
the Bank of America agreement on the grounds that neither Pellerani nor Rees knew why it had been
includedinthefirstplace,anditappearedtothemtobeagainstLehmansinterests.EmailfromCarlo
Pellerani,Lehman,toHuwRees,Lehman,etal.(Sept.9,2008)[LBEXAM008965](Iwouldalsoliketo
questionwhythatclausewasembeddedintheBofAagreementandremoveit.).AsdiscussedinApp.
19,accordingtoBofA,thethreedayprovisionhadbeenincludedexpresslytoallowLehmantocontinue
1381

clearing banks to secure clearing and settlement services were not available liquidity
and should not have been included in the pool.5301 Nevertheless, this exchange
illustrates one of Lehmans responses to argumentsagainst including in its liquidity
pooldepositsLehmanhadplacedtoinducebankstocontinueprovidingintradaycredit
or clearing and settlement services. This issue is analyzed in more detail in the
LiquiditySectionofthisReportatSection5.i.
g) LehmansDealingsWithStandardBank
Standard Bank was Lehmans clearing and settlement bank for trades in South
Africa.5302StandardBank,likeotherclearingbanks,demandedandreceivedacollateral
deposit shortly before Lehmans bankruptcy.5303 The Standard Bank deposit $200
million5304 is small relative to the other clearingbank deposits, only applied to LBIE
andLBIsclearingrelateddebtsintheSouthAfricanmarket,5305andwassetoffagainst
approximately$10millioninadvancesofsettlementfundsonSeptember16.5306
counting the BofA deposit in its liquidity pool. See Memorandum of Law in Opposition to Lehman
Brothers Motion for Summary Judgment and in Further Support of Bank of Americas Motion for
Summary Judgment, at pp. 6, 17, Docket No. 58, Bank of Am., N.A. v. Lehman Bros. Holdings, Inc. (In re
LehmanBros.Holdings,Inc.),No.0801753(Bankr.S.D.N.Y.Oct.19,2009).
5302Email from Jonathan Seeranj, Lehman, to Stirling Fielding, Lehman, et al. (Sept. 4, 2008) [LBEX
DOCID455717].
5303Email from Joseph Igoe, Lehman, to Steve Durrant, Lehman, et al. (Sept. 9, 2008) [LBEXDOCID
455717].
5304Id.
5305LetterfromKennyFihla,StandardBank,toHuwRees,Lehman,re:NoticeofEnforcementofPledge
andCession(Sept.16,2008),atp.1[LBEXDOCID1090737].
5306Id.
1382

OnAugust7,2008,LBIEsaccountwithStandardBankrananintradayoverdraft
ofZAR2.1billion(approximately$280million)thatwasnotcleareduntilshortlybefore
the close of the day.5307 As a consequence, Standard Bank was unsettled by the
possible overnight overdraft of a substantial amount.5308 On August 18, Standard
BankrequestedthatLehmanbeginprefundingitstrades.5309OnAugust21,Lehmanran
anotherintradayoverdraftatStandardBankand,again,didnotrepaythefundsuntil
justbeforethecloseoftheday.5310
Standard Bank and Lehman continued discussing how to address Standard
Banksconcerns5311untilSeptember5,2008,whenStandardBankinformedLehmanthat
itmustpledge$200millionincollateral,andthatStandardBankwouldfailLehmans
5307Letter from Hugh Lilienfeld, Standard Bank, to Joseph Igoe, Lehman, re: Custody Settlement
Arrangements(Aug.18,2008),atp.1[LBEXDOCID2806149](demandingprefundingfortradesbecause
ofsubstantialpossibleoverdraftthatunsettledStandardBankonAugust7);emailfromOdettevan
der Merwe, First Rand Bank, to Abbie Goddard, Lehman, et al. (Aug. 7, 2008) [LBEXDOCID 49831]
(chronicling attempts to ensure payments arrive in time to clear overdraft before the end of the day).
ThereareconflictingaccountsamongthepartiestotherelevanttransactionsCitigroup,Lehman,First
Rand, and Standard Bank over which bank was responsible for the delay. Email from Joseph Igoe,
Lehman, to Steve Durrant, Lehman, et al. (Sept. 9, 2008) [LBEXDOCID 1058373] (Citibank was late in
paying our cash agent, First Rand, who in turn was late in paying Standard Bank); email from
CatherineMwangi,Citigroup,toKatherineLukas,Citigroup(Aug.7,2008)[CITILBHIEXAM00017552]
(internal Citigroup email chain stating that Citigroup was waiting on First Rand); email from Odette
vanderMerwe,FirstRandBank,toAbbieGoddard,Lehman,etal.(Aug.7,2008)[LBEXDOCID49831]
(chroniclingattemptstoensurepaymentsarriveintimetoclearoverdraftbeforetheendoftheday).
5308Letter from Hugh Lilienfeld, Standard Bank, to Joseph Igoe, Lehman, re: Custody Settlement
Arrangements(Aug.18,2008),atp.1[LBEXDOCID2806149].
5309Id.
5310Email from Abbie Goddard, Lehman, to Stirling Fielding, Lehman, et al. (Aug. 21, 2008) [LBEX
DOCID617](discussingcomplaintsfromStandardBank).
5311Email from Stirling Fielding, Lehman, to Robert Eby, Lehman, et al. (Sept. 3, 2008) [LBEXDOCID
1669].
1383

trades that were not timely funded or supported by adequate collateral.5312 The next
day,StandardBanksetadeadlineofSeptember9toreceivethefundsoritwouldcease
settlingLehmanstrades.5313
Accordingly, Lehman made a $200 million deposit on September 9.5314 On
September11,LBIEexecutedanddeliveredapledgeagreementtocoverthedeposit.5315
ThepledgeagreementallowsStandardBanktosetoffdebtsLBIEorLBIowedStandard
in connection with clearing and settlement in the South African market.5316 On
September 16, Standard Bank set off $10,422,859.72 from LBIEs account to cover
advancesfortradessettlingonSeptember15and16.5317
Lehmans revised September 9, 2008 ability to monetize chart, discussed in
moredetailinSection5.i,includesanentryforacollateraldepositof$200milliontitled
STANDARDJOB, associated with LBIE and assigned to the mid category of the
5312EmailfromSteveDurrant,Lehman,toShaunLawrence,Lehman,etal.(Sept.8,2008)[LBEXDOCID
1058390](emailchaindiscussinghowtorespondtoStandardBank).
5313Email from Joseph Igoe, Lehman, to Steve Durrant, Lehman, et al. (Sept. 9, 2008) [LBEXDOCID
455717](briefchronologyofeventsinLehmansinteractionwithStandardBankbetweenMarch2008and
September2008).
5314Id.AtleastoneemailclaimsthatthedepositwasactuallymadeonSeptember8,2008.Emailfrom
MariaBarrio,Lehman,toNealUllman,Lehman,etal.(Sept.10,2008)[LBEXDOCID1075773](referring
to pledged collateral requested and received on September 8). The confusion may have arisen from
overnight deposits Lehman had placed with Standard Bank since September 5. Email from Carlo
Pellerani,Lehman,toPaoloR.Tonucci,Lehman(Sept.5,2008)[LBEXDOCID2443971].
5315EmailfromStirlingFielding,Lehman,toMariaBarrio,Lehman,etal.(Sept.11,2008)[LBEXDOCID
1777132].
5316LetterfromKennyFihla,StandardBank,toHuwRees,Lehman,re:NoticeofEnforcementofPledge
andCession(Sept.16,2008),atp.1[LBEXDOCID1090737].
5317Id.
1384

ability to monetize.5318 To date, neither the Examiner nor the Examiners financial
advisors have been able to identify a transfer from a U.S. debtor as the source of the
September9depositof$200million.
h) LehmansDealingsWiththeFederalReserveBankofNewYork
This Section analyzes Lehmans relationship with the Federal Reserve Bank of
New York (FRBNY). The FRBNY was a major creditor of Lehman Brothers, in
particular during the oneweek period between LBHIs petition date and that of its
brokerdealer subsidiary, LBI. The Examiner has investigated Lehmans interactions
with the FRBNY in the context of the FRBNYs role as a secured lender to Lehman
followingBearStearnsnearcollapse.5319
This Section of the Report is divided into two parts: (1) an overview of the
FRBNYsrolemanagingmonetarypolicy;and(2)adiscussionofLehmansborrowings
undervariousFRBNYliquidityfacilities.
(1) TheFRBNYSupervisesDepositTakingInstitutionsand
AssistsinManagingMonetaryPolicy,butLacksAuthorityTo
RegulateInvestmentBankHoldingCompanies
The FRBNY is the largest of the 12 regional Federal Reserve Banks, which
together with the Federal Reserve Board of Governors, comprise the U.S. Federal
5318Lehman,LiquidityPoolSummary(Sept.9,2008),atp.2[LBHI_SEC07940_557815].
5319In
its capacity as a potential secured lender, the FRBNY also conducted intensive monitoring of
Lehmans liquidity position, and embedded analysts onsite at Lehman to that end. The FRBNYs
liquiditymonitoringfunctionisdiscussedatSectionIII.A.6.
1385

Reserve System.5320 The Federal Reserve Banks supervise and regulate bank holding
companies, or depository institutions such as national and statechartered banks.5321
These depository institutions are distinguished from securities brokerdealers, such as
investmentbanks,forwhichtheSECservesasprimaryregulator.5322
In addition to examining deposittaking institutions, the FRBNY occupies a
special role in discharging the Federal Reserve Systems statutorilymandated
obligationtosetmonetarypolicy.Section2aoftheFederalReserveActof1913charges
theBoardofGovernorsandtheFederalOpenMarketCommittee(FOMC)ofwhich
thePresidentofFRBNYisamemberwithsettingmonetarypolicyinordertoachieve
maximumemployment,stableprices,andmoderatelongterminterestrates.5323The
Federal Reserve System employs three policy tools toward this end. The first tool,
known as Open Market Operations (OMO), allows the FRBNY to buy and sell
Treasuries on the secondary market in transactions with certain securities dealers; the
FRBNY adds credit to the banking system when it buys Treasuries, and drains credit
when it sells the securities.5324 Second, each of the 12 Federal Reserve Banks is
authorized to extend, on a collateralized basis, shortterm loans directly to depository
5320Federal Reserve Bank of New York, Introduction to the New York Fed,
http://www.newyorkfed.org/aboutthefed/introtothefed.html(Nov.2009).
5321Id.
5322SeeSystemicRiskandFinancialMarkets:BeforetheH.Comm.onFinancialServs.,110thCong.68(2008)
(statement of thenSEC Chairman Christopher Cox) (distinguishing banking activity and securities
relatedactivity,anddescribingtheSECsresponsibilityasaregulatorofthelatter).
532312U.S.C.225a(2006).
5324Federal Reserve Bank of New York, Introduction to the New York Fed,
http://www.newyorkfed.org/aboutthefed/introtothefed.html(Nov.2009).
1386

institutionstemporarilyinneedofliquidity;suchlendingisconductedviathesocalled
discount window.5325 Third, the FOMC sets requirements for levels of funds
depositoryinstitutionsmustleaveonreservewithFederalReservebanks;byincreasing
ordecreasingreserverequirementstheFOMCcanincreaseordecreasebankcredit,and
consequently encourage or restrain monetary activity. According to the FRBNY, a
reduction in the reserve [requirements], by freeing up funds for banks to lend to
commercial borrowers, would be viewed as stimulative monetary policy.5326 The
three mechanisms outlined above all influence the supply of money in the economy,
and thereby the cost and availability of credit, and affect economic activity and
prices.5327
(2) InResponsetotheBearStearnsNearCollapse,theFRBNY
BrokerDealers;Lehman,InTurn,DrewonTheseFacilities
(a) ThePrimaryDealerCreditFacility
BearStearnsnearcollapseoccurredlargelyoverthecourseofameretwodays
March13and14,2008.Thenearcollapsewasviewedbythemarketasaclassicrunon
the bank; counterparties and customers lost confidence in the firms viability, pulled
depositsandwithdrewshorttermsecuredfinancing.TheBearStearnsrunwasunique,
however,inthattheinvestmentbanksufferedacompletelossofliquiditydespitebeing
5325Id.
5326Id.
5327Id.
1387

considered adequately capitalized by regulators, and possessing liquid collateral
againstwhichitshouldhavebeenabletosecurefinancing.Bearsregulatorstooknote
of this novel circumstance. As thenSEC Chairman Christopher Cox stated in an
addresstosecuritiestraders:
The Bear Stearns experience demonstrated . . . that the prevailing

measurements of capital and liquidity that were then being used by the
SEC and by every bank and securities regulator . . . were inadequate to
prevent the run on the bank that Bear endured. In just two days
betweenThursday,March13,andthecloseofbusinessonFriday,March
14,Bearsliquiditypoolfellbyover83%from$12billionto$2billion.
This was a development that . . . [no] bank regulatory model had

anticipated. Shortterm secured financing was unavailable even when
Bear offered high quality collateral such as agency securities. What
neitherthe[SEC]regulatoryapproachnoranyexistingregulatorymodel
had taken into account is the possibility that secured funding, even if it
was overcollateralized with U.S. Treasury or agency securities, might
disappearinacrisisofconfidence.5328
Thus, after Bear Stearns, market participants were sensitive to the fact that an
investmentbankmaybeadequatelycapitalized,holdliquidcollateral,andnonetheless
collapse in a liquidity crisis. In response, Chairman Cox called for a system of
mandatoryregulationofinvestmentbankholdingcompanies.5329TheFRBNY,however,
devisedaprogrammorenarrowlytailoredinanefforttomitigatetheproblemathand.
Section 13(3) of the Federal Reserve Act allows the Board of Governors of the
Federal Reserve to authorize the Federal Reserve Banks to make secured loans to
5328ChristopherCox,thenChairman,Secs.andExchangeComm.,AddresstotheSecuritiesTraders12th
Annual Washington Conference (May 7, 2008), available at

http://www.sec.gov/news/speech/2008/spch050708cc.htm.
5329Id.
1388

virtually any individual or corporation in unusual and exigent circumstances when
theborrowerisunabletosecureadequatecreditaccommodationsfromotherbanking
institutions.5330OnMarch16,2008,attheheightoftheBearStearnscrisistheBoard
ofGovernorsof the FederalReservegranted theFRBNYthe authority to establish the
PrimaryDealerCreditFacility(PDCF).5331
UnderthePDCF,theFRBNYwouldmakecollateralizedloanstobrokerdealers,
such as LBI, and in effect, act as a repo counterparty. Unlike a typical counterparty,
though, with the creation of the PDCF, the FRBNY was generally understood by
marketparticipantstobethelenderoflastresorttothebrokerdealers.5332Reflecting
the fact that brokerdealer liquidity had become increasingly dependent on overnight
repos to obtain shortterm secured financing,5333 the PDCF was structured as an
overnightfacility.
Pursuant to the Federal Reserve Acts requirement that a Federal Reserve Bank
lend only on a secured basis, and according to the convention in repo lending, the
FRBNY advanced funds against a schedule of collateral. Collateral accepted by the
PDCF initially consisted of: Treasuries, government agency securities, mortgage
533012U.S.C.343(2006).
5331TobiasAdrian,etal.,TheFederalReservesPrimaryDealerCreditFacility,CurrentIssuesinEcon.&Fin.,
Aug. 2009,at p.1, available at http://www.newyorkfed.org/research/current_issues/ci154.pdf [hereinafter

Current Issues: PDCF]; see also Press Release, Board of Governors of the Federal Reserve System
(March 16, 2008) (announcing creation of the PDCF), available at
http://www.federalreserve.gov/newsevents/press/monetary/20080316a.htm.
5332EmailfromStephenLax,Lehman,toStephenLax,Lehman(Mar.23,2008)[LBHI_SEC07940_077953]
(quotingPressRelease,Standard&Poors,S&PAffirmsLemanBros.,GoldmanSachs(Mar.23,2008)).
5333CurrentIssues:PDCF,atpp.12.
1389

backedsecuritiesissuedorguaranteedbygovernmentagencies,andinvestmentgrade
corporate,municipal,mortgageandassetbackedsecuritiespricedbyclearingbanks.5334
The FRBNY set the lending rate for PDCF advances equal to the rate charged by the
FederalReservesdiscountwindow,availabletodepositoryinstitutions.5335Infact,the
PDCF was frequently analogized to the traditional discount window, or viewed as
expandingthediscountwindowtosecuritiesbrokerdealers.5336
On Sunday, September 14, 2008, the day before LBHI filed for bankruptcy, the
class of eligible collateral was expanded to closely match the types of collateral that
canbepledgedinthetripartyreposystemsofthetwomajorclearingbanks.5337That
is, the pool of eligible collateral was expanded to include noninvestment grade
securitiesandequities.
(b) TheMarketGreetedtheCreationofthePDCFasaPositive
StepTowardBackstoppingBrokerDealerLiquidity,and
asShoringUpLehmansLiquidity
The market greeted the news of the creation of the PDCF positively. The
Canadianratingagency, DBRS,statedina pressrelease: DBRSviewsthe [PDCF]as
particularly valuable in the current stressed market conditions, as it adds a highly
5334Press Release, Board of Governors of the Federal Reserve System (Sept. 14, 2008) (announcing the
expansionofPDCFeligiblecollateral),availableat
http://www.federalreserve.gov/newsevents/press/monetary/20080914a.htm.
5335CurrentIssues:PDCF,atp.8.
5336Id.atp.4.
5337Press Release, Board of Governors of the Federal Reserve System (Sept. 14, 2008) (announcing the
expansion of PDCFeligible collateral), available at http://www.federalreserve.gov/newsevents/press/

monetary/20080914a.htm.
1390

reliable source of liquidity to the range of existing funding options available to the
major broker dealers.5338 Given that Lehman was widely perceived to be the
investmentbankwithabusinessmodelclosesttoBearStearns,andasaresult,thenext
most vulnerable firm,5339 the PDCF was viewed as particularly helpful in buoying
Lehmans liquidity. Citigroups Global Markets Equity Research division upgraded
LehmantobuyonthebackoftheexpansionofthePDCF.ReferringtothePDCF,the
Citigroupanalysisstates:Inourview,itstoughtohavealiquiditydrivenmeltdown
when youre being backed by government entities that have the ability to print
money.5340TheCitigroupanalysiselaboratedonthatpoint:With$34binliquidityat
theparentcompany,[and]theabilitytogetaccess toover $200b in liquidityfrom the
Feds primary dealer credit facility, . . . access to liquidity is a nonissue.5341 Lehman
alsopromotedthislineofthinking.InastatementissuedonMondayMarch17,2008,
Fuld said: The Federal Reserves decision to create a lending facility for primary
dealers and permit a broad range of investmentgrade securities to serve as collateral
5338Press Release, DBRS, DBRS Confirms Lehman Brothers at AA (low), Keeps Stable Trend (Mar. 18,
2008)[LBHI_SEC07940_076814].
5339LandonThomas,Jr.,AftershocksofaCollapse,WithaBankattheEpicenter,N.Y.Times,Mar.18,2008,at
p.C1.
5340CitiGlobalMarketsEquityResearch,Citigroup,LehmanBrothersHoldingsInc.(LEH):UpgradingTo
Buy;RealityWillTrumpFear(Mar.28,2008),atp.1[CITIGROUP0006117].
5341Id.
1391

improves the liquidity picture and, from my perspective, takes the liquidity issue for
theentireindustryoffthetable.5342
PDCFasanOutletforItsIlliquidPositions
The PDCF not only provided Lehman with a ready response to those who
speculateditwouldgothewayofBearStearns,butalsoapotentialvehicletofinanceits
illiquid corporate and real estate loans. A day after the PDCF became operational,
Lehman personnel commented: I think the new Primary Dealer Credit Facility is a
LOTbiggerdealthanitisbeingplayedtobe....5343TheymusedthatifLehmancould
use the PDCF as a warehouse for all types of collateral, we should have plenty of
flexibility to structure and rethink CLO/CDO structures....5344 Additionally, by
viewing the PDCF as available to serve as a warehouse for short term securities
[b]acked by corporate loans,5345 the facility MAY BE THE EXIT STRATEGY
FUNDINGSOURCEWENEEDTOGETNEWCOMPETITIONINTHECORPORATE
LOANMARKET.5346
5342ZacheryKouwe,LehmanIsNotReadyToFuldChairmanBullishDespite19%Drop,N.Y.Post,Mar.18,
2008,atp.37.
5343Email from Geoffrey Feldkamp, Lehman, to Eric Felder, Lehman, et al. (Mar. 18, 2008)
[LBHI_SEC07940_390192].
5344Id.
5345Id.
5346Id.(capitalizationinoriginal).Feldkamphypothesizedthatbankswouldbeabletotakeadvantageof
the PDCFs warehousing potential over the long term, believing the FRBNY could not discontinue the
temporaryprograminthenearterm,andthattheprogramwouldeventuallybecomeentrenched:
Bernankeandcomayhavesavedtheday,andJPMhasagreatpublicaffairsapproachtomake
the Bear deal look extremely positive for everyone, by emphasizing how it will be looking
1392

Lehman did indeed create securitizations for the PDCF with a view toward
treating the new facility as a warehouse for its illiquid leveraged loans. In March
2008, Lehman packaged 66 corporate loans to create the Freedom CLO.5347 The
transaction consisted of two tranches: a $2.26 billion senior note, priced at par, rated
single A, and designed to be PDCF eligible, and an unrated $570 million equity
tranche.5348 The loans that Freedom repackaged included highyield leveraged
loans,5349whichLehmanhaddifficultymovingoffitsbooks,5350andincludedunsecured
loanstoCountrywideFinancialCorp.5351
Lehman did not intend to market its Freedom CLO, or other similar
securitizations,toinvestors.Rather,LehmancreatedtheCLOsexclusivelytopledgeto
the PDCF.5352 An internal presentation documenting the securitization process for
forwardtoapplyingthisnew[CDOpackaging]technologyto[the]resolutionofthiscrisis.Once
appliedsuccessfully,theFedwillnotbeabletoendthefacility.Theyllhavetoconti[n]ueitand
manageitasastandardmonetarypolicytool.
Id.
5347Lehman,LiquidityFundingandReviewSpecialTopics,Apr.14,2008,atp.5[LBEXWGM677805].
5348Id.;MemorandumfromMargaretSear,Lehman,etal.,toFiles,Lehman(Apr.11,2008),atp.1[LBEX
WGM762264](discussingaccountingpracticesappliedtoFreedomCLOnotesanduseatthePDCF).
5349Lehman,SecuritizingLeveragedLoans:Freedom,Spruce,ThaliaCLOs[LBEXWGM835699].
5350Pierre Paulden, Lehman Creates CLO to Get Buyout Loans Off Its Books, Bloomberg.com, Mar. 3, 2008,
http://www.bloomberg.com/apps/news?pid=20601087&sid=a4fHfr0N0dbI&refer=home.Thearticlenotes
thatCreditSuisseandDeutscheBankhadengagedinsimilartransactionstoreducetheimpactofbuyout
loansontheirbalancesheetswithoutsellingthoseloansontheopenmarket.
5351Email from Jan H. Voigts, FRBNY, to Arthur G. Angulo, FRBNY, et al. (Apr. 9, 2008) [FRBNY to
Exam.030264](coveremailandattachedexcerptoftheindenturefortheFreedomCLO)).
5352See Lehman, Securitizing Leveraged Loans: Freedom, Spruce, Thalia CLOs, at p. 2 [LBEXWGM
835699](notingthattheopeningoftheFed/ECBdiscountwindowstononbanksprovidedtriggerto
complete [Freedom securitization] immediately and that Freedom, Spruce, Thalia, and other Lehman
structured products were not meant to be marketed); see also email from Marie Stewart, Lehman, to
Jonathan Cohen, Lehman, et al. (May 8, 2008) [LBHI_SEC07940_1069905] (noting that the SASCO
1393

Freedom and similar CLOs named Spruce and Thalia, noted that the
[r]epackage[d] portfolio of HY [high yield leveraged loans] constituting the
securitizations, are not meant to be marketed.5353 Handwriting from an unknown
sourceunderlinesthissentenceandnotesatthemargin:Nointentiontomarket.5354
Lehmanmayhavealsomanageditsdisclosurestoensurethatthepublicdidnot
becomeawarethattheCLOswerenotcreatedtobesoldontheopenmarket,butrather
were intended solely to be pledged to the PDCF. An April 4, 2008 email containing
editstotalkingpointsconcerningtheFreedomCLOtobedeliveredbyFuldstated:
Giventhatthepresshasnotfocused(yet)ontheFedwindowinrelation
tothe[Freedom]CLO,Idsuggestdeletingthereferenceinthesummary
below. Press will be in attendance at the shareholder meeting and my
concernisthatvolunteeringthisinformationwouldresultinastory.5355
It is unclear, based solely on the email, why a reference linking the FRBNYs
liquidity facility to the Freedom CLO was deleted. One explanation could be that
securitization [l]ike Freedom CLO and Spruce CLO . . . is just creating securities to take to the Fed
window).FurtherevidencethatFreedomCLOstyletransactionshadlimitedliquidityvalueoutsideof
the PDCF is found in Citibanks rejection of Freedom and similar CLOs when they were offered by
Lehman as collateral to secure Citis intraday clearing exposure. E.g., email from Anthony Lieggi,
Citigroup,toMichaelMauerstein,Citigroup,etal.(Aug.1,2008)[CITILBHIEXAM00082156](quoting
exchange among Citigroup analysts and Mauerstein about pricing Lehman CLOs). Lieggi noted that
Citibank was unable to obtain pricing data from Bloomberg for the collateral offered by Lehman
(Freedom,Spruce,Pine,VeranoandKingfisherCLOs).Id.LieggialsonotedthataCitibank
risk manager assigned to Lehman, Tom Fontana, expressed strong concern about this collateral. Id.
AccordingtoMauerstein,theseCLOswerebottomofthebarrelsecuritiesthatLehmancouldnotrepo
out. Examiners Interview of Michael Mauerstein, Sept. 16, 2009, at p. 8. Mauerstein said that the
securitiesmayhavebeeninvestmentrated,butweknowwhatthatmeansnow.Id.
5353Lehman,SecuritizingLeveragedLoans:Freedom,Spruce,ThaliaCLOs,atp.2[LBEXWGM835699].
5354Id.
5355Email from Kerrie Cohen, Lehman, to Erin Callan, Lehman, et al. (April 8, 2008)
[LBHI_SEC07940_087671]. The talking points included below the break of the email do not include
referencetoanyFRBNYfacility,soitseemsthatCohenmayhavedeletedthereferencesalready,inthee
mailshesenttoCallan.
1394

Lehman did not want the public to learn that it had securitized illiquid loans
exclusivelytobepledgedtothePDCF.Anotherreasonmayhavebeentohidethefact
that Lehman needed to access the PDCF in the first place, given that accessing the
securitiesdealerslenderoflastresortcouldhavenegativesignalingimplications.5356
The FRBNY was aware that Lehman viewed the PDCF not only as a liquidity
backstop for financing quality assets, but also as a means to finance its illiquid assets.
Describing a March 20, 2008 meeting between the FRBNY and Lehmans senior
management, FRBNY examiner Jan Voigts wrote that Lehman intended to use the
PDCF as both a backstop, and business opportunity.5357 With respect to the Freedom
securitizationinparticular,VoigtswrotethatLehmansawthePDCF
asanopportunitytomoveilliquidassetsintoasecuritizationthatwould
bePDCFeligible.They[Lehman]alsonotedtheyintendedtocreate2or3
additional PDCF eligible securitizations. We avoided comment on the
securitization but noted the firms intention to use the PDCF as an
opportunitytofinanceassetstheycouldnotfinanceelsewhere.5358
Thus,theFRBNYwasawarethatLehmanviewedthePDCFasanopportunityto
finance its repackaged illiquid corporate loans. The Examiners investigation has not
determined whether the FRBNY also understood that these Freedomstyle
securitizations were never intended for sale on the broader market. In response to a
question from FRBNY analyst Patricia Mosser on whether Voigts knew if they
5356LehmansconcernsregardingthenegativesignalingeffectsoftappingthePDCFarediscussedbelow.
5357Email from Jan H. Voigts, FRBNY, to Timothy F. Geithner, FRBNY, et al. (Apr. 9, 2008) [FRBNY to
Exam.026077].
5358Id.
1395

[Lehman] intend to pledge to triparty or PDCF,5359 Voigts replied that the Freedom
CLOwascreatedwiththePDCFinmind.5360
According to internal Lehman documents, Lehman did in fact pledge the
Freedom CLO to the PDCF. On three dates, March 24, 25 and 26, 2008, Lehman
pledged the Freedom CLO to the FRBNY on an overnight basis, and received $2.13
billionforeachtransfer.5361FRBNYdiscussionsconcerningtheCLOsunderlyingassets,
however,tookplaceonoraroundApril9,20085362morethanaweekaftertheFRBNY
beganacceptingtheCLO.
(d) LehmanWasReluctanttoDrawonthePDCFBecauseofa
PerceivedStigmaAttachedtoBorrowingfromthe
Facility
Paradoxically,whilethePDCFwascreatedtomitigatetheliquidityflightcaused
bythelossofconfidenceinaninvestmentbank,useofthePDCFwasseenbothwithin
Lehman, and possibly by the broader market, as an event that could trigger a loss of
confidence. A report by Lehman Brothers Capital Markets Prime Services captured a
commoncritiqueofthefacility:
5359EmailfromPatriciaMosser,FRBNY,toJanH.Voigts,FRBNY,etal.(Apr.9,2008)[FRBNYtoExam.
026079].
5360Email from Jan H. Voigts, FRBNY, to Patricia Mosser, FRBNY (Apr. 9, 2008) [FRBNY to Exam.
026078].
5361Memorandum from Margaret Sear, Lehman, et al., to Files, Lehman (Apr. 11, 2008), at p. 1 [LBEX
WGM762264](accountingpolicymemorandum).
5362E.g.,emailfromJanH.Voigts,FRBNY,toTimothyF.Geithner,FRBNY,etal.(Apr.9,2008)[FRBNY
to Exam. 026077] (internal FRBNY exchange regarding the Freedom CLO); email from Jan H. Voigts,
FRBNY,toArthurG.Angulo,FRBNY,etal.(Apr.9,2008)[FRBNYtoExam.030264](same).
1396

PDCFborrowinghasaconsiderablestigmainspiteoftheFedseffortsto
cloakaccessandguaranteeanonymity.Instead,primarydealersviewthe
PDCF as a last resort and will exhaust all other financing sources before
pledging collateral here. For this reason, borrowing at this program has
evaporatedsincethe[BearStearns]mergerclosed.5363
Lehmancomplainedinternally,andtotheFRBNY,aboutthestigmaattachedto
PDCFborrowing.Inaninternalemail,LehmanpersonnelappearedtoviewthePDCF
asanetnegative,writingthatLehmancouldnotuseitduetoitsstigma,owingtothe
factthatshouldtheFeddisclosethe[PDCF]borrowers,itwouldlikelyfurtherdamage
confidence in the institutions that tapped the facilities.5364 Yet, at the same time,
LehmanpersonnelsuggestedthatthemereexistenceofFRBNYfacilitiesforcedLehman
to quell rumors and bad press,5365 presumably regarding whether Lehman was
suffering liquidity problems or was forced to access the PDCF. Tonucci also
complained of the stigma, elevating his concerns to the FRBNY. Tonucci relayed the
rumor to the FRBNY, which he attributed to Standard & Poors, that usage of the
PDCF would cause [the rating agency] to change [Lehmans] outlook from stable to
negative.5366
5363Lehman,LiquidMarkets:TSLFexpansion(Aug.21,2008),atp.2[LBHI_SEC07940_2218563].
5364Email from Stephen Lax, Lehman, to Kevin Thatcher, Lehman, et al. (June 4, 2008)
[LBHI_SEC07940_3207832].
5365Id.
5366EmailfromBrianPeters,FRBNY,toStevenManzari,FRBNY,etal.(Mar.19,2008)[FRBNYtoExam.
032418](quotingearlieremailfromManzari).PetersrepliedthathespoketoStandard&PoorsDiane
Hintonwhosaidtherumorwasnotatalltrue.Id.
1397

Inrecognitionofthedangerinherentinallowingmarketparticipantstobelieve
Lehman had tapped the PDCF, in the late spring, summer, and early fall of 2008, the
firmwascarefultoadvisethemarketthatitwasnotcurrentlyaccessingthefacility.5367
(e) LehmanAccessedthePDCFTenTimesin2008;Lehmans
UseofthePDCFWasConcentratedinPeriods
ImmediatelyAftertheBearStearnsNearCollapse,and
ImmediatelyAfterLBHIFiledforBankruptcy
Lehman drew on the PDCF facility sparingly prior to its bankruptcy. Lehman
accessed the PDCF seven times in the liquidity stress period that followed the Fed
brokered sale of Bear Stearns to JPMorgan.5368 Both internally, and to third parties,
Lehman characterized these draws as tests,5369 although witnesses from the FRBNY
have stated that these were not strictly tests, but instances in which Lehman drew
uponthefacilityforliquiditypurposes.5370
Lehman documents reveal the dates for all seven instances, prior to LBHIs
bankruptcy, on which Lehman pledged collateral to the PDCF in exchange for cash
loans. On March 18, 19 and 20, Lehman pledged collateral to the PDCF in return for
5367Joe Bel Bruno, Lehman Bros. Denies It Approached Federal Reserve, Associated Press (June 3, 2008)
(quoting Tonucci as saying Lehman last accessed the primary brokerdealer facility on April 16 for
testingpurposes).
5368RobertAzerad,Lehman,2008Q2LiquidityPosition(June6,2008),atp.3[LBHI_SEC07940_516173]
(attached to email from Robert Azerad, Lehman, to John Feraca, Lehman, et al. (June 7, 2008)
[LBHI_SEC07940_516172]).
5369E.g., Robert Azerad, Lehman, 2008 Q2 Liquidity Position (June 6, 2008), at p. 3
[LBHI_SEC07940_516173](referringtotesttradeswiththePDCF);seealsoJoeBelBruno,LehmanBros.
DeniesItApproachedFederalReserve,AssociatedPress(June3,2008)(quotingTonucciasstating[t]helast
timeweaccessedthe[PDCF]facilitywasonApril16fortestingpurposes).
5370E.g.,ExaminersInterviewofThomasBaxter,Jr.,May20,2009,atp.4.
1398

$1.6billion,$2.3billion,and$2.3billionincash,respectively.5371OnMarch24,25and
26,Lehman,viaLBI,pledgedthe$2.26billionseniortrancheofitsFreedomCLOtothe
PDCF for $2.13 billion in cash financing.5372 On April 16, 2008, Lehman pledged an
unknownclassofcollateraltothePDCF,likelyintheamountof$2billion.5373
Lehman abstained from obtaining liquidity from the PDCF during the week
prior to bankruptcy, as its liquidity pool came under pressure due to clearing bank
collateral requests and associated liens. Immediately after LBHI filed for Chapter 11,
however,LBIagainresortedtothefacility.OnSeptember15,2008,LBIborrowed$28
billionfromthePDCFagainst$31.7billionofcollateral.5374Likewise,onSeptember16,
LBI obtained $19.7 billion of financing against $23 billion of collateral.5375 Finally, on
September17,2008,thedayBarclaysannounceditwouldacquiretheLehmanbroker
dealer,LBIobtained$20.4billionagainst$23.3billionofcollateral.5376
5371Lehman,PresentationtotheFederalReserve:UpdateonCapital,Leverage&Liquidity(May28,2008)
[LBHI_SEC07940_062599].
5372Memorandum from Margaret Sear, Lehman, et al., to Files, Lehman (Apr. 11, 2008), at p. 2 [LBEX
WGM762264](accountingpolicymemorandum).
5373RobertAzerad,Lehman,2008Q2LiquidityPosition(June6,2008),atp.3[LBHI_SEC07940_516173];
see also Joe Bel Bruno, Lehman Bros. Denies It Approached Federal Reserve, Associated Press (June 3, 2008)
(quoting Tonucci as stating [t]he last time we accessed the [PDCF] facility was on April 16 for testing
purposes).
5374SeeemailfromDavidWeisbrod,JPMorgan,toJamieL.Dimon,JPMorgan,etal.(Sept.15,2008)[JPM
2004 0080146] (noting that Lehman borrowed $28 billion from the PDCF on September 15, 2008);
ExaminersInterviewofRobertAzerad,Sept.23,2009,atp.5.
5375Id.
5376Id.AnalysisofpotentialclaimsarisingfromLehmansborrowingsfromtheFRBNYareanalyzedin
SectionIII.BofthisReport.
1399

(3) OtherFRBNYLiquidityFacilities
(a) TheTermSecuredLendingFacility
The Term Securities Lending Facility (TSLF) was created on March 11, 2008
amidtheseriesofeventsthatledtothenearcollapseofBearStearns.5377Intheweeks
preceding the near collapse of Bear, the FRBNY was growing increasingly concerned
over the tightening of liquidity in the mortgagebacked securities (MBS) market.5378
During that period, officials in the FRBNY were involved in intense discussions over
how to restore liquidity to the market. One idea was to swapout treasuries to
brokerdealersinexchangefortheirotherwiseilliquidMBS.5379
ThisproposalwaseventuallyrealizedintheTSLF.UndertheTSLF,tothisday,
every 28 days, brokerdealers engage in a competitive auction where they can swap
MBSandothersecuritiesforTreasuries.5380
Lehman borrowed from the TSLF,5381 which, unlike the PDCF, did not have a
stigmaassociatedwithitsuse.
5377ExaminersInterviewofThomasBaxter,Jr.May20,2009,atp.6.
5378Id.
5379Id.
5380FederalReserveBankofNewYork,FrequentlyAskedQuestions,http://www.newyorkfed.org/
markets/tslf_faq.html(June25,2009).
5381DeclarationofShariD.LeventhalInSupportofTrusteesMotionforEntryofanOrderApprovinga
SettlementAgreement,atp.2,DocketNo.387,SpecialInvestorProtectionCorp.v.LehmanBrothersInc.,(In
reLehmanBrothersHoldingsInc.)No080420(Bankr.S.D.N.Y.Dec.5,2008)(notingthattheFRBNYtraded
withLBIunderthePDCF,OMO,andTSLF).
1400

(b) OpenMarketsOperations
OpenMarketOperations(OMO)lendingisoneofthebasicwaystheFRBNY
controls the supply of Treasuries, and thereby implements monetary policy.5382 The
FRBNY buys and sells Treasuries in transactions with brokerdealers under the OMO
program by engaging in repo and reverse repo transactions with those entities. The
FRBNY advances Treasuries against a large pool of eligible collateral, including
investment grade assetbacked securities, corporates and MBS. The FRBNY was a
creditortoLehmanundertheOMO.5383
i) LehmansLiquidityPool
(1) IntroductionandExecutiveSummary
The Examiners investigation of Lehmans clearing banks and other lenders, as
directedbytheeighthbulletoftheExaminerOrder,requiredthattheExaminerreview
Lehmans liquidity pool, that is, cash, government securities and other highquality
assets that Lehman set aside for its known funding needs.5384 Multiple witnesses
confirmedthatcertain assets Lehman deposited with or pledged to its clearing banks
were counted in Lehmans liquidity pool. By the second week of September 2008, as
5382Id.
5383Id.
5384TheJanuary16,2009OrderdirectingtheU.S.TrusteetoappointanExaminerchargedtheExaminer
withinvestigating,amongotherthings:
Thetransactionsandtransfers,includingbutnotlimitedtothepledgingorgrantingofcollateral
securityinterestamongthedebtorsandtheprechapter11lendersand/orfinancialparticipants
including but not limited to, JPMorgan Chase, Citigroup, Inc., Bank of America, the Federal
ReserveBankofNewYorkandothers.
OrderDirectingAppointmentofanExaminerPursuanttoSection1104(c)(2)oftheBankruptcyCode,at
p.4,DocketNo.2569,InreLehmanBrothersHoldings,Inc.,No.0813555(Bankr.S.D.N.Y.Jan.16,2009).
1401

marketpressuresandcollateralcallsincreased,Lehmannolongerhadsufficientassets
in its liquidity pool to weather a crisis. The inadequacy of Lehmans liquidity pool is
directlyconnectedtoLehmansbankruptcyfiling.5385
Likeitspeerinstitutions,Lehmanwasheavilyreliantuponwholesalefinancing
sources5386 to fund a substantial portion of its balance sheet every 24 hours using
overnightrepos.Liquiditytheimmediateabilitytoaccessfundsisthelifesbloodof
aninvestmentbank.Liquidityismoreimportantthancapital;mostentitieswhichgo
bankruptdosobecausetheyrunoutoffinancing,notbecausethevalueoftheirassets
fallsbelowthevalueoftheirliabilities.5387Onewitnessexplained,corporatesdieof
cancer,butfinancialfirms[likeLehman]dieofheartattacks.5388
Lehman knew that liquidity played a crucial role in its business model. Its
annual report stated, Liquidity, that is access to funds, is essential to our
businesses.5389Lehmanalsoknewthattheconsequencesofaliquiditydisruptioncould
becatastrophic.AsErinCallannotedafterBearStearnsnearcollapse,liquidityisthe
5385The Examiner Order also mandates that the Examiner investigate [t]he events that occurred from
September 4, 2008 through September 15, 2008 or prior thereto that may have resulted in the
commencementoftheLBHIchapter11case.Id.
5386DianeHinton,Standard&PoorsRatingsDirect,LiquidityManagementInTimesOfStress:HowThe
MajorU.S.BrokerDealersFare(Nov.8,2007),atp.2[LBHI_SEC07940_439424].
5387Email from Paul Shotton, Lehman, to Christopher M. OMeara, Lehman (Apr. 15, 2008)
[LBHI_SEC07940_768467].
5389LehmanBrothersHoldingsInc.,AnnualReportfor2007asofNov.30,2007(Form10K)(filedonJan.
29,2008),atp.17(LBHI200710K).
1402

thingthatwillkillyouinamoment.5390Forthisreason,Lehmanpaidcarefulattention
to its liquidity pool and to how it described the pool to the public. But as pressures
mountedduringthesummerof2008,Lehmanbegantoincludeencumberedassetsinits
liquiditypool.
Beginning in June 2008, Lehman agreed to deposit$2 billionwith Citigroup to
cover clearingrelated concerns. Lehman believed it could call the deposit back, so it
continuedtocountthe$2billioninitsliquiditypool.ButCitigroupheldtheviewthat
ithadarightofsetoffagainstthedepositandLehmanunderstoodthatawithdrawalof
the deposit would have an impact on Citis willingness to clear and settle trades for
Lehman.5391
LehmansdepositwithCitigroupwasthestartofatrend.Duringthesummer,
Lehmanpostedbillionsincollateraltoitsclearingbanksthroughmoredirectpledges.
A week after Citigroup requested collateral, Lehman pledged more than $5 billion in
securitiestoJPMorgan,LehmansprimaryU.S.clearingbank,tomitigatetheeffectsof
thebanksrevisedmarginrequirements.ButLehmancontinuedtoincludemostofthis
collateralinitsliquiditypool.
5390MariaBartiromo,LehmanCFOErinCallan:BackfromUglyMonday,BusinessWeek,Mar.20,2008.
5391 See, e.g., FRBNY, Lehman IB Update, (July 14, 2008) [FRBNY to Exam. 008163] (an FRBNY analyst
reportedthatLehmansGlobalTreasurer,PaoloR.Tonuccisaid,eventhoughLehmantechnicallyhas
access to the $2B [Citigroup deposit], if they [Lehman] pull it or a major portion thereof, Citi will stop
clearing.).
1403

August 2008 brought additional demands for collateral. Lehman met these
demandsbutstillcountedthecollateralinitsliquiditypool.OnAugust14,2008,Bank
ofAmericabegandemandingcollateraltosecureintradayexposures.Lehmanposted
$500 million with the bank, subject to a security agreement dated August 25, 2008.
Lehman included this collateral in its liquidity pool despite the fact that the collateral
wassubjecttoasecurityinterest,wasreturnabletoLehmanonlyonthreedaysnotice
andwasplacedtoensurethatBankofAmericawouldcontinueitsclearingoperations.
Likewise, in late August, at JPMorgans request, Lehman and JPMorgan executed a
security agreement and holding company guaranty, formalizing JPMorgans intraday
security interest in two specified accounts. Lehman included amounts in these
accountsinitsliquiditypool,eventhoughJPMorganrequiredalmostallofthefundsin
thoseaccountseachmorningtounwindthepreviousdaystripartyrepotrades.HSBC
requestedandreceivedmorethan$800milliontosecureitsintradaycreditexposureto
LehmanonAugust28,anamountalsoincludedinLehmansliquiditypool.Andfrom
September9through12,JPMorganrequestedandreceivedmorethan$8billionincash
tosecureJPMorgansexposuretoLehman,anamountthatLehmanalsoincludedinits
liquiditypool.
Lehman took the position thatincluding the Citigroup deposit andLehmans
intraday collateral with JPMorgan in its liquidity pool was appropriate. But the SEC
and the rating agencies later expressed contrary views. While there may have been
1404

legitimate differences of opinion as to the appropriateness of counting the Citigroup
depositandtheintradaycollateralintheliquiditypool,itisfarmoredifficulttojustify
LehmanscountingofpledgedassetsinLehmansliquiditypool,suchasthoseLehman
pledgedtoJPMorganonorafterSeptember10,2008.
TheFRBNYknewthatLehmanincludedpledgedassetsinitsliquiditypool,but
as Lehmans lender rather than its regulator, the FRBNY took no steps to compel
Lehman to disclose the discrepancy between Lehmans reported liquidity pool figure
andtheactual,smallernumber.Lehmansprimaryregulator,theSEC,wasunawareof
theextenttowhichLehmanwasincludingclearingbankcollateralinitsliquiditypool.
TheSECdidnothaveafullunderstandingoftheencumbrancesonLehmansliquidity
pooluntilSeptember12theFridaybeforeLehmansbankruptcyfiling.5392
Most significantly, Lehman never advised the rating agencies or the investing
public of the deposits and pledges affecting its liquidity pool. During Lehmans
earnings announcement on September 10, CFO Ian Lowitt said nothing about these
encumbrances. Although there is some evidence that Lowitt knew that the liquidity
pool contained clearingbank collateral, the Examiner concludes that there is not
sufficientevidencetosupporttheexistenceofacolorableclaimthatLowittbreachedhis
5392TheSECassertsthatitwasaware,priortothisdate,thatLehmanpledged$5billionofpreviously
unencumberedassets,andnotcashtoJPMorganonanintradaybasis.TheSECalsoasserts,however,
that it was told by Lehman personnel that [the pledge did] not affect the liquidity pool. Letter from
Samuel M. Forstein, Assistant General Counsel, Securities and Exchange Commission, to Robert L.
Byman,CounseltotheExaminer(Jan.29,2010)(onfilewiththeExaminer).TheExaminerhasnoother
documentationtosupportthisassertion.
1405

fiduciarydutiestothecorporationanditsshareholdersthroughmaterialomissionsand
misrepresentationsregardingLehmansliquiditypool.
(2) TheImportanceofLiquiditytoBrokerDealersandInvestment
BankHoldingCompaniesGenerally
Liquidityistheabilityofabanktofundincreasesinassetsandmeetobligations
as they come due, without incurring unacceptable losses.5393 Liquidity is absolutely
criticaltothebrokerdealerandinvestmentbankholdingcompanybusinessmodeldue
tothefactthatthesefinancialentitiesaredependentonshorttermsecuredfinancingto
fund their daily operations.5394 The near collapse of Bear Stearns, and ultimately, the
collapse of Lehman, is testimony to the fact that investment banks live and die by
liquidity.5395
After Bear Stearns fell, Lehman was widely regarded as the investment bank
secondmost dependent on shortterm secured financing.5396 A June 30, 2008 Morgan
StanleyresearchreportnotedLehmansdisproportionaterelianceonrepofunding
5393Bank for International Settlements, Basel Committee on Banking Supervision, Principles for Sound
LiquidityRiskManagementandSupervision(Sept.2008),atp.1.
5394See,e.g.,CurrentIssues:PDCF,atp.2(Primarydealers[i.e.,brokerdealers]relyheavilyontherepo
market the market for repurchase agreements to finance their portfolios of securities. . . . [T]he
primarydealersstandoutasthemarketslargestgroupofborrowers....Reposconstituteamajorsource
ofshorttermfinancingforbrokerdealers....).
5395DianeHinton,Standard&PoorsRatingsDirect,LiquidityManagementInTimesOfStress:HowThe
MajorU.S.BrokerDealersFare(Nov.8,2007),atp.3[LBHI_SEC07940_439424].
5396See, e.g., Morgan Stanley, Bruised, Not Broken and Poised for Profitability (June 30, 2008), at p. 8
[FRBNY to Exam.027135] (Given[Lehmans] relative size, lessdiverserevenue composition vs. larger

peers, and shortterm funding profile, the firm had to contend with heightened scrutiny leading up to
andfollowingtheliquidityrunonBearStearns.).
1406

a type of shortterm (usually overnight) financing.5397 As of the first quarter of 2008,
repo funding accounted for 5.7x of [Lehmans] liquidity reserve compared with 2.6x
forpeers.5398Inthesecondquarteroffiscalyear2008,repoborrowingsaccountedfor
nearly26%oftheliabilitiesonLehmansbalancesheet.5399Lehmansrelianceonshort
termreposfordaytodayfundingleftitvulnerabletotheriskofaliquiditycrisisinthe
event those repos stopped rolling. Lehman acknowledged this point in its public
filings,noting:
Liquidity, that is ready access to funds, is essential to our businesses.

Financialinstitutionsrelyonexternalborrowingsforthevastmajorityof
their funding, and failures in our industry are typically the result of
insufficientliquidity.5400
AninternalLehmandocumentnoted:Shorttermsecuredfinancingrepresents
thelargestsourceofsecuredfundingfortheFirm.Consequently,onekeyobjectiveisto
ensurethatthesefundingsourcesaremaintainedinadversemarketenvironments[.]5401
Thus,forafirmdependentonshorttermfinancing,theimportanceofliquiditytakeson
aspecialdimension.
5397Id.
5398Id.
5399Seeid.atp.17(AccordingtoatablecreatedbyMorganStanleyresearch,usingLehmancompanydata
andMorganStanleyresearchestimates,Lehmansbalancesheetincluded$158.677billionofSecurities
Sold Under Repo Agreements included in the Collateralized Borrowings portion of Lehmans
Liabilities.Totalliabilitieswereestimatedtobe$612.724billion.$158.677billionis25.9%of$612.724
billion.).
5400LBHI200710K,atp.17.
5401Lehman,FundingLehmanBrothers(Sept.11,2008),atp.6[LBHI_SEC07940_744139].
1407

(3) LehmansLiquidityPool
(a) ThePurposeandCompositionofLehmansLiquidityPool
In regulatory filings and disclosures to the public, Lehman represented that it
maintainedaliquiditypool...primarilyintendedtocoverexpectedcashoutflowsfor
twelvemonthsinastressedliquidityenvironment.5402Thepoolwasdesignedonthe
assumption that Lehman could not issue new unsecured debt or generate liquidity
outside that pool of assets to satisfy the expected cash outflows during the stressed
twelvemonthperiod.5403Theseexpectedcashoutflowsconsistedofobligationssuch
as: portions of longterm debt coming current; maturing shortterm, unsecured debt
suchascommercialpaper;andbankloansandhybridfinancialinstrumentscomingdue
within a oneyear span.5404 Additionally, the liquidity pool was designed to cover
contingent collateral calls in connection with Lehmans derivatives contracts, that is,
automatic collateral pledges to derivatives counterparties under ISDA (International
Swaps and Derivatives Association, Inc.) CSA (Credit Support Annex) agreements,
triggeredintheeventthatLehmansufferedaratingsdowngrade.5405
5402Lehman Brothers Holdings Inc., Quarterly Report as of May 31, 2008 (Form 10Q) (filed on July 10,
2008),atp.80(LBHI10Q(July10,2008)).
5403Id.
5404Seeid.
5405Seeid.atpp.8082(notingthattheliquiditypoolwassizedtocover,amongotherthings,additional
collateral that would be required to be posted against derivative contracts and other secured funding
arrangementsintheeventofaonenotchratingsdowngrade).
1408

Althoughthepoolwasprimarilyintendedtocoverexpectedcashoutflowsfor
twelve months in a stressed liquidity environment,5406 Lehman described the pool as
beingavailabletocoverothereventsaswell.Forinstance,Lehmanreportedthat[a]sa
last resort, the liquidity pool was available to the firm to mitigate the loss of
secured funding capacity.5407 Specifically, the liquidity pool was reported to be
available to mitigate a loss of repo capacity on at least $32 billion in illiquid
assets.5408
Lehmanreportedthesizeofitsliquiditypoolas$34billionattheendofthefirst
quarterof2008,5409$45billionattheendofthesecondquarter5410and$42billionatthe
end of the third quarter.5411 Intraquarter in 2008, following the near collapse of Bear
Stearns, Lehman, primarily through Laura Vecchio, head of the Project Management
Office,5412 and Global Treasurer Paolo Tonucci,5413 provided daily liquidity pool
5406Id.atp.80.
5407Id.atp.84.
5408Id.atp.85.
p.9.
5410FinalTranscriptofLehmanBrothersHoldingsInc.,SecondQuarter2008EarningsCall(June16,2008),
atp.10.
5411FinalTranscriptofLehmanBrothersHoldingsInc.,ThirdQuarter2008EarningsCall(Sept.10,2008),
atp.11.
5412VecchiotransmittedreportsregardingLehmansliquiditypoolandriskmanagementtotheFRBNY
and SEC; however, she did not create the reports. Rather, Treasury and Risk Management were
responsible for the contents of their respective reports. Examiners Interview of Laura M. Vecchio,
Apr.16,2009,atp.4.
5413TonucciprovidedverbalupdatestoFRBNYonsiteanalystJanVoigts.See,e.g.,FRBNY,LehmanIB
Update (July 11, 2008) [FRBNY to Exam. 008207] (summarizing updated liquidity pool and repo
informationgleanedthroughaDiscussionwithTreasurer).
1409

estimates to the SEC and FRBNY.5414 The quarterend figures disclosed to regulators
were the same as those disclosed publicly. The intraquarter liquidity pool estimates
weresimilartothosedisclosedatquarterend.5415
Lehmans 10Q for the second quarter of 2008 reported that the pool of assets
held to meet its maturing obligations was composed primarily of cash instruments,
governmentandagencysecuritiesandovernightrepurchaseagreementscollateralized
by government and agency securities.5416 In the second quarter of 2008, Lehmans
liquidity pool did indeed contain such assets: true to its regulatory filings and
disclosures,asofMay31,2008,themajorityofthepoolwasinvestedintreasuries,and
governmentandagencysecurities.5417
Lehman represented that its liquidity pool was unencumbered. After detailing
the composition of the liquidity pool, the second quarter 10Q provided [e]stimated
values of the liquidity pool and other unencumbered (i.e., unpledged) asset
5414See,e.g.,FEDDocumentation[LBEXWGM030111](attachmenttoemailwithlistofdocumentation
and verbal updates that Lehman was to provide to the FRBNY on daily, weekly, and quarterly bases.
Liquidity Pool Detail Footnoteand LiquidityExecutiveSummary were two dailywritten reports
distributedtotheFRBNY.TheFRBNYalsoreceivedadailyverbalEstimateofLiquidityPool.);email
fromLauraM.Vecchio,Lehman,toPaoloR.Tonucci,Lehman,etal.(Mar.31,2008)[LBEXWGM030110]
(attaching FED Documentation); Examiners Interview of Jan H. Voigts, Aug. 21, 2009, at p. 6
(confirming that the FRBNY received the documents listed in Vecchios March 31, 2008 email to
Tonucci).
5415See,e.g.,FRBNY,LehmanIBUpdates(Aug.18,2008Sept.12,2008)[FRBNYtoExam.007943](updates
producedbyFRBNYinthecourseofmonitoringLehmansliquidity;theintraquarterreportingforthird
quarter2008reflectsthatLehmanspoolfluctuated,dayoverdaybetween$38and$42billion).
5416LBHI10Q(July10,2008),atp.81.Inadditiontodescribingunencumberedassetsasunpledged
assets,Lehmanpubliclydescribedunencumberedassetsasthosethathavenotbeenfinancedagainst,
[andare]available...togetadditionalcashatanytime.TranscriptofLehmanBrothersHoldingsInc.,
FirstQuarter2008EarningsCall(March18,2008).
5417SeeLehman,DetailedLiquidityPoolComposition,(May31,2008),pp.114[LBEXBARLQP0000437].
1410

portfolios.5418Lehmanemphasizedtheliquid,unencumberednatureoftheassetsinits
liquiditypooltoregulators.Forexample,inapresentationtotheSECdatedMarch14,
2008,Lehmancharacterizeditsliquiditypoolascomposedofprimarilycashandcash
equivalents and unencumbered, liquid, investment grade collateral.5419 Likewise, in a
presentation to the Office of Thrift Supervision (OTS) on April 4, 2008, Lehman
represented that its liquidity pool was composed of primarily cash and cash
equivalents and unencumbered, liquid, investment grade collateral.5420 Similarly, in
materialspreparedforajointpresentationtotheFederalReserveandSECdatedMarch
26, 2008, Lehman held out its liquidity pool as invested in instruments that can be
monetizedatshortnoticeinallmarketenvironments.5421
Lehman emphasized the purportedly liquid, easytomonetize nature of its
liquidity pool to its significant repo counterparties and clearing banks as well. For
example, in response to inquiries about Lehmans liquidity pool by JPMorgans Mark
Doctoroff, Lehman Cash and Collateral Management head Dan Fleming said on
5419 Lehman, Presentation to: U.S. Securities & Exchange Commission, Liquidity & Funding 2008 Q1
Review (Mar. 14, 2008), at p. 5 [LBHI_SEC07940_446200] (emphasis added); see also email from Peter
Giacone,Lehman,toLauraM.Vecchio,Lehman,etal.(Mar.14,2008)[LBEXDOCID4227753](describing
themeetingashavinggoneverywellandhavinglastedabout90minutes).
5420 Lehman, Presentation to: OTS, OTS Quarterly Review, First Quarter 2008 (Apr. 4, 2008), at p. 26
[LBHI_SEC07940_473107] (emphasis added); see also email from Ronald S. Marcus, OTS, to Thomas
Francis, Lehman, et al. (Apr. 9, 2008) [LBEXDOCID 357853] (following up on the April 7 presentation
LehmanmaderegardingAudit,FinanceandRiskManagement).
5421 Lehman, Presentation to Federal Reserve and SEC, Liquidity Management at Lehman Brothers
(Mar.26,2008),atp.2[LBHI_SEC07940_741690](emphasisadded);seealsoemailfromPaoloR.Tonucci,
Lehman, to John F. Coghlan, Lehman, et al. (Mar. 28, 2008) [LBEXDOCID 125099] (forwarding the
presentationgiventhepreviousdaytotheSECandFederalReserve).
1411

September 2, 2008 that about 90% of Lehmans $42 billion liquidity pool was
invested in cash and cash equivalents, [g]overnment and [a]gency securities and E1
(majorindex)equities,allofwhichcanbemonetizedatveryshortnotice.5422Tonuccitold
the Examiner that Lehmans internal definition of a liquid asset, appropriate for
inclusion in the liquidity pool, was one that could be monetized within five days.5423
However, International Treasurer Carlo Pellerani was not familiar with this internal
definition, and the Examiner is not aware of any document that sets forth such a
definition of liquidity.5424 No law, SEC regulation or GAAPstyle rule governed the
definitionofaliquidassetinthecontextofaCSEsliquiditypool,althoughMatthew
Eichner,formerAssistantDirectoroftheSECsDivisionofTradingandMarkets,which
supervisedLehmanundertheCSEprogram,toldtheExaminerheconveyedtoLehman
thatassetsinitsliquiditypoolshouldbemonetizablewithintwentyfourhours.5425
5422EmailfromDanielJ.Fleming,Lehman,toMarkG.Doctoroff,JPMorgan,etal.(Sept.2,2008)[LBEX
AM042892](emphasisadded).Flemingalsodisclosedthat[t]hebalance...wasinvestedinLehman
CLOsecurities,twothirdsofwhicharebackedbycorporateloans,whichhavebeenrelativelyliquid.Id.
5423ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atp.17.Tonuccicouldnotciteaparticular
Lehmandocumentthatestablishedthisfivedaydefinition,buthestatedhisbeliefthatthiswasofficial
policy, predating his tenure as Global Treasurer. Id. Steven Engel, former Global Head of Funding at
Lehman,echoedthisstandard;hestatedthatassetsinLehmansliquiditypoolshouldbemonetizablein
aboutaweek.ExaminersInterviewofStevenJ.Engel,Oct.30,2009,atp.9&n.6.
5424ExaminersInterviewofCarloPellerani,Jan.13,2010,atpp.2,5.
5425 Examiners Interview of Matthew Eichner, Nov. 23, 2009, at p. 6. Eichner said that he conveyed to
Lehman the twentyfour hour monetization standard found in an SEC memorandum defining the
scope of SEC liquidity inspections; however, Eichner could not recall to whom at Lehman or when he
conveyedthemonetizationstandard.Id.SeealsoMemorandumfromPhillipMinnick,SEC,etal.,toErik
Sirri, SEC, et al., re: Parent Company Liquidity Inspections Scope Memorandum for the Consolidated
SupervisedEntities(CSE)(Feb.20,2008),atp.2[LBEXWGM017294](providingthetwentyfourhour
standard).ItislikelythatLehmansawthismemorandumaswell,giventhatitbearsaLehmanBates
stamp.
1412

(b) LehmanTestedItsLiquidityPoolandSharedtheResults
ofTheseTestswithRatingAgencies
Periodically, throughout2008, Lehmantested the adequacy of its liquidity pool
in selfrun analyses designed to ensure that liquidity could be mobilized to satisfy
obligations,notonlyovera12monthperiod,butalsoinamoresevereliquidityshock
closer to the run on the bank scenario that befell Bear Stearns.5426 For example, a
presentationdatedMay28,2008includedananalysisdesignedtotesttheadequacyof
Lehmans liquidity pool against a stressscenariothreetofour timesmoresevere than
whatLehmanexperiencedduringtheBearStearnscrisistheweekofMarch17,2008.5427
In that analysis, Lehman entered a hypothetical fourweek stress period with a $44.4
billionliquiditypool,andsuccessfullyweatheredthescenario,retaining$20.5billionat
theendofthestressperiod.5428Lehmanthereafterdisclosedinitspublicfilingsthatthe
liquidity pool was available to mitigate[] the cash outflows contemplated in its
liquiditystresstesting.5429
5426 See, e.g., Lehman, Presentation to the Federal Reserve, Update On Capital, Leverage & Liquidity
(May28,2008),atpp.514[LBHI_SEC07940_527576](includingaliquiditystressscenariodesignedtotest
theadequacyofLehmansliquiditypool).
5427Id.atp.12.
5428Id.atp.13.
5429LBHI10Q(filedJuly10,2008),atp.85.Theseliquiditystresstests,conductedbyLehmansTreasury
function, are distinct from Lehmans market risk stress tests conducted by Lehmans Market Risk
Managementfunction.SeeLehman,ICAAPSupportingDocument:MarketRiskManagementOverview
(May2008),atp.19[LBEXDOCID383057].
1413

Although such analyses were originally developed at the request of Lehmans
regulators,5430 Lehman distributed the results of the stress tests to rating agencies,
counterparties,andothermarketparticipants.Thefirmdistributedonesuchanalysisto
Standard&Poorsinthethirdquarterof2008atimewhenLehmanwasbesiegedby
short sellers, market rumors, and increasingly large CDS spreads, and was pressed to
demonstrateitsabilitytowithstandaloomingliquiditycrisis.5431Similartotheanalyses
sharedwithregulators,thisscenarioassumedLehmanwouldincursubstantiallossesin
bothsecuredandunsecuredfunding,andcontingentcollateralcallstriggeredbyatwo
level ratings downgrade. More specifically, the stress scenario assumed a significant
loss in Lehmans ability to obtain shortterm secured financing from its repo of asset
backed securities, equities and corporates, as well as prime broker free credit
balances.5432 Further, the analysis assumed Lehman would not be able to roll its
unsecured shortterm debt or commercial paper.5433 While these liquidity sources
evaporated, outstanding debt obligations would continue to come due, requiring
Lehman to draw on its liquidity pool to satisfy maturing shortterm debt, current
portions of its maturing longterm debt, commercial paper, and CSAmandated
5430ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atp.22;JointRequestofSECandFRBNY:
LiquidityScenariosforCSEs(May20,2008),atp.1[LBHI_SEC07940_505195];Lehman,Finance&Risk
Committee of the Board: Risk, Liquidity, Capital And Balance Sheet (Sept. 9, 2008), at. p. 11
[LBHI_SEC07940_742509].
5431Lehman,Standard&PoorsOverviewofLehmans3Q2008,ResultsandGamePlan(Sept.5,2008),at
pp.4142[LBHI_SEC09740_747779].SeeSectionIII.A.3ofthisReport,whichdiscussesLehmansfinancial
conditionduringthethirdquarterof2008.
5432Id.atp.41.
5433Id.
1414

collateral calls.5434 According to Lehmans analysis, its $42 billion liquidity pool,
combined with LBIs, LBIEs, LBJs and Bankhaus liquidity pools, would allow it to
withstand a fourweek liquidity shock and emerge from the crisis with a $13 billion
cashposition.5435
RepresentationsAboutItsLiquidityPool
On the basis of Lehmans reported liquidity pool, specifically its reported size
and composition of easytomonetize assets, market participants formed positive
opinions of Lehmans liquidity profile. Certain influential participants, and rating
agencies in particular, cited Lehmans liquidity pool as the basis for concluding that
Lehmansliquiditypositionwassound.Forexample,anApril15,2008Moodysreport
titled Liquidity Risk Assessment: Lehman Brothers Holdings Inc. concludes:
Moodys views the liquidity profile of [LBHI] as very strong.5436 The basis for
Moodys assessment of Lehmans liquidity, the report continues, is the strength of
their overall funding framework, which includes an ample liquidity cushion of high
qualityunencumberedassets.5437
5434 See id. (noting that the liquidity stress scenario assumed that CSA agreements would require
additional collateralization and that loans would continue to be funded per the funding schedule for
leveragedloans).
5435Id.atp.42.
5436 Moodys Investment Service Global Credit Research, Liquidity Risk Assessment: Lehman Brothers
HoldingsInc.(Apr.15,2008),atp.1[LBHI_SEC07940_090274].
5437Id.
1415

Even as late as September 11, 2008 less than two business days before LBHI
filed for bankruptcy market analysts cited Lehmans large liquidity pool as support
fortheconclusionthatthefirms[l]iquidityriskappearslow.5438Inaresearchmemo
recommendinganeutralratingforLBHI,TheBuckinghamResearchGroupanalysts
cited Lehmans $42 billion reported liquidity pool, along with its lack of reliance on
primebrokeragefreecreditbalancesandaccesstotheFederalReservesPrimaryDealer
CreditFacility(PDCF)window,toreachtheconclusionthat[Lehman]remainswell
positioned in a run on the bank scenario;5439 and: [B]ottom line, run on the bank
scenarioriskseemsverylowwithrespectto[Lehman].5440ThusLehmanslarge,and
reportedlyunencumbered,liquiditypoolgaveratingagenciesandmarketparticipants
a positive impression of Lehmans liquidity and financial viability right up to the
daysimmediatelyprecedingLBHIsbankruptcy.
5438TheBuckinghamResearchGroup,LehmanBrothers(LEH),RatingAgencyRiskTooHigh(Sept.11,
2008),atp.3[LBEXWGM928802].
5439Id.
5440Id.
1416

(4) LehmansClearingBanksSoughtCollateralPledgesandCash
DepositsToSecureIntradayCreditRisk;LehmanIncluded
ThisCollateralinItsLiquidityPool
AfterthesuddennearcollapseofBearStearnsinMarch2008,counterpartiesand
clearing banks focused their attention on those institutions regarded as the nextmost
vulnerable.Lehman,withitslargeleverageratiosandrealestateheavybalancesheet,
waswidelyseenasaparticularlyvulnerablefirm.5441Inaprogressionofevents,banks
demanded collateral from Lehman; Lehman met those demands but continued to
includethecollateralinitsliquiditypool.
(a) LehmanPledgedCLOsandOtherSecuritiestoJPMorgan
ThroughouttheSummerof2008toMeetTripartyRepo
MarginRequirements
JPMorgan served as Lehmans clearing bank for triparty repos.5442 In a triparty
repo, Lehman pledged collateral to a counterpartys account at JPMorgan, typically
overnight in exchange for cash, which was then transferred to Lehmans account at
JPMorgan. The following morning the repo matured, and JPMorgan unwound the
trade: Lehman returned the cash, plus interest, to the repo counterpartys account,
5441 See, e.g., Examiners Interview of BenS. Bernanke, Dec. 22, 2009, at p. 6 (Bernankeknew Lehman
wastheweakestoftheinvestmentbanks,afterBearStearns);ExaminersInterviewofTreasurySecretary
Timothy F. Geithner, Nov. 24, 2009, at p. 2 (after Bear Stearns nearly collapsed, Geithner regarded
Lehman as the weakest investment bank, followed by Merrill Lynch); Jenny Anderson, At Lehman,
Allaying Fears About Being the Next to Fall, N.Y. Times, Mar. 18, 2008 (noting similarities between Bear
Stearns and Lehman business models, in particular reliance on shortterm financing and the mortgage
market).
5442SeeSectionIII.A.5.bofthisReport,whichdiscussesLehmansdealingswithJPMorgan.JPMorganis
oneofonlytwoclearingbanksprovidingtripartyrepoclearingservicesintheUnitedStates.Theotheris
BankofNewYorkMellon.WorkingGrouponGovernmentSecuritiesClearanceandSettlement,Report
totheFederalReserveBoard(Dec.2003),atp.10.
1417

while the counterparty returned the collateral to Lehman. To facilitate the unwind
process,JPMorganadvancedLehmanintradaycredit,securedbythecollateralreturned
by triparty investors, which was, ideally, repaid by the end of the day as Lehman re
bookedtrades.5443
JPMorgan historically gave full value to the securities pledged by Lehman
securing intradaycredit advances. Citing [m]arket [r]isk inherent in tripartyrepo
financing, JPMorgan advised Lehman in February 2008 that it would begin applying
haircuts to collateral that Lehman posted to secure intraday credit advances.5444 As
originally envisioned by JPMorgan, this margin requirement would be phased in
incrementallyoverthecourseoffivetosixweeks.5445Thesizeofthehaircutwastobe
equivalent to the haircut that triparty investors imposed on Lehman collateral.5446 In
other words, JPMorgan would retain intraday the same margin that triparty investors
heldovernight.UponlearningofJPMorgansproposaltodiscountLehmancollateral,
FlemingelevatedtheissuetoTonucci,noting:The[haircut]proposalmaycreatevery
5443SeeSectionIII.A.5.bofthisReport,whichprovidesamoredetaileddiscussionofJPMorgansrolein
clearing Lehmans tripartyrepo trades; see also Counterparty Risk Management Policy Group III,
Containing Systemic Risk: The Road to Reform (Aug. 6, 2008), at p. 114 (noting that clearing banks extend
intraday credit to dealers through unwinding triparty repos at the beginning of the trading day by
creditingthetripartyinvestorsaccountonbehalfofthedealer).
5444Email from Janet Birney, Lehman, to Daniel J. Fleming, Lehman et al. (Feb. 26, 2008)
[LBHI_SEC07940_436414].
5445Id.Itultimatelytookthecourseofthesummer.SeeSectionIII.A.5.bofthisReport,whichdiscusses
LehmansdealingswithJPMorgan.
5446 Email from Janet Birney, Lehman, to Daniel J. Fleming, Lehman et al. (Feb. 26, 2008)
[LBHI_SEC07940_436414].
1418

sizeableintradayliquiditychallengesforus.5447Thus,Flemingrecognizedthismargin
requirementcreatedatensionbetweentwocompetingprioritiesforLehman:providing
its clearing banks with adequate security so that Lehman could continue obtaining
shorttermsecuredfinancing,whilesimultaneouslyattemptingtomaintainitsreported
liquiditypool.5448
Subsequently, JPMorgan imposed the investor margin in 20% increments
beginning on March 17, 2008.5449 The full tripartyinvestor margin was imposed by
August14,2008.5450
JPMorgansmarginrequirementsnegativelyaffectedLehmansNetFreeEquity
(NFE).5451 NFE was the measure of risk exposure that JPMorgan calculated to
determinewhetheritwouldcontinueextendingclearingadvancestoitsclientbroker
dealers.5452 In its simplest form, NFE was the market value of Lehman securities
pledged to JPMorgan plus any unsecured credit line JPMorgan extended to Lehman
5447Email from Daniel Fleming, Lehman to Paolo R. Tonucci, Lehman (Feb. 26, 2008)
[LBHI_SEC07940_436414].
5448FlemingwasnotreferringspecificallytotheliquiditypoolinhisFebruary26,2008email;rather,he
was referring to potentialintradayliquidityissues. These are, however, two sides of the same coin,as
intradayliquidityshortfallsmayhaverequiredLehmantodipintoitsliquiditypool.
5449SeeSectionIII.A.5.bofthisReport,whichdiscussesLehmansdealingswithJPMorgan.SeeJPMorgan
SecondWrittenResponses,atp.4.
5450Email from Craig L. Jones, Lehman, to Paolo R. Tonucci, Lehman, et al. (Aug. 14, 2008) [LBEXAM
001764](informingTonuccithattheintradaymarginimposedbyJPMorganreached100%thatday).The
totalamountofthehaircutwas~$5bn.Id.
5451SeeemailfromJanetBirney,Lehman,toJackFondacaro,Lehman,etal.(May2,2008)[LBEXDOCID
036292]; Discussion Points [LBEXDOCID 077455] (noting that changes to JPMorgans margin
requirementswouldimpactLehmansNFE).
5452 See Section III.A.5.b of this Report, which discusses Lehmans dealings with JPMorgan, and NFE in
particular.
1419

minus cash advanced by JPMorgan to Lehman.5453 An NFE value greater than zero
indicatedthatLehmanhadnotdepleteditsavailablecreditwithJPMorgan.Ifatrade
would put NFE below zero, that trade would be stopped.5454 Fleming relayed to the
ExaminerthatanNFEdeficitwouldresultinaninabilitytoclearparticulartriparty
repo trades a scenario which he characterized as disastrous for Lehman, given
Lehmansdependenceontripartyrepofinancing.5455
Additionally, JPMorgan concluded that tripartyrepo investors had themselves
inadequatelyassessedrisksinthemarginstheycharged.5456Thus,inordertomitigate
liquidation and price risk, JPMorgan advised Lehman, as well as other brokerdealer
clients,thatadditionalmarginwouldberequired,basedoncollateraltype, aboveand
beyond the margin required by tripartyrepo investors. JPMorgans new riskbased
margin would take into account liquidation risk (to account for oneday price
5454Id.
5455ExaminersInterviewofDanielJ.Fleming,Sept.24,2009,atpp.45,7.Whenaskedwhatwouldhave
happened if JPMorgan ceased to provide secured financing on an intraday basis through its clearing
services, Fleming responded: September 15 [2008] [the date of LBHIs bankruptcy filing] is a good
exampleofwhathappens.Id.atp.5.Laterintheinterview,FlemingreiteratedthatwithoutJPMorgans
clearingservices,Lehmanwouldntbeabletoopenitsdoors.AndalossofJPMorganclearingservices
wouldbeakintohavingnogasinyourcar.Id.atp.7.SeeSectionIII.A.5.b.1.cofthisReport,which
discussesLehmansdealingswithJPMorgan,tripartyrepos,andNFE.
5456 Examiners Interview of Ricardo S. Chiavenato, Sept. 21, 2009, at pp. 910; Examiners Interview of
BarryL.Zubrow,Sept.16,2009,atp.4(overnightinvestorswerenotoverlyconcernedaboutliquidation
pricingbecausetheyassumedclearingbankswouldunwindsecurities).
1420

volatility for securities) and price risk (an estimate of potential vendorprice
overstatementforilliquidsecurities).5457
Lehman initially transferred roughly $5.7 billion face value in collateral to
JPMorgan on June 19, 2008, to begin covering riskbased margin.5458 This collateral
consistedofcertaincollateralizedloanobligations(CLOs)includingFreedom,Spruce
and Pine, a commercial real estate (CRE) collateralized debt obligation (CDO)
known as SASCO and the assetbacked commercial paper (ABCP) known as
Fenway.5459
Lehman continued to transfer collateral to JPMorgan after the initial June 19,
2008 delivery. By the beginning of August 2008, as part of continuing efforts by
LehmantomitigatetheeffectsofJPMorgansmarginrequirements,Lehmanhadposted
approximately $9 billion of collateral at JPMorgan.5460 By August 7, 2008, an LBI
clearance account at JPMorgan called LCD held securities called Freedom, Pine,
5458EmailfromCraigL.Jones,Lehman,toJohnFeraca,Lehman,etal.(June19,2008)[LBEXAM001775]
(Todaywemovedseveralunencumberedassets(Sasco,Freedom,Spruce,Pine,Fenway)toLCPIsDTC
boxatChase);JPMorganSecondWrittenResponses,atp.5.
CLOsandCDOsareformsofassetbackedsecuritiesthatderivetheirvaluefromunderlyingassets;inthe
case of these two security types, revenue streams from loan and debt payments respectively. ABCP is
commercialpaperthatderivesitsvalueinpartfromunderlyingassetsratherthansolelyfromitsissuers
promisetopay.
5460Email from Janet Birney, Lehman, to Paolo R. Tonucci, Lehman, et al. (Aug. 5, 2008)
[LBHI_SEC07940_534733];emailfromRicardoS.Chiavenato,JPMorgan,toEdwardJ.Corral,JPMorgan,
et al. (Aug. 5, 2008) [JPM2004 0061153] (noting that JPMorgan held $9 billion in Lehman collateral).
AlthoughinanAugust5,2008emailChiavenatoreferredtoLehmanscollateralascomingfromLCPI,
JPMorgancounselstatedthatthisemailisincorrectinthatregard;thecollateralwaslocatedinLCD,an
accountownedandpledgedbyLBI.SeeJPMorganSecondWrittenResponses,atpp.56.
1421

Spruce,Verano,SASCO,Kingfisher,HDSupplyandFenway.5461SecuritiesheldinLCD
contributedtoLBIsNFE.5462Then,fromAugust8to11,2008,Lehmantransferredthe
Spruce, Freedom, Pine, Kingfisher, Verano, and Fenway securities from LCD to an
LBHI account at JPMorgan called LCE.5463 Securities in LCE did not contribute to
LBIs NFE; yet LBHI was operationally required to maintain securities valued at $5
billion in the LCE account.5464 On August 15, 2008, Lehman removed Freedom from
LCEandonSeptember2,LehmantransferredKingfisherfromLCEtoLCD.5465
(b) TheSecuritiesPostedtoMeetJPMorgansMargin
RequirementsWereIncludedinLehmansLiquidityPool
Lehman posted five securities with JPMorgan on June 19, 2008 (SASCO,
Freedom, Spruce, Pine,and Fenway).5466On thatsamedate, Lehman included four of
thefivesecuritiesinitsliquiditypool(SASCO,Spruce,Pine,andFenway).5467
5461SeeJPMorganSecondWrittenResponses,atpp.56.
5462Seeid.
5463 See, e.g., email from Michael Prestolino, Lehman, to Craig L. Jones, Lehman, et al. (Aug. 8, 2008)
[LBEXDOCID 046703]; Lehman, Prices for LCD Box (Aug. 8, 2008) [LBEXDOCID 023772] (showing
prices for Freedom, Pine, Spruce, Verano assets located in the LCD box, and noting that they are to be
transferredtoLBHI).
5464 JPMorgan First Written Responses, at p. 10 (noting that, because Lehman had the ability to move
collateralinandoutoftheLCEaccountbutJPMorganwantedLehmantokeepcollateralintheaccountto
securemarginrequirements,JPMorganplaceda$5billiondebitontheLCEaccount,requiringLehmanto
maintainatleastthatamountinLCE);seeemailfromMichaelA.Mego,JPMorgan,toKarenM.Sharf,
JPMorgan, et al. (Aug. 23, 2008) [JPMEXAMINER00005942] (describing the $5 billion debit); see also
SectionIII.A.5.bofthisReport,whichdiscussesLehmansdealingswithJPMorgan.
5465JPMorganSecondWrittenResponses,atpp.78;seealsoAppendix18ofthisReport,whichdiscusses
LehmanscollateralatJPMorgan.
(Todaywemovedseveralunencumberedassets(Sasco,Freedom,Spruce,Pine,Fenway)toLCPIsDTC
boxatChase);JPMorganSecondWrittenResponses,atp.5.
1422

Tonucci acknowledged that at least some of the securities posted to meet
JPMorgans margin requirements were included in Lehmans liquidity pool.5468 A
JPMorgan internal agenda from a September 4, 2008 meeting with Lehman reflects
JPMorgansknowledgethatthesecuritieswereincludedinLehmanspool.5469
The Examiner has reviewed detailed CUSIPbyCUSIP inventories of the
liquiditypoolfordatesinMarchthroughSeptember2008.Thefollowingtableshows
the securities collateral that Lehman transferred to either the LCD or LCE collateral
accountsatJPMorganandsimultaneouslyincludedintheliquiditypool.
5467Lehman,DetailedLiquidityPoolComposition(June19,2008),atpp.2122[LBEXBARLQP0002062]
(showingSASCO,Spruce,Pine,andFenwaysecuritiesintheliquiditypool).
5469 JPMorgan, Lehman Brothers Holdings Inc. Briefing Memorandum (Sept. 4, 2008), at p. 2 [JPM2004
0006170].
1423

PledgeValue(in$billions)ofJPMorgan
SecuritiesCollateralintheLiquidityPool5470

19Jun 10Jul 24Jul 14Aug 11Sep
Freedom 1.1
Pine 1.0 1.0 0.1 1.0 0.9
Spruce 1.0 0.9 0.8 0.8 0.7
Verano 1.3 1.2
SASCO 1.1 1.1 0.9 1.7 0.5
Fenway 1.7 1.0 2.0
Kingfisher 0.8 0.8 0.8 0.9

Total
CDO/ABCPIn
theLiquidity
Pool: 4.8 4.8 4.6 6.7 4.2
As the table indicates, as of June 19, 2008, the date that Lehman initially
transferred the securities collateral to JPMorgan, $4.8 billion of the liquidity pool was
comprisedofassetspostedtoJPMorganclearingaccounts.
(c) OnJune12,2008,LehmanTransferred$2BilliontoCitias
ComfortforContinuingCLSSettlement
Citibank,N.A.wasLBIsagentbankontheCLSsystem.5471TheCLSsystemwas
atradingplatform,operatedbyaconsortiumofbanks,fortheclearanceandsettlement
5470Duff&Phelps,LBHISecuritizationsintheLiquidityPool(Jan.10,2010)(datacompiledbycomparing
securities in the LCE and LCD Position Summaries for specified dates (sourced from RCBPPR92
Reports)withtheDetailedLiquidityPoolCompositionsforthosesamedates).
5471 See Section III.A.5.c of this Report, which discusses Lehmans dealings with Citigroup. The LBI
Citibank CLS relationship was established by a CLS Settlement Services Agreement for CLS User
MembersdatedDecember19,2003.ThisCLSagreementwasamendedandrestatedinaCitibankCLS
SettlementServicesAmendedandRestatedAgreementforCLSUserMembersdatedOctober28,2004.
ReferencestotheCLSAgreementrefertotheagreementasamendedandrestated.
1424

ofFXtrades.5472AsausermemberoftheCLSsystem,LBIreliedonCititoexecuteits
FX trades on CLS.5473 In doing so, Citi would extend intraday credit to LBI, and by
extensionassumeacertainamountofintradayriskinconnectionwiththatcredit.5474
OnJune5, 2008, Lehmanpreviewedits secondquarterearningsannouncement
toCiti,inwhichLehmandisclosedananticipatedrecord$2.6billionloss.5475CFOErin
Callanformallydeliveredtheannouncementofa$2.8billionlossonJune9.Themarket
reacted poorly.5476 Lehman announced on June 12 that Callan and Lehman President
and COO, Joe Gregory, had been removed from their positions.5477 As a result of
Lehmans rapidly declining stock price and negative market reactions to Lehmans
earningsannouncement,Citiexperiencedathreefoldincreaseinnovationrequests.5478
Citibank risk manager Thomas Fontana stated, in an internal June 12 Citi email
5472 See Section III.A.5.c of this Report, which discusses Lehmans dealings with Citigroup; Examiners
InterviewofJonathanD.Williams,Aug.5,2009,atp.5.
5473ThreeotherLehmanentitieswereusermembers.SeeSectionIII.A.5.cofthisReport,whichdiscusses
LehmansdealingswithCitigroup.ExaminersInterviewofJonathanD.Williams,Aug.5,2009,atp.5.
5474 See Section III.A.5.c of this Report, which discusses Lehmans dealings with Citigroup; see also
Lehman,CitibankClearingandIntradayCredit(June17,2008),atp.3[LBHI_SEC07940_745595](noting
thatCitibanksprovisionofintradaycreditisnecessaryforefficientCLSsettlement).
5475 Lehman, Q2 2008 Update (June 4, 2008), at p. 2 [CITILBHIEXAM 00078768]; email from Michael
Mauerstein, Citigroup, to Christopher M. Foskett, Citigroup, et al. (June 4, 2008) [CITILBHIEXAM

00081461](describingtheagendafortheJune5meetingasincludingalookatLehmanssecondquarter
results).
5476 Email from Thomas Fontana, Citigroup, to Christopher M. Foskett, Citigroup, et al. (June 12, 2008)
[CITILBHIEXAM00072923](notingnegativemarketreaction).
5477Id.(FuldoustCFO[Callan]andCOO[Gregory].LowittbroughtbacktoCFOrole.).
5478 Lehman, CITIGROUP Call Report (June 17, 2008), at p. 1 [LBEXAM 008578] (recounting remarks
madebyCitiCROBrianLeachinaJune17,2008meetingwithLehman).Inanovation,theclearingbank
steppedintothecounterpartysshoes,andfacedLehmandirectlyinatrade.Theclearingbankbecame
fullyexposedtothetradingrisksassociatedwithfacingLehman.
1425

exchange,thatCitiwaspassingonnovationrequestsandlossofconfidenceinLehman
washuge.5479
Citi was loath to reject these counterparty requests and desired additional
securityfortheincreasedriskexposureitfacedinnovatingthesetrades.5480Inalatere
mail in the same chain, Fontana wrote that Citis internal team has lost complete
confidence[inLehman].Notellingwhatwillhappen.5481
Thus, on June 12,2008,FleminginformedLowitt(onhisfirstdayon thejob as
CFO) that Citi was seeking a $3 to 5 billion cash deposit to cover its intraday
exposure.5482Laterthatday,Lehmanagreedtodeposit$2billionwithCitibank.5483Inan
emailtoLowittandTonucci,Flemingcharacterizedthetermsofthedepositas:[n]o
lienorrightofoffset,astraightovernightfedfundsdeposit.5484Theassumptionthat
thedepositwasfreelyreturnable,anddistinguishablefromapledgeofcollateral,was
5480 Jasmin Herrera, Lehman, Global Creditor RelationsHighlights Citigroup (June 16, 2008), at p. 1
[LBEXAM008660](UntilJune12,2008,CitibankhasconsistentlybeenLehmansstrongestproviderof
credit.However,duetoasubstantialincreaseinnovationrequestsfromcounterparties,Citirequested
thatwecollateralize$3$5Binintradayexposure.Lehmandeclined,butdidagreetoa$2Btermdeposit,
callabledaily.).
5482EmailfromDanielJ.Fleming,LehmantoIanT.Lowitt,Lehman(June12,2008)[LBEXAM008609];
JasminHerrera,Lehman,GlobalCreditorRelationsHighlightsCitigroup(June16,2008),atp.1[LBEX
AM008660](statingthatCitirequestedLehmancollateralize$35billioninintradayexposure).
5483 Email from Daniel J. Fleming, Lehman to Ian T. Lowitt, Lehman, et al. (June 12, 2008) [LBEXAM
008608].CitihadrequestedandreceivedasimilardepositfromBearStearnsinthesummerof2007.E
mailfromChristopherM.Foskett,Citigroup,toJohnHavens,Citigroup,etal.(June12,2008)[CITILBHI
EXAM00026400].
5484 Email from Daniel J. Fleming, Lehman to Ian T. Lowitt, Lehman, et al. (June 12, 2008) [LBEXAM
008608].
1426

widelyheldwithinLehman.5485InhisinterviewwiththeExaminer,Tonuccistatedthat
there were no restrictions on Lehmans ability to get the deposit back.5486 He also
stated that the deposit was a good faith deposit intended to maintain Citibanks
good will.5487 Lehman was always beholden to an extent on the good will of its
clearingbanks,Tonucciexplained.5488
LehmansinternalstatementsthatCitididnothavearightofoffsetagainstthe
deposit and that no conditions attached to the return of the deposit were not shared
within Citi. It was Citis view that under either New York state law or the Uniform
Commercial Code, Citibank had a right of setoff against the $2 billion.5489 Citi
recognized that it was not secured by a pledge agreement.5490 Fontana, in one email,
notedthatasimilardepositagreementCitireachedwithBearStearnsayearearlierwas
betterthanthatwithLehmanbecauseitprovidedarighttooffset,whereastherewasno
clean right of offset with respect to the Lehman deposit.5491 Michael Mauerstein, a
relationshipmanagerforLehmanatCitigroup,alsocontrastedtheLehmandepositwith
5485 For example, an internal Lehman agenda for a meeting with Citibank, dated June 17, 2008, stated:
LehmandidnotagreetopledgecashorgivetherighttosetoffoncollateralasCitirequested,butwe
reluctantly did agree to deposit $2B in a call account, callable daily. Lehman, Citigroup Agenda
(June17,2008),atp.2[LBEXAM008597].
5487Id.
5488Id.
5489 Examiners Interview of Thomas Fontana, Aug. 19, 2009, at p. 5; Examiners Interview of Michael
Mauerstein,Sept.16,2009,atp.5;ExaminersInterviewofChristopherM.Foskett,Sept.24,2009,atp.5.
5490 Email from Paul S. Galant, Citigroup, to Jerry Olivo, Citigroup, et al. (Aug. 29, 2008) [CITILBHI
EXAM00076678](distinguishingbetweenthe$2billiondepositandaformalpledgeofsecurities).
1427

theBearStearnsdeposit,notingthatLehmanwasnotborrowingfromCitiandhadnot
executedapromissorynotewithrightofoffsetlanguagewithLehmanasithadwith
BearStearns.5492InlateAugust,however,MauersteinstatedthatalthoughCitididnot
view the deposit as collateral and that Lehman could ask [for it] to be returned at
any time, we consider that we have a right of offset under NYS [New York state]
law.5493 In response to Mauersteins email highlighting the distinction between
treating the $2 billion as collateral versus a deposit, Citibanks Jerry Olivo stated,
Mike,Iamawareandunderstandallofthisthoughtheiraskingforthedepositback
doeshavedistinctimpactsonclearingcapacity.5494
WhileLehmancharacterizedthe$2billiondepositasanovernightdepositwith
no strings attached, Citibank subjected it to a number of internal controls designed to
keepthe$2billionwithinCiti.ShortlyafterLehmanmadethedeposit,Fontanastated
inaninternalCitiexchangethathismainconcernswerekeepingtheliquidity[ofthe
deposit]withinCitiandbeingabletocontrolthereleaseofthedeposit.5495Withthose
5493EmailfromMichaelMauerstein,Citigroup,toKatherineLukas,Citigroup,etal.(Aug.29,2008)[CITI
LBHIEXAM 00076678]. In this same email exchange, Citigroups Paul Galant also stated: Overnight
depositsthatcanbeyankedatanytimebytheclientcountfornothingasitrelatestocollateral/security
interest.GalantthendirectedMauersteinandhisteamtogetacollateralpledgeofsecuritiestoreplace
the deposit as soon as possible. Email from Paul S. Galant, Citigroup, to Jerry Olivo, Citigroup, et al.
(Aug.29,2008)[CITILBHIEXAM00076678].
5494 Email from Jerry Olivo, Citigroup, to Michael Mauerstein, Citigroup, et al. (Aug. 29, 2008) [CITI
LBHIEXAM00076678].
5495EmailfromThomasFontana,Citigroup,toRobertBlackburn,Citigroup,etal.(June19,2008)[CITI
LBHIEXAM00018405].
1428

concernsinmind,CitisetupanotificationstructurewherebyCitisRiskTreasurydesk
was instructed to notify Fontana of any Lehman request for the deposit prior to the
releaseofthedeposit.5496
IndiscussionsconcerningthemostappropriateinterestratetoprovideLehman
on the $2 billion, and how to count the comfort deposit internally within Citis
systems,Olivocharacterizedthedepositasessentiallycaptivefunds.5497Additionally,
Citi described the comfort deposit internally as an overnight investment that gets
rolled on a daily basis and explained that a process was in place for Fontana to be
notifiedbeforeanywithdrawalwasmade.5498
Fontana confirmed that a notification process such as the one described above
governed the release of the deposit. Fontana said that while Citi would likely have
releasedthedepositifasked,Citiwouldhavedecidedinternallyifitwouldcontinueto
conductbusinessasusualwithLehmanpriortoreleasingthedeposit.5499
Thus,whileLehmanconsideredthedeposittobelienfreeandofferedmerelyas
agoodfaithgesturetomaintainapositiveworkingrelationship,Citibelievedthatit
had the right to set off against the deposit, and that withdrawal of the deposit would
5496Id.
5497EmailfromJerryOlivo,Citigroup,toRobertBlackburn,Citigroup,etal.(June25,2008)[CITILBHI
EXAM00020787].
5498 Email from Katherine Lukas, Citigroup, to Ranjit Chatterji, Citigroup, et al. (Aug. 27, 2008) [CITI
LBHIEXAM00020787].
1429

have negative implications for Citis ability to clear for Lehman.5500 Further, Citi
subjectedthedeposittoaninternalprocedureunderwhichreleaseofthedepositwould
havebeensubjecttoitsriskdesksnotificationandapproval.
(d) TheCitiComfortDepositWasIncludedinLehmans
LiquidityPool
TonucciacknowledgedthatLehmanincludedthecomfortdepositinLehmans
liquidity pool.5501 Fleming stated that, because Lehman was at least legally entitled to
the$2billiondepositanditwasreturnableonrelativelyshortnotice,itwasappropriate
for Lehman to include it in the liquidity pool.5502 Yet Erin Callan, when asked if she
would have included in the liquidity pool deposits that were required to conduct
business,suchasthe$2billioncashdepositwithCiti,saidsheprobablywouldnothave
been comfortable doing so.5503 Lehman International Treasurer Carlo Pellerani,
although unaware that Lehman included clearingbank collateral or deposits in its
liquidity pool, agreed that funds allocated to clearing banks to cover exposures,
intraday or otherwise, were not appropriate for inclusion in the liquidity pool.5504
Similarly,SteveEngel,formerLehmanSeniorVicePresident,FundingDesk,expressed
hisdisagreementwithLehmansdecisiontoincludethe$2billioncashdepositatCitiin
5500LehmanmanagementknewatleastasofearlyAugustthatCitibankbelievedithadarighttooffset
the deposit. See Lehman, CITIGROUP Call Report (Aug. 7, 2008), at p. 1 [LBEXDOCID 450310]
(reportingthatCitibankbelievedithadarighttooffsetthedeposit).
5503ExaminersInterviewofErinM.Callan,Oct.23,2009,atpp.4,16.
1430

itsliquiditypool.5505Hereasonedthat,iftheassetswerenotreadilyconvertibletocash
orcapableofbeingrepoed,theydidnotbelongintheliquiditypool.5506
Citi understood that Lehman included the $2 billion deposit in its liquidity
pool.5507FromMauersteinsperspective,Lehmansdecisionaboutwhattoreportinits
liquiditypoolwasamatterbetweenLehmananditsregulators.5508Foskett,Mauerstein
and Fontana each acknowledged that they did not consider the June 12 cash deposit
formallyencumberedwhenitwasinitiallymade.5509
Officials from the SEC advised the Examiner that they knew Lehman included
the$2billionCitidepositinLehmansliquiditypool,andthattheSECdidnotthinkit
wasappropriateforLehmantoincludethesefundsinitsliquiditypool.5510Accordingto
the SEC, the issue was escalated internally at the SEC and the SEC discounted those
5505ExaminersInterviewofStevenJ.Engel,Oct.30,2009,atp.10.
5506Id.
5507ExaminersInterviewofThomasFontana,Aug.19,2009,atpp.2,5.However,Fontanadidnotknow
whetherLehmanwasincludingotherclearingbankdepositsorpledgesinitspool.Whenpresentedwith
suchahypothetical,Fontanastated,thewholething[pool]couldhavebeenpledgedout!andsaidthis
wasaquestionCitishouldhaveaskedatthetime.Id.atp.5;emailfromMichaelMauerstein,Citigroup,
to Thomas Fontana, Citigroup, et al. (June 17, 2008) [CITILBHIEXAM 00073791]; email from Michael
Mauerstein, Citigroup, to Christopher M. Foskett, Citigroup, et al. (July 2, 2008) [CITILBHIEXAM
00073015](Mauersteinwrotethat[w]eshouldremind[people]inourorganizationthatLehmanhas$50
billion of holding company cash/liquidity (including the $2B with us) and access to the Fed discount
window);ExaminersInterviewofChristopherM.Foskett,Sept.24,2009,atp.5.
5509 Examiners Interview of Christopher M. Foskett, Sept. 24, 2009, at p. 5; Examiners Interview of
MichaelMauerstein,Sept.16,2009,atp.6;ExaminersInterviewofThomasFontana,Aug.19,2009,atp.5
(Fontana distinguished the deposit from a pledge but noted that Citi believed it had a right of offset
againstthedeposit).
5510ExaminersInterviewofSECstaff,Aug.24,2009,atp.11.TheSECsMatthewEichnerstatedthathe
wasnotawarethatLehmanincludedthe$2billiondepositatCitiinitsliquiditypoolandsaidthatsucha
depositwouldnothaveraisedeyebrowsinFebruaryof2008,butthat,bySeptember2008,peoplewere
focusedonhowmuchwasondepositatthevariousbanks.ExaminersInterviewofMatthewEichner,
Nov.23,2009,atp.8.
1431

fundsfromitsinternalcalculationofLehmansliquiditypool.5511Notably,theFRBNY
also discounted Lehmans liquidity pool by the amount of the deposit with Citi; the
FRBNY did not find the inclusion of the deposit prudent because it was not freely
available for other uses, particularly in August and September 2008 when companies
were becoming increasingly anxious about liquidity.5512 FRBNY Senior Vice President
ArtAngulosaidtherewasarealquestionwhetherthe$2billiondepositshouldhave
beenincludedinthepoolatallgiventhatithadtobereturnedtoCitieverymorningto
supportLehmansclearing.5513
Additionally,ratingagencyanalystswhomtheExaminerinterviewedstatedthey
werenotawareofthe$2billiondepositLehmanplacedwithCiti,butthattheywould
have wanted to know about it for purposes of their rating analysis of Lehman.5514
Further, two rating agency analysts stated that it would not have been appropriate to
include a deposit in the liquidity pool like the one Lehman provided Citi beginning
June12becausethefundscouldnotbeusedforanyotherpurpose.5515
5512ExaminersInterviewofArthurG.Angulo,Oct.1,2009,atp.4;ExaminersInterviewofJanH.Voigts,
Oct.1,2009,atpp.34.
Sept.22,2009,atp.4;ExaminersInterviewofPeterE.Nerby,Oct.8,2009,atp.4.
Sept.22,2009,atpp.45.
1432

(e) OnAugust25,2008,LehmanExecutedaSecurity
AgreementwithBankofAmerica,GrantingtheBanka
SecurityInterestina$500MillionDeposit
BankofAmerica(BofA)wasoneofLehmansclearingbanksfortransactions
inAsia.5516BofAwasviewedbyLehmanascriticalforLehmanBrothersJapan(LBJ)
operations, as well as for FX clearing for Japanese Yen.5517 Lehman moved over $10
billion a day through BofAs clearing function, via several Lehman entities.5518
Moreover,astheglobalbusinessdayopenedwithtradingactivityinAsia,Lehmanwas
dependent on reliable clearing operations in that region to finance its positions
elsewherearoundtheworldlaterintheday.5519
As with JPMorgan and Citibank, BofA approached Lehman in the summer of
2008withconcernsregardingriskexposuresincurredthroughitsprovisionofintraday
credit. Thus, on the evening of August 20, 2008, BofAs James Dever placed a call to
LehmansEmilCornejoandTonucci,informingthemthatBofAwoulddropLehmans
$1billionintradaylineofcredittozerothecomingMondayifLehmandidnotplacea
5516SeeSectionIII.A.5.eandAppendix19ofthisReport,whichdiscussLehmansdealingswithBankof
America.
5517 See Email from Gregory Ito, Lehman, to Carlo Pellerani, Lehman, et al. (Aug. 21, 2008), at p. 2
[LBHI_SEC07940_547285].
5518Email from Stirling Fielding, Lehman, to Paolo R. Tonucci, Lehman, et al. (Aug. 21, 2008), at p. 1
[LBHI_SEC07940_547285].
5519Email from Gregory Ito, Lehman, to Carlo Pellerani, Lehman, et al. (Aug. 21, 2008), at p. 2
[LBHI_SEC07940_547285] (Without their [BofA] support we are unable to borrow from the O/N
[overnight]callmarketinareliableway.).
1433

depositwithBofA.5520TonucciraisedtheissuewiththeFRBNY,informinghisFRBNY
contacts of the consequences of BofAs actions, namely that Lehman would lose
intraday credit from BofA and would be required to prefund all clearing through the
bank.5521 In an internal Lehman email, he characterized the FRBNY as suitably
concerned about BofAs actions.5522 Tonucci contacted Government officials the next
dayaswelltoinformthemthatBofAstillhadnotforwardedthedraftdocumentation
toestablishtheintradaycollateralisationthat[would]replacetheintradaycredit.5523
The SECs Matthew Eichner asked that Tonucci keep him in the loop on his
discussions with BofA.5524 Recognizing the importance of the relationship, Lehman
mobilized to place a deposit with BofA to induce the bank to continue clearance
operations.Initially,Tonucciapprovedplacinga$200milliondepositwiththebank.5525
Stirling Fielding, head of Cash, Collateral, and Network Management in Lehmans
International Treasury, reported back that BofA was reducing all of Lehmans credit
5520Email from Emil F. Cornejo, Lehman, to Daniel J. Fleming, Lehman et al. (Aug. 20, 2008)
[LBHI_SEC07940_547120].
5521EmailfromPaoloR.Tonucci,Lehman,toWilliamBrodows,FRBNY,etal.(Aug.20,2008)[LBEXAM
055584].
5522Email from Paolo R. Tonucci, Lehman, to Julie Boyle, Lehman (Aug. 21, 2008)
[LBHI_SEC07940_547284].
5523 Email from Paolo R. Tonucci, Lehman, to Matthew Eichner, SEC, et al. (Aug. 21, 2008) [LBEXAM
055372].
5524 Email from Matthew Eichner, SEC, to Paolo R. Tonucci, Lehman, et al. (Aug. 21, 2008) [LBEXAM
055372].
5525Email from Paolo R. Tonucci, Lehman, to Gregory Ito, Lehman, et al. (Aug. 21, 2008)
LBHI_SEC07970_547284].
1434

lines, and that Lehman would need to post a $500 million deposit.5526 Further, BofA
soughtaliengrantingasecurityinterestinthedeposit.5527Tonuccielevatedtheissueto
COO Bart McDade, and requested that McDade elevate it to Richard Fuld to discuss
withBofACEOKennethLewis.5528
In considering the proper amount to deposit with BofA, Fielding suggested an
amountlargerthanthe$500million.Inthatsameexchange,FieldingwroteTonucci:
Paolo, if you are going to include this deposit as part of the liquidity
profile and it doesnt impact other models[,] we should consider being
prudent and starting with a larger deposit. The main risk is that it
becomes evident to the market that we have liquidity issues. Without
intraday liquidity[,] our clients, counterparts and agent banks will all be
receivingpaymentsmuchlaterthanusual.Manyofthemanhourbefore
cutoff. It also increases the risk that some large payments are released
toolateinthedayandfail,eithertoanagentbankortoaclient.5529
Thus, while Tonucci was inclined to transfer as small an amount as possible,
Fielding,inadvocatingforalargerdeposit,notedtheimportanceofintradayliquidity,
andtheroleofclearingbanksinprovidingthatliquidity.Healsonotedthatsolongas
Lehman would include this deposit in its liquidity pool, there would be no harm in
makingalargerdeposit.
5526Email from Stirling Fielding, Lehman, to Paolo R. Tonucci, Lehman, et al. (Aug. 21, 2008)
[LBHI_SEC07940_547284].
5527SeeemailfromAndrewYeung,Lehman,toPaoloR.Tonucci,Lehman,etal.(Aug.23,2008)[LBEX
SIPA003280](recountingLehmanseffortstonegotiatetermsofthesecurityagreementinitiallyadvanced
byBofAandnoting[t]hesecurityagreementwillonlysecureoverdraftobligations[;t]heinitialdraft...
couldhavebeeninterpretedtosecureotherdebtobligationstoBofA).
5528See email from Paolo R. Tonucci, Lehman, to Heidimarie Echtermann, Lehman (Aug. 21, 2008)
[LBHI_SEC07940_547415].
5529EmailfromStirlingFielding,Lehman,toPaoloR.Tonucci,Lehman,etal.(Aug.21,2008)[LBEXSIPA
003306].
1435

Ultimately, Lehman acceded to BofAs demand for the $500 million and
documentation establishing a lien over the deposit via a security agreement dated
August 25, 2008.5530 The agreement provided that the $500 million collateral was
transferableoutsideBofAonlyuponthreedayswrittennoticefromLehman,andonly
to the extent that doing so would leave sufficient collateral to cover the aggregate
amountofoverdraftsLehmanincurredagainstBofA.5531Withthe$500milliondeposit
in place, encumbered by the August 25, 2008 Security Agreement, BofA continued to
clearforLehman.
The $500 million Bank of America deposit, subject to the August 25, 2008
SecurityAgreement,wasincludedinLehmansliquiditypool.5532
(f) LBHIandJPMorganExecutedanAmendmenttotheJune
2000ClearanceAgreement,aSecurityAgreementanda
HoldingCompanyGuaranty,allDatedAugust26,2008
JPMorgan and Lehman executed an amendment to their standing Clearance
Agreement (the August Amendment), a security agreement (the August Security
Agreement), and a guaranty by LBHI for clearing obligations of certain of its
5530SeeSecurityAgreement(Aug.25,2008)[LBEXDOCID000584].
5531Seeid.atp.2.
5532
See, e.g., email from Robert Azerad, Lehman, to Paolo R. Tonucci, Lehman, et al. (Sept. 9, 2008)
[LBHI_SEC07940_557814]; Lehman, Liquidity Pool Summary (Sept. 9, 2008), at pp. 2, 4
[LBHI_SEC07940_557815](showingthe$500millionBofAdepositintheliquiditypool).
1436

subsidiaries (the August Guaranty) on August 29, 2008 (backdated to August 26,
2008).5533
TheAugustAmendmentaddedLBHI,LBIE,LehmanBrothersOTCDerivatives
andLBJtothestandingClearanceAgreement,towhichLBI,LCPI,andJPMorganwere
alreadyparties.5534
The August Guaranty bound LBHI to guarantee the clearing obligations of its
affiliatesthatwerepartiestotheClearanceAgreement,incurredunderthetermsofthe
ClearanceAgreement.5535UndertheClearanceAgreement,theLehmanborrowerswere
obligatedtorepayJPMorgansdiscretionarycreditadvances.5536
The August Security Agreement established a JPMorgan lien on two specific
accountstosecureobligationsundertheClearanceAgreement:1)anLCESecurities
Account and 2) a DDA 066141605 Cash Account.5537 The August Security
Agreementalsoestablishedalienoncertainrelatedaccounts.5538TheAugustSecurity
Agreement notably provided for an Overnight Account into which at the end of a
business day LBHI could transfer amounts from the liened accounts provided that it
5533 See Section III.A.5.b.1 of this Report, which discusses Lehmans dealings with JPMorgan; see also
AmendmenttoClearanceAgreement(Aug.26,2008),atpp.12[JPM20040005856];SecurityAgreement
(Aug.26,2008),atp.6[JPM20040005867];Guaranty(Aug.26,2008),atp.6[JPM20040005879].
5534AmendmenttoClearanceAgreement(Aug.26,2008),atp.1[JPM20040005856].
5535Guaranty(Aug.26,2008),atp.1[JPM20040005879].
5537SecurityAgreement(Aug.26,2008),atpp.12[JPM20040005867].
5538Id.
1437

owed no outstanding obligations to JPMorgan as defined under the Clearance
Agreement.5539
In early August, JPMorgan sought a continuing as opposed to an intraday
lienonLehmancollateral.5540Asexecuted,however,theAugustAgreementsprovided
thatLehmanscollateralwasonlymeanttocoverintradayobligations.5541
Lehman structured the lien provisions of the August Security Agreement,
limiting the lien to its intraday clearing exposure, so that Lehman could claim the
collateralaslienfreeovernightforthepurposeofreportingitaspartofLBHIsliquidity
pool.5542 Andrew Yeung acknowledged that he received an email from Dan Fleming
providing this specific guidance.5543 JPMorgan risk manager Donna Dellosso and
JPMorgans Doctoroff stated that Lehman structured the Overnight Account
provisionoftheAugustAgreementssuchthatLehmancouldincludecollateralpledged
5539Id.atp.3;seeSectionIII.A.5.b.1.fofthisReport,whichdiscussesLehmansdealingswithJPMorgan
andprovidesgreaterdetailontheOvernightAccount.
5540SeeSectionIII.A.5.b.1.fofthisReport,whichdiscussesLehmansdealingswithJPMorgan;Examiners
Interview of Craig L. Jones, Sept. 28, 2009, at p. 13; email from Craig L. Jones, Lehman, to Paolo R.
Tonucci, Lehman, et al. (Aug. 8, 2008) [LBEXDOCID 457557] (relaying an urgent call from a group at
ChaseinwhichJPMorganstatedtheywant[ed]toensuretheassetshaveacontinuinglienandnotjust
anintradaylien).
5541SeeemailfromCraigL.Jones,Lehman,toPaoloR.Tonucci,Lehman,etal.(Aug.14,2008)[LBEXAM
001764] (Mark Doctoroff [of JPMorgan] called from Singapore to apologize for the issues raised when
Chase requested the continuing lien acknowledging he was well aware it was only intended to be an
intradaylien.).
5543 Examiners Interview of Andrew Yeung, May 14, 2009, at p. 8 (Yeung recalled an email exchange
with Dan Fleming in which Fleming instructed him that Lehman had to be able to claim collateral
pledgedwithJPMorganwaslienfreeforliquidityreporting).
1438

toJPMorganintradayinitsliquiditypool.5544Doctoroffwasmostexplicitonthispoint,
specifically stating that it was Tonucci who insisted that JPMorgans intraday lien not
extend overnight so that Lehman could include the collateral subject to the August
SecurityAgreementinitsliquiditypool.5545
(g) LehmanAssetsSubjecttotheAugustSecurityAgreement
WereIncludedinLehmansLiquidityPool
At least some of the assets subject to the intraday lien, memorialized in the
August Security Agreement with JPMorgan, were included in the liquidity pool.
TonucciconfirmedthisfactinhisinterviewwiththeExaminer.5546Doctoroffexplained
thatheunderstoodfromLehmanthatassetssubjecttotheAugustSecurityAgreement
wereincludedinLehmansliquiditypool.5547Thedocumentaryevidenceconfirmsthis
point. The August Security Agreement encumbered assets in LBHIs LCE and DDA
066141605accountsatJPMorgan.Asnapshot oftheLCE accountdistributedwithin
LehmanonAugust26,2008showsthatCLOsandABCPpledgedtomeetJPMorgans
margin requirements, namely Fenway, Pine, Spruce, Kingfisher and Verano, were
5544 Examiners Interview of Donna Dellosso, Feb. 27, 2009, at p. 3 (Lehman informed JPMorgan that it
wanted overnight access to the collateral, presumably for its overnight liquidity pool); Examiners
InterviewofMarkG.Doctoroff,Apr.29,2009,atp.12(recallingthatPaoloTonuccirepresentedthatthe
purpose of the overnightaccount provision was to preserve Lehmans ability to include in Lehmans
liquiditypoolcollateralpledgedtocoverJPMorgansintradayrisk).
5545ExaminersInterviewofMarkG.Doctoroff,Apr.29,2009,atp.12.ForhispartDoctoroffsaidhewas
not concerned with Lehmans inclusion of JPMorgan intraday collateral in its liquidity pool because
JPMorgandidnotfaceclearingexposuretoLehmanattheendoftheday.Id.atp.14.Further,Doctoroff
was comforted by the inclusion of the collateral in the pool because of the implied liquidity of the
collateral.Id.atp.13.
5547ExaminersInterviewofMarkG.Doctoroff,Apr.29,2009,atpp.17,2223.
1439

locatedinthatencumberedaccount.5548ThecollateralintheLCEboxasshownonthis
chartwasworthabout$7.2billion.5549AllofthesesecuritieswereincludedinLehmans
liquidity pool in late August as well.5550 As of September 2008, the Pine, Spruce,
Kingfisher, and Verano funds were still in the liquidity pool.5551 As of that date, those
funds were simultaneously held as collateral by JPMorgan.5552 A JPMorgandrafted
agenda for the September 4 meeting with Lehman also makes plain that collateral
placedtocoverJPMorgansmarginrequirementswasincludedintheliquiditypool.5553
Tonucci stated that, had Lehman attempted to remove collateral posted at
JPMorgan, there were steps short of not clearing that the bank might have taken.
Perhaps, Tonucci suggested, JPMorgan would have agreed to reduce the volume of
clearing in exchange for the return of some collateral.5554 Had Lehman contracted its
5548Email from Kristen Coletta, Lehman, to Craig L. Jones, Lehman (Aug. 26, 2008) [LBEXDOCID
055369];Lehman,Spreadsheet(Aug.26,2008)[LBEXDOCID046640](showingLCEboxasofAugust20,
2008).
5549Lehman,Spreadsheet(Aug.26,2008)[LBEXDOCID046640](showingparvaluesforcollateralinthe
LCEboxasofAugust20,2008).
5550 See Lehman, Detailed Liquidity Pool Composition, (Aug. 21, 2008), at pp. 1920 [BARLQP0003950]
(showingSpruce,Pine,Fenway,Kingfisher,andVeranosecuritiesintheliquiditypool).
5551 Lehman, Liquidity Update (Sept. 10, 2008), at p. 3 [LBEXWGM 725919] (showing the [a]bility to
[m]onetizeassetsintheliquiditypoolandlistingPineandVeranoaslowabilitytomonetize;Spruce
is given a mid level ability to monetize because it is PDCF [e]ligible). Note that the Kingfisher
securities were in the LCD, not LCE, account by this point. Thus, Kingfisher was subject to the lien
provisionsofSection11oftheClearanceAgreement,ratherthanthelienprovisionoftheAugustSecurity
Agreement.
5552 See Lehman, Collateral Pledged to JPM for Intraday As of 9/10/2008 COB [LBEXDOCID 046681]
(showingPine,Spruce,KingfisherandVeranofunds,amongothers,ascollateralpledgedtoJPMorgan).
000862],attachingJPMorganAgenda(Sept.3,2008),atp.2[LBEXAM000863](notingthatthecollateral
placedasmarginconsistedofassetsthatLehmanincludedinitsliquiditypool).
1440

tripartyrepobook,forexample,presumablylesstripartyinvestormarginwouldhave
beenrequiredbyinvestorsovernightandretainedbyJPMorganthenextmorning.This
actionarguablycouldhaveresultedinJPMorganrequiringlesscollateral.5555Moreover,
throughcounsel,JPMorganconfirmedthatLehmancouldremovecollateralfromLCE
totheextentthetotalvalueofthataccountdidnotdropbelow$5billion.5556Although
therewouldbenooperationalbarriertosuchatransaction,JPMorganscounselcould
not address what alarms would have gone off within JPMorgan had Lehman given
such an instruction.5557 Indeed, it appears that Lehman effected two such transfers:
LehmanremovedFreedomfromLCEonAugust15andmovedKingfisherfromLCEto
LCDonSeptember2.5558
(h) September2,2008:LehmanTransferredJustUnder$1
BilliontoHSBCtoContinueClearingOperations,and
EncumberedThiswithCashDeedsExecutedon
September9andSeptember12
HSBCclearedandsettledsterlingdenominatedsecuritiestradesforLehmanvia
theCRESTsystem.5559CRESTisanetworkofserversonwhichCRESTmembers,such
5555 Contraction of collateral required by triparty investors overnight (and thus required by JPMorgan
intraday) would have affected the amount of collateral Lehman was required to maintain in the LCD
account or other LBI clearing account. See Section III.A.5.b.1 of this Report, which discusses Lehmans
dealings with JPMorgan (Lehman posted securities to the LCD account to mitigate the effect of the
marginretainedbyJPMorganintraday).
5556 Jenner & Block, Memorandum re November 16, 2009 Teleconference with JPMorgan Counsel (Nov.
16,2009),atp.2.
5557Id.
5558 JPMorgan Second Written Responses, at p. 7; Jenner & Block, Memorandum re November 18, 2009
TeleconferencewithJPMorganCounsel(Nov.19,2009),atp.2.
5559SeeSectionIII.A.5.d.1ofthisReport,whichdiscussesLehmansdealingswithHSBC.
1441

asLBIE,trade,usingtheservicesofaCRESTSettlementBanktoexecutethosetrades.
HSBC was LehmansCREST Settlement Bank. As with a bank clearing triparty repos
(JPMorgan), or FX trades on the CLS system (Citi), HSBC intermediated between
Lehman and counterparties seeking to make securities trades. As with other clearing
andsettlementbanks,HSBCextendedintradaycredittofacilitatethisfunction.
AssetforthinfurtherdetailinSectionIII.A.5.dofthisReport,beginninginmid
tolate2006,HSBCbeganreducingitscreditexposureindustrywideandtoLehmanin
particular. After the near collapse of Bear Stearns, those efforts were increased. By
August 18, 2008, HSBC decided to exit its relationship with Lehman entirely. This
decisionwasdrivenbymacrolevelandLehmanspecificconcerns:
Thedecisiontowithdrawisonthebasisofdeterioratingriskandbusiness
fundamentals, continuing performance/valuation uncertainty, capital
erosion and significant Group exposure to Lehman in particular and the
sector as a whole. . . . On balance, Lehman is the weakest with less
diversification and relatively more exposure to troubled fixed income
classes.Also,arguably,withitsbusinessmodelterminallydamaged,itis
perhaps the least likely to be saved. . . . It has $50bn of risky real
estate/mortgageassetsincluding $10bnof Alt A. It also retains $11bn of
leveraged loans. Many now predict further write downs and a
consequent fiscal Q3 loss (ending August) c$2bn instead of the $250m
profitpreviouslyexpected.5560
5560NicholasJ.Taylor,HSBC,BriefingNoteProjectMilan(Aug.18,2008),atp.2[HBUS90].Project
Milan was the name given by HSBC to its efforts to minimize its exposure to Lehman Brothers, and
ultimately, withdraw from the relationship. Memorandum from HSBC Financial Institutions Group, re
ProjectMilan(Aug.2008),atp.1[HBUS17459];ExaminersInterviewofNicholasTaylor,Oct.15,2009,at
p.5;seeSectionIII.A.5.d.1ofthisReport,whichdiscussesLehmansdealingswithHSBC.
1442

HSBCFinancialInstitutionsGroupheadNicholasTaylorrelayedthisdecisionto
Tonucci in New York on August 18.5561 According to internal HSBC documents,
Tonucci expressed surprise at Taylors announcement, and concern over Lehmans
abilitytoreplaceHSBCasacoreclearingbankinmarketssuchastheU.K.andIndia.5562
TonucciurgedTaylortodiscussHSBCsconcernswithPellerani,whileindicatingthat
Lehmanwouldlookintothisandhowwecanreduceyourriskquickly.5563InAugust,
HSBCcontinueddrawingdowncreditlines,workingwithPelleranitodeterminewhich
lineswereunderutilizedbyLehman.5564
OnAugust22,HSBCsGuyBridgeinformedPelleranithatthebankwouldseek
collateralization of HSBCs credit lines, formalized by a cash deed [that] can be
executedveryquickly.5565OnWednesday,August27,PelleraniinformedTonuccithat
HSBCwouldrequireLehmantopostroughly$1bnofdepositbyFriday,withalegal
righttosetoff,nonnegotiable,ortheywillnotsettleforus.5566Pelleranirecommended
to Tonucci that Lehman [i]nform FSA, [i]nform FED and SEC, and [f]ind out if
5562Id.
5563 See email from Carlo Pellerani, Lehman, to Guy Bridge, HSBC, et al. (Aug. 27, 2008) [HBUS 3];
Lehman,SpreadsheetofCreditLinesSubjecttoExaminationbyHSBCandLBHI(Aug.28,2008)[HBUS
237](createdinconcertwithLehmantodetermineutilizationoflinesforfurtherreductions).
5564SeeemailfromCarloPellerani,Lehman,toPaoloR.Tonucci,Lehman,etal.(Aug.22,2008)[LBEX
AM008959](SpokeatlengthyesterdayandtodaywithHSBC.Theyarebringingtozeroalllinesthey
see as unutilised and work on reducing exposure for the settlement lines. . . . I was unsuccessful in
convincingthemtobemeasuredon[thecreditlinesthatHSBCbroughttozero].).
5565EmailfromGuyBridge,HSBC,toCarloPellerani,Lehman,etal.(Aug.22,2008)[LBEXAM008906].
5566 Email from Carlo Pellerani, Lehman, to Paolo R. Tonucci, Lehman (Aug. 27, 2008) [LBEXAM
008916].
1443

legally we can stop them from doing this.5567 Tonucci, in turn, elevated the issue to
Lowitt, communicating that a deposit by Friday was essential if they [HSBC] are to
continueclearingforus.5568Similarly,inenlistinginhousecounselYeungsassistance,
Lehmans Huw Rees remarked there is a possibility that, without an agreement, our
UKclearingoperationswillbeimpacted.5569
Subsequently, Lehman deposited GBP 435 million (nearly $800 million at the
time)withHSBCintheU.K.onthemorningofAugust28.5570Followingconversations
betweenLowittandHSBCsChiefRiskOfficer,however,onAugust28HSBCagreedto
allowLehmantotemporarilyretrievethedepositandholdituntilaftertheendofthe
quarter,inordertohelpwith[Lehmans]quarterend[balancesheet]targets.5571
LehmanreturnedGBP435milliontoHSBCintheU.K.onSeptember1forvalue
on September 2.5572 In addition, on September 2, Lehman deposited the equivalent of
approximately$180millioninaHongKongaccount.5573
5567Id.
5568 Email from Paolo R. Tonucci, Lehman, to Ian T. Lowitt, Lehman, et al. (Aug. 27, 2008) [LBEXAM
008918].
5569EmailfromHuwRees,Lehman,toAndrewYeung,Lehman,etal.(Aug.28,2008)[LBEXAM008941].
5571 Email from Carlo Pellerani, Lehman, to Ian T. Lowitt, Lehman, et al. (Aug. 28, 2008) [LBEXAM
008853];emailfromCraigGoldband,Lehman,toHuwRees,Lehman,etal.(Aug.28,2008)[LBEXAM
008853];seealsoemailfromIanT.Lowitt,Lehman,toJeremyIsaacs,Lehman(Aug.28,2008)[LBEXAM
008940].
5572EmailfromGuyBridge,HSBC,toNicholasJ.Taylor,HSBC,etal.(Sept.1,2008)[HBUS401].
5573EmailfromPatriciaGomes,HSBC,toGuyBridge,HSBC,etal.(Sept.1,2008)[HBUS397](statingthat
HongKongdepositisequivalentto$180million).ButseeemailfromStirlingFielding,Lehman,toCarlo
Pellerani, Lehman, et al. (Sept. 1, 2008) [LBEXAM 00896364] (recording instant message conference
stating that Hong Kong deposit is equivalent to $192 million with unspecified credit due to Lehman).
1444

TheHSBCdepositsintheU.K.wereencumberedbytwoCashDeedsexecuted
on September 9, 2008 by LBHI(U.K.) and LBIE (the U.K. Cash Deeds).5574 One Cash
DeedprovidedthatLBHI(U.K.)wasrequiredtomaintainadepositwithHSBCequalto
the amount that HSBC estimated, in its good faith, was required to cover aggregate
intradayexposurestoLBHI(U.K.),LBIE,andLehmanBrothersLimited.5575Thedeposit
was only available to Lehman provided that HSBC was satisfied that none of these
specifiedLehmanentitiesowedanyoutstandingdebttoHSBC.5576HSBChadtheright
to setoff against the deposit.5577 The LBHI(U.K.) Cash Deed formally recognized that
anyextensionofcreditbyHSBCtothesamethreeLehmanentitieswaslefttoHSBCs
discretion.5578
AthirdCashDeedwastobeexecutedbetweenHSBCandLehmanBrothersAsia
Holdings Limited (LBAH) to securethe Hong Kong deposit (theHong KongCash
Deed).5579Thefunds,however,werenotmovedintoacollateralaccountuntilafterthe
petitiondate.AtLehmansrequest,thefundsweremovedbackintoacashaccounton
TheExaminersinvestigationhasnotrevealedanyotherreferencestoaHongKongdepositequivalentto
$192 million. The Examiners financial advisors identified a September 1 transfer equivalent to $192
millionfromaLehmanBrothersAsiaHoldingsmoneymarketaccount,butwerenotabletodetermineif
allofthesefundswereusedforadeposit.Duff&Phelps,PreliminaryFindingsre:HSBCDeposits(Dec.
2,2009),atp.2.
5574 Cash Deed between HSBC and LBHI(U.K.) (Sept. 9, 2008) [HBUS 1190]; Cash Deed between HSBC
andLBIE(Sept.9,2008)[HBUS1180].
5575CashDeedbetweenHSBCandLBHI(U.K.)(Sept.9,2008),5[HBUS1190].
5576Id.6.
5577Id.4.
5578Id.10.
5579EmailfromPatriciaGomes,HSBC,toNicholasTaylor,HSBC,etal.(Sept.12,2008)[HBUS1760].
1445

September 16, 2008 (that was subsequently frozen on September 19 by KPMG, the
provisionalliquidatorsforLBAH).5580
(i) TheHSBCDepositWasRepresentedasLiquidandWas
IncludedinLBHIsLiquidityPool
TonucciconfirmedthatthetotalHSBCdeposit,valuedatalmost$1billion,was
includedinLBHIsliquiditypool.5581Documents,includingliquiditypresentationsand
ability to monetize tables prepared during Lehmans final week before bankruptcy,
reveal that approximately $1 billion of Lehmans liquidity pool was earmarked
HSBC, and assigned a low ability to monetize.5582 The deposit was maintained in
the liquidity pool despite the fact that it was placed with HSBC as a precondition for
HSBCs clearance of trades in vital markets, that the deposit could not be removed
unless Lehman zeroed its exposure with HSBC, and that HSBC held a clear right of
setoffagainstthedeposit.
(j) LehmanandJPMorganExecutedAnotherRoundof
SecurityDocumentationDatedSeptember9,2008;Lehman
Made$3.6Billionand$5BillionPledgestoJPMorgan
SubjecttotheTermsofTheseAgreements
On the eve of Lehmans accelerated earnings announcement, scheduled to be
delivered September 10, 2008, JPMorgan engaged various senior officials at Lehman
andadvisedthattheywereseekinganewroundofsecuritydocumentation.JPMorgan
5580Id.
5582See,e.g.,Lehman,LiquidityUpdate(Sept.10,2008),atp.3[LBEXWGM725919];Lehman,Abilityto
MonetizeTable(Sept.12,2008)[LBEXWGM784607].
1446

insisted that Lehman execute the documents before the commencement of the next
morningsearningscall.5583
The new agreements consisted of a revised Security Agreement, a revised
Guaranty, and a new Amendment to the Clearance Agreement. The new
documentationexpandedJPMorgansrightsoverLehmancollateral.For instance,the
newSecurityAgreementandGuarantygaveJPMorganasecurityinterestinallLehman
accounts(savetheOvernightAccount)tosecureallLehmanobligationstoJPMorgan
not simply clearancerelated obligations.5584 Unlike the August Security Agreement,
under the September Security Agreement collateral was returnable to Lehman only
upon threedays written notice to JPMorgan,5585 a provision inserted at Lehmans
requestforliquidityreportingpurposes.5586
On September 9, JPMorgan requested $5 billion of additional collateral from
LehmanandLehmanagreedtopost$3billionimmediately.Lehmanposted$1billion
incashand$1.7billioninmoneymarketfundsonSeptember9.Lehmanthenposted
5583 Examiners Interview of Andrew Yeung, March 13, 2009, at p. 4; Examiners Interview of Paolo R.
Tonucci,Sept.16,2009,atp.13.
5584 See Guaranty (Sept. 9, 2008), at p. 1 [JPM2004 0005813]; Security Agreement (Sept. 9, 2008), at p. 1
[JPM20040005873].
5586EmailfromMarkG.Doctoroff,JPMorgan,toJaneBuyersRusso,JPMorgan,etal.(Sept.9,2008)[JPM
EXAMINER00005933] (noting that Doctoroff [j]ust spoke to Dan Fleming. The one condition they
[Lehman]wantingivingus[a]lienagainst[thecollateral]isthattheyhavea3daynoticeperiodtocall
thecash[collateral]backthiswillallowthemtocountthecashaspartoftheirliquiditypool....Ifnot
abletoprovidethis,then...thereisthepublicissueoftheirliquiditypoolhavingtodrop....).
1447

$300 million in cash the following day. On September 11, Lehman delivered an
additional$600millionincashtoJPMorgan.5587
JPMorgan demanded $5 billion more in cash collateral on September 11, 2008,
whichLehmanprovidedbytheafternoonofSeptember12.5588Althoughthecollateral
was posted pursuant to the September Agreements, which covered all Lehman
obligations to JPMorgan not just intraday exposures Lehman believed that
JPMorgansdemandfor$5billionwassolelyforintradaypurposes.5589Anemailsent
byJPMorgantoLehmanmemorializingthetransaction,however,containsnomention
ofreturningthecollateraltoLehmanattheendoftheday.5590
(k) LehmanMadeaDeposittoBankofNewYorkMellonto
CoverIntradayExposure,andIncludedThatDepositinIts
LiquidityPool
OnSeptember1,2008,LehmansGrahamKettleinformedPelleranithatBankof
New York Mellon (BNYM), one of Lehmans clearance and settlement banks, was
seeking to eliminate any intraday exposure.5591 In response, on September 11, 2008,
LBHI and BNYMs London branch executed an agreement that required Lehman to
deposit $125 million initially and thereafter maintain a collateral account with at least
5587SeeSectionIII.A.5.b.1.gofthisReport,whichdiscussesLehmansdealingswithJPMorgan.
5588Seeid.
5590EmailfromJaneBuyersRusso,JPMorgan,toPaoloR.Tonucci,Lehman,etal.(Sept.11,2008)[JPM
20040005411].
065890].
1448

$50millionwithmorerequiredifBNYMforecastedgreaterintradayexposure.5592The
fundsweretransferredtoBNYMsLondonbranchbyLBHI(U.K.).5593
There is evidence that Lehman included this deposit in its liquidity pool.5594
WhilethedepositwassubjecttoBNYMscontractualrightofsetoffandwasplacedto
cover the banks intraday exposure to Lehman, thus facilitating BNYMs settlement
activity, Kettle relayed to Pellerani that the deposit would not [a]ffect the liquidity
pool.5595Pelleraniresponded:Disagreewiththatview.Ifweneedtohavethislocked
upthenthereisanargumentforthisnottobeavailableliquidity.5596LehmansEmil
5592 Email from Gerry Barber, BNYM, to Carlo Pellerani, Lehman, et al. (Sept. 11, 2008) [LBEXDOCID
1065087] (attaching Final Version of collateral deposit agreement); Collateral Deposit Agreement
between Lehman Brothers Holdings, Inc. and the Bank of New York Mellon, London Branch (Sept. 11,
2008), 1.1, 2.3 [LBEXDOCID 1031225] (setting minimum deposit at $50 million). The agreement
allowed BNYM to set off all present and future monies, obligations and liabilities LBHI or other
specifiedLehmanentitiesowedunderanylegaldocumentation...relatedtotheissuanceofsecurities.
Id. 1.1, 4. If any of BNYMs agreements with Lehman required BNYM to make a payment on
Lehmansbehalf,LehmanhadthreebusinessdaystorepayBNYM,afterwhichBNYMcouldwithdraw
an equivalent amount from the collateral deposit. Id. 3. Lehman was entitled to direct BNYM to
transfer any excess collateral out of the account. Id. 3.1.5. Further, BNYM could, in its absolute
discretion,allowLehmantowithdrawfundsfromthecollateralaccounteventhoughLehmanwasnot
otherwiseentitledtodosoundertheagreement.Id.5.3.
5593SeeemailfromGrahamKettle,Lehman,toHuwRees,Lehman,etal.(Sept.12,2008)[LBEXDOCID
65923](announcingsuccessfulpaymentof$120milliontoBNYMbyLBHI(U.K.),pertheagreement).
5594 See email from Emil F. Cornejo, Lehman, to Daniel J. Fleming,Lehman et al. (Sept.8,2008)[LBEX
DOCID 065890] (indicating that Lehman would include the collateral in its liquidity pool after the
collateral deposit agreement was executed). Lehman authorized BNYM to invest the Collateral
Account in a Dreyfus Cash Management Plus money fund. Collateral Deposit Agreement between
LehmanBrothersHoldings,Inc.andtheBankofNewYorkMellon,LondonBranch(Sept.11,2008),atp.
20 (Schedule 3) [LBEXDOCID 1031225]. Lehman directed that the $125 million BNYM deposit be
investedinthatDreyfusfund.EmailfromGrahamKettle,Lehman,toScottAlvey,Lehman,etal.(Sept.
10, 2008) [LBEXDOCID 1065130]; Lehman included this money fund in its liquidity pool. Lehman,
DetailedLiquidityPoolComposition(Sept.11,2008)atpp.7,9[LBEXBARLQP0003839].
065890].
065890].
1449

Cornejo, in turn, responded that the deposit was not structured as a formal pledge
andwasinsteadonlyinaLehmanaccount,withsomerightofoffset,implyingthatit
couldbecountedintheliquiditypool.5597InhisinterviewwiththeExaminer,Pellerani
rejected the pledge versus deposit distinction, and expressed his view that the
BNYM deposit was not appropriate for the liquidity pool.5598 Pellerani, however, said
hedidnotknowthattheBNYMoranyotherclearingbankcollateralwasincluded
inLehmansliquidityprofile.5599
(l) TheCumulativeImpactofLehmansInclusionof
ClearingBankCollateralandDepositsinItsLiquidity
Pool
Tonucci confirmed that by the second week of September 2008, a material
portionofLBHIsliquiditypoolhadbecomelockedupasassetsthatweretransferredto
Lehmans clearing banks.5600 This trend began in June 2008 as Lehman attempted to
navigate the competing demands of providing clearing banks with adequate security
and preserving Lehmans public liquidity pool numbers. In its attempts to strike a
balance between these demands, Lehman included both the billions of dollars in
collateral for JPMorgans margin requirements and the $2 billion Citibank comfort
depositinitsliquiditypool.InadditiontotheJPMorganandCitibankamounts,bylate
5597 Email from Emil F. Cornejo, Lehman, to Daniel J. Fleming, Lehman et al. (Sept. 8, 2008) [LBEX
DOCID065890].
5599Id.atp.4.
1450

summer Lehman was also including in its liquidity pool $500 million in Bank of
America collateral, and nearly $1 billion in HSBC collateral. Lehmans liquidity pool
wasfurtherencumberedinthesecondweekofSeptember2008,whenLehmanpledged
more than $8 billion of additional collateral to JPMorgan under the September
Agreements,andwhenCitibankandHSBCobtainedformalrightsofsetoffandsecurity
interestsinLehmansdeposits.
These collateral calls and intraday credit usages were satisfied from Lehmans
liquiditypool, withoutthatfact being disclosed to the marketor tosignificantmarket
participantssuchasratingagencies.Thelackofdisclosureisparticularlyevidentwhen
the liquidity updates and ability to monetize charts produced by Lehman during
theweekofSeptember8arecomparedtoLehmanspublicdisclosures.5601Forexample,
theLiquiditySummaryasof9/135602deckcirculatedwithinLehman,anddistributed
to the SEC and FRBNY (the first time Lehman had circulated such data), described
Lehmans [r]eportable [l]iquidity in the context of the [a]bility to [m]onetize that
putative liquidity.5603 Lehman ended the prior week with a reportable pool of $42.1
5601See,e.g.,Lehman,LiquidityUpdate(Sept.11,2008),atp.2[LBEXWGM784543].
5602 Lehman, LiquiditySummary (Sept.13, 2008)[LBEXDOCID 647325](attachment containing ability
tomonetizechart);emailfromRobertAzerad,Lehman,toIanT.Lowitt,Lehman,etal.(Sept.13,2008)
[LBEXDOCID717430](attachingsame).
5603 Lehman, LiquiditySummary (Sept.13, 2008)[LBEXDOCID 647325](attachment containing ability
tomonetizechart);emailfromRobertAzerad,Lehman,toIanT.Lowitt,Lehman,etal.(Sept.13,2008)
[LBEXDOCID 717430] (attaching chart); email from Laura M. Vecchio, Lehman, to Michael A.
Macchiaroli,SEC,etal.(Sept.14,2008)[LBEXDOCID69577](distributingsametotheSEC);emailfrom
LauraM.Vecchio,Lehman,toJanH.Voigts,FRBNY(Sept.14,2008)[LBEXDOCID731444](distributing
1451

billion,andahighlymonetizableportionofthatpoolof$33.8billion.5604OnSeptember
10,astheeffectsofthesecuritydocumentationdemandedbyLehmansclearingbanks
and JPMorgans September 9 cash collateral pledge took hold, Lehmans reportable
liquiditydeclinedto$37.6billion,whilethelowabilitytomonetizeportionjumpedto
$27.3 billion.5605 Finally, by Friday, September 12, Lehmans last day operating as a
going concern, the firms reportable liquidity dropped and, reflecting the impact of
JPMorgans $5 billion collateral call, $30.1 billion of $32.5 billion reportable liquidity
was classified as assets with a low ability to monetize.5606 In other words, only $2.4
billion of Lehmans $32.5 billion liquidity pool was readily convertible to cash on
September 12. Another internal Lehman document succinctly captures the impact of
including the clearingbank collateral in the liquidity pool on Lehmans ability to
monetizethatpool;asofSeptember12,2008:5607
same to FRBNY). The September 13 deck is the first instance of which the Examiner is aware of any
disclosuretoLehmansregulatorsofthefirmsabilitytomonetizetheliquiditypool.
5604Lehman,LiquiditySummary(Sept.13,2008)[LBEXDOCID647325].
5605Id.
5606Id.
5607Lehman,AbilitytoMonetizeTable(Sept.12,2008)[LBEXWGM784607](handwritingintheoriginal).
1452

SECanalystMichaelHsu,realized,albeitonSeptember12,2008,thatLehmans
pool of purportedly liquid assets was mostly composed of assets placed to secure
clearingbank risk. His reaction presaged LBHIs liquidity reckoning, due the coming
Monday.Keypoint,Hsuwrote:[L]ehmansliquiditypoolisalmosttotallylocked
upwithclearingbankstocoverintradaycredit($15bnwithjpm,$10bnwithotherslike
citiandbofa).Thisisareallybigproblem.5608
Lehmansownpostmortemanalysis(preparedbyTonucciandAzerad)reflects
the fact that Lehmans liquidity crisis was traceable to the inclusion of clearingbank
deposits and pledges in the pool. Four slides throughout the deck, Liquidity of
LehmanBrothers,implicatetheusageofintradayliquidityasclearingbankcollateral
5608EmailfromMichaelHsu,SEC,toTilSchuermann,FRBNY(Sept.12,2008)[FRBNYtoExam.014851].
1453

asasignificantfactorinLBHIsbankruptcyfiling.5609Indeed,accordingtotheTonucci
Azeradanalysis,thedepletionoftheliquiditypoolappearstohavebeentheimmediate
causeofLBHIsbankruptcyfiling.Thatanalysisconcludes:
Post earnings announcement on September 9[, 2008], Holdings liquidity

decreased . . . from $41 billion to $25 billion $16 billion of which was
required by clearing banks at the start of the day and approximately $7
billion of which was in liquid securities that became near impossible to
monetize immediately in this extremely stressed market environment
primarilybecauseofalossofrepocapacity.
As a result, . . . free cash available intra day was less than $2 billion.
With LBIE facing a projected cash shortage of $4.5 billion on September
15,LehmanhadnochoicebuttoplaceLBIEintoadministrationbecauseof
potential director liability. This resulted in a crossdefault of and
triggeredthefiling[ofLBHI]onSeptember15.5610
(5) DisclosuresConcerningtheInclusionofClearingBank
CollateralinLehmansLiquidityPool
(a) LehmanDidNotDiscloseonItsJune16,2008Second
QuarterEarningsCallThatItWasIncludingthe$2Billion
CitiComfortDepositinItsLiquidityPool
Lowitt led the portion of Lehmans June 16, 2008 second quarter earnings call
concerningLehmansliquidityposition.Hestated:wehavesignificantlyincreased...
our liquidity pool to $45 billion from $34 billion.5611 Lowitt did not disclose that
between the end of the quarter (May 31, 2008) and the June 16 call that Lehman had
5609 See Lehman, Liquidity of Lehman Brothers (Oct. 7, 2008), at pp. 4, 7, 9, 15 [LBEXWGM 787681].
Tonucci said that he directed Azerad to prepare the deck and that it reflects Tonuccis analysis.
ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atp.20.
5610Lehman,LiquidityofLehmanBrothers(Oct.7,2008),atp.9[LBEXWGM787681].Notethatwhilethe
presentation states that the earnings announcement occurred on September 9, it in fact occurred on
September10.
5611FinalTranscriptofLehmanBrothersHoldingsInc.,SecondQuarter2008EarningsCall(June16,2008),
atp.10(statementofIanT.Lowitt).
1454

placed a $2 billion comfort deposit (on June 12) with Citigroup to allay Citigroups
intradayriskconcerns.
Anumberoffactorsmilitateagainstthepotentialimpropriety,ormateriality,of
such a nondisclosureoftheCiti deposit: (1)Lehman believed thedeposit to be lien
free and did not grant Citi the right to setoff;5612 (2) the deposit was understood to
simply cover intraday risk and was callable by Lehman daily;5613 and (3) market
conditions were probably not yet such that Citi would have refused to return the
deposit. The Examiner is aware, for example, that Lehman requested, and Citibank
granted,thereturnof$210millionofthisdepositonJune30,2008.5614
(b) LehmanDidNotDiscloseinItsSecondQuarter200810Q,
FiledJuly10,2008,ThatItWasIncludingBoththe$2
BillionCitibankComfortDepositandApproximately
$5.5BillionofSecuritiesCollateralPledgedtoJPMorgan
inItsLiquidityPool
Lehman filed its 10Q for the second quarter of 2008 on July 10, 2008. Lowitt
signedthecertification.The10QdisclosedthefollowingregardingLehmansliquidity
andliquiditypool:
The funding market environment became very challenging during the

second quarter of 2008 as a series of credit and liquidity events . . .
resulted in a sharp decrease in the supply of liquidity in March, which
was partially reversed in April and May. Despite this difficult
5612SeeemailfromDanielJ.Fleming,LehmantoIanT.Lowitt,Lehman,etal.(June12,2008)[LBEXAM
008608].
5613Lehman,CitigroupAgenda(June17,2008),atp.2[LBEXAM008597].
5614 See, e.g., email from Michael Mauerstein, Citigroup, to Christopher M. Foskett, Citigroup (June 30,
2008) [CITILBHIEXAM 00074989]. Lehman replenished the deposit the morning of the next business
day.Id.
1455

environment, the Company strengthened its liquidity position, finishing

the quarter with record levels of liquidity. . . . The Companys liquidity
pool at May 31, 2008 was approximately $45 billion, up from
approximately $34 billion at February 29, 2008 and $35 billion at
November30,2007.5615
The 10Q further characterized Lehmans liquidity pool as unencumbered.
Recounting the [e]stimated values of the liquidity pool, the 10Q referred to the
liquiditypoolandotherunencumbered(i.e.,unpledged)assetportfolios....5616
Whilethedatainthe10Qrepresenteddataforthesecondquarterof2008,which
ended May 31, 2008, the 10Q itself was filed July 10, 2008. Between the end of the
reportingperiodandthefilingdate:
Lehman made its $2 billion Citibank comfort deposit (June 12, 2008) that
wassimultaneouslyincludedinLehmansliquiditypool;5617and
Lehman began pledging securities collateral to JPMorgan to mitigate the

effects of JPMorgans margin requirements for triparty collateral (June 19,
2008 and dates following). The securities collateral was apparently owned
initially by LCPI and placed in an LBI collateral account at JPMorgan.
Pursuant to a June 2000 Clearance Agreement between JPMorgan and LBI,
JPMorganhadalienoncollateralinsuchaccounts.5618Asofthe10Qfiling
date,LehmansimultaneouslycountedSpruce,Pine,SASCO,Kingfisherand
Fenwaysecuritiesinbothitsliquiditypoolandclearingaccountsmaintained
5615LBHI10Q(July10,2008),atp.80.
5616Id.atp.81.
5617Lehman Brothers, Detailed Liquidity Pool Composition (July 10, 2008), at p. 7 [LBEXBARLQP
0002443](showing$2billionCitibankdepositintheliquiditypool).
5618SeeClearanceAgreement(June15,2000),atpp.1112[JPM20040031786]amendedbyAmendmentto
Clearance Agreement (May 30, 2008), at p. 1 [JPM2004 0085662] (establishing a lien upon . . . every
accountmaintainedbyapartytotheClearanceAgreementwithJPMorgan).AtleastasoflateJuly2008,
LehmanpersonnelacknowledgedininternalemailsthatJPMorganhadalienoversomeofthecollateral
placed to mitigate margin requirements. See email from Craig L. Jones, Lehman, to James W. Hraska,
Lehman(July31,2008)[LBEXDOCID077621](notingthatChasehastakenanofficiallienover$5bn[of
collateral]).
1456

withJPMorgan.5619Lehmanincludedapproximately$5.5billionofJPMorgan
margincollateralinitsliquiditypoolasofthefilingdate.5620
EarningsCallThataSubstantialPortionofItsLiquidity
PoolWasEncumberedbyClearingBankPledges
On September 10, 2008, Lehman held its third quarter 2008 earnings
announcementviaconferencecall.Lowittledtheportionofthecallupdatinginvestors
on Lehmansliquidityposition. Lowitts remarkson Lehmans liquiditypool were as
follows:
I will now provide an update on our liquidity position, which remains

verystrong.Wemaintainedourcashcapitalsurplusat$15billionatthe
end of the third quarter. Our liquidity pool also remains strong at $42
billion, versus a record $45 billion at May 31. The decline in this figure
versus the end of the second quarter is strictly attributable to our
managing down our commercial paper outstandings, which ended the
quarterat$4billionversus$8billionattheendofthesecondquarter....
Throughlastnight,ourliquiditypoolremainedessentiallyunchangedat
$41billion.5621
Lowitt did not disclose that Lehman, as of the night before the earnings call,
includedinitsliquiditypool:
5619 CompareLehman, Detailed LiquidityPool Composition (July10,2008), at pp.2021[LBEXBARLQP
0002443] (showing Spruce, Pine, SASCO, Kingfisher, and Fenway securities in the liquidity pool), with
Duff & Phelps, JPMC Collateral Account LCD Position Summary, showing the contents of the LCD
account as of July 10, 2008 (Jan. 3, 2010) (showing Fenway, Kingfisher, Pine, SASCO and Spruce in the
LCDaccount).
5620Duff&Phelps,JPMCCollateralAccountLCDPositionSummary,showingthecontentsoftheLCD
account as of July 10, 2008 (Jan. 3, 2010) (the combined trade value of the Fenway, Kingfisher, Pine,
SASCO, and Spruce securities in both the encumbered LCD account and in the liquidity pool was
$5,457,847,089).
5621FinalTranscriptofLehmanBrothersHoldingsInc.,ThirdQuarter2008EarningsCall(Sept.10,2008),
atp.11.
1457

Roughly $4 billion of CLOs pledged to JPMorgan (Spruce, SASCO, Pine,

Kingfisher,andVerano);5622
$2.7 billion in cash and money market funds pledged to JPMorgan on

September9,2008;5623
The$2billionCitibankcashdeposit,subjecttoarightofsetoffformalizedin
aGuarantyAmendmentexecutedbetweenCitiandLehmantheeveningof
September9,2008;5624
The $500 million Bank of America cash deposit, subject to a Security

Agreement executed between Bank of America and Lehman on August 25,
2008;and5625
Thenearly$1billioncollateraldepositwithHSBC,subjecttoarightofsetoff
formalized against the U.K. deposit by the U.K. Cash Deeds executed
betweenHSBCandLBHI(U.K.)andLBIEonSeptember9,2008.5626
Lowitt also did not disclose that Lehman and JPMorgan executed expanded
securitydocumentationonthemorningofSeptember10,beforetheearningscall.This
documentationgrantedJPMorganasecurityinterestinpracticallyallLehmanaccounts
5622CompareDuff&Phelps,JPMCCollateralAccountLCEPositionSummaryforSept.9,2008(Jan.3,
2010)(showingSpruce,PineandVeranolocatedintheLCEaccount),andDuff&Phelps,JPMCCollateral
AccountLCDPositionSummaryforSept.9,2008(Jan.3,2010)(showingSASCOandKingfisherin
the LCD), with Lehman, Liquidity Pool Summary (Sept. 9, 2008), at pp. 12 [LBHI_SEC07940_557815]
(showingSpruce,Pine,Verano,SASCOandKingfishersecuritiesintheliquiditypool)(attachedtoemail
from Robert Azerad, Lehman, to Paolo R. Tonucci, Lehman, et al. (Sept. 9, 2008)
[LBHI_SEC07940_557814])(thetotalvalueofthesecuritiesdependsonwhetheroneaggregatesthevalues
intheLCDandLCEpositionsummaries,orwhetheroneaggregatesthoseintheliquiditypoolsummary;
intheformerthecombinedvalueofthesecuritiesis$4,668,490,656,forthelatterthecombinedvalueis
$3,994,841,869).
5623 See Section III.A.5.b.1.g of this Report, which discusses Lehmans dealings with JPMorgan, and its
pledges to JPMorgan in particular; JPMorgan Second Written Responses, at p. 9; Lehman, Collateral

Pledged to JPM for Intraday As of 9/12/2008 COB [LBEXAM 047008]; see also email from Mark G.
Doctoroff, JPMorgan, to Jane BuyersRusso, JPMorgan, et al. (Sept. 9, 2008) [JPM2004 0032520]; email
fromDanielJ.Fleming,Lehman,toPaoloR.Tonucci,Lehman(Sept.9,2008)[LBEXDOCID0073380].
5624Lehman,LiquidityPoolSummary(Sept.9,2008),atpp.2,4[LBHI_SEC07940_557815](attachedtoe
mail from Robert Azerad, Lehman, to Paolo R. Tonucci, Lehman, et al. (Sept. 9, 2008)
[LBHI_SEC07940_557814]).
5625Lehman,LiquidityPoolSummary(Sept.9,2008),atpp.2,4[LBHI_SEC07940_557815].
5626Id.
1458

atJPMorganforallLehmanexposurestoJPMorganbeyondthoseexposuresrelatedto
tripartyclearance.
Reproduced below is a snapshot of Lehmans liquidity pool, on the evening of
September9,2008,extractedfromoneofLehmansinternaldocuments.Itreflectsthat
the collateral pledges itemized above were included in the pool, reducing Lehmans
abilitytomonetizethatreserve:5627
While the total size of the pool was approximately $40.6 billion, Lehman
managershaddeterminedthattheyhadahighabilitytomonetizeapproximately$25
billionofthepool,amidabilitytomonetizeapproximately$1billionofthepool,and
onlyalowabilitytomonetizeapproximately$15billion,or37%,ofthetotalpool.
5627Id.atp.4.
1459

(d) SeniorExecutivesDidNotDisclosetotheBoardof
DirectorsattheSeptember9,2008FinanceCommittee
MeetingtheFactThataSubstantialPortionofIts
LiquidityPoolWasEncumberedbyClearingBankPledges
TheFinanceandRiskCommitteeoftheBoardofDirectorsforLBHImetat10:00
a.m.onSeptember9,2008.5628PresentfortheBoardwereHenryKaufman,JohnAkers,
Roger Berlind, Marsha Johnson Evans and Roland Hernandez.5629 Lehman officers
presentbyinvitationwereLowitt,OMeara,Tonucci,andJeffreyWelikson.5630
According to Committee minutes, Tonucci updated the Committee on LBHIs
liquidity and capital, as well as general market conditions, over the third quarter of
2008.5631 Board minutes, as well as a deck prepared to guide Tonuccis presentation,
show that Tonucci debriefed the Committee on the status of Lehmans liquidity pool,
cash capital, commercial paper, and secured funding, among other topics related to
liquidity.5632 The deck accompanying Tonuccis presentation states: Despite [the]
challenging market environment, Lehman Brothers was able to broadly maintain the
statusquointermsofliquidity[.]5633
5628LehmanBrothersHoldingsInc.,MinutesofMeetingofFinanceandRiskCommittee(Sept.9,2008),at
p.1[LBEXAM059210].
5629Id.
5630Id.
5631Id.atpp.12.
5632Id.atp.2.
5633Lehman,Finance&RiskCommitteeoftheBoard,Risk,Liquidity,CapitalAndBalanceSheet(Sept.9,
2008),atp.2[LBEXAM067342].
1460

Absent from either the Committee minutes, or the deck guiding Tonuccis
presentation,isanydisclosureofsignificanteventsaffectingtheliquiditypooloverthe
courseofthethirdquarter,5634including:
On June 12, 2008, Lehman provided Citi with a $2 billion cash deposit to
allayCitisintradayriskconcerns,andthatthisdepositwassimultaneously
includedintheliquiditypool;
On or aboutJune 19,2008,Lehmanbeganpledging more than $5billion in

securitiestoJPMorgantomitigatetheeffectsofitsmarginrequirementsfor
triparty repo, and that many of the securities pledged were included in
Lehmansliquiditypool;
LBHI and BofA executed a security agreement dated August 25, 2008 that
granted BofA a security interest in a $500 million collateral deposit, which
wasalsoincludedinLehmansliquiditypool;
LBHI and JPMorgan executed a security agreement dated August 26, 2008
thatgrantedJPMorganasecurityinterestintheLCE account.Collateralin
thisaccountwasincludedinLehmansliquiditypool,ontherationalethatit
waslienfreeatnight.JPMorganrequiredalmostallofthatcollateraltobe
returned to the encumbered accounts every morning, however, to facilitate
thedailyunwindoftripartyrepos;and
OnAugust28,2008,LehmantransferredatHSBCsrequestapproximately$1
billion in collateral to HSBC to secure the intraday clearing and settlement
risk. HSBC returned that collateral to Lehman the same day to assist
Lehmanwithmonthendreporting.LehmanreturnedthecollateraltoHSBC
on September 1, 2008. This collateral was simultaneously counted in
Lehmansliquiditypool.
In his interview with the Examiner, the Chairman for the Boards Finance and
Risk Committee, Dr. Henry Kaufman, stated that he was never told that Lehman
5634 Tonucci did not disclose that Lehman executed documentation on September 9, 2008 with Citibank
andHSBC,strengtheningtheclaimofthosebanksonLehmancollateral,althoughitshouldbenotedthat
those documents were executed after the 10:00 am Committee meeting. Likewise, the September
Agreements between LBHI and JPMorgan, which also strengthened JPMorgans claim on Lehman
collateral,wereexecutedthemorningofSeptember10(i.e.,aftertheCommitteemeeting).
1461

included clearingbank collateral in its liquidity pool.5635 However, Kaufman did not
think it was improper to include this collateral in the pool, from a reporting sense.5636
Under the circumstances such as Lehman faced the week of September 8, Kaufman
thought it would have been impossible for Lehman to obtain and maintain adequate
liquiditytosaveitself.5637
OtherDirectors,withoneexception,madestatementssimilartoKaufmansview.
Director Roger Berlind said he did not recall much discussion over the effect of
collateral calls on Lehmans liquidity; indeed he was not concerned about collateral
demandsbecauseofLehmansrecordlevelsofliquidity.5638Hesaidheassumedthat
funds pledged intraday were included in the liquidity pool.5639 Director Thomas
Cruikshank said he had no knowledge as to whether Lehman included clearingbank
collateral,ordifficulttomonetizeassetsinitsliquiditypool.5640NeithertheBoardnor
the Audit Committee reviewed the liquidity pool in that level of detail, he said.5641
DirectorSirChristopherGentsaidhedidnotrecallanydiscussionoverpledgedassets
being included in Lehmans liquidity pool;5642 Gent said that Lehmans management
repeatedlyassuredtheBoardthatassetsintheliquiditypoolwereappropriateforthe
5635ExaminersInterviewofDr.HenryKaufman,Sept.2,2009,atpp.3,12.
5636Id.
5637Id.atp.20.
5638ExaminersInterviewofRogerBerlind,May8,2009,atp.2.
5639Id.
5640ExaminersInterviewofThomasCruikshank,Oct.8,2009,atp.9.
5641Id.
5642ExaminersInterviewofSirChristopherGent,Oct.21,2009,atp.13.
1462

pool.5643 Director Jerry Grundhofer said he could not recall whether Lehmans
management disclosed that intraday clearingbank collateral was included in the
liquiditypool;5644butstatedthattheinclusionofintradaycollateralwouldnotconcern
him because Lehman had other sources of liquidity and that it could negotiate with
counterpartiestoeffectthereturnofintradaycollateral.5645Grundhofersaidtheissueto
himwaswhatpercentageofLehmanstotalliquidityconsistedofintradaycollateral.5646
Whenpressedforwhatpercentageoftheliquiditypoolwouldhavebeensignificant
to him, Grundhofer said that ultimately it did not matter whether Lehman had $30
billion or $50 billion in its liquidity pool, because a run on the bank would have
depletedallliquidity.5647GrundhoferalsohadconfidencethatifLehmansinclusionof
intraday collateral in its liquidity pool were an issue, that Lehmans management
wouldhaveinformedtheBoard.5648
Director Marsha Johnson Evans, however, stated that she did not focus on
whetherfundspledgedtoclearingbankswereincludedinLehmansliquiditypool,but
saidthatherimpressionwasthatsuchassetsshouldnotbeincludedinthepool.5649
5643Id.atp.3.
5644ExaminersInterviewofJerryA.Grundhofer,Oct.15,2009,atp.6.
5645Id.
5646Id.
5647Id.
5648Id.atp.2.
5649ExaminersInterviewofMarshaJohnsonEvans,May22,2009,atp.3.
1463

(e) LehmanOfficersDidNotDisclosetotheBoardof
DirectorsThatItsLiquidityPositionWasSubstantially
ImpairedbyCollateralHeldatClearingBanksUntilthe
EveningofSeptember14,2008
TheBoardofDirectorsconvenedtheeveningofSeptember14,2008,todiscuss,
among other things, the status of its prospective deal for a sale to Barclays, the
deterioration of the firms financial condition and the possibility of filing bankruptcy
andwindingdownthefirm.5650TheBoardvotedtofileforChapter11bankruptcyatthe
conclusionofthemeeting.5651
It was only at this meeting that Lehman officers, namely Chief Legal Officer
ThomasRussoandLowitt,disclosedtotheBoardthatLehmansliquiditypositionhad
beencompromisedbypledgesanddepositswiththefirmsclearingbanks.According
totheminutesofthatmeeting:Mr.RussoreportedthattheFirm[LBHI]hadaliquidity
problem, with much of its liquidity tied up at clearing banks (primarily JPMorgan
ChaseBank)....5652Afterthemeetingadjournedat6:10p.m.andreconvenedat7:55
p.m.,Lowitt:
reportedthatcashandcollateralwerebeingtiedupbytheFirmsclearing
banks,withChaseholdingapproximately$17billionofcollateral(halfin
collateralandhalfincash)....Mr.Lowittreportedthatcashhaddrained
veryquicklyoverthelastthreedaysofthepreviousweekandthatChase
haddemandedanadditional$5billiononFriday.5653
5650SeegenerallyLehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Sept.14,2008)
[LBEXAM003932].
5651Id.atp.5.
5652Id.atp.2.
5653Id.atp.4.
1464

AccordingtotheBoardminutesandsupplementalBoardmaterials,thiswasthe
firsttimethatthequalificationsonLehmansreportedliquiditypositionweredisclosed
totheBoardofDirectors.Lowittwasaccurateinhisdisclosurethatcashhaddrained
very quickly over the previous week, as JPMorgan received over $3 billion in cash
and money market collateral on September 9, 10, and 11, 2008, and an additional $5
billionincashcollateralonSeptember12,2008.Despitebeingtransferredascollateral
toJPMorgan,andsubjecttoasecurityinterestgrantedbytheSeptember9,2008LBHI
JPMorganSecurityAgreement,theseassetsremainedinthefirmsliquiditypool.5654
Lowitt did not disclose, in the September 14 Board meeting or any other, that
Lehman had begun including clearingbank deposits (and eventually collateral) in its
liquiditypoolonoraboutJune12,2008,andcontinuedtodosoinincreasingamounts
throughoutthequarter.
5654CompareLehman,LiquidityUpdate(Sept.11,2008),atp.3[LBEXWGM784543],withLehman,Ability
toMonetizeTable(Sept.12,2008)[LBEXWGM784607](showingthatbetweenSeptember11,2008and
September12,2008thelowabilitytomonetizeUSDepositheldbyclearingbanksincludingJPMorgan
increased exactly $5 billion, confirming that Lehman included the $5 billion JPMorgan pledge on
September12,2008initsliquiditypool).ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atp.19
(confirmingthatthe$3billionincollateralpledgedtoJPMorgantheweekofSeptember8,2008,priorto
theSeptember12,2008pledge,wasincludedintheliquiditypool).
1465

(f) LowittsViewsonIncludingClearingBankCollateralin
theLiquidityPool5655
According to Lowitt, Treasury (headed by Tonucci) was responsible for
monitoringtheliquiditypool,5656andLowitthimselfwasnot...veryattentivetowhat
wasintheliquiditypool.5657WhileLowittsaidhedidnotknowwhattherationalewas
forincludingclearingbankcollateralintheliquiditypoolatthetimeLehmandidso,he
said he later learned that Lehman considered the collateral transferred to banks to be
Lehmans and that Lehman could recall the collateral if it wished, although doing so
wouldentailconversationswiththeentitieswithwhichcollateralwasplaced.5658Lowitt
alsosaidthathedidnotrecallanyoneatLehmansuggestingthatLehmandisclosethe
firmsabilitytomonetizeassetsintheliquiditypoolontheSeptember10,2008third
quarterearningscall.5659
Nevertheless,theClearanceAgreement(asamended),SecurityAgreements,and
GuarantiesgrantedJPMorganliensovercollateralthatwassimultaneouslyreportedas
partofLehmansliquiditypool.BySeptember9,2008,Citibank,HSBCandBofAhad
executed documentation granting security interests and/or rights of setoff against
5655TheviewsofadditionalformerseniormembersofLehmanmanagementontheinclusionofclearing
bank collateral in the liquidity pool can be found in the appendix. See Appendix 20 of this Report.
Tonucci defended including the collateral in the liquidity pool. Lehman International Treasurer Carlo
PelleraniwasunawarethatLehmanincludedthecollateralinitsliquiditypool,andstatedthatitwould
havebeenimproperforLehmantohavedoneso.
5657Id.atp.23.
5658Id.atpp.2324.
5659Id.atp.26.
1466

collateralLehmanplacedwiththemaswell.Pullingcollateralfromtheclearingbanks
likelywouldhaveaffectedLehmansabilitytoclearthroughthosebanks.
(6) RatingAgenciesWereUnawareThatLehmanWasIncluding
ClearingBankCollateralinItsLiquidityPool
(a) Fitch
Eileen Fahey, a managing director at Fitch, was involved in rating broker
dealers, such as Lehmans U.S. brokerdealer, LBI.5660 Faheys primary contact at
Lehman was Tonucci.5661 Fahey said she was not aware of any restricted cash or
pledged securities being included in Lehmans liquidity pool.5662 Fahey said it would
have been completely inappropriate to include encumbered assets in Lehmans
liquiditypool.5663Inheropinion,cashdepositsthatwerenotformallypledgedwould
be inappropriate for a firms liquidity pool if that firms clearing bank demanded the
depositduetodeterioratingmarketconditions.5664FaheysaidLehmandidnotinform
Fitchthatitmadeanycollateralpledgesordepositstoitsclearingbanks,andthatshe
consideredsuchinformationmaterialtoheranalysisofLehman.5665
5660ExaminersInterviewofEileenA.Fahey,Sept.17,2009,atpp.12.
5661Id.atp.2.
5662Id.atp.5.
5663Id.
5664Id.
5665Id.
1467

(b) Standard&Poors
DianeHintonofStandard&Poors,orS&P,wastheprimaryanalystassignedto
LehmanatS&PthroughJuly2008.5666HintonstatedthatS&Pdidnotrenderopinions
abouttheappropriatenessofthecontentsofLehmansliquiditypool,nordidS&Paudit
the contents of the pool.5667 Hinton said she was not aware that Lehman included
encumberedassetsinitsliquiditypool.5668WhenaskedbytheExamineriftheinclusion
of a hypothetical $5 billion pledge to a clearing bank in a firms liquidity pool would
have been relevant to her analysis of that firms liquidity pool, Hinton replied that it
would have been.5669 Hinton said that S&P does not include pledged assets in its
assessment of liquidity, and that S&P would likely subtract the value of any pledged
assets from a firms liquidity pool; thus if a $40 billion liquidity pool contained $5
billioninpledgedassets,S&Pwouldconsiderthepooltoactuallycontain$35billion.5670
Hintons answer did not change when the Examiner asked that she assume that the
assets were encumbered by a lien intraday, but were lienfree overnight she would
havesubtractedanyintradaycollateralaswell.5671Hintonfurtherstatedthatifshehad
5667Id.atp.4.
5668Id.atp.5.
5669Id.atp.4.
5670Id.
5671Id.
1468

known that Lehman was including deposits held by third parties in its liquidity pool
thatshewouldlikelyhavecommunicatedthistoothersatS&P.5672
(c) Moodys
Peter Nerby was Moodys lead analyst assigned to Lehman from 1998 to 2003,
anditsbackupanalystfrom2004to2008.5673Nerbydidnotrecalleverbeingtoldthat
Lehmanincludedpledgedassets,intradayorotherwise,initsliquiditypool.5674Nerby
said that he would have wanted to know if Lehman had been including a $2 billion
clearing bank cash deposit in its liquidity pool.5675 Likewise, he said he would have
wantedtoknowifLehmanhadbeenincludinginitsliquiditypoolcollateralthatwas
encumberedbyalienintraday,butwhichwasswepttoalienfreeaccountovernight.5676
Nerby said that Lehman represented to Moodys that liquidity pool assets were
unencumbered.5677
(7) TheFRBNYDidNotViewtheClearingBankCollateralinthe
LiquidityPoolasUnencumbered
TheFRBNYmonitoredLehmansliquiditypositioncontinuously,andembedded
severalFRBNYanalystsonsiteatLehmantowardthisend.5678TheFRBNYwasaware
thatasoflateAugust2008,Lehmanhadposted,orwasplanningtopost,collateralto
5672Id.atp.5.
5673ExaminersInterviewofPeterE.Nerby,Oct.8,2009,atp.1.
5674Id.atp.4.
5675Id.NerbydidnotexpressanopinionastowhetherMoodyswouldhavedeductedtheclearingbank
collateralfromtheliquiditypoolifMoodyshadknownabouttheissue.
5676Id.
5677Id.atpp.45.
5678ExaminersInterviewofJanH.Voigts,Aug.25,2009,atpp.2,5.
1469

JPMorgan,Citigroup,BofAandBNYM.LehmansPaoloTonuccitoldtheFRBNYthat
noneofthese[collateral]requirementswillaffecttheliquiditypool.5679
On August 20, 2008, in his daily Lehman update email, FRBNY onsite
Lehman liquidity monitor Jan Voigts summarized recent clearingbank collateral
requests, and Lehmans posting of collateral to satisfy some of those requests.5680 In
responsetoVoigtsupdate,AngulonotedthatLehmanwasapparentlyincludinginthe
liquiditypoolits$2billionCitibankcashdepositand$5billionofcollateralpostedwith
JPMorgan.5681 Angulo wrote, seems like LEH has $7B (and perhaps soon to be $8B+)
less in available liquidity than reported . . . [.]5682 Voigts replied: The liquidity pool
lookslargelyunchangedwhichleadsmetowanttolookmorecloselyatthethreecard
monteroutineweseeinintercompanyfunding.5683Anguloresponded:
Conceptually,Icanseeanargumentforincludingthe$7Bintheliquidity
poolifJPMandC[itigroup]releasethecollateraltoLEHeverynightif
triparty investors decline to roll at the end of the day, LEH can repo the
$7B to replace the funding for the assets not financed by the triparty
5679 FRBNY, Lehman IB Update (Aug. 26, 2008) [FRBNY to Exam. 007969] (summarizing Lehmans
collateralpostingssecuringintradayfundingwithBofA,BNYM,JPMorganandCiti,andprefacingthat
summary with the statement: The Treasurer [Paolo Tonucci] provided the following recap and noted
thatnoneoftheserequirementswillaffectLehmansliquiditypool.).
5680 Email from Jan H. Voigts, FRBNY, to Arthur G. Angulo, FRBNY, et al. (Aug. 20, 2008) [FRBNY to
Exam.033297].
5681Id.
5682 Email from Arthur G. Angulo, FRBNY, to Jan H. Voigts, FRBNY, et al. (Aug. 20, 2008) [FRBNY to
Exam.033297].
5683EmailfromJanH.Voigts,FRBNY,toArthurG.Angulo,FRBNY(Aug.20,2008)[FRBNYtoExam.
033297].InaninterviewwiththeExaminer,Voigtsexplainedthathisthreecardmonteinintercompany
fundingremarkalludedtothefactthatdailytransfersofassetsbetweenLBIE,LBHI,LBI,andLehman
BrothersBankhaus,AGallaffectedLehmansliquiditypool.ExaminersInterviewofJanH.Voigts,Oct.
1, 2009, at p. 8. Voigts stated that the FRBNY tried, but was never able to gain an adequate
understandingofthefundingeffectsofLehmansintercompanytransactions.Id.
1470

investors[.] On the other hand, doesnt feel quite right to view the $7B as
unencumbered[.]5684
Voigtsreplied:Agreed.5685
Angulo explained to the Examiner that collateral posted to Lehmans clearing
banks, which was simultaneously included in Lehmans liquidity pool, doesnt seem
liquid and could only be considered liquid in the limited event that counterparties
weretostoprollingtheirreposandthecollateralwouldthereforenolongerbeneeded
to support the intraday clearing risk associated with clearing those repos.5686 Absent
such a narrow situation, Angulo said, it wouldve been very difficult to monetize
thiscollateral for otherliquidity purposes.5687Angulofurthernoted thatinthe period
immediately preceding LBHIs bankruptcy, the FRBNY discounted the value of
Lehmans liquidity pool to subtract out the value of the clearingbank collateral that
Lehmanwasincludinginthepool.5688Atsomepoint,Angulosaid,theFRBNYcame
totheconclusionthattheliquiditypoolisntX;itsXminussomething,wherethat
somethingwastheclearingbankcollateral.5689
5684EmailfromArthurG.Angulo,FRBNY,toJanH.Voigts,FRBNY(Aug.20,2008)[FRBNYtoExam.
033297].
5687Id.
5688Id.
5689Id.
1471

TheFRBNYdiscountedthevalueofLehmanspooltoaccountforthesecollateral
transfers.5690However,theFRBNYdidnotrequestthatLehmanexcludethiscollateral
fromitsreportedliquiditypool.InthewordsofoneoftheFRBNYsonsitemonitors:
howLehmanreportsitsliquidityisbetweenLehman,theSEC,andtheworld.5691In
the same vein, FRBNY witnesses repeatedly stated that they were mindful that the
FRBNY was not Lehmans primary regulator under the CSE program, and that the
FRBNYwasnotmonitoringLehmanwithaneyetowardcomplianceorenforcement.5692
(8) TheSEC,LehmansPrimaryRegulator,WasUnawareofthe
CollateralinItsLiquidityPool;totheExtentItWasAware,the
SECDidNotViewThisPracticeasProper
SEC statements concerning its monitoring of Lehmans reported liquidity are
somewhat contradictory. On the one hand, according to SEC personnel, the SEC did
not monitor Lehmans liquidity pool from a disclosure perspective; instead, it
monitoredLehmansliquidityinternallybyapplyinghaircutstoassetsintheliquidity
poolthattheSECviewedaslessthancompletelyliquidinordertodetermineLehmans
5690See,e.g.,emailfromArthurG.Angulo,FRBNY,toJanH.Voigts,FRBNY(Aug.20,2008)[FRBNYto
Exam.033297](discountingCitibankandJPMorgancollateralfromLehmansliquiditypool);emailfrom
Arthur G. Angulo, FRBNY, to Timothy F. Geithner, FRBNY, et al. (Sept. 12, 2008) [FRBNY to Exam.
014855](discountingCitibankandJPMorgancollateralfromLehmansliquiditypool);emailfromJanH.
Voigts, FRBNY, to Timothy F. Geithner, FRBNY, et al. (Sept. 13, 2008) [FRBNY to Exam. 000709]
(discountingvalueofliquiditypoolbysubtractingamountofcollateralallocatedtoclearingbanks).
5692 Examiners Interview of Treasury Secretary Timothy F. Geithner, Nov. 24, 2009, at p. 4 (repeatedly
emphasizingthattheSEC,nottheFRBNY,wasLehmansprimarysupervisor);ExaminersInterviewof
ArthurG.Angulo,Aug.12,2009,atpp.34.
1472

overall capital position.5693 Further, in meetings with the Examiner, the SEC stated it
hadlittleauthoritytoregulateCSEbehaviorwithrespecttoliquiditypractices.5694Yet,
aninternalFebruary20,2008SECmemorandumdefinestheSECsmandatetoinspect
Lehmansliquiditypoolbroadly.Accordingtothatmemorandum:
To verify the composition of assets that comprise parent company

liquidity, the [SECsTrading and MarketsDivision] staff will identify all
components of liquidity held by, or available to, the parent company
withoutanyrestrictions.
...
Once the pool of assets is defined, the staff will sample the pool to
confirm, among other things, the existence of the assets, the legal entity
withrightstotheassets,thattheassetsareliquid,andthattheassetsare
availabletotheparentwithoutrestriction.5695
ThememorandumfurtherstatesthattheSECsprimaryfocuswillbetoverify
that[noncashassetsintheliquiditypool]maybemonetizedquicklyandthatthecash
proceedsareavailabletotheparentcompanyimmediately,usuallywithintwentyfour
5694Id.atp.12.
5695MemorandumfromPhillipMinnick,SEC,etal.,toErikSirri,SEC,etal.,re:ParentCompanyLiquidity
InspectionsScopeMemorandumfortheConsolidatedSupervisedEntities(CSE)(Feb.20,2008),atp.1
[LBEXWGM017294].InhisinterviewwiththeExaminer,formerSECAssistantDirectorofTradingand
Markets, Matthew Eichner, shed additional light on this document. In early 2007, the SEC determined
thatitshouldhirestaffwhosesoleresponsibilitywastoexamineCSEfirmsliquidity.TheSECfinished
hiringstaffinlate2007,andtheprogramwentliveinearly2008.Thismemorandumdefinedprocedures
for the justhired staff to follow for parent company liquidity inspections. Examiners Interview of
MatthewEichner,Nov.23,2009,atp.5.TheSEClaterassertedthatthememorandumdoesnotestablish
Commission guidelines or policy, rather, the SEC clarifies, it defined the scope of the upcoming
liquiditypoolinspectiontobeperformedatCSEfirms.LetterfromSamuelM.Forstein,SEC,toRobert
L.Byman,Jenner&Block(Jan.29,2010)(onfilewiththeExaminer).TheSECdidconfirmthattheCSE
inspections staff was asked to verify (1) the composition of assets that comprise liquidity held by the
parentcompany,[and](2)themechanismforimmediatemonetizationofnoncashassets....Id.
1473

hours.5696 According to former SEC Assistant Director for Trading and Markets
Matthew Eichner, the SEC conveyed this twentyfour hours standard to Lehman,
although Eichner could not recall who at the SEC conveyed it, or when.5697 That this
standard was conveyed, however, is confirmed by the fact that the SECs memo was
produced to the Examiner by Weil, Gotshal & Manges, counsel for the Debtors, and
thereforewasinLehmanscustody.5698
The SEC acted upon its authority to verify the contents of the liquidity pool at
certaintimes.TheSECanalyzedLehmansliquiditypoolcritically,identifiedassetsin
thepoolthatshouldnothavebeenthere,anddirectedLehmantoremovethoseassets.
Forexample,in2005 theSEC identified andobjectedtotheinclusionofa certain $1.5
billionbankfacility.5699Further,TonuccitoldtheExaminerthattheSECrequestedthat
Lehman remove a certain Aegis commercial paper (backstopped by Lloyds of
London)fromitsliquiditypoolinlate2007orearly2008,andthatLehmandidso.5700
InspectionsScopeMemorandumfortheConsolidatedSupervisedEntities(CSE)(Feb.20,2008),atp.2
[LBEXWGM017294].
5698TheLBEXWGMBatesprefixindicatesthatthedocumentwasproducedtotheExaminerbyWeil,
Gotshal&Manges.
5699 SEC, Lehman Brothers Holdings, Inc. Report on Liquidity & Funding Risk Management (July 26,
2005),atp.7[LBEXSEC010903].
5700 Examiners Interview of Paolo R. Tonucci, Sept. 16, 2009, at p. 25; see Lehman, Confidential
PresentationTo:U.S.Securities&ExchangeCommissionLiquidity&Funding2007Q4Review(Jan.18,
2008), at pp. 67 [LBHI_SEC07940_323589] (noting that Lehman agreed to remove a $1.5 billion
committedfacilityfromitsliquiditypoolinordertobringitsdefinitionofliquidityinlinewiththatofthe
SEC,andnotingthatinthefourthquarterof2007thatLehmandecidedtoremovetheAegisinvestments
fromitsliquiditypoolaswell).
1474

TheSECwasawarethatLehmanwasincludingacashdepositwithCitibankin
its liquidity pool. The SEC didnot believe the deposit belonged in the pool, elevated
theissueinternally,anddiscountedthevalueofthedepositfromitsowncalculationsof
Lehmans liquidity.5701 Lehman, however, continued to include the Citi deposit in its
reported liquidity pool.5702 In August 2008, the SEC learned that JPMorgan wanted
Lehman to post additional collateral, but was told by Tonucci that the posting would
not affect the liquidity pool.5703 The SEC was also aware of grumblings on
September12 that Lehman pledged an additional $5 billion to JPMorgan.5704 The SEC
was unaware of the August 26 and September 9, 2008 security agreements executed
between LBHI and JPMorgan, however, which substantially expanded JPMorgans
powerovercollateralthatLehmansimultaneouslyincludedinitsliquiditypool.5705
Despite the SECs knowledge ofthe inclusion of the Citi deposit and Lehmans
September12pledgetoJPMorgan,theSECdidnotbelievethattherewereanystrings
attached to Lehmans $34 billion liquidity pool as of September 12, 2008.5706 Asked
whether collateral pledged to clearing banks, even if putatively lienfree overnight,
shouldhavebeenincludedintheliquiditypool,theSECstatedthatitwouldhavebeen
5701ExaminersInterviewofSECStaff,Aug.24,2009,atp.11.
5702Id.
5703Id.
5704Id.
5705Id.
5706Id.
1475

inappropriate to include such assets in the liquidity pool.5707 Eichner, however, stated
that he was not sure whether the SEC ever reached a final view concerning the
proprietyofintradaycollateralinafirmsliquiditypool.5708
Moreover, Eichner stated, the SEC applied a much different standard to
holding company liquidity pools than the companies themselves did.5709 Eichner
characterizedtheSECsstandardasnarrowerthanthestandardtowhichtheholding
companiesheldthemselvesinpublicdisclosures.5710Additionally,hesaidthattheSEC
wasverycomfortablelivingwithaworldwherenumbersinthepublicweretheones
the firms worked out with their accountants, as opposed to the narrower numbers
workedoutbytheSEC.5711
(9) CertainLehmanCounselWereAwareThatAgreementswith
ItsClearingBanksWereStructuredtoIncludeClearingBank
CollateralinItsLiquidityPool,butDisclaimedKnowledge
ConcerningWhatAssetsWereAppropriateorInappropriate
fortheLiquidityPool
Lehman inhouse counsel Andrew Yeung was involved in drafting security
documentation with both JPMorgan and Bank of America.5712 Yeung recalled an
exchangebetweenhimselfandFleminginwhichFleminginstructedYeungtolimitany
lien in the August JPMorgan Security Agreement to the intraday period so that
5707Id.
5709Id.atp.7.
5710Id.
5711Id.
5712ExaminersInterviewofAndrewYeung,May14,2009,atpp.67.
1476

Lehmanwouldbeabletocharacterizethecollateralaslienfreeforliquidityreporting
purposes.5713Yeungwasunabletorecallfurtherexchangesonthistopic,however,and
statedthattheliquidityreportingissuewasnotgivenmuchattentioninthenegotiation
of the August and September JPMorgan agreements.5714 Yeung offered, however, that
around the time that the August JPMorgan agreements were being documented,
Lehman was negotiating agreements with other clearing banks with an eye toward
preservingliquiditywhilesimultaneouslygivingthosebanksincreasedsecurity.5715In
particular,Yeungsaidthatconcernsregardingthepreservationofliquidityweremore
pronouncedinthecontextofLehmansnegotiationswithBankofAmerica,culminating
in the August 25, 2008 Security Agreement.5716 That security agreement, like the
September 9, 2008 Security Agreement between Lehman and JPMorgan, included a
provisionallowingforthereturnofcollateraluponthreedayswrittennotice.5717
LehmanChiefLegalOfficerThomasRussowasunawarethatLehmanincluded
clearingbankcollateralinitsliquiditypool.5718TotheextentthatLehmandidinclude
such collateral in its liquidity pool, Russo had no opinion regarding the propriety of
5713Id.atp.7.
5714Id.
5715Id.
5716Id.
5717 Id. at pp. 78; see Security Agreement (Aug. 25, 2008) [LBEXDOCID 000584] (containing threeday
provisionforthereleaseofcollateral).
1477

Lehmans actions.5719 He further stated that he did not know what collateral was
appropriate or inappropriate for inclusion in the pool and that he had no role in
advisingLehmanonthisissue.5720
Andrew Keller, a partner at Simpson, Thacher & Bartlett, served as Lehmans
disclosure counsel. Mr. Keller recalled working on the liquidity portion of the
September 10, 2008 earnings call.5721 He was not aware, however, of any collateral
pledges, deposits or agreements, aside from the $500 million Bank of America
deposit.5722Hewasnotawarethatthisdeposit,oranyothersimilardepositorpledge,
was included in Lehmans liquidity pool at the time of the earnings call, nor did he
becomeawareatanypointbeforehisinterviewwiththeExaminer.Mr.Kellersaidhe
couldnotrecallanysignificantissuesordebatesregardinghowtodiscloseLehmans
liquiditypool.5723
(10) LehmansAuditorsMonitoredLehmansLiquidityPool,but
ViewedtheCompositionofthePoolasaRegulatoryIssue
William Schlich, lead auditor for Ernst & Youngs Lehman audit team,
represented to the Examiner that he was highly involved in monitoring Lehmans
5719Id.
5720Id.
5721ExaminersInterviewofAndrewR.Keller,Jan.6,2010,atp.2.
5722Id.
5723Id.
1478

liquidity pool following Bear Stearns near collapse in March 2008.5724 Schlich said he
wantedtoknowwhatLehmanwastellingitsregulators,specificallywhetherLehman
wasrollingitsreposorwhethercounterpartieswerebackingaway.5725Askedwhether
Ernst&YoungwasawareoforhadconcernswithLehmansinclusionofcertainassets,
such as the Citibank deposit or JPMorgans intraday collateral, in its liquidity pool,
Schlich stated that the composition of the liquidity pool was a regulatory issue.5726
Rather,Ernst&YoungsfocuswaswhetherLehmancouldfunditsbalancesheetona
dailybasisand,ifnot,whetherthefirmhadacontingencyplan.5727
(11) ThereIsInsufficientEvidenceToSupportaDetermination
ConnectionWiththePublicDisclosureofLehmansLiquidity
Pool
ItisnotwithinthescopeofhismandateandtheExaminerexpressesnoviewas
towhetherornotthedisclosuresmadebyLehmanaboutthesizeandcompositionofits
liquiditypoolmightgiverisetocausesofaction.TheExaminerdidconsiderwhether
anyofficer ordirectorbreachedafiduciarydutyby actingwithactual or constructive
knowledge to cause Lehman to make misleading statements about liquidity and
therebypotentiallyexposeLehmantocausesofactionbythirdparties.
5724 Ernst & Young Presentation to the Examiner, Sept. 16, 2009 (held at Ernst & Youngs request to
providetheExaminerwithanoverviewofErnst&YoungsroleasLehmansexternalauditor).
5725Id.
5726Id.
5727Id.
1479

Giventhat:(1)therearenodefinitivestandardsorrequirementsforreportinga
liquiditypool;(2)therearenodefinitivestandardsorrequirementsforwhatshouldor
should not be included in a liquidity pool; (3) the SEC and FRBNY had some
knowledgeofLehmansinclusionofquestionablecomponentsinitsreportedpoolbut
didnotdirectLehmantomakeanydisclosureorcorrectivestatement;(4)theamountof
questionable components in the reported pool did not becomea significant portion of
thereportedtotaluntillateAugust2008;and(5)theindividualwhopubliclyreported
theamountoftheliquiditypoolafterthattimemayvalidlyassertrelianceuponothers
fortheaccuracyoftheinformationherecited,theExaminerfindsinsufficientevidence
to support a determination that any officer or director breached a fiduciary duty in
connectionwiththereportingofLehmansliquiditypool.
1480

x
:
:
etal., :
Debtors. :
x
REPORTOF
TABLEOFCONTENTS
a) Introduction ................................................................................................1482
1481

6. TheInteractionBetweenLehmanandtheGovernment
a) Introduction
InthecourseoftheExaminersinvestigation,itbecameclearthatananalysisof
Lehmanssurvivalstrategies,itsliquidity,itscollateralpledgesandtheeventsleading
to the bankruptcy filingmustinclude adiscussion of the interactionbetweenLehman
andtheGovernmentagenciesthatregulatedandoversawLehman.Forexample,when
the Examiner questioned Lehman executives and other witnesses about Lehmans
financial health and reporting, a recurrent theme in their responses was that Lehman
gave full and complete financial information to Government agencies, and that the
Government never raised significant objections or directed that Lehman take any
corrective action. To test that assertion, and to understand the events leading to
Lehmansbankruptcyfiling,theExaminerhadtoanalyzetheroleoftheagencies.
At the highest levels, each of these agencies recognized as early as 2007 but
certainlybymidMarch2008,aftertheBearStearnsnearcollapsethatLehmancould
fail.5728 Treasury Secretary Paulson, Fed Chairman Bernanke, FRBNY President
Geithner and SEC Chairman Cox all had direct communication with Fuld. The day
5728ExaminersInterviewofBenS.Bernanke,Dec.22,2009,atp.5(notingthatafterBearStearnsnearly
collapsed, the Government focused on the stability of investment banks, and that Lehman was seen as
particularly vulnerable); Examiners Interview of Timothy F. Geithner, Nov. 24, 2009, at p. 3 (noting
concernswithLehmanthroughout2008,particularlyaroundthetimeofBearStearnsnearcollapse,and
that Lehman was viewed as the nextmost vulnerable after Bear); Examiners Interview with Henry M.
Paulson, Jr., June 25, 2009, at p. 11 (noting that Paulson was particularly concerned with Lehman after
BearsnearcollapseandthusurgedLehmanCEODickFuldtoraisecapitalorarrangeforaninvestment
byorsaletoathirdparty).
1482

afterBearStearnsWeekend,teamsofGovernmentmonitorsfromtheSECandFRBNY
weredispatchedtoandtookupresidenceatLehmantoreviewandmonitoritsfinancial
condition.5729
The SEC monitored Lehman as the companys primary regulator under the
Consolidated Supervised Entities (CSE) Program. Chief among the SECs
regulatory obligations was its responsibility to monitor and verify the contents of
Lehmansliquiditypool.5730TheFRBNYservedasalendertoLehmanundertheFeds
discount window, which became available to brokerdealers after Bear Stearns near
collapse. In this capacity, the FRBNY lent billions of dollars to Lehman secured by
certainofLehmansassets.OtherGovernmententities,includingtheDepartmentofthe
TreasuryandtheFederalReserve,alsohadoversightauthorityoverLehman.
Although various Government agencies had information that raised serious
questionsaboutLehmansreportedliquidityandaboutthesufficiencyofitscapitaland
liquiditytowithstandstressscenarios,theagenciesgenerallylimitedtheiractivitiesto
collectingdataandmonitoring.
5729 Examiners Interview of Arthur G. Angulo, Aug. 12, 2009, at p. 2; Examiners Interview of Jan H.
Voigts,Aug.25,2009,atpp.23.
InspectionsScopeMemorandumfortheConsolidatedSupervisedEntities(Feb.20,2008),atp.1[LBEX
WGM 017294] (defining the scope of the SECs inspection of CSE liquidity, and directing the SEC to
inspectCSEliquiditypools).
1483

b) TheSECsOversightofLehman
(1) TheCSEProgram
TheFRBNY,theFederalReserve,andtheTreasuryDepartmentall viewed that
the SEC was Lehmans primary regulator.5731 The SEC has statutory authority over
brokerdealers such as LBI, but its authority over LBHI as the holding company is
voluntary,notstatutory.
In 2003, the European Union (EU) issued the Financial Conglomerates
Directive, which required that financial conglomerates operating within the EU be
supervisedeitherunderEUfinancialregulationsorbyasetofsubstantiallyequivalent
rules.5732ThemajorinvestmentbankspreferredSECregulationtoEUregulation.The
GrammLeachBliley Act of 1999 had created a void in the regulation of systemically
importantlargeinvestmentbankholdingcompanies.5733NeithertheSECnoranyother
agency was given statutory authority to regulate such entities. To fill this regulatory
5731ExaminersInterviewofBenS.Bernanke,Dec.22,2009,atp.4(BernankenotedthattheSECnotthe
Fed was Lehmans regulator); Examiners Interview of Timothy F., Geithner, Nov. 24, 2009, at p. 4
(Geithner told the Examiner that the SEC not the FRBNY was Lehmans primary regulator);
ExaminersInterviewofHenryM.Paulson,Jr.,June25,2009,atp.8(PaulsonexplainedthattheSECnot
Treasury bore primary responsibility for regulating Lehman); SEC/FRBNY, Memorandum of
Understanding Between the United States Securities and Exchange Commission and the Board of
GovernorsoftheFederalReserveSystemRegardingCoordinationandInformationSharinginAreasof
Common Regulatory and Supervisory Interest (July 7, 2008), at p. 4 (Memorandum of Understanding
betweentheSECandFRBNYstatingthattheSECistheprimarysupervisoroftheCSEs).
5732ExaminersInterviewwiththeSECstaff,Aug.24,2009,atp.3.
5733 SEC, Press Release, Chairman Cox Announces End of Consolidated Supervised Entities Program
(Sept.26,2008).
1484

gap,theSECcreatedtheConsolidatedSupervisedEntities(CSE)Programin2004.5734
The CSE Program was technically voluntary: holding companies that agreed to the
SECs supervision on a consolidated basis received an exemption from the SECs net
capital rule in exchange for agreeing to submit to CSE regulation, but the firms
remained free to comply with the net capital rule and withdraw from CSE
supervision.5735 The consequence of withdrawal would have been EU regulation,
however, so as a practical matter the firms had little choice but to submit to CSE
regulation.5736 Goldman Sachs, Morgan Stanley, Bear Stearns, Merrill Lynch, and
LehmanBrothersalloptedintotheCSEProgramandbecamesupervisedconsolidated
entities.5737
The CSE Program was designed to protect brokerdealers affiliated with CSEs
from collapse.5738 Unlike commercial banks that could access income streams from
customerdeposits,theCSEinvestmentbankswerecompletelydependentonthecredit
5734Id.
5735Id.Sincethenetcapitalrulerequiredonly$5billionofcapital,compliancewasnotanissueforthe
CSEfirms.
5736 Examiners Interview of Matthew Eichner, Nov. 23, 2009, at p. 4 (noting that CSEs had strong
incentivestojointheCSEProgramduetoEUregulations).
5737ExaminersInterviewofSECstaff,Aug.24,2009,atpp.34.
5738Id.atp.4.FormerSECChairmanChristopherCoxexplainedtoCongressthatthepurposeoftheCSE
Programwastomonitorfor,andactquicklyinresponseto,financialoroperationalweaknessinaCSE
holding company or its unregulated affiliates that might place regulated entities . . . or the broader
financialsystem,atrisk.TheStateoftheUnitedStatesEconomyandFinancialMarkets:HearingBeforetheS.
Comm.onBanking,Housing,andUrbanAffairs,110thCong.2(2008)(StatementofChristopherCox,Former
SEC Chairman). Cox told the Examiner that the SECs authority was limited to the brokerdealer, and
that when he told Congress that the purpose of the CSE Program was to act quickly, he meant to act
quickly with respect to the brokerdealer entity. Examiners Interview of Christopher Cox, January 8,
2010,atp.6.
1485

markets for funding and did not enjoy backup protection from the Federal Deposit
Insurance Corporation. As a result, liquidity risk was the SECs foremost concern
undertheCSEProgram.5739
TheCSEProgramgavetheSECtherighttoinspect.5740TheSECsoversightwas
particularly focused on the firms liquidity and riskmanagement monitoring
functions.5741AlthoughtheSECdidnotdevelopaformulaofrigidfilingrequirements,
it did require the firms to satisfy a number of liquidity and riskmanagement related
conditions.CSEswererequiredtoimplementliquiditymodelsthatensuredalevelof
liquiditysufficienttosustainthemselvesonastandalonebasisforaminimumofone
yearwithoutaccesstounsecuredfundingandwithouthavingtoliquidateasubstantial
position.5742 Assets in the firms liquidity pools needed to be funded and accessible
withoutregulatoryinterferenceorotherimpediments.5743
Each CSE was also required to maintain and document a system of internal
controls for riskmanagement purposes. The CSEs internal controls needed to be
approved by the SEC prior to their implementation and the firms were required to
submittoregularmonitoringoftheir internalcontrolmechanisms.TheCSEProgram
5740Id.atp.4.
5741Id.
5742Id.
5743Id.
1486

required the firms to conduct regular marketbased and liquidityrelated stress
testing.5744
(2) LehmansParticipationintheCSEProgram
Lehman became a CSE participant in 2005.5745 The SEC found Lehman to be
highlycooperative,andtheregulatorsreceivedeverythingtheyaskedfor.5746Even
beforemidMarch2008,whenSECstaffperiodicallyinspectedLehmanonsite,theSEC
staff met frequently with Lehman risk managers, internal auditors and financial
personnel.AprimaryfocusoftheSECwasliquidityandthecompositionofLehmans
liquiditypool.5747
Although the SEC staff scrutinized both the size of and ability to monetize the
pool, it did not look at Lehmans liquidity pool from a disclosure perspective.5748
Instead,theSECapplieddiscountstotheassetsthatitviewedaslessthancompletely
liquid, or easy to monetize, to assess Lehmans overall capital position.5749 The SEC
did not, however, suggest or demand that Lehman take similar haircuts when it
publiclydisclosedtheamountofitspool.5750
5744Id.
5745Id.atp.5.
5746Id.
5747Id.atp.10.
5748Id.
5750Id.(theSECdiscountedtheCitibankdepositfromthevalueofLehmansliquiditypool;theSECwas
notaware,however,oftheotherclearingbankpledgesanddepositsLehmanincludedinthepool).
1487

For example, in June 2008, the SEC became aware that Lehman included in its
liquiditypoolamultibilliondollardepositthatLehmanhadmadewithCitigroupasa
precondition of continued banking relations.5751 Because the deposit could not be
withdrawn without adverse effects upon Lehmans daytoday business, the SEC staff
disagreedwithLehmansviewthatthedepositwasproperlyincludedintheliquidity
pool. Accordingly, the SEC staff discounted that amount for its own assessments of
Lehmansliquidity.5752TheSECdidnot,however,takeanyactiontorequireLehmanto
removethedepositfromtheamountitcontinuedtoreportpublicly.
LiquiditywasanimportantfactorinthestresstestingthatLehmanwasrequired
torunundertheCSEProgram.AfterMarch2008whentheSECandFRBNYbeganon
site daily monitoring of Lehman, the SEC deferred to the FRBNY to devise more
rigorousstresstestingscenariostotestLehmansabilitytowithstandarunorpotential
run on the bank.5753 The FRBNY developed two new stress scenarios: Bear Stearns
andBearStearnsLight.5754Lehmanfailedbothtests.5755TheFRBNYthendevelopeda
5751 Id. Although the SEC believed that Lehman had deposited $5 billion with Citigroup, the actual
amount of the deposit was $2 billion. See Section III.A.5.c of this Report, which discusses Lehmans
dealingwithCitigroup.TheSEClaterstatedthatthiswasaninaccuraterecollectiononthepartofanSEC
staffer and further stated that SEC was aware that the correct size of the deposit was $2 billion. SEC,
ReferencestoSEC(Jan.29,2010),atp.11.
5753Id.Theregulatorsuseddifferentstresstestsforriskandliquidity.SeeSectionIII.A.1ofthisReport,
whichdiscussesriskmanagementandriskstresstests.
5754 William Brodows, et al., FRBNY, Primary Dealer Monitoring: Initial Assessment of CSEs (May 12,
2008),atp.9[FRBNYtoExam.000017](describingtheframeworkforboththeBearandBearLight
scenarios).
1488

new set of assumptions for an additional round of stress tests, which Lehman also
failed.5756 However, Lehman ran stress tests of its own, modeled on similar
assumptions,andpassed.5757Itdoesnotappearthatanyagencyrequiredanyactionof
Lehmaninresponsetotheresultsofthestresstesting.
The SEC recognized in 2007 that there were potential assetvaluation problems
across the investment banking industry.5758 SEC staff reviewed Lehmans asset
valuationstoensurethatthefirmmaintainedanindependentpricevaluationfunction
thatcompliedwithvariousCSEreportingrequirements.Lehmansvaluationproblems
were more pronounced than those of other firms because its exposure to commercial
realestateandAltAmortgageswaslargerthanthatofanyoftheotherCSEfirms.5759
InJanuary2008,theSECbegananinspectionofvaluationproceduresinallofthe
CSE firms to ensure that the firms were complying with internal controls, to compare
procedures across the five firms and to provide feedback to the firms.5760 The SEC
inspection revealed significant problems at Lehman. The SEC found that Lehmans
5755Id.atp.10(showingthatLehmanwouldneedtoraise$84billiontosurviveaBearrunonthebank,
and$15billiontosurviveaBearLightliquidityevent).
5756FRBNY,PrimaryDealerMonitoring:LiquidityStressAnalysis(June25,2008(RevisedJune26,2008)),
atpp.3,5[FRBNYtoExam.000033](concludingthatLehmanrequired$15billioninadditionalliquidity
tosurvivealiquiditystresseventonthistestsrevisedassumptions).
5757 See, e.g., Lehman, Presentation to the Federal Reserve & SEC: Updated Stressed Liquidity Scenario
(July2,2008),atp.9[LBHI_SEC07940_348894](showingthatLehmanwouldsurvivethestresstestwith
$13.1billioninexcesscash).
5759Id.
5760Id.
1489

Price Valuation Group was understaffed; and it found that Lehmans asset pricing
function was overly process driven.5761 But the SEC did not release its findings or
formallypresentthemtoLehmanpriortoLehmansdemise.
(3) TheSEC/OIGFindings
OnApril2,2008,IowaSenatorCharlesE.GrassleyrequestedtheSECOfficeof
Inspector General (SEC/OIG) to analyze the SECs oversight of the CSE Program in
the wake of Bear Stearns near collapse. The SEC/OIG released its audit report on
September 25, 2008, shortly after Lehman had filed for bankruptcy,5762 but the report
wascirculatedindraftformduringthesummerof2008andwasreviewedbytheCSE
staff.5763
The SEC/OIG Report was critical of the SECs regulation of Bear Stearns in
particularandtheCSEProgramingeneral.TheReportfoundthattheSECknewBear
Stearns had high leverage, had insufficient capital, and held an excessive volume of
mortgagebackedsecurities;yettheSEChadtakennoactiontorequireachangeinthe
firms policies, despite the many potential red flags of excessive risk evident at Bear
Stearns.5764
5761 Notably, noone at the SEC ever sawany evidencesuggesting that Lehman managedits valuations
basedonpredeterminedbalancesheettargets.Id.atp.14.
5762SEC/OIG,SECsOversightofBearStearnsandRelatedEntities:TheConsolidatedSupervisedEntity
Program,Rpt.No.446A(Sept.25,2008).
5764SEC/OIG,SECsOversightofBearStearnsandRelatedEntities:TheConsolidatedSupervisedEntity
Program,Rpt.No.446A(Sept.25,2008)atp.ix.
1490

The SEC/OIG questioned why the SEC imposed no leverage ratio limit on CSE
firmssuchasBearStearns.5765TheSEC/OIGnotedthattheSEChadalsobeenawareof
deficiencies in Bear Stearns risk management but did not require changes.5766 The
SEC/OIG concluded that the SECs capital requirements for CSEs were inadequate.5767
The SEC/OIG Report found the SECs liquidity requirements for CSEs to be
unrealisticallylow.5768
AtthetimeofBearStearnsnearcollapseinMarch2008,itwaswidelythoughtat
thehighestlevelsofeveryrelevantGovernmentagencythatLehmancouldbethenext
investment bank to fail.5769 Lehmans business model was markedly similar to Bear
Stearns: high leverage, low capitalization, and a concentration of assets in illiquid
5765 The CSE Program did not impose leverage ratio limits. The SEC/OIG Report emphasized Bear
Stearnshighgrossleverageratio33:1atthetimeofitsnearcollapse.TheReportobservedthathigh
leverage can both cause a loss of liquidity during a financial crisis and adversely influence market
confidenceinahighlyleveragedfirm.Id.atpp.x,1920.
5766 The SEC/OIG found that, based upon the experience of Bear Stearns U.K. mortgage originator
subsidiaryinthesecondquarterof2006,theSEChadidentifiedtherisksthataroseinthesubprimecrisis
in the U.S. less than a year later. Yet the SEC did not apply pressure to Bear Stearns to reduce its
subprimeexposure.Id.atpp.x,18,2122,25.
5767 The SEC/OIG found no evidence that the SEC required Bear Stearns to take increased charges to
capitalforitspositionsinstressedrepos.Id.atpp.1113,3032.
5768Id.atpp.1415.
5769ExaminersInterviewofBenS.Bernanke,Dec.22,2009,atp.5(notingthatafterBearStearnsnearly
collapsed, the Government focused on the stability of investment banks, and that Lehman was seen as
particularlyvulnerable);ExaminersInterviewofChristopherCox,Jan.8,2010,atpp.78(followingthe
near collapse of Bear Stearns, liquidity concerns made Lehman the SECs number one focus);
Examiners Interview of Timothy F. Geithner, Nov. 24, 2009, at p. 3 (noting concerns with Lehman
throughout 2008, particularly around the time of Bear Stearns near collapse, and that Lehman was
viewedasthenextmostvulnerableafterBear);ExaminersInterviewofHenryM.Paulson,Jr.,June25,
2009,atp.11(notingthatPaulsonwasparticularlyconcernedwithLehmanafterBearnearlycollapsed
andurgedFuldtoraisecapitalorarrangeforaninvestmentbyorsaletoathirdparty).
1491

investmentssuchassubprimeorAltAmortgages.5770TheExamineraskedtheCSEstaff
whetheritmodifieditsapproachtoLehmanordirectedanyactionbyLehmaninlight
of the SEC/OIG proposed findings that it saw in summer 2008. The CSE officer in
chargeofLehmanrespondedthattheSECdidnottakeanyaction:Weweretiedtothe
mast here; the opportunities for reengineering were quite limited, and to imply
otherwiseiswrong.5771
(4) TheViewFromtheTop
TheExaminerinterviewedformerSECChairmanChristopherCox,whorelated
thattheinvestmentbankingindustrywasincreasinglyviewedasprecariousin2008
and,asaresult,allinvestmentbankswereaconcernfortheSEC.5772TheSECfocused
on increasing capital and liquidity for all investment banks.5773 The SEC had some
successinthatBearStearnsincreaseditsliquidity,butnotenoughtosurvive.Coxdid
notthinktherewasanyliquiditynumberlargeenoughtowithstandarunonthebank:
Theresnoamountofliquiditythatcanprotectyoufromanindefiniterun.5774After
5770 Jenny Anderson, At Lehman, Allaying Fears About Being the Next to Fall, N.Y. Times, Mar. 18, 2008
(noting similarities between Bear Stearns and Lehmans business models, in particular their common
relianceonshorttermfinancingandthemortgagemarket).
5773Id.
5774Id.
1492

Bear Stearns was sold to JPMorgan in March 2008, Lehman became the number one
focus.5775
Before Bear, Cox believed that he should not hobnob with the CEOs of
regulatedentities.HeexplainedthattheSECmighthavetoinvestigatethosefirms,or
theymightalreadybeunderinvestigation,andCoxdidnotwanthiscommunications
to have any influence on those investigations.5776 But Cox deliberately changed that
approach after the near collapse of Bear Stearns.5777 He told the Examiner: Things
weremovingtoofasttoobservecarefulprotocols.5778
BeginninginMarch,2008,CoxhaddirectcallswithFuldeverycoupleofweeks,
generallyontwoissues:(1)FuldsdesirethattheSECdealwithshortsellers,and(2)
LehmansplanswithrespecttoSpinCo.5779
TheExamineraskedCoxwhether,in hindsight,hebelievedthattheSECcould
have done anything different that might have saved Lehman. Cox responded that
manyanalystshavewonderedwhyFulddidnotsellLehmanatalowerprice,ortake
otheractionstosaveLehmanearlierthanhedid.5780Coxsaidthatitcameasasurprise
[to Lehman] that the Government would not financially participate, and he believed
5775Id.atp.8.
5776Id.
5777Id.atp.9.
5778Id.
5779Id.SpinCo,andotherofLehmanssurvivalstrategies,arediscussedinSectionIII.A.3.
1493

thattheGovernmentsunwillingnesstomakeacommitmenttoLehmanenteredinto
theFSAsjudgmentindecidingnottoapproveaBarclaysLehmandeal.5781Although
hesaidthathehasnocriticismofanyagency,Coxstatedthatnostatutoryframework
existed on September 14, 2008, that allowed the Government to help Lehman in a
materialway.5782Yet,Coxsaid,Ithinkpeoplewouldhavebehaveddifferentlyifthey
werenotexpectingtheGovernmenttodosomething.Intheend,thefactthattherewas
no Government contribution made it impossible to get across the finish line.5783
Further, Cox stated: Maybe if the message could have been provided [that no
Governmentfundingexisted]morethanaweekbefore[thebankruptcy],peoplemight
haveorderedtheiraffairsdifferentlyiftheyhadknownwhatwasgoingtohappen.5784
c) TheFRBNYsOversightofLehman
Timothy Geithner, current Secretary of the Treasury and thenPresident of the
FRBNY, developed serious concerns about Lehman as early as August 2007.5785 The
concerns grew in 2008, particularly in March after Bear Stearns nearly collapsed.5786
5781Id.
5782Id.
5783Id.
5784Id.Notehowever,thatSecretaryPaulsonneverpromisedFuldGovernmentassistanceforLehman.
Examiners Interview with Henry M. Paulson, Jr., June 25, 2009, at p.17; Examiners Interview with
RichardS.Fuld,Jr.,Sept.30,2009,atp.21.
5786Id.
1494

AfterBear,GeithnerviewedLehmanasthemostexposedinvestmentbank,withMerrill
Lynchadistantsecond.5787
TheproblemwasfarbroaderthanLehman.5788Throughthesummerof2008,it
becamecleartoGeithnerthattherecessionwasbuildinginmagnitudeandthatitwas
goingtoimperilarangeofinstitutions.5789Geithnerbecameworriedthattheeconomic
crisiswasagatheringstormthatwasgettingawayfromusandthatitcouldescalate
intermsofforceandwemightnotbeabletocontainit.5790Evenso,everyonegotit
wrongbyunderestimatingthescaleoftheproblem.5791
In March 2008, the FRBNY installed teams of monitors at Lehman, not as a
regulator but as a potential lender.5792 The FRBNY onsite analysts received realtime
dataonLehmansliquidityandcapitalpositionthroughformalandinformalchannels
at the firm, and synthesized this data in comprehensive daily reports distributed
5787Id.;ExaminersInterviewofArthurG.Angulo,Aug.12,2009,atp.5(FRBNYanalystsviewedLehman
as the nextmost vulnerable firm after Bear Stearns nearly collapsed); Examiners Interview of Jan H.
Voigts, Aug.25, 2009,at p. 3 n.3 (FRBNY viewed Lehman as the weakest of the pack following Bear
Stearnscollapse).
5788ExaminersInterviewofJanH.Voigts,Aug.25,2009,atp.3(whileLehmanwasperceivedtobeweak,
itwasnotidiosyncraticinthisregard;ratherLehmanwassymptomaticofmorestructuralproblems
inthefinancialsectoraroundthistime).
5790Id.
5791Id.;ExaminersInterviewofJanH.Voigts,Aug.25,2009,atpp.56(statingthattheFRBNYdidnot
fullyappreciatetheconsequencesofabankruptcybyLehmansholdingcompany).
5792ExaminersInterviewofThomasC.Baxter,Jr.,May20,2009,atp.4(FRBNYmonitoredLehmanasa
potentiallenderundertheTSLFandPDCFprograms);ExaminersInterviewofArthurG.Angulo,Aug.
12, 2009, at p. 2 (FRBNY monitored Lehman as a prospective lender); Examiners Interview of Jan H.
Voigts,Aug.25,2009,atpp.23(same).
1495

throughouttheFRBNY.5793GeithnerparticipatedinseveralmeetingswithLehmanand
otherinvestmentbankstounderstandwhere[theinvestmentbanks]were[withcapital
andliquidity],andwheretheyweregoing,andpullthemtoamoreconservativeplace
regarding capital and liquidity.5794 Geithner was consumed with the challenge to
figureouthowtomake[Lehman]getmoreconservativelyfunded.5795
Although the SEC and FRBNY had equal access to the same data and Lehman
personnel, the two agencies did not necessarily share their conclusions and analyses
withoneanother.5796Indeed,becauseofwhatBernankedescribedastrickyissues,he
and Cox became directly involved in the negotiation of a formal Memorandum of
Understanding (MOU) that would allow the exchange of information between the
twoagencies.5797TheMOUwasnotexecuteduntilJuly2008.5798YetevenwiththeMOU
5793 See, e.g., FRBNY, Lehman IB Update (Aug. 27, 2008) [FRBNY to Exam. 007968] (a representative
FRBNY daily report analyzing Lehmans liquidity pool, the status of Lehmans secured and unsecured
funding, intraday funding, stock price, clearing bank actions, and significant stories about Lehman
circulatinginthepress).
5795Id.
5796ExaminersInterviewofJanH.Voigts,Aug.25,2009,atp.3(theFRBNYandSECdidnotoftenshare
theirconclusionsinthecourseofmonitoringLehmansliquidity).
5797 Examiners Interview of Ben S. Bernanke, Dec. 22, 2009, at p. 7. Bernanke described the tricky
aspects of the MOU as whether, for example, the SEC could use information shared by the FRBNY to
undertakeaninvestigation.Bernankedidnotstatewhethertherehadbeenanyresolutiontothisissue.
5798 SEC/FRBNY, Memorandum of Understanding Between the United States Securities and Exchange
Commission and the Board of Governors of the Federal Reserve System Regarding Coordination and
InformationSharinginAreasofCommonRegulatoryandSupervisoryInterest(July7,2008).
1496

in place, FRBNY witnesses noted that they did not receive all the documents they
requestedfromtheSECinconnectionwithLehmansliquidity.5799
Certain FRBNY onsite personnel expressed the view to the Examiner that the
SEConsitepersonneldidnothavethebackgroundorexpertisetoadequatelyevaluate
thedatatheyweregiven.5800
GeithnerhadanumberoftelephoneconversationswithFuldaroundthetimeof
Bear Stearns near collapse, Lehmans announcement of its second quarter 2008
earningsandthedaysleadinguptoLehmansbankruptcy.Thecallscenteredaround
threetopics:(1)GeithnerrepeatedlyinformedFuldthattheGovernmentcannotsolve
this problem for you; and, therefore, (2) Lehman needed to raise more capital; or (3)
formastrategicalliancewithanotherentitywithastrongerbalancesheet.5801Geithner
also spoke with Fuld about Fulds proposal that Lehman become a bank holding
5799 Examiners Interview of Jan H. Voigts, Oct. 1, 2009, at p. 7 (noting that the FRBNY did not receive
certain SEC analyses regarding CSE commercial real estate positions and CSE liquidity pools despite
asking for such information); Examiners Interview of Arthur G. Angulo, Aug. 12, 2009, at p. 3 (noting
thattheMOUwasnotsignificant).
5800ExaminersInterviewofArthurG.Angulo,Aug.12,2009,atp.3(notingthattheSEClackedsufficient
staffandsufficienttimetoanalyzeLehmanindepth);ExaminersInterviewofThomasC.Baxter,Jr.,
Aug.31,2009,atpp.2,5(theprimaryweaknessoftheCSEProgramwasSECunderstaffingandthe
lackofhigherlevelskillsetsforSECstaffers).Thoseviewspercolatedtothetop.Bernankeobserved
thattheFedhadsomeskepticismandconcernabouttheSECscapacity,goingbacktoBear,wherethey
wereblindsidedtoasignificantextentthereaswell.Bernankewascarefulnottoassignblameorfault,
butobservedthattheSECwasinover[its]head.ExaminersInterviewwithBenS.Bernanke,Dec.22,
2009, at p. 8. Chairman Cox countered the suggestion that SEC personnel were not competent by
pointingoutthatotheragencies,includingTreasuryandtheFed,hiredthemaway.ExaminersInterview
ofChristopherCox,Jan.8,2010,atpp.1920.
5801ExaminersInterviewofTimothyF.Geithner,Nov.24,2009,atpp.56.
1497

company. Geithner viewed that as gimmicky: You cant solve a liquidity/capital
problembybecomingabankholdingcompany.5802
Geithner believed that Fuld understood by July 2008 that Lehman required a
very substantial and expensive change to survive.5803 Geithner told the Examiner:
Thereisalwayssomehopeanddenialinthesethings,butthatithadappearedFuld
was attempting to find solutions with due urgency.5804 The fundamental difficulty
facing Lehman was timing. Lehman needed to persuade an investor (or investors) to
buyintoLehmanjustatthetimewhenthesouringeconomymadepotentialinvestors
highlyskittishaboutabsorbingmorerisk.5805
FRBNYwitnessesuniformlyemphasizedtotheExaminerthattheSECnotthe
FRBNY was Lehmans primary regulator.5806 The FRBNYs role was as a potential
lender, not a regulator; after Bear Stearns nearly collapsed, the FRBNY opened the
discountwindowtoinvestmentbankssuchasLehman,andtherebybecamearather
5802Id.atp.6.
5803Id.
5804Id.
5805Id.
5806ExaminersInterviewofArthurG.Angulo,Aug.12,2009,atp.3(SEC,nottheFRBNY,wasLehmans
main supervisor); Examiners Interview of Thomas C. Baxter, Jr., Aug. 31, 2009, at p. 4 (the SEC was
withoutquestionLehmansprimaryregulator);ExaminersInterviewofTimothyF.Geithner,Nov.24,
2009,atp.4(theSEC,notFRBNY,wasLehmansprimarysupervisor);ExaminersInterviewofJanH.
Voigts, Aug. 25, 2009, at p. 2 (the SEC was Lehmans primary regulator); Examiners Interview of
William L. Rutledge, Aug. 27, 2009, at p. 4 (the SEC was absolutely without question the primary
regulatoroftheCSEs).
1498

late,reluctantcreditor.5807Assuch,theFRBNYmonitoredLehmansliquidityprofileto
be wellpositioned to lend to Lehman under its new liquidity facilities.5808 But the
FRBNY, as an interested creditor, worked with the SEC to induce a series of
behaviorsregardingliquidityacrosstheinvestmentbanks.5809
In advance of September 2008, the FRBNY was considering proactive measures
to prevent, or mitigate, the collapse of major brokerdealers, and Lehman specifically.
For example, in July 2008, FRBNY analysts presented Geithner with a proposal to
provide intraday financing for brokerdealers via clearing banks in addition to
providingovernightfinancingtobrokerdealersviathePDCF.5810Insuchascenario,the
FRBNYcouldenterintoaconditionalnonrecourseloanwiththeclearingbankatthe
beginning oftheday,collateralizedbyacashclaimonthedealerinquestion,andthe
associatedcollateral.5811Theclearingbankwouldthencontinuetoextendcredittothe
dealer,andassumingthedealersurvivedthetradingday,theclearingbankwouldthen
repay the FRBNY loan.5812 The FRBNY tailored this plan to Lehmans repo book,
5808ExaminersInterviewofJanH.Voigts,Aug.25,2009,atp.2.
5809ExaminersInterviewofTimothyF.Geithner,Nov.24,2009,atp.4.Indeed,theFRBNYworkedwith
theSECtoproducetheliquiditystressscenariosthaturgedLehmantoincreaseitsliquidityandreduce
reliance on overnight commercial paper and lessliquid repos. See FRBNY, Primary Dealer Monitoring:
LiquidityStressAnalysis(June25,2008(RevisedJune26,2008)),atp.5[FRBNYtoExam.000038].
5810MemorandumfromLucindaBrickler,FRBNY,etal.,toTimothyF.Geithner,FRBNY,reManaginga
LossofConfidenceinaMajorTripartyRepoBorrower(July7,2008),atp.1[FRBNYtoExam.027043].
5811Id.atp.2.
5812Id.TheplanwasdesignedtoaddressthepossibilityofaninvestmentbanksuchasLehmanBrothers
los[ing][the]confidenceofitsinvestorsorclearingbank,whichwouldthenpullawayfromproviding
1499

applyinghaircutstoLehmansavailablecollateral,andarrivingatanadditionalamount
of collateral that Lehman would need, in order to realize the full pledge value of that
collateral.5813
In July 2008, senior FRBNY official (and current FRBNY president) William
Dudleyproposedaplan[v]erymuchinthespiritofwhatwedidwithBeartoextend
toLehmanaMaidenLanetypevehicle.5814TheMaidenLanevehicleemployedin
Bear Stearns was a special purpose vehicle (SPV) set up to induce JPMorgan to
acquire Bear and to guarantee Bears outstanding obligations; the FRBNY extended to
JPMorgan a $30 billion nonrecourse loan, collateralized by illiquid Bear assets.5815
UnderDudleysproposal,thisnewMaidenLanetypevehiclewouldhold$60billion
in illiquid Lehman assets backstopped by $5 billion in Lehman equity.5816 The Fed
would then guarantee[] financing or finance [] the remaining $55 billion.5817 After
removing the illiquid assets via the Maiden Lane SPV, a Clean Lehman (Clean
intraday credit a result that would be disastrous for the firm and also cast widespread doubt on
[tripartyrepos]asanearlyriskfree,liquidovernightinvestment.Id.
5813Id.atpp.48.Theproposalnotedthatsuchaplanwouldrequirefurtherlegalresearch.
5814EmailfromTimothyF.Geithner,FRBNY,toWilliamDudley,FRBNY(July7,2008)[FRBNYtoExam.
034332](quotingandrespondingtoDudleysproposal).
5815FRBNY,MaidenLaneTransactions,availableathttp://www.newyorkfed.org/markets/
maidenlane.html.
5816EmailfromTimothyF.Geithner,FRBNY,toWilliamDudley,FRBNY(July7,2008)[FRBNYtoExam.
034332](quotingandrespondingtoDudleysproposal).
5817Id.
1500

Lehman) would remain. The FRBNY, in turn, would have an equity stake in Clean
Lehman.5818
Dudleys plan, while taking illiquid assets off the market, and preserv[ing]
Lehmanfranchisevalue,providedfor[p]rotectionsto the Fed as well.5819Geithner
respondedthatfurtherthoughtwasrequiredonhowwedecidewhatassetstotake,
andthatanyplanwouldrequirehighproceduralhurdles.5820
Ultimately, the FRBNY decided not to extend a Maiden Lanestyle vehicle to
Lehman.Rather,duringtheweekendofSeptember1214,2008,theFRBNYconvened
meetingstoencourageaconsortiumofWallStreettofinanceLehmansilliquidassets,
withtheintentionoffacilitatingasaleofLehmantoBarclaysoranotherbuyer.5821
TheExamineraskedGeithnerwhether,inhindsight,hebelievedthattheFRBNY
couldhavedoneanythingdifferentthatmighthavesavedLehman.Geithnersanswer
was no. He noted that the Government of the United States left too much of the
burdenontheFedtocontain[thedamage],anditwastoolatetousethefullarsenalof
Government powers . . . If these [emergency statutory powers] had come earlier, we
5818Id.
5819 Id. The plans envisaged protections included interest from repayments to the FRBNY on the non
recourseloan,andequityinCleanLehman.Dudleysplanalsoaccountedformoralhazard,notingthat
the[m]oralhazardconsiderations[wouldbelow]given[the]equitydilutioninvolvedforthesalvaged
investmentbank.Id.
5820Id.
1501

could have made it somewhat less damaging.5822 However, Geithner noted that he
wouldhaveopposedanyefforttogiveLehmanorotherinvestmentbanksearlieraccess
to the Feds liquidity facilities. The challenge for the Government, and for troubled
firmslikeLehman,wastoreduceriskexposure,andtheactofreducingriskbyselling
assets could result in collateral damage by demonstrating weakness and exposing
airinthemarks.5823GeithnersaidthattheFRBNYhadtomakesurethatthesystem
would be held together and that the strongest institutions would not be imperiled by
theweakest.5824
d) TheFederalReservesOversightofLehman
Federal Reserve Chairman Bernanke agreed with Geithner that the SEC was
Lehmans regulator and that the Fed had neither direct [n]or indirect responsibility
forLehman;neverthelesstheFedfollowed[Lehmans]progress.5825
The Fed became interested in investment banks around the time that
JPMorgan acquired Bear Stearns with the Feds assistance in March 2008. Bernanke
believed Lehman was the nextmost vulnerable investment bank after Bear Stearns.5826
5822ExaminersInterviewofTimothyF.Geithner,Nov.24,2009,atpp.910;see,e.g.,theTroubledAsset
ReliefProgram(TARP),12U.S.C.520161.
5824Id.
5826Id.
1502

Although he viewed Lehmans $6 billion capital raise in June 2008 positively, he
believedthatLehmanwasstillperceivedasaweakinstitution.5827
Bernanke had frequent communications with Geithner and thenSecretary
Paulson about Lehman. Bernanke noted that Paulson was frustrated and
dissatisfied by Fulds more inertial behavior with respect to raising capital and
finding strategic partners.5828 The Fed, the FRBNY and the Treasury department were
tryingtopressureFuldtobemoreaggressive,buttheFedwasveryconsciousofits
appropriaterolegiventhattheSECwastheregulator.5829
TheExamineraskedBernankewhether,inhindsight,hebelievedthatheorthe
Fed could have done anything different that might have saved Lehman. Bernanke
responded that he should have been more engaged in dealings with the U.K. about
BarclaysprebankruptcyeffortstoacquireLehman.5830Nevertheless,Bernankedidnot
believethattheFedhadthelegalauthoritytobailoutLehmaninSeptember2008.He
notedthataFederalReserveBanksuchastheFRBNYcouldmakealoanonlyifitwas
satisfactorily secured, that is, that the bank could reasonably expect a 100 percent
return.5831 Bernanke said a fundamental impediment existed for Lehman: By mid
5827Id.
5828Id.atp.6.
5829Id.
5830Id.atp.15.
5831Id.at11.
1503

September, Lehman lacked not just standard collateral, but any collateral.5832
Lehmans tangible assets and securities fell considerably short of the obligations that
would come due.5833 Bernanke believed that Lehman was insolvent by the week of
September8,2008.5834ProvidingaloantoLehmanunderthosecircumstanceswouldbe
lending into a run.5835 If, as was the case, Lehmans collapse appeared imminent, a
Federal Reserve loan would not stop the run; the collateral would run out before
Lehmanpaidoffalloftheclaims.Bernankestated:Theassessmentwasthatifthere
wasarun,whichtherewouldbe,thebusinessvaluewouldbecompromised,andallwe
wouldhaveaccomplishedwouldbetomakecounterpartieswholeandnotsucceedin
preventingthecollapseofthecompany.5836
Bernanke noted that, after passage of the TARP legislation, the Treasury had
authoritytoinjectcapitaldirectlyintoinstitutions:Ifwehadthat[TARP]authorityon
September14,wewouldhavebeenabletosave[Lehman],noquestionaboutit.5837
5832Id.
5833Id.
5834Id.atp.13.
5835Id.at11.
5836Id.atp.12.Incontrast,Bernankeexplained,AIGhadconsiderablebusinessvalueasreflectedinits
stock price. He stated that AIG had a large insurance company, which was a valuable asset and
providedsufficientsecurityforaloan.Id.
5837Id.atp.13.TheExamineraskedBernankeifhecouldhavemadethecaseforTARPtoCongressif
Lehmanhadnotfailed.Bernankeresponded:Letmepushbackagainstanyinferencethatwethought
[Lehman]shouldfailinordertogetthetools[toinjectcapitaldirectly].Bernankewasemphatic:We
neverbelievedthattheFedshouldletamajorinstitutionfailwhenithadtheoptiontohelp.Id.
1504

Bernanke told the Examiner: I speak for myself, and I think I can speak for
others,thatatnotimedidwesay,WecouldsaveLehman,butwewont.Ourconcern
wasaboutthefinancialsystem,andweknewtheimplicationsforthegreaterfinancial
system would be catastrophic, and it was.5838 According to Bernanke, a range of
viewsexistedaboutthelikelyeffectofLehmansfailureontheeconomy.Iftheeffect
wasmeasuredonascaleof0to100,somethoughtaLehmanfailurewouldbeaminor
disruption in the 115 range. Bernankes own view was in the 9095 range.5839
However,theactualeffectturnedouttobemaybe140.5840Itwasworsethanalmost
anybodyexpected.5841
e) TheTreasuryDepartmentsOversightofLehman
Like Geithner and Bernanke, thenTreasury Secretary Paulson considered the
SECtobeLehmansregulator.5842
5838Id.atp.14.
5839Id.
5840Id.
5841Id.
5842ExaminersInterviewofHenryM.Paulson,Jr.,June25,2009,atp.8.TheOfficeofThriftSupervision
(OTS),adivisionofTreasury,didhaveregulatoryjurisdictionoverLehmansbanksubsidiary,andin
thecourseofthatauthority,issuedareportinJuly2008thatwascriticalofLehmansriskprocedures.See
RonaldS.Marcus,OTS,ReportofExaminationLehmanBrothersHoldingsInc.(July7,2008),atpp.12
[LBEXOTS000392].ThereportconcludedthatLehmanhadmadeanoutsizedbetoncommercialreal
estate larger than its peer firms, despite Lehmans smaller size. The report further concluded that
Lehman was materially overexposed, id. at p. 1, to the commercial real estate sector, which was
experiencingdeterioratingmarketconditions.Id.atp.2.ThereportfaultedLehmanformajorfailings
in its risk management process, and noted that Lehman had made its outsized bet in violation of
establishedinternalrisklimits.Id.Asaresult,thereportstatedthatsheddingasubstantialportionof
thesepositionsmaybekeytothesurvivalofLBHIasanindependentfirm.Id.Itisunclearthatany
correctivecourseofactionwaseverdirectedorimplementedfollowingtheissuanceoftheOTSReport.
1505

PaulsontoldtheExaminerthat,inhisview,theeconomiccrisisstartedinAugust
2007whentwoBearStearnshedgefundsfailed.Despitethosefailures,Paulsoninitially
believed the economic effects of the subprime crisis were contained and would not
infect the rest of theeconomy.5843 Paulson did not fully appreciate the global reach of
theeconomiccrisisuntilOctober2008.5844
Paulson first became concerned about Lehman in November 2007, when he
heard about Lehmans purchase of the ArchstoneSmith Trust and immediately
perceived the decision as unwise, given the condition of the market.5845 After Bear
StearnsfailedinMarch2008,PaulsonviewedLehmanasthenextmostvulnerablebank.
Paulson repeatedly urged Fuld to raise capital, find a strategic partner or sell
Lehman.5846
Paulson never promised Fuld or Lehman that the Government would provide
Lehman financial assistance.5847 Fuld confirmed that no promise was made;
nevertheless, Fuld continued to hold the belief that the Government would not let
Lehmanfail.5848
5844Id.
5845Id.atp.9.
5846Id.atp.11.
5847Id.atp.14.
1506

Paulson believed that the Government lacked authority to inject capital into
LehmanBrothers.TheFederalReserveswillingnesstoprovidefinancialhelptoBear
Stearns (toward the JPMorgan purchase) and AIG was not, in his view, inconsistent
with the Federal Reserves decision to deny aid to Lehman. With Bear Stearns, the
FederalReservehadawillingbuyer(JPMorgan);Lehmandidnot.WithAIG,AIGhad
valuable insurance subsidiaries to use as collateral; again, Lehman had nothing
comparable.5849
f) TheRelationshipoftheSECandFRBNYinMonitoringLehmans
Liquidity
TheSECandFRBNYbothmonitoredLehmansliquidity.TheSECmonitoredto
verifythatLehmansliquiditypoolwasunrestrictedandcouldbemonetizedquickly,5850
while the FRBNY monitored Lehmans liquidity as a potential lender. While both
agenciestheoreticallyhadaccesstothesameinformation,theydidnotnecessarilyshare
theinformationtheycollectedwithoneanother.5851
InspectionsScopeMemorandumfortheConsolidatedSupervisedEntities(Feb.20,2008),atp.1[LBEX
WGM017294].
5851ExaminersInterviewofJanH.Voigts,Oct.1,2009,atp.7(FRBNYdidnotreadilyshareinformation
withoutpromptingbecauseSECwasLehmansprimaryregulator).
1507

(1) TheSECPerformedOnlyLimitedMonitoringofLehmans
LiquidityPool
A February 20, 2008 memorandum from the SEC titled Parent Company
Liquidity Inspections Scope for the Consolidated Supervised Entities (the Liquidity
InspectionsScopeMemorandum)states:
[T]he [SEC] staff will identify all components of liquidity held by, or
available to, the parent company without any restrictions. These assets
generallywillincludeamixtureofcashandhighlyliquidsecurities....
Once the pool of assets is identified the staff will sample the pool to
confirm among other things, the existence of the assets, the legal entity
withrightstotheassets,thattheassetsareliquid,andthattheassetsare
availabletotheparentwithoutrestriction....Theprimaryfocuswillbe
to verify that the cash proceeds are available to the parent company
immediately, usually within twentyfour hours. Accordingly, the staff
willreviewthefirmsmonetizationpolicies.5852
The primary focus of the SECs liquidity monitoring, as explained by the
Liquidity Inspections Scope Memorandum, was to verify that CSE liquidity pools
were available to the parent without restriction and could be monetized
immediately, usually within twentyfour hours.5853 A former senior SEC CSE staff
member, Matthew Eichner, told the Examiner that the Liquidity Inspections Scope
Memorandum was never formally implemented as part of the CSE Program.5854
Nevertheless,Eichnerrecalledthathecommunicatedthetwentyfourhoursstandard
Inspections Scope Memorandum for the Consolidated Supervised Entities (Feb. 20, 2008), at pp. 12
[LBEXWGM017294].
5853Id.atp.2.
5854ExaminersInterviewofMatthewEichner,Nov.23,2009,atpp.56.
1508

toLehman.5855LehmanhadacopyoftheLiquidityInspectionsScopeMemorandumin
itspossession,implyingthattheSEChadshareditwithLehman.ButLehmanapplied
a five days monetization standard for assets in its liquidity pool.5856 There is no
evidencethattheSECdirectedLehmantocomplywiththe24hourstandard.
EichnersaidthattheSEConlysampledtheCSEsliquiditypoolstoensurethat
the firmsrepresentations wereaccurate.5857Eichnerstatedthatthis sampling was not
statistically significant, and that he never received any report indicating that Lehman
did not pass these sampling tests.5858 Eichner said that the SEC never had the
opportunity to implement fully the steps set forth in the Liquidity Inspections Scope
MemorandumbecauseofthechaossurroundingBearStearnsnearcollapse.5859
On several occasions, the SEC did ask Lehman to remove questionable assets
from its liquidity pool. For example, in a July 26, 2005 report on liquidity and risk
management, the SEC identified a $1.5 billion committed, multicurrency unsecured
bank facility as part of Lehmans liquidity pool. Contrary to Lehmans internal
accounting,however,theSECdidnotconsiderthefacilityaproperpartoftheliquidity
5855Id.atp.6.
5858Id.
5859Id.atp.5.
1509

pool.5860 In late 2007 or early 2008, the SEC disagreed with Lehmans inclusion in its
liquiditypoolofcertainclassesofassets,andaskedLehmantoremovethem.5861
The SEC was aware in June 2008 that Lehmans liquidity pool included a $2
billioncomfortdepositatCitigroup.5862TheSECstaffviewedLehmansinclusionof
thatdepositinitsliquiditypoolasproblematic,5863anddiscountedthevalueofthepool
accordingly.5864 Nevertheless, there is no evidence that the SEC directed Lehman to
removethecomfortdepositfromitscalculationofreportedliquidity.Eichnertoldthe
Examiner that we applied a much different standard [for including assets in the
liquiditypool]thananyoneelse,andthattheSECwasverycomfortablelivingwitha
worldwherethenumbersinthepublicweretheonesthefirmsworkedoutwiththeir
accountants.5865
5860 SEC, Lehman Brothers Holdings Inc.: Report on Liquidity & Funding Risk Management (July 26,
2005),atp.9[LBEXSEC010895].
5861ExaminersInterviewofPaoloR.Tonucci,Sept.16,2009,atp.25(TonuccisaidtheSECaskedLehman
toremoveanAEGISfacilityfromitsliquiditypool,andthatLehmancomplied).
5862ExaminersInterviewofSECstaff,Aug.24,2009,atp.11.ThereissomequestionwhethertheSEC
thoughtthedepositwas$2billionor$5billion.Id.
5863 The SEC states that the SECs CSE staff noted that it was a problem to include the [Citi] deposit[]
whendeterminingthesizeofthepool....TheCSE[s]taffdid,however,raisethisasaconcernwiththe
DivisionDirector.SEC,ReferencestoSEC(Jan.29,2010),atp.20.
5865ExaminersInterviewofMatthewEichner,Nov.23,2009,atp.6.Noristhereevidencethatwithinthe
SEC,theDivisionofTradingandMarketsadvisedtheDivisionofCorporationFinancethattherewasan
issueastowhetherLehmanshouldhaveupdateditspublicdisclosuresaboutitsliquiditypool.Id.atp.
8.
1510

InlateAugust2008,theSEClearnedthatJPMorganwantedLehmantopledge$5
billion in collateral to continue to fund Lehman trades.5866 SEC personnel spoke to
Lehman, and Lehman Treasurer Paolo Tonucci told them that $5 billion would not
affect Lehmans liquidity pool.5867 The SEC did not know that JPMorgan had
demanded that Lehman post additional capital the week of September 8.5868 The SEC
wasnotawareofanysignificantissueswithLehmansliquiditypool5869untilSeptember
12,2008,whenofficialslearnedthatalargeportionofLehmansliquiditypoolhadbeen
allocated to its clearing banks to induce them to continue providing essential clearing
services.5870InaSeptember12,2008email,oneSECanalystwrote:
Key point: Lehmans liquidity pool is almost totally locked up with

clearingbankstocoverintradaycredit($15bnwithjpm,$10bnwithothers
likecitiandbofa).Thisisareallybigproblem.5871
(2) TheSECandFRBNYDidNotAlwaysShareInformation
aboutLehman
The SEC and FRBNY each gathered and analyzed data concerning Lehmans
liquiditypool.AlthoughthetwoagenciesexecutedaformalMOUsharingagreement,
theagenciesdidnotinfactsharedocumentsinseveralsignificantinstances.
5866ExaminersInterviewofSECstaff,Aug.24,2009,at1112.
5867Id.
5868Id.
5869Id.
5870EmailfromMichaelHsu,SEC,toTilSchuermann,FRBNY(Sept.12,2008)[FRBNYtoExam.014851].
5871Id.
1511

AsaparticipantintheCSEProgram,Lehmancontinuouslytransmittedliquidity
information to the SEC for use in its scheduled onsite liquidity inspections. The
FRBNY,bycontrast,installedteamsofofficersonsiteateachofthefourCSEs,andthe
teams conducted their monitoring inperson and on a daily basis, in addition to
receiving a continuous stream of liquidityrelated reports. Given their overlapping
monitoring functions, the SECandBoardofGovernorsoftheFederalReserveSystem
executed an MOU on July 7, 2008, which allowed the regulators to share information
regarding Lehmans liquidity position.5872 Article III of the MOU established
procedures for sharing information in areas of common regulatory and supervisory
interest.TheMOUsetforth:
13. As primary supervisor of CSEs, the [SEC] will provide the Federal
Reserve,onanongoingbasistotheextentrequested
a. Information and analysis regarding the financial condition,

risk management systems, internal controls and capital, liquidity
andfundingresourcesoftheCSEs....5873
Likewise,theMOUstated:
12.TheFederalReservewillprovidethe[SEC]onanongoingbasistothe
extentrequested
Information Sharing in Areas of Common Regulatory and Supervisory Interest (July 7, 2008), at p. 4,
availableathttp://www.federalreserve.gov/newsevents/press/bcreg/bcreg20080707a1.pdf.
5873Id.(emphasisadded.)
1512

a. Information and analysis regarding the financial condition,

risk management systems, internal controls and capital, liquidity
andfundingresourcesoftheCSEs....5874
Thatis,bythetermsoftheMOU,theFRBNYandSECweretoshareinformation
insofar as the other agency affirmatively requested it. Bernanke said that the
premiseoftheMOUwasthattheagencieswouldshareinformationaboutthe
CSEs.5875TheMOUfurtherstated:
17. The[SEC]andFederalReservewillcollaborateandcooperatewith
eachotherin
a. Obtaining (including through visitations, reports and other

means), analyzing and evaluating information regarding the
capital, liquidity, and funding position, and resources, and
associatedriskmanagementsystemsandcontrolsofCSEs...;
b. Settingsupervisoryandregulatoryexpectations,guidelines,
orrulesconcerningthecapital,liquidity,andfundingpositionand
resources, and associated risk management systems and controls,
ofCSEs....5876
5874Id.
5875ExaminersInterviewofBenS.Bernanke,Dec.22,2009,atp.7.Whilenotingthebroadpremiseofthe
MOU, Bernanke noted some tricky aspects of the MOU as well, e.g., whether the SEC could use
informationsharedbytheFRBNYtoundertakeaninvestigation.Bernankedidnotstatewhetherthere
hadbeenanyresolutiontothisissue.BernankefurtherstatedthatheworkedontheMOUpersonally,
withSECChairmanChristopherCox.Id.
Information Sharing in Areas of Common Regulatory and Supervisory Interest (July 7, 2008), at p. 5,
availableathttp://www.federalreserve.gov/newsevents/press/bcreg/bcreg20080707a1.pdf.
1513

Lehman prepared materials for distribution to both agencies, and gave
presentations on liquidity issues to both agencies simultaneously.5877 The SEC and
FRBNY did share information and insight they obtained individually regarding
Lehmansliquidity,5878butnotalways.
OnoraboutAugust20,2008,theFRBNYbecameawarethatasubstantialportion
of Lehmans liquidity pool was also allocated to clearing banks as collateral. In an e
mail exchange pertaining to Lehmans ongoing negotiations with clearing banks,
FRBNYofficerVoigtsupdatedseniorFRBNYpersonnel(includingGeithner)onrecent
requestsbyLehmansclearingbanksforadditionalintradaycollateral.5879Voigtsnoted
(1)thatLehmanhadposted$5billiontoJPMorgantomatchtripartyinvestorhaircuts,
soon to be encumbered by a lien; and (2) that Lehman continued to post $2 billion in
5877See,e.g.,emailfromDanielledelaVega,Lehman,toMichaelA.Macchiaroli,SEC,etal.(July29,2008)
[LBEXDOCID731328](forwardingdailyexecutivesummaryofLehmansliquiditypositionforJuly29,
2008); email from Danielle de la Vega, Lehman, to Jan H. Voigts, FRBNY, et al. (July 30, 2008) [LBEX
DOCID697484](forwardingsame);emailfromDanielledelaVega,Lehman,toMichaelA.Macchiaroli,
SEC, et al. (Aug. 21, 2008) (forwarding daily executive summary of Lehmans liquidity position for
August20,2008);emailfromDanielledelaVega,Lehman,toJanH.Voigts,FRBNY,etal.(Aug.21,2008)
[LBEXDOCID731312](forwardingsame).
5878 See e.g., email from Arthur G. Angulo, FRBNY, to Timothy F. Geithner, FRBNY (Sept. 12, 2008)
[FRBNY to Exam. 014851] (forwarding email exchange between Hsu and Schuermann) (discussed
above);emailfromTilSchuermann,FRBNY,toWilliamBrodows,FRBNY,etal.(July14,2008)[FRBNY
toExam.047757](forwardingemailexchangebetweenHsuandSchuermann).
033297].
1514

collateraltoCitibank,intraday.5880TheanalystsconcludedthatLehmanhad$7billion
lessinliquiditythanreported.5881
TheFRBNYdiscountedthevalueofLehmanspooltoaccountforthesecollateral
transfers.TheFRBNYdidnotaskLehmantoexcludethiscollateralfromitspool,orto
take further action as a result of these revelations. Voigts explained: how Lehman
reports its liquidity is up to the SEC and the world.5882 In the same vein, FRBNY
witnessesrepeatedlystatedthattheyweremindfulthattheFRBNYwasnotLehmans
primaryregulatorundertheCSEProgram,andthattheFRBNYwasnotmonitoring
Lehmanwithaneyetowardregulatorycomplianceorenforcement.5883Thesefunctions,
the witnesses have uniformly stated, were within the ambit of the SECs CSE
oversight.5884Nevertheless,theFRBNYapparentlydidnottakestepstoensurethatthe
SEChadthesameinformation.5885
5880Id.
5881Id.AngulowrotetoVoigts:SeemslikeLEHhas$7B(andperhapssoontobe$8B+)lessinavailable
liquidity than reported, and later: [c]onceptually I can see an argument for including the $7B in the
liquidity pool if JPM and C[iti] release the collateral to LEH every night . . . . On the other hand, [it]
doesntseemquiterighttoviewthe$7Basunencumbered.EmailfromArthurG.Angulo,FRBNY,to
Jan H. Voigts, FRBNY (Aug. 20, 2008) [FRBNY to Exam. 033297]. Voigts agreed with Angulos
assessment.EmailfromJanH.Voigts,FRBNY,toArthurG.Angulo,FRBNY(Aug.21,2008)[FRBNYto
Exam.033297].
5883ExaminersInterviewofArthurG.Angulo,Aug.12,2009,atp.3;ExaminersInterviewofThomasC.
Baxter,Jr.,Aug.31,2009,atp.4(theSECwaswithoutquestionLehmansmainsupervisor,andthe
FRBNYmonitoredLehmanasapotentiallender).
5885Id.
1515

There is no evidence that the FRBNY declined to share information that was
specificallyrequestedbytheSEC;howevertheFRBNYwitnessestoldtheExaminerthat
they did not perceive any duty to volunteer liquidity information to the SEC because
theSECdidnotalwaysshareinformationwiththeFRBNY.TheFRBNYwasawareof
and asked the SEC to share two horizontals, or sectorwide reviews of CSE
commercialrealestateexposuresandliquiditypositions,theSEChadconducted.The
SEC affirmatively declined to share these horizontals.5886 In the words of one FRBNY
witness: there was not a warm audience for sharing information between the two
entities.5887TheSECconfirmedthatitdidnotsharetheseanalyseswiththeFRBNY,but
representedthattheanalyseswerestillindraftatthetimeofLehmansbankruptcy,and
assuch,notinaconditiontobesharedexternally.5888
Insum,eventhoughtheSECandFRBNYhadanMOUinplacetofacilitatethe
exchange information about CSE liquidity, the FRBNY and the SEC did not share all
materialinformationthateachcollectedaboutLehmansliquiditypool.
MeetingsattheFRBNY
TheFRBNY,TreasuryDepartment,theSECandtheFederalReservecoordinated
actions in what became known as the Lehman Weekend meetings of September 12
5887Id.
5888LetterfromSECtoRobertL.Byman,CounseltotheExaminer(Jan.29,2010).
1516

14, 2008, at the FRBNY, in which the Government attempted to orchestrate a private
sectorrescueofLehman.
OnWednesday,September10,2008,FRBNYstaffputtogetheradraftgameplan
foraliquidityconsortiumofmajorWallStreetbankstoprovideaforumwherethese
firms can explore possibilities of joint funding mechanisms to avert Lehmans
insolvency.5889 Although a draft, the staffs proposed gameplan is an instructive,
contemporaneousrecordofthethinkingofsomeintheFRBNYwithrespecttohowto
approachLehmanduringtheuncertainweekofSeptember8,2008.
The draft gameplan contemplated that the meeting would occur at the very
latest on Friday the 12th.5890 Consortium members would be given [v]ery little
advancenotice,2hoursmax,inordertominimizetheriskofoutsideleaks.5891The
gameplan further specified: FRBNY to host. [Treasury Secretary Henry] Paulson
delivers introductory remarks.5892 Substantively, the gameplan provided that the
officialsfromtheassembledbankswouldbe
5889FRBNY,LiquidityConsortium(Sept.10,2008),atp.1[FRBNYtoExam.003517];emailfromMichael
Nelson, FRBNY, to Christine Cummings, FRBNY, et al. (Sept. 10, 2008) [FRBNY to Exam. 003516]
(distributingLiquidityConsortiumoutlinewiththesubjectline,revisedliquiditygameplan).Possible
consortiummemberswouldincludethosedepositoryandinvestmentbankswithexposurestoLehman
through loans, triparty repos and derivatives; such firms would include: Citibank, Credit Suisse,
Deutsche Bank, Goldman Sachs, Morgan Stanley, Merrill Lynch, JPMorgan, and the Royal Bank of
Scotland.FRBNY,LiquidityConsortium(Sept.10,2008),atp.1[FRBNYtoExam.003517].
5890Id.
5891Id.
5892Id.atp.2.
1517

told by Paulson that they have until the opening of business in Asia
(Sunday night N[ew] Y[ork] time) to explore whether they can jointly
come up with a credible plan to recapitalize Lehman to an extent
necessary to enable an orderly winding down. Paulson conveys
willingnessoftheofficialsectortoletLehmanfail.5893
ThedraftstatesthattheFRBNYshouldfixamaximumamountthatitwouldbe
willing to finance to the consortium, but not divulge our willingness to do so to the
consortium.5894 Similarly, the draft states that the FRBNY must hone in on the
monetaryfigurewethinktheconsortiumwillhavetoprovideinnewcapital,aswell
as the type/maximum amount of any FR [Federal Reserve] financing to support the
consortium.5895 Geithner later told the Examiner that any extension of Government
funding to Lehman contemplated in the gameplan draft was contingent on Lehman
havingawillingbuyer.5896
As of September 10, 2008, the FRBNY had settled on the public line that no
government funds would be invested to rescue Lehman.5897 This public line was a
bargaining strategy to encourage a private consortium of banks to provide the funds
themselves.5898Thedraftliquidationconsortiumgameplan,however,didnotforeclose
5893Id.
5894Id.atp.2.
5895Id.atp.5.
5896 Examiners Interview of Timothy F. Geithner, Nov. 24, 2009, at p. 9 (when shown the Liquidity
Consortiumgameplandocument,GeithnerconfirmedthattheFRBNYwouldhaveconsideredextending
financingtoLehman,butonlyifawillingbuyerforthefirmhadsurfaced).
5897ExaminersInterviewofThomasC.Baxter,Jr.,Aug.31,2009,atp.7.
5898 Id. (shown the Liquidity Consortium gameplan document, Baxter confirmed the Examiners
understandingthatthereferencesinthedocumenttoawillingnessintheofficialsectortoletLehman
1518

thepossibilitythattheFRBNYwouldfinancesomeamountofliquidity;despitenoting
legal and fiscal obstacles in other areas, the draft did not raise any concern about the
possibility of FRBNY financing.5899 The gameplan slated the FRBNY to communicate
withforeignsupervisorsontheeveningofFridaySeptember12whiletheconsortium
convenedforitsinitialmeeting.5900
A more detailed draft timeline for the implementation of the FRBNYs
liquidationconsortiumplanwascirculatedthenextmorning,Thursday,September11,
2008.5901 The timeline provided that later in the morning Geithner would (1) inform
Bernanke and Paulson that the FRBNY would convene the liquidity consortium on
Friday;and(2)askPaulsontomakeanintroductoryaddresstothegroup.5902Geithner
would then contact BofA CEO Kenneth Lewis to probe BofAs interest in acquiring
fail,andtheFRBNYsunwillingnesstodivulgetheamountoffinancingitwaswillingtoextendto
theconsortiumwasastrategytoencouragethegatheredbanksnottoexpectaBearStearnssolution,
andthustocontributetheirownfundstoanindustrysolutiontotheLehmanproblem).
5899 The Open Issues section of the document identifies issues to be resolved in advance of the
consortiummeeting.FRBNY,LiquidityConsortium(Sept.10,2008),atpp.23[FRBNYtoExam.003517].
These issues include: shareholder approval for any deal emerging from the meeting; the risk that
creditors could put Lehman into involuntary bankruptcy prior to a resolution; and the need to obtain
[r]egulatoryapprovals,includingfromregulatorsoutsideoftheUnitedStates.Id.Concernoverlegal
authorityorfinancialmeanstointervenetorescueLehmanisnotpresentundertheLegalsubsection
ofthedraftagendasOpenIssuesdiscussion.Id.
5900Id.atp.2.
5901 Email from Michael Nelson, FRBNY, to Christine Cumming, FRBNY (Sept. 11, 2008) [FRBNY to
Exam. 003513] (cover email); FRBNY, Timeline Liquidation Consortium (Sept. 11, 2008) [FRBNY to
Exam.003514].
5902FRBNY,TimelineLiquidationConsortium(Sept.11,2008),atp.1[FRBNYtoExam.003514].
1519

Lehman.5903IfLewisdeclinedtomakeabidonbehalfofBofA,orifLehmanrejectedthe
bid,theFRBNYwouldproceedwithitsconsortiumplan.5904
The September 11 draft timeline contemplated that the FRBNY would prepare
the final list of consortium members on the evening of September 12, and settle on
minimumcapitalcontributionsexpectedfromtheconsortiumaswellasthelevelor
type ofliquidityto be offered,ifnecessary,bytheFederalReserve.5905Thetimeline
wouldhavetheFRBNYcontactforeignregulatorsontheeveningofSeptember12.5906
The timeline proposed that on Saturday and Sunday, after the consortium was
convened, itwould engageinduediligenceon Lehmansassets in order to gauge the
feasibility of any recapitalization plan, and report its progress to Bernanke, Paulson,
and Geithner.5907 If no plan was forthcoming, the FRBNY would reach out to
regulators in DC and abroad to inform them of potential market disruptions at the
openingofbusinessonMondayand/orpossiblebankruptcyfilingbyLehman.5908
In his interview with the Examiner, FRBNY General Counsel Thomas Baxter
describedtheGovernmentsapproachtotheLehmancrisissuccinctly.Thereweretwo
possiblemodelsforGovernmentintervention,Baxterexplained:(1)theFRBNYcould
5903Id.
5904Id.
5905Id.
5906Id.
5907Id.atp.2.
5908Id.
1520

extendaMaidenLanestylenonrecourseloantoapotentialpurchaserofLehman,as
itdidtoJPMorganwithBearStearns;5909or(2)theFRBNYcouldconveneaconsortium
ofprivatemarketparticipantstofinanceLehmansbadassets,asithadinthecaseofthe
nearfailure of the hedge fund Long Term Capital Management (LTCM) in 1998.5910
Thegoal,Baxtersaid,wastomakeWallStreetviewtheLTCMintervention,ratherthan
theBearStearnsintervention,asthemodelforLehman.5911
TheFRBNYsactionsintheBearStearnsrescueplacedpublicfundsatriskand
stoodincontrasttotheFRBNYsapproachtoLTCM.LTCMwasahedgefundthathad
becomeoverleveragedandwasbroughttothebrinkofcollapsebymarketconditions
caused by Russias default on its debt obligations in 1998.5912 The FRBNY feared that
LTCMs creditors and counterparties would close out their positions, and liquidate
collateralsupportingthosepositionssimultaneously.Suchanenmasseliquidation,the
5909 In order to contain the economic fallout of the Bear Stearns near collapse and to facilitate an
acquisitionofthefailedinvestmentbankbyJPMorgan,onMarch16,2008,theFederalReserveBoardof
GovernorsgrantedtheFRBNYauthoritytoextenda$29billionseniorloantoanewlycreatedDelaware
LLC called Maiden Lane. JPMorgan also extended a $1 billion subordinated note to Maiden Lane.
MaidenLane,inturn,purchased$30billionofilliquidassetsfromBearStearns,asmarkedtomarketby
BearonMarch14,2008.Thetransferinvolved$30billioninilliquidrealestaterelatedassetsfromBear
Stearns to Maiden Lane. Because the FRBNY loan was styled as a nonrecourse loan, the FRBNYs
commitment was secured only by the portfolio of assets held by Maiden Lane. Thus the U.S.
Governmentwasresponsibleforanylossesintheeventtheliquidationofthetransferredassetscouldnot
fully repay the principal advanced by the FRBNY. See FRBNY, Press Release: Summary of Terms and
Conditions Regarding the JPMorgan Facility (Mar. 24, 2008), available at
http://newyorkfed.org/newsevents/news/markets/2008/rp080324b.html.
5911Id.
5912GeneralAccountingOffice,LongTermCapitalManagement:RegulatorsNeedtoFocusGreaterAttentionon
SystemicRisk,ReporttoCongressionalRequesters(Oct.29,1999),at42.
1521

FRBNYbelieved,wouldresultinalikelihoodthatanumberofcreditandinterestrate
markets would experience extreme price moves and possibly cease to function for a
periodofoneormoredaysandmaybelonger.5913AfterremediesshortofGovernment
interventionhadfailed,theFRBNYconvenedaconsortiumofLTCMsmajorcreditors
todeviseanindustrycreatedplantorecapitalizethehedgefund.Thus,onSeptember
22and23,1998,14banksandsecuritiesfirmsmetattheFRBNYsoffices,createdaterm
sheetforarecapitalizationofthehedgefundand,ultimately,committedtoinject$3.6
billion in LTCM to avoid a disorderly liquidation.5914 As former FRBNY President
William McDonough emphasized in his testimony before the U.S. House of
Representatives: [T]his was a private sector solution to a private sector problem,
involving an investment of new equity by LongTerm Capitals creditors and
counterparties.5915
Rather than a Bear Stearnsstyle bailout for Lehman,5916 the FRBNY went
forwardwithplansforaLTCMstyleliquidationconsortiumonSeptember12,2008.
5913StatementbyWilliamJ.McDonough,PresidentoftheFederalReserveBankofNewYorkBeforethe
Comm.onBankingandFinancialServs.,U.S.HouseofRepresentatives,Oct.1,1998,at4.
5914Id.atpp.67;GAOReporttoCongressionalRequesters,LongTermCapitalManagement:Regulators
NeedtoFocusGreaterAttentiononSystemicRisk(Oct.29,1999),at44.
5915StatementbyWilliamJ.McDonough,PresidentoftheFederalReserveBankofNewYorkBeforethe
Comm.onBankingandFin.Servs.,U.S.HouseofRepresentatives,Oct.1,1998,atp.7.
1522

ConvenedaMeetingoftheMajorWallStreetFirmsinanAttempt
toFacilitatetheRescueofLehman
Byallaccounts,theliquidationconsortiummeetingsattheFRBNYbeganlargely
asconceivedinthedraftagendaandtimelines.TheFRBNYconvenedameetingofthe
major Wall Street financial institutions, all of which agreed to finance Lehmans bad
assets and thereby facilitate the sale of Lehman to one of its suitors.5917 However, the
dealfounderedontheissueofwhetherBarclayswouldbeabletoguaranteeLehmans
outstandingtrades,asrequestedbytheFRBNY.
True to the FRBNYs draft gameplan, Geithner spoke with Callum McCarthy,
thenChairman of the British Financial Services Authority (FSA) on September 11,
and informed McCarthy of FRBNY plans to convene a consortium of financial
institutions...torescueLehman.5918
During the morning of September 12, 2008, John S. Varley, Group Chief
Executive of Barclays, spoke with Paulson.5919 Varley informed Paulson that Barclays
was interested in making a bid for Lehman.5920 Paulson responded that any purchaser
would need to make a bid before the end of the weekend, after which time the
5917Id.atpp.910.
5918FinancialServicesAuthority(U.K.),StatementoftheFinancialServicesAuthority(Jan.20,2010),atp.
2.
5919Id.atp.3.
5920Id.
1523

GovernmentplannedtoplaceLehmanintoanorderlywinddown.5921Accordingtothe
FSA,inaconversationlaterthatday,AlistairM.Darling,ChancelloroftheExchequer,
advisedPaulsonthatnotransactionwithBarclayswouldbepossibleifthelevelofrisk
toBarclayswasinappropriate.5922PaulsonacceptedthisandadvisedthattheFRBNY
might be prepared to provide Barclays with regulatory assistance to support such a
transactionifitwasrequired.5923
On the evening of Friday, September 12, 12 investment bank CEOs were
summoned to the FRBNYs headquarters at 33 Liberty Street in New York City.5924
BernankeremainedinWashington,giventhepossibilitythattheFederalReservemight
needtoexerciseitsemergencylendingpowers,whichwouldrequirehimtoconvenea
FederalReserveBoardmeeting.5925TheCEOparticipantspresentat33Libertyincluded:
JPMorgansJamieDimon,MorganStanleysJohnMack,CitigroupsVikramPanditand
RobertWolfofUBS.ExecutivesfromLehmanBrothersdidnotattend.5926
PaulsonopenedthemeetingbynotingtheabsenceofLehmanrepresentatives.5927
Paulson said their absence was intentional, because the meeting was convened to
5921Id.
5922Id.atp.5.
5923Id.
5927Id.
1524

discussLehmanspecifically.5928PaulsonnotedtheabsenceofBofAandBarclaysCapital
executivesaswell,duetothefactthatthesebankswereinvolvedinpotentialdealsto
acquireLehman.5929
Paulson stated that the purpose of the meeting was twofold. First, the
Government tasked the CEOs with creating a plan to facilitate the acquisition of
Lehman,andsecond,ifsuchaplanwasnotforthcoming,Paulsonstatedtheonuswas
ontheCEOstoprovidetheGovernmentwiththemeanstoresolvetheconsequencesof
Lehmansfailure.5930Moreover,withregardtothefinancingofanypotentialrescueof
Lehman,Paulsonstated:NotonepennywillcomefromtheGovernment.5931Paulson
did not elaborate, but Lehmans only options were to be rescued by a firm (or a
consortiumoffirms)ortofileforbankruptcyonMonday,September15.5932
Secretary Paulson told the Examiner that no Government aid would be
forthcoming because he concluded that the Government lacked authority to inject
capitalinto strugglinginstitutions.5933WhilePaulsonallowed thatunderSection 13(3)
5928Id.
5930Id.atp.16.
5931ExaminersInterviewofThomasC.Baxter,Jr.,May20,2009,atp.9(reportingPaulsonsstatement).
5932Id. Cox said that most attendees probably assumed that [Secretary Paulsons statement of no
governmenthelp]wasanegotiationstrategyandweregenerallysurprisedwheninfacttherewasno
moneythere.ExaminersInterviewofChristopherCox,Jan.8,2010,atp.15.
1525

of the Federal Reserve Act the Fed might be able to lend against any collateral,5934 he
fearedthatprovidingemergencyfundstotheailingbankwouldcauseitsclientstoflee,
ensuringitsdemise.5935
That weekend, Lehmans financial team came onsite to the FRBNY and
openedtheirbookstorepresentativesfromtheinvestmentbanksinordertoworkout
the details of any potential rescue.5936 Barclays was permitted to examine Lehmans
books,inordertoconducttheduediligencenecessarytodeterminewhetheritwould
acquireLehman.5937Baxternotedconcernamongthefirmsthatbynegotiatingarescue
for Lehman, they would be financing a sweetheart deal for one of their
competitors.5938Nevertheless,duediligenceandplanningcontinued.
But Barclays and the British regulators had their own reservations. During the
evening of September 13, 2008, Barclays advised the FSA that the FRBNY was asking
Barclays to guarantee Lehmans financial obligations in a manner similar to that
5934 Section 13(3) provides that a Federal Reserve Bank may, [i]n unusual and exigent circumstances
lendtoanyindividualorcorporationsolongasthelendingissecuredtothesatisfactionoftheFederal
Reserve Bank. 12 U.S.C. 343. But the Fed and FRBNY emphasized that they could not lend against
insufficient collateral. Examiners Interview of Ben S. Bernanke, December 22, 2009, at 2 (thenFRBNY
PresidentTimothyF.GeithnerinformedChairmanBernankethattheFedwouldbelendingintoarun,
and that, while a loan might help pay off some counterparties, it would not save Lehman. Chairman
BernankeconcludedthatLehmanwasinsolventandlackedanycollateral,giventhatitsassetsfellshort
ofobligationsthatwouldcomedue).
5.
1526

providedbyJPMorganwhenitacquiredBearStearns.5939Barclaysrecognized,andthe
FSA confirmed, that British regulations would require shareholder approval before
suchaguarantycouldbegranted.5940Laterthatevening,BarclaysadvisedtheFSAthat
becauseoftheguaranteeissue,itwasunlikelythatasuitablestructuretopurchase
Lehmancouldbeputinplacewhichwouldsatisfy[its]Board.5941McCarthyspoketo
Geithnerthat eveningabout the stateofthenegotiations,andMcCarthy reported that
althoughnoproposalhadyetbeenshowntotheFSAbyBarclays,ifonewasitwould
raisesignificantissues.5942Yet,becausenoproposalhadbeenputforward...itwas
impossibletosaywhetheranyparticularproposalwouldproveacceptable.5943
On the afternoon of Sunday, September 14, 2008 (London time), the FSA
informed the FRBNY that the guaranty issue would need to be resolved before any
takeover could be approved.5944 According to the FSA, Geithner replied that the
FRBNY had arranged for a consortium of Wall Street firms to take Lehmans illiquid
assets,butthataguarantyfromBarclayswouldstillberequired.5945Barclays,theFSA
7.
5940Id.
5941Id.
5942Id.
5943Id.
5944Id.atp.8.BaxteradvisedtheExaminerthattheFRBNYdidnotlearnthatprovidingaguarantyhad
become an issue until late on Sunday, September 14. Examiners Interview of Thomas C. Baxter, Jr.,
Aug.31,2009,atp.8.
8.
1527

andtheFRBNYcontinuedtodiscusstheregulatoryandprudentialobstaclespresented
bytheguarantyissuethroughoutthedayonSeptember14.Bylateafternoonorearly
evening,howevertheFSAandBarclaysagreedthatneithertheBarclaysBoardnorthe
FSA could approve any transaction structure that required Barclays to provide the
guaranteeaskedforbytheFRBNY.5946
Over the weekend, the assembled banks had agreed to provide at least $20
billion in financing to facilitate Lehmans acquisition by Barclays.5947 According to
Governmentwitnesses,itwasnotforwantofcooperation,coordinationorGovernment
pressure thatLehman was notacquired.5948Rather,thoseGovernmentrepresentatives
presentforthemeetingslaidthefailureofthedealonBarclaysinabilitytoguarantee
tradinglossesassociatedwiththeacquisition.5949
Baxter was clear in his conviction that the inability of Barclays to obtain a
guarantywasduetotheunwillingnessoftheBritishgovernment,specificallytheFSA,
to waive the British legal requirement that Barclays obtain a shareholder vote on the
issue.5950 This critical viewpoint was uniformly held among the FRBNY witnesses
interviewed by the Examiner. Voigts agreed that a sale of Lehman was not possible
because Barclays was unable to obtain a waiver from the FSA to guarantee Lehmans
5946Id.atp.10.
5947ExaminersInterviewofHenryM.Paulson,June25,2009,atp.18.
5949Id.;ExaminersInterviewofJanH.Voigts,Aug.25,2009,atp.7.
1528

obligations.5951 Geithner echoed these comments, stating that a deal during Lehman
WeekendwasimpracticablebecauseLehmanlackedabuyer.5952InGeithnersview,had
LehmanhadabuyerinBarclaysoranyotherthirdparty,theGovernmentwouldhave
extendedfinancingtothatbuyertohelpfacilitatethesale.5953Bernankealsoattributed
theGovernmentsultimateinabilitytorescueLehmantotheabsenceofabuyerforthe
firm.5954
BaxterstatedhisbeliefthattheBritishgovernmentsimplydidnotwantBarclays
to acquire Lehman, and therefore refused to allow Barclays to guarantee the deal, or
otherwisebackstopthetransaction.5955TheFSAexplainedtotheExaminerthat,because
BarclayswasoneoftheU.K.sclearingbanks,itwasimportanttoensurethatBarclays
didnotexposeitselftoalevelofriskthatwouldweakenittoanextentthatcouldhave
awidersystemicimpactontheU.K.financialsystem.5956Further,ChairmanMcCarthy
toldChairmanCoxthattherewasnoprecedentforwaivingtheU.K.lawrequirement
that Barclays obtain shareholder approval prior to agreeing to any guaranty in these
5951ExaminersInterviewofJanH.Voigts,Aug.25,2009,atp.7.
5953Id.
5956TheExaminersought,butwasnotgranted,aninterviewwiththeFSAdecisionmakers;buttheFSA
didprovidewrittenanswerstoquestions.FinancialServicesAuthority(U.K.),StatementoftheFinancial
ServicesAuthority(Jan.20,2010),atp.6.
1529

exigentcircumstances.5957CoxindirectlyconfirmedtotheExaminerthattheFSAacted
reasonably.5958 For his part, Baxter stated that there was a policy issue with the
FRBNY providing a backstop for an acquisition by a British bank.5959 Baxter said that
the FRBNY lacked this authority because the FRBNY could not issue a guaranty to
supportthetransaction.5960Rather,theFRBNYcouldonlyprovidesecuredfinancingin
supportofsuchatransaction.5961Baxterstatedthathefounditshockingthatthedeal
wouldfounderforlackofaguaranty,andthatitwasthefinancingofthedeal,rather
thantheguarantywhichshouldhavebeenthemostchallengingbarriertoovercomein
anyrescueofLehman.5962
Paulson distinguished the Governments action to intervene to backstop AIG,
from the absence of Government action to backstop Lehman. According to Paulson,
Lehmanhad liquidity problemsandnohardassetsagainstwhich tolend.5963AIG,by
contrast, Paulson said, had a capital problem at the holding company level, but
5957Id.atp.10.
5958ExaminersInterviewofChristopherCox,Jan.8,2010,atp.18.(Coxrecalledaspecificconversation
on the subject, but after SEC counsel would not permit him to recount that conversation, invoking the
deliberativeprocessprivilege,Coxansweredthegeneralquestion:Inallyourconversationswiththe
FSA, did they ever take an unreasonable position? Chairman Cox responded: At no time in my
dealingswiththeFSAdidIthinktheywereunreasonable;theyhadreasonsforwhattheydid.).
5960Id.
5961Id.
5962Id.
1530

otherwise had regulated insurance companies that were perceived by the market as
stable,wellcapitalized,andhavingrealvalue.5964
A bankruptcy filing by the holding company was another of the contingency
plansdiscussedattheFRBNYthatweekend.5965TheGovernmentconcludedthatanen
masseliquidationoftheholdingcompanywouldbeawful,andshouldbeavoided.5966
Nevertheless, assuming no alternative was available, the plan envisioned by the
Government would be for LBHI to file for Chapter 11, while JPMorgan continued to
lendtoLBIasagoingconcern.LBIwouldthenbeeasedintoaSIPAproceeding,and
wounddowninanorderlyway.5967ThisplandidnotplayoutonceBarclayscameback
tothebargainingtablewithaproposaltoacquirethebrokerdealerafterLBHIentered
bankruptcy.
OnSundaySeptember14,BaxterandCoxparticipatedinaconferencecallwith
LehmansBoardofDirectors.5968AlsopresentontheGovernmentsideofthecallwere
SEC General Counsel Brian Cartwright and Alan Beller of Cleary Gottlieb Steen &
Hamilton, who wasengagedby the TreasuryDepartment.5969Baxtersaid the call was
5964Id.
5966Id.
5967Id.atpp.1011.
5968LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Sept.14,2008)[LBEXAM
003932](notingthatBaxterandCoxaddressedtheBoardbytelephone).
1531

arranged at the request of Paulson and Geithner.5970 According to Lehman Board
minutes, Baxter and Cox emphasized that the Board needed to make a decision
regarding whether to file for bankruptcy quickly, and that this was a decision for the
Boardalone.5971Baxterrecalledmakingstatementstothiseffect.5972Coxrecalledthathe
did not mention bankruptcy, but rather stated that whatever decision Lehman might
makeneededtobemadeimmediately.5973CoxalsorecalledthatothersfromtheFed
whowereonthecalladdedthattheGovernmenthadmadeitclearinearliermeetings
thatLehmanshouldfileforbankruptcy.5974Baxtersaidhemadethepointthatopening
onMondaywasnotanoptionbecauseofthechaosinthemarkets.5975
Also that evening, the Federal Reserve broadened the collateral eligible for
financing through the PDCF to closely match the types of collateral that can be
pledgedinthetripartyreposystemsofthetwomajorclearingbanks.5976However,the
FRBNYlimitedthecollateralLBIcoulduseforovernightfinancingtothecollateralthat
5970Id.
5971LehmanBrothersHoldingsInc.,MinutesofMeetingofBoardofDirectors(Sept.14,2008),atpp.56
[LBEXAM003932].
5974Id.
5975LehmanBrothersHoldingsInc.,MinutesoftheMeetingoftheBoardofDirectors(Sept.14,2008),at
pp.56[LBEXAM003932];ExaminersInterviewofThomasC.Baxter,Jr.,May20,2009,atp.10.
5976FRBNY,PressRelease(Sept.14,2008),availableathttp://www.federalreserve.gov/
newsevents/press/monetary/20080914a.htm.
1532

wasinLBIsboxatJPMorganasofFriday,September12,2008.5977Thisrestrictionwas
referred to as the Friday criteri[on].5978 In addition, the FRBNY imposed larger
haircuts on LBIs PDCF borrowing than it did on other investment banks,5979 and the
haircuts imposed on LBIs PDCF borrowing were larger than under Lehmans pre
bankruptcytripartyborrowing.5980
In connection with Lehmans preparations to file the LBHI Chapter 11 petition,
theFRBNY,actingasalenderoflastresort,advisedLehmanthatitwouldprovideup
5977 Examiners Interview ofRobert Azerad, Sept. 23,2009,at p. 5;Examiners Interview ofChristopher
Burke, July 7, 2009, at p. 3. An experimental allocation by Lehman to the PDCF on Monday morning
showedatleast$72billionofeligibleLehmansecuritiesbeingsweptintothePDCFsystem.Seeemail
from John N. Palchynsky, Lehman, to Craig L. Jones, Lehman, et al. (Sept. 15, 2008) [LBEXDOCID
076981];.seealsoLehman,PDCFScheduleofEligibleSecurities(Sept.14,2008)[LBEXDOCID405695].
5978 Examiners Interview ofRobert Azerad, Sept. 23,2009,at p. 5;Examiners Interview ofChristopher
Burke, July 7, 2009, at p. 3. According to Azerad, this restriction prevented Lehman from posting the
range of collateral to the PDCF that other firms were allowed to post after September 15, 2008.
Examiners Interview of Robert Azerad, Sept. 23, 2009, at p. 5; see also email from Timothy Lyons,
Lehman,toIanT.Lowitt,Lehman(Sept.14,2008)[LBEXDOCID070210](statingthefedislettingthe
othereighteenbrokerdealersfundamuchbroaderrangeofcollateralthanus).
5979 Examiners Interview of Christopher Burke, July 7, 2009, at p. 3; see also email from Ricardo S.
Chiavenato, JPMorgan, to Christopher Carlin, JPMorgan, et al. (Sept. 15, 2008) [JPM2004 0055329];
ExaminersInterviewofRobertAzerad,Sept.23,2009,atp.5.AccordingtoAzerad,theFedimposedthe
widerhaircutsonLehmanbecausetheFedwasnotwillingtotakeanylossesinitsovernightfinancingof
Lehman.Id.
5980SeeemailfromSindyAprigliano,Lehman,toPaoloR.Tonucci,Lehman,etal.(Sept.15,2008)[LBEX
DOCID 4572426,4579671] (attaching list of an estimated haircut impact of approximately $4 billion); e

mail from Sindy Aprigliano, Lehman, to George Van Schaick, Lehman, et al. (Sept. 15, 2008) [LBEX
DOCID 077028] (discussing the larger haircuts imposed by the Fed on Lehmans PDCF borrowing); e
mail from Robert Azerad,Lehman, to Susan McLaughlin, Lehman, et al.(Sept.15,2008) [LBEXDOCID
457643] (explaining the PDCF haircuts would result in a $4 billion drain in liquidity . . . .); see also
Lehman,PDCFScheduleofEligibleSecurities(Sept.14,2008)[LBEXDOCID405695](detailingthePDCF
haircuts applied to Lehman for the various categories of accepted securities); email from Ricardo S.
Chiavenato,JPMorgan,toChristopherCarlin,JPMorgan,etal.(Sept.15,2008)[JPM20040055329].But
see email from Sindy Aprigliano, Lehman, to Paolo R. Tonucci, Lehman, et al. (Sept. 15, 2008) [LBEX
DOCID068353](statingthehaircutimpactfromusingthePDCFwouldbe$2billion).
1533

to two weeks of overnight secured financing through the PDCF to allow LBI to
accomplishanorderlyliquidation.5981
Baxter rejected the idea that moral hazard arguments played a role in
allowing Lehman to fail. Baxter said the whole purpose of the FRBNYs
extraordinaryactionsthatweekendwastorescueLehmaninsomeform:5982Innoway
was the idea tomakeLehman a poster child for moral hazard.5983Clearly,Baxter
said, my sense was that [the Government] was not just going through the motions
andthatLehmanwasnotsacrificedtomoralhazard.5984Baxterattributedthefailure
oftherescueefforttotheBritishgovernmentsrefusaltoofferaguarantytobackstop
the acquisition.5985 In his interview, Paulson said that although economic health
dependsonWallStreetfirmsbelievingthattheGovernmentcannotandwillnotrescue
them in a crisis, economic stability was nevertheless more important to the economy
thanmoralhazard.5986
5981 Examiners Interview of Shari D. Leventhal, Apr. 30, 2009, at pp. 45. Some FRBNY employees
thoughttheFRBNYwasriskingtoomuchexposurewiththetwoweekfundingtimeframe.Id.atp.5.
5982Id.
5983Id.
5984Id.
5985 Id. There were two distinct issues: (1) The U.K. regulators refusal to waive the shareholder vote
requirementnecessarytoapproveaBarclaysguarantyofoutstandingLehmantrades;and(2)Lehmans
failuretoobtainaguarantyfromBarclays,oranyotherentity,forpotentialtradinglosses.
1534

i) LehmansBankruptcyFiling
LBHI filed for bankruptcy protection on Monday, September 15. The FRBNY
wassurprisedbytheconsequencesthatLehmansfilinghadintermsoffundingLBIE,
which was taken into administration by British regulators due to inadequate
capitalization.5987 The FRBNY was unaware that LBIE was financed entirely by the
parentthatis,thatLBHIpulledliquidityintoNewYork,andwouldthenreroutethat
fundingtoLBIEintheU.K.5988BaxtersaidhewasunawareuntilthatMondaythatLBIE
wasdependentonitsLBHIparent,buthelearnedotherwisewhenLBHIwasforcedto
file for bankruptcy due to cross defaults from LBIE going into administration in the
U.K.5989Eventhen,BaxterassumedthattheBankofEnglandhadthecapacitytofund
LBIEinamannersimilartothatbywhichtheFRBNYfundedLBIthroughthePrimary
Dealer Credit Facility discount window for brokerdealers.5990 The FSA told the
Examiner that once it became known that LBHI would file for bankruptcy, the FSA
asked the FRBNY if financing (via the FRBNYs discount window for brokerdealers)
wouldbemadeavailabletoLBIEandwastoldthatitwouldnot.5991
5987ExaminersInterviewofThomasC.Baxter,Jr.,May20,2009,atp.11;ExaminersInterviewofJanH.
Voigts,Aug.25,2009,atpp.78(notingsurpriseattheextenttowhichLBIEwasdependentonLBHI,the
consequencesofLBHIsbankruptcy,andtheimportanceandcomplexityofintercompanyfundingwithin
Lehmangenerally).
5989Id.
5990Id.
5991 Financial Services Authority (U.K.), Statement of the Financial Services Authority (Jan. 20, 2010), at
pp.1011.
1535

FollowingLehmansbankruptcy,Lehman,throughitsbrokerdealer,LBI,relied
on the PDCF to obtain $40 to $50 billion in overnight financing needed to repay its
clearingbanks.5992Inaddition,Lehmanfundeditselfafterthebankruptcyfilingthrough
two other FRBNY programs, the Open Market Operations (OMO) and the Term
SecuritiesLendingFacility(TSLF),5993aswellastripartytermreposthathadnot yet
expired.5994 The FRBNYs overnight financing of LBI began Monday evening,
September15,withLehmanborrowingapproximately$28billionviathePDCF.5995The
FRBNYs overnight financing continued through Thursday morning, September 18,
2008.5996LBIwasplacedintoSIPAproceedingsonSeptember19,2008.
5992SeeemailfromDavidA.Weisbrod,JPMorgan,toJamieL.Dimon,JPMorgan,et.al.(Sept.15,2008)
[JPM20040080146](listingLehmanstripartyrepoborrowingat$51billion($28billionfromthePDCF,
$2billionfromBarclays,and$21billionfromotherinvestors)forMonday);Alvarez&Marsal,Summary
ofMeetingwithJamesHraskaon10/08/08[Draft](Oct.8,2008),atpp.14[LBEXAM003302](listingthe
FedsfundingofLehman(viathePDCF,OMO,andTSLF)fortheweekfollowingtheLBHIpetition).
5993 Examiners Interview of Christopher Burke, July 7, 2009, at p. 4; Alvarez & Marsal, Summary of
MeetingwithJamesHraskaon10/08/08[Draft](Oct.8,2008),atpp.14[LBEXAM003302].
5994SeeemailfromDavidA.Weisbrod,JPMorgan,toJamieL.Dimon,JPMorgan,et.al.(Sept.15,2008)
[JPM2004008014647](listing$21billioninmainlytermreposaspartofLBIstripartyborrowingfor
September15).
5995SeeemailfromEdwardJ.Corral,JPMorgan,toWilliamWalsh,JPMorgan,etal.(Sept.15,2008)[JPM
20040031195](notifyingtheFedthattheLehmanassetsusedinLBIs$28billionPDCFrepoonMonday
nightsatisfiedtheFridaycriterion).EarlieronMonday,Lehmanestimatedthatitwouldborrowupto
$35 billion through the PDCF on Monday night. See email from Sindy Aprigliano, Lehman, to Robert
Azerad,Lehman(Sept.15,2008)[LBEXDOCID1071653](providingJohnFeracasPDCFestimateof$27
billionplusabufferof$8billion);emailfromRobertAzerad,Lehman,toSusanMcLaughlin,Lehman,et
al.(Sept.15,2008)[LBEXDOCID071550](estimating$34billionofPDCFborrowing);emailfromPaolo
R. Tonucci, Lehman, to Susan McLaughlin, Lehman, et al. (Sept. 15, 2008) [LBEXDOCID 071550]
(estimating$28.3billionforthecollateralvalueofthePDCFborrowing).
5996ExaminersInterviewofRobertAzerad,Apr.20,2009,atp.5.
1536

x
:
:
etal., :
Debtors. :
x
REPORTOF

Jenner&BlockLLP
353N.ClarkStreet
Chicago,IL606543456
3122229350

919ThirdAvenue
37thFloor
NewYork,NY100223908
2128911600


VOLUME5OF9
Section III.B: Avoidance Actions
Section III.C: Barclays Transaction
EXAMINERSREPORT
TABLEOFCONTENTS
(SHORTFORM)
VOLUME1
Introduction...................................................................................................................................2
C. SystemsAccess..............................................................................................................33
SectionIII.A.1:Risk
b) Facts..................................................................................................................58
c) Analysis .........................................................................................................163
VOLUME2
2. Valuation ..............................................................................................................203
Portfolio .........................................................................................................215
Book................................................................................................................266
Positions.........................................................................................................356
Portfolio .........................................................................................................527
Positions.........................................................................................................568
DebtPositions ...............................................................................................583
ii

Stearns............................................................................................................622
VOLUME3
4. Repo105................................................................................................................732
b) Introduction ..................................................................................................750
Transactions ..................................................................................................764
oftheFirm .....................................................................................................914
iii

VOLUME4
a) Introduction ................................................................................................1482
iv

VOLUME5
(SecondBullet) ...................................................................................................1912
2. Facts .....................................................................................................................1965
5. Conclusions ........................................................................................................2063
vi

x
:
:
etal., :
Debtors. :
x
REPORTOF

TABLEOFCONTENTS
a) Summary .....................................................................................................1546
b) Introduction ................................................................................................1547
c) LehmansCashManagementSystem .....................................................1549
(1) LBHIsRoleasCentralBanker..........................................................1550
(2) GlobalCashandCollateralManagement .......................................1551
(3) LehmansExternalandVirtualBankAccounts..............................1554
(4) BankAccountReconciliations...........................................................1560
d) EffectoftheBankruptcyontheCashManagementSystem................1562
e) CashTransfersGivingRisetoAdministrativeClaims.........................1564
(1) CashTransfersfromLBHIAffiliatestoLBHI.................................1565
(2) CashReceivedbyLBHIonBehalfofLBHIAffiliates....................1566
(3) OtherRelevantTransactions .............................................................1568
a) Summary .....................................................................................................1570
b) LBHISolvencyAnalysis............................................................................1570
(1) Introduction .........................................................................................1570
(2) MarketBasedValuationAnalysis ....................................................1573
(a) BasisforUtilizationofaMarketBasedValuation
Analysis ........................................................................................ 1573
(b) MarketValueofAssetsApproach ........................................... 1577
(i) ImpliedAssetValue.......................................................... 1578
(ii) SmallEquityCushion ....................................................... 1580
(iii) LimitationsoftheMarketBasedApproach .................. 1581
a. ApplicationofRetrojection....................................... 1583
b. TheApplicationofCurrentAwareness.............. 1584
(3) Conclusion ...........................................................................................1587
c) LBHIAffiliateSolvencyAnalysis ............................................................1587
1537
(1) Summary ..............................................................................................1587
(2) DescriptionoftheExaminersAnalysis...........................................1595
(3) DebtorbyDebtorAnalysis ...............................................................1610
(a) LehmanCommercialPaperInc. ............................................... 1610
(b) CESAviation,CESAviationVLLC,CESAviationIX .......... 1615
(c) LBSpecialFinancing .................................................................. 1618
(d) LBCommodityServices............................................................. 1622
(e) LuxembourgResidentialPropertiesLoanFinance
S.A.R.L. ......................................................................................... 1627
(f) LBOTCDerivatives.................................................................... 1628
(g) LB745LLC................................................................................... 1629
(h) LBDerivativeProducts .............................................................. 1631
(i) LBFinancialProducts ................................................................ 1633
(j) LBCommercialCorporation ..................................................... 1635
(k) BNCMortgageLLC.................................................................... 1638
(l) EastDoverLimited..................................................................... 1638
(m) LehmanScottishFinance ........................................................... 1640
(n) PAMIStatlerArms ..................................................................... 1641
d) UnreasonablySmallCapital .....................................................................1642
(1) Summary ..............................................................................................1645
(2) AnalysisoftheUnreasonablySmallCapitalTest ......................1648
(a) SummaryofLegalStandard ..................................................... 1648
(b) LehmansCountercyclicalStrategy.......................................... 1650
(c) LehmansRepoBookandLiquidityRisk................................ 1654
(i) BearStearnsDemonstratestheLiquidityRisk
AssociatedwithRepoFinancing..................................... 1656
(ii) QualityandTenorofLehmansRepoBook .................. 1658
(d) DeleveragingtoWinBackMarketConfidence .................. 1662
(e) BeginningintheThirdQuarterof2008,LehmanCould
HaveReasonablyAnticipatedaLossofConfidence
WhichWouldHaveTriggeredItsLiquidityRisk.................. 1665
Government,NonAgencyRepoFunding.............................. 1674
1538
(i) LehmansLiquidityPool.................................................. 1675
(ii) LiquidityStressTests........................................................ 1678
(iii) OtherCapitalAdequacyMetrics .................................... 1687
a. CashCapitalSurplus ................................................. 1687
b. EquityAdequacyFramework .................................. 1688
c. CSECapitalRatio ....................................................... 1690
(g) LBHIAffiliateUnreasonablySmallCapitalAnalysis ....... 1692
e) InsiderPreferencesAgainstLBHI(ThirdBullet) ..................................1694
(1) Summary ..............................................................................................1694
(2) LegalSummary ...................................................................................1696
(3) SourcesofPotentialPreferentialActivity........................................1698
(4) DeterminationsandAssumptionsonSection547(b)
Elements ...............................................................................................1705
(5) ScopeofDefensesUnderSection547(c) ..........................................1710
(6) FindingsforLBSF................................................................................1713
(7) FindingsforLBCS ...............................................................................1718
(8) FindingsforLCPI................................................................................1722
f) PreferencesAgainstNonLBHILehmanAffiliates(FourthBullet) ....1730
g) AvoidanceAnalysisofLBHIandLBHIAffiliatesAgainst
FinancialParticipantsandPreChapter11Lenders(Fourthand
EighthBullets) ............................................................................................1731
(1) Summary ..............................................................................................1731
(2) APBAnalysis .......................................................................................1734
(3) CashDisbursementAnalysis ............................................................1737
(4) PledgedCollateralAccountsAnalysis.............................................1738
(5) AvoidanceAnalysisforCertainPreChapter11Lendersand
FinancialParticipants .........................................................................1739
(a) JPMorganAvoidanceAnalysis ................................................. 1739
(i) Background ........................................................................ 1739
TransfersinConnectionwiththeSeptember
Agreements ........................................................................ 1742
ConstructiveFraudulentObligation ....................... 1743
1539
1. ThereIsEvidenceToSupportAFinding
ThatLBHIIncurredanObligationWithin
theApplicableLookBackPeriodsWhenit
ExecutedtheSeptemberGuaranty................... 1743
2. ThereIsEvidenceToSupportAFinding
ThatLBHIReceivedLessThanReasonably
EquivalentValueorDidNotReceiveFair
ConsiderationinExchangeforGranting
JPMorgantheSeptemberGuaranty ................. 1744
3. InsolvencyasofSeptember10,2008 ................ 1757
4. UndercapitalizationasofSeptember10,
2008 ....................................................................... 1758
b. DefensestoAvoidabilityoftheSeptember
Guaranty...................................................................... 1758
1. ApplicabilityoftheGoodFaithDefenseof
Section548(c)oftheBankruptcyCodeand
Section279oftheN.Y.DebtorCreditor
LawtotheSeptemberGuaranty....................... 1758
2. ApplicabilityoftheSafeHarborProvisions
oftheBankruptcyCodetotheSeptember
Guaranty .............................................................. 1762
c. AvoidabilityofTransfersofCollateralin
ConnectionwiththeSeptemberGuaranty............. 1767
1. LBHIsCollateralTransfersandPost
PetitionSetoffs..................................................... 1767
2. ApplicationoftheSafeHarborstothe$8.6
BillionCashCollateralTransfers ...................... 1776
3. ThereIsEvidencetoSupportPotential
StateLawClaimsAvailabletoLBHI
PursuanttoSection541toAvoidthe
TransfersInConnectionwiththe
SeptemberGuaranty........................................... 1781
4. TotheExtenttheSeptemberGuaranty
ProvidedforaGuarantyofNonProtected
ContractObligations,ortotheExtent
JPMorganLiquidatedCollateralPursuant
toNonProtectedContractExposure,a
1540
ColorableBasisExistsThattheSafeHarbor
ProvisionsAreNotApplicable ......................... 1787
(iii) AvoidabilityoftheAugustAgreementsand
TransfersinConnectionWiththeAugust
Agreements ........................................................................ 1794
a. AvoidabilityoftheAugustGuarantyasa
ConstructiveFraudulentObligation ....................... 1794
1. LBHIIncurredanObligationWithinthe
ApplicableLookBackPeriodsWhenit
ExecutedtheAugustGuaranty ........................ 1794
2. ThereIsEvidenceThatLBHIReceived
LessThanReasonablyEquivalentValueor
DidNotReceiveFairConsiderationin
ExchangeforGrantingJPMorganthe
AugustGuaranty ................................................ 1795
3. InsolvencyasofAugust29,2008...................... 1797
4. UndercapitalizationandInabilitytoPay
DebtsasTheyComeDueasofAugust29,
2008 ....................................................................... 1797
b. DefensestoAvoidabilityoftheAugust
Guaranty...................................................................... 1797
c. AvoidabilityofTransfersofCollateralin
ConnectionWiththeAugustGuaranty.................. 1798
(iv) AvoidabilityoftheAugustandtheSeptember
SecurityAgreementsAndCollateralTransfers
PursuanttoSection548(a)(1)(A) ..................................... 1801
(v) AvoidabilityoftheTransfersofCollateralin
ConnectionwiththeSeptemberGuarantyPursuant
toSection547(b)oftheBankruptcyCode ..................... 1806
(vi) AvoidabilityofObligationsofLBHItoFunds
ManagedbyJPMorgan..................................................... 1813
(b) CitiAvoidanceAnalysis ............................................................ 1817
(i) Background ........................................................................ 1817
(ii) Avoidabilityofthe$2BillionDeposit............................ 1821
(iii) AvoidabilityoftheAmendedGuaranty........................ 1821
(iv) Avoidabilityofthe$500MillionTransferFroman
LBHIAccounttoanLBIAccount ................................... 1827
1541
(c) FRBNYAvoidanceAnalysis ..................................................... 1829
(d) HSBCAvoidanceAnalysis ........................................................ 1830
(i) Background ........................................................................ 1830
(ii) TheU.K.CashDeedTransactions .................................. 1832
(iii) TheHongKongCashDepositTransactions ................. 1833
(iv) September9,2009Stipulation ......................................... 1834
(v) AvoidabilityoftheJanuary4,2008Guaranty .............. 1835
(vi) AvoidabilityoftheHongKongCashDeed
Transactions ....................................................................... 1836
(vii) AvoidabilityoftheU.K.CashDeed ............................... 1836
(viii) AvoidabilityoftheTransferoftheRemaining
Collateral ............................................................................ 1837
(e) StandardBankAvoidanceAnalysis......................................... 1837
(f) BNYMAvoidanceAnalysis....................................................... 1839
(g) BofAAvoidanceAnalysis.......................................................... 1840
(h) CMEAvoidanceAnalysis.......................................................... 1841
(i) Summary ............................................................................ 1841
(ii) Background ........................................................................ 1843
a. EnergyDerivatives .................................................... 1851
b. FXDerivatives ............................................................ 1852
c. InterestRateDerivatives........................................... 1852
d. EquityDerivatives ..................................................... 1853
e. AgriculturalDerivatives ........................................... 1854
(iii) DefensestoAvoidabilityofClaims ................................ 1855
a. ApplicabilityofCEAPreemption............................ 1855
b. ApplicabilityofSelfRegulatoryOrganization
Immunity..................................................................... 1862
c. ApplicabilityoftheSafeHarborProvisionsof
theBankruptcyCode................................................. 1870
h) AvoidanceAnalysisofLBHIAffiliatePaymentstoInsider
Employees(FourthBullet) ........................................................................1871
(1) Summary ..............................................................................................1871
(2) Methodology........................................................................................1873
(3) ApplicableLegalStandards...............................................................1874
1542
(4) Findings ................................................................................................1882
(a) LBHIAffiliateSeverancePayments ......................................... 1882
(b) LBHIAffiliateBonusPayments................................................ 1887
(c) LBHIsAssumptionsofLimitedPartnershipInterests ......... 1889
a) FiduciaryDutyStandardforaWhollyOwnedAffiliate
SubsidiaryunderDelawareLaw .............................................................1896
b) FiduciaryDutyStandardforaWhollyOwnedAffiliate
SubsidiaryunderNewYorkLaw ............................................................1902
(1) LCPIsBackgroundandOfficersandDirectors ............................1905
(a) DutyofCare ................................................................................ 1907
(b) DutytoMonitor .......................................................................... 1909
c) BreachofFiduciaryDutyforAidingorAbettingUnder
DelawareLaw .............................................................................................1911
(SecondBullet) ...................................................................................................1912
a) Summary .....................................................................................................1912
b) ForeignExchangeatLehman ...................................................................1913
c) ForeignExchangeTransactionsDuringtheStubPeriod .....................1923
a) Summary .....................................................................................................1938
b) Discussion....................................................................................................1939
c) Analysis .......................................................................................................1942
d) AnalysisofOverallNetIntercompanyDataforthe2007and
2008PeriodsofAnalysis ...........................................................................1942
(1) LBHI ......................................................................................................1942
(2) LBIE.......................................................................................................1945
(3) LBSF ......................................................................................................1947
e) AnalysisofNetDailyIntercompanyDataforthe2007and2008
PeriodsofAnalysis ....................................................................................1949
1543
VoidableTransfers
1. ExecutiveSummary
ThisSectionoftheReportaddressesthefirst,second,third,fourth,seventhand
eighthbulletpointsoftheExaminerOrder.TheExaminersfindingsareasfollows:
Administrative Claims (First Bullet). The Examiner concludes that LBHI
Affiliates may have administrative claims against LBHI related to cash sweeps
totalingapproximately$60million.
Transfers in Respect of Foreign Exchange Transactions (Second Bullet). The
Examiner identified foreign exchange (FX) transaction settlements involving LBHI
Affiliates that took place between September 15, 2008 and the date upon which each
applicableLBHIAffiliatecommenceditsChapter11case.TheExaminerconcludesthat,
(1)asaresultofLBHIsbankruptcy,LBCCdidnothavesufficientfundstomeetallof
its obligations to its FX counterparties, and (2) operational disruption impacted
whether,andinwhatorder,counterpartieswerepaid.
Preference Claims AgainstLBHI(ThirdBullet).TheExaminerconcludes that
LBSFandLBCShavecolorablepreferenceclaimsagainstLBHIunderSection547(b)of
the Bankruptcy Code, but there is also evidence to support LBHIs assertion of new
valueandordinarycoursedefenses.
PotentiallyVoidableTransfersorIncurrencesofDebtClaims(FourthBullet).
The Examiner has not identified any fraudulent transfers under Section 548 of the
1544
Bankruptcy Code or under state law based on the methodologies employed by the
Examinersfinancialadvisors.TheExaminersfinancialadvisorsreviewedtheDebtors
expansive trading databases, SOFAs, and general ledger. Ultimately, the Examiner
identifiedseveraltransfersintheDebtorstradingdatabasesthatmaywarrantfurther
investigation,butanysuchpotentialclaimsbelongtoLBI.TheSIPATrusteehasbeen
contacted about these transfers. As for the other analytical approaches, the Examiner
has not been able to complete his analyses because the Debtors have not been able to
providebackupmaterialforcertaintransfersofinterest.
Intercompany Accounts and Transfers Thirty Days Prior to the Petition Date
(Seventh Bullet). The Examiner has investigated and catalogued intercompany
fundingtransfersnotinvolvingcollateralbetweenLBHIandcertainLBHIAffiliatesthat
took place between August 1, 2008 and September 12, 2008, as well as for the
correspondingtimeperiodin2007.
Avoidance Transactions (Eighth Bullet). The Examiner reviewed various
guaranties entered into by LBHI shortly before its bankruptcy filing and transfers of
collateralinconnection withthoseguaranties. The Examinerconcludesthat there are
colorable claims against JPMorgan and Citi to avoid the guaranties that they received
from LBHI and to avoid certain of the transfers made in connection with those
guaranties under Sections 547(b), 548 and 544 of the Bankruptcy Code and state law.
Suchclaims,however,aresubjecttosubstantialdefensesincludingthatthetransfersof
1545
collateraltoJPMorganorCitiareprotectedfromavoidancebaseduponthesafeharbor
provisionsoftheBankruptcyCode.TheExaminerconcludesthattheevidencedoesnot
support the existence of colorable claims against FRBNY, BNYM, HSBC and the CME
Group (CME). The Examiner elected not to examine the BofA transactions for
purposes of determining whether colorable claims exist with respect to such
transactions because they are the subject of ongoing litigation. The Examiner was
unable to reach a conclusion with respect to a $200 million collateral transfer to
StandardBankbecauseofthelackofinformationshowingwhetheraLehmanChapter
11debtorwasthesourceofthiscollateraltransfer.5997
LBHI(FirstBullet)
a) Summary
The Examiner investigated and identified cash transfers constituting post
petition extensions of credit that may give rise to administrative claims by LBHI
Affiliates.SuchtransfersincludethosefromLBHIAffiliatestoLBHI,aswellasreceipts
of cash by LBHI for the benefit of LBHI Affiliates. The Examiner concludes that cash
transfersinatotalamountofapproximately$60millionmaygiverisetoadministrative
claims.
5997TheExaminernotesthattheclaimsanalyzedhereinarisingunderSections547(b),548and544ofthe
BankruptcyCodeandstatelawaredependentuponananalysisofLehmansfinancialconditionasofthe
time of these transfers. Because the Examiner was directed only to determine if these claims were
colorable,theExaminersfinancialadvisorshavelimitedtheiranalysistoadeterminationastowhether
evidenceexiststosupportafindingoftherequisitefinancialcondition.
1546
b) Introduction
This Section of the Report examines whether LBCC or any other entity that
currentlyisanLBHIChapter11debtorsubsidiaryoraffiliate(LBHIAffiliate(s))has
any administrative claims against LBHI resulting from LBHIs cash sweeps of cash
balances, ifany,from September15,2008,the commencementdateofLBHIs Chapter
11case,throughthedatethatsuchapplicableLBHIAffiliatecommenceditsChapter11
case.5998
Neither the Examiner Order nor the Bankruptcy Code define the term cash
sweep. However, in seeking authority to continue its prepetition cash management
system after the LBHI petition date, the Debtors described their practice of collecting,
concentratinganddisbursingcash,includingintercompanyfundingandthesweeping
of excess cash.5999 In a Cash Management Order, the Bankruptcy Court thereafter
approved the Debtors postbankruptcy continuation of its cash management system,
including intercompany funding, and provided that any postpetition intercompany
cash sweep by the Debtors was a postpetition extension of credit entitled to
superpriority status.6000 Specifically, the Court ordered that from and after the
5998ExaminerOrderatp.3,firstbullet.
5999See Debtors Motion Pursuant to Sections 105(a), 345(b), 363(b), 363(c) and 364(a) of the Bankruptcy
Code and Bankruptcy Rules 6003 and 6004 (A) for Authorization to (i) Continue Using Existing
CentralizedCashManagementSystem,asModified(CashManagementMotion),atpp.67,Docket
No.669,InreLehmanBrothersHoldingsInc.,No.0813555(Bankr.S.D.N.Y.Oct.3,2008).
6000FinalOrderPursuanttoSections105(a),345(b),363(b),363(c)and364(a)oftheBankruptcyCodeand
Bankruptcy Rules 6003 and 6004 (A) Authorizing the Debtors to (i) Continue to Use Existing Cash
1547
CommencementDate,(i)thetransferofcashtoorforthebenefitofanyDebtordirectly
or indirectly from any Debtor or nonDebtor affiliate shall entitle the transferring
affiliate to an allowed claim in the recipient Debtors Chapter 11 case, under Sections
364(c)(1) and 507(b) of the Bankruptcy Code, having priority over any and all
administrative expenses of the kind specified in Sections 503(b) and 507(b) of the
Bankruptcy Code.6001 Section 364(c) of the Bankruptcy Code allows a debtor to
obtaincreditorincurdebtwithpriorityoveradministrativeexpenses.6002
Thus,inlightofthetermsoftheCashManagementOrder,inthisSectionofthe
Report,cashsweeprefers to anycashtransferthat occurredbetween September 15,
2008andthedatethattheapplicableLBHIAffiliatecommenceditsChapter11case(in
eachcase,theStubPeriod),from(1)anLBHIAffiliatetoLBHIor(2)athirdpartyto
LBHIforthebenefitofanLBHIAffiliate.Excludedfromthedefinitionofcashsweep
arepostpetitioncash transfersmadeinpaymentor settlementofexisting obligations;
such transfers would not be postpetition extensions of credit in accordance with
Section364(c)(1)oftheBankruptcyCode.
Management System, as Modified (the Cash Management Order), at p. 6, Docket No. 1416, In re
LehmanBrothersHoldingsInc.,No.0813555(Bankr.S.D.N.Y.Nov.6,2008).
6001Id.
6002Section 364(c)(1) of the Bankruptcy Code states, in relevant part, the court may authorize the
obtainingofcreditortheincurringofdebtwithpriorityoveranyoralladministrativeexpensesofthe
kind specified in section 503(b) of this title. 11 U.S.C. 364(c)(1). Section 503(b) of the Bankruptcy
Code states, in relevant part, that there shall be allowed administrative expenses including the
actual,necessarycostsandexpensesofpreservingtheestate.11U.S.C.503(b).
1548
In order to provide the context for identifying cash sweeps giving rise to
administrativeclaims,thisSectionoftheReportbeginswithanoverviewofLehmans
prepetition cash management system, which, as the Bankruptcy Court noted, was
extraordinarily complex and involved the regular movement of vast sums among
affiliatedentities.6003
c) LehmansCashManagementSystem
Lehmans Global Treasury Group (the Treasury Group) was responsible for
managing the firms liquidity pool, funding the entities business needs and ensuring
effectiveuseofthefirmscapital.6004TheTreasuryGroupwassubdividedintovarious
departments,6005 including the Cash and Collateral Management Group.6006 The Cash
andCollateralManagementGroup,amongotherthings,monitoredthecashpositionof
Lehmanentitiesandmanagedtheirintradayfundingrequirements.
6003MemorandumDecisionDenyingRelieffromtheAutomaticStaytoEffectuateSetoffunder11U.S.C.
553(a),atp.16,DocketNo.3551,InreLehmanBrothersHoldingsInc.,No.0813555(Bankr.S.D.N.Y.May
12,2009).
6004SeeLehman,FSAArrowAssessmentTreasury(Aug.11,2008),atp.2[LBHI_SEC07940_3272979].
6005TheTreasuryGroupwascomprisedofthefollowingdepartments:CashandCollateralManagement,
Asset Liability Management, Financial Planning and Analysis, Creditor Relations, Treasury Controllers
andNetworkManagement.Seeid.
6006Id.AtthetimeoftheLBHIbankruptcyfiling,DanielJ.FlemingwasSeniorVicePresidentandGlobal
HeadoftheCashandCollateralManagementGroup.ExaminersInterviewofDanielJ.Fleming,Apr.22,
2009,atp.1.
1549
(1) LBHIsRoleasCentralBanker
LBHI acted as the central banker for the Lehman entities, controlling the cash
disbursementsandreceivablesforitself,itssubsidiariesanditsaffiliates.6007Inaddition,
through its central banking system, LBHI managed cash globally, allowing Lehman
entitiestousecashefficiently.LBHIscashmanagementsystemwasdesignedtotrack
all cash activity, manage cash, maximize investment opportunities and minimize
costs.6008 The firmwide cash management system also streamlined Lehmans
managementandregulatoryreportingprocess.6009
LBHIs cash management system was not completely integrated, and certain
elements of the system functioned independently.6010 As such, in order to view
Lehmans global cash picture, LBHIs cash management team gathered information
from various financial software management tools,6011 as opposed to retrieving the
6007CashManagementMotion,atp.4(10),DocketNo.669,InreLehmanBrothersHoldingsInc.,No.08
13555(Bankr.S.D.N.Y.Oct.3,2008).NotwithstandingLBHIsroleascentralbanker,LBIpaidexpenses
forthebenefitofmanyU.S.Lehmanentities.However,LBHIwasprimarilyresponsibleforfundingthe
businessoperationsoftheseentities.Id.atpp.4(10),8(21).
6008SeeLehman,GCCMSystemDescription/ProjectOverview[LBEXLL385979];Lehman,Introduction
to GCCM; Concepts and Detail of GCCM Disbursements and Receipts Accounting, at p. 2 [LBEXLL
029285].
6009Whilethecashmanagementsystemwasthesameforregulatedandnonregulatedentities,regulated
entitiesweresubjecttocertainregulatoryrequirementswhich,amongotherthings,causedsuchentities
toaccountforsomeintercompanytransactionsdifferentlyandtoretainmorecashintheirbankaccounts
thantheywouldabsentsuchregulatoryrequirements.ExaminersInterviewofDanielJ.Fleming,Dec.
17,2009,atp.2.
6010ExaminersInterviewofDavidForsyth,Oct.29,2009,atp.2.
6011LBHIusedvariousapplicationsandplatformsincludingtheSummitTreasuryWorkstation(TWS)
tomanageitstreasuryfunctions.Withrespecttocashmanagement,LBHIalsousedavarietyofsoftware
programsinconjunctionwithTWS,includingtheGlobalCashandCollateralManagementsystem,which
1550
informationfromoneintegratedsystem.Becausethesystemwasnotfullyintegrated,
the cash management team could obtain only an approximation of Lehmans cash
positionatanypointintime.6012
(2) GlobalCashandCollateralManagement
In2006,LBHIbegantoimplementtheGlobalCashandCollateralManagement
(GCCM)system,aninhousebankingplatform.GCCMwascreatedto,amongother
things: (1) generate realtime integrated views of cash positions across time zones; (2)
providetransparencyintothegenerationanduseofcash;(3)manageriskbycalculating
realtime unsecured bank credit usage and minimize payment by systematically
releasing payment messages based on credit availability; and (4) forecast and fund
efficientlybyprovidingstartofday,intradayandendofdayprojectedandactualcash
positionsacrossallcurrencies,legalentitiesandbankaccounts.6013
While GCCM was intended by Lehman to facilitate efficient monitoring of the
cashactivityofitsentities,anentitymayhaveusedmultiplesourcesystems6014thatmay
or may not have been integrated into GCCM at the time of the LBHI bankruptcy
functionedasagatewayforcashflowstoandfromthefirm,andLehmansgeneralledgersystem(DBS).
Lehman,FinanceSystemsOverview,pp.8,14[LBEXAM004340].
6012ExaminersInterviewofDanielJ.Fleming,Dec.17,2009,atp.5.
6013Lehman,GCCMSystemDescription/ProjectOverview[LBEXLL385979].
6014Source systems are the applications in which business transactions were recorded, and which
subsequentlytransmittedtransactioninformationtoDBS.AtthetimeoftheLBHIbankruptcypetition,
the source systems integrated with GCCM served various functions, including: (1) clearance, payment
and settlement of trades; (2) loan product administration; (3) employee compensation, benefits and
expenses;(4)cashnettingandwiretransfers;and(5)firmfunding.Examplesofsourcesystemsinclude
(1)ASAP,apaymentandsettlementsystemforfixedincomeandequity;(2)LoanIQ,asourcesystemfor
loan product transactions and; (3) ITS, a multicurrency trade processing, settlement and bookkeeping
system.
1551
filing.6015 Therefore, the Treasury Group was able to track only a portion of certain
entitiescashactivityusingGCCM.
Lehman also used GCCM to consolidate cash for investment purposes, reduce
the number of bank accounts at other financial institutions and manage its bank
accountsmoreefficiently.6016CashconsolidationwithintheGCCMsystemwasunlikea
traditional cash sweep system in that funds from individual accounts were not
automatically transferred into a consolidation account on a daily basis. Rather, the
TreasuryGroupusedGCCMtomanuallysweepcashfromLBHIAffiliateaccountsto
anLBHIconsolidationaccountonanintradayordailybasis,asneeded.6017
Inotherwords,TreasuryGrouppersonnelmonitoredGCCMonadailybasisto
determine whether affiliate bank accounts had excess cash that was not immediately
needed for the affiliates business operations. If an affiliate had excess cash, the
Treasury Group manually wired such cash to a designated consolidation account of
6015Integrationinto GCCM was done on a systembysystem basis, not on an entitybyentity basis.

ExaminersInterviewofDanielJ.Fleming,Dec.17,2009,atp.4.TheExaminerobservedthatLoanIQ,a
global multicurrency system for the processing and administration of bank loan products utilized by
LCPI,hadbeenintegratedintoGCCMatthetimeoftheLBHIbankruptcyfiling,andthereforedatafrom
LoanIQwastransmittedtoGCCM.Ontheotherhand,MTS(MainframeTradingSystem),asecurities
tradingsystemutilizedbyLBCC,hadnotbeenintegratedintoGCCMatthetimeoftheLBHIbankruptcy
filing,andthereforenodatafromMTStradeswasincludedinGCCM.
6016See Lehman, Introduction to GCCM; Concepts and Detail of GCCM Disbursements and Receipts
Accounting,atp.4[LBEXLL029285](discussingLehmansgoalofcreatinganinhousebankmodelto,
amongotherthings,reducethenumberofexternalbankaccounts).
6017CashManagementMotion,atp.5(12),DocketNo.669,InreLehmanBrothersHoldingsInc.,No.08
13555 (Bankr. S.D.N.Y. Oct. 3, 2008). The Treasury Group did not manually transfer cash between the
ExternalBankAccountsofLBHIanditsregulatedsubsidiariesonadailybasis.Rather,LBHIprefunded
theobligationsofitsregulatedsubsidiaries,andsuchsubsidiariesperiodicallytransferredfundstoLBHI
ormadepaymentstothirdpartiesonbehalfofLBHItodecreasetheirintercompanypayable.Seeid.
1552
LBHI.Ontheotherhand,ifanaffiliatehadanegativecashposition,LBHIfundedthe
affiliate by wiring cash from its consolidation account to the affiliates bank account.
ThefollowingdiagramillustratesthepathsofthesecashtransfersamongLBHIandits
affiliates.

As indicated in the diagram above, Lehman entities entered into transactions
withotherLehmanentitiesintheordinarycourseofbusiness.Suchtransactionsmay
have resulted in transfers of cash among Lehman entities. However, in order to
minimizetheneedtotransfercashamongaffiliates,Lehmanestablishedintercompany
relationships in GCCM called funding trees.6018 Lehman entities connected to the
samefundingtreedidnottransfercashtoeachotherinconnectionwithintercompany
6018ExaminersInterviewofDanielJ.Fleming,Dec.17,2009,atpp.34.
1553
transactions. Instead, such intercompany transactions were recorded on the books of
theseentitiesasintercompanypayablesandreceivables.6019
Because GCCM was not fully integrated with Lehmans source systems, some
transactions related to cash management took place outside of GCCM. For instance,
certain cash transfers between LBHI and LCPI were recorded in the MTS system,6020
whichwasresponsibleforthetradingoffixedincomesecurities.6021BecauseMTSwasa
trading system that was not designed to record cash transfers, cash transfers were
recordedinMTSassecuritiesrepurchasetransactions.6022
(3) LehmansExternalandVirtualBankAccounts
LBHI maintained accounts at various banking institutions (collectively, the
ExternalBankAccounts).Lehmantrackedthemovementandallocationoffundsin
ExternalBankAccountsusingvirtualaccountswithinGCCM.GCCMmaintainedtwo
types of virtual accounts: (1) Nostro Accounts, which mirrored External Bank
Accounts,6023 and (2) InHouse Accounts, which reflected the cash position,
receivablesanddisbursementsforeachaffiliate.6024
6019Id.atpp.35.
6020InadditiontocashtransfersbetweenLCPIandLBHI,theMTSsystemwasalsousedtorecordcash
transfersbetweenLCPIandotherLehmanentities.Id.atp.7.
6021Id.atpp.67.
6022Id.SeeSectionIII.B.3.e,8ofthisReport,whichdiscussescashtransfersrecordedinMTS.
6023Nostro referred both to the actual accounts maintained at outside financial institutions and a
representationofthoseactualaccountsmaintainedwithintheGCCMsystem.
6024See Lehman, Introduction to GCCM; Concepts and Detail of GCCM Disbursements and Receipts
Accounting,atpp.34[LBEXLL029285].
1554
TheInHouseAccountsdocumentedtheamountofcashinLBHIsExternalBank
Accountallocatedtoaparticularentity.WhenanaffiliatetransferredmoniestoLBHI,
those monies would be recorded with an accounting entry as an intercompany
payablebyLBHIowedtotheaffiliate,andacorrespondingintercompanyreceivable
wouldberecordedonthebooksoftheaffiliate.6025Inthisway,GCCMallowedLBHIto
conduct its funding activity through a small number of External Bank Accounts,
withoutsegregatingaffiliatefunds.
Furthermore, because Nostro Accounts and InHouse Accounts within GCCM
captured cash payment and receipt information, GCCM served as a conduit between
theLehmansourcesystemsandexternalbanks.6026ThetransactionsrecordedinGCCM
were ultimately recorded on the books of the participating Lehman entities via
Lehmansgeneralledgersystem(DBS).6027
GCCM also facilitated the process by which LBHI and its affiliates made and
receivedpaymentsforthebenefitofotheraffiliates.6028Areceiptorpaymentoffunds
by one Lehman entity for the benefitofanother was recordedinthe NostroAccounts
and InHouse Accounts within GCCM via an automated realtime process, and was
6025Seeid.atpp.617.Thisrecordingofintercompanypayablesandreceivablesappliedtocashtransfers,
butnotnecessarilytotransactions,suchassecuritiestrades,wherecashisexchangedforitemsofvalue.
6026See Yury Marasanov, Ernst & Young, Accounts Payable / Fixed Assets / NPE / Cash Mgmt. Process
Walkthrough(Nov30,2008),atp.11[EYSECLBHICORPGAMX08056981].
6027JayChan,Lehman,GCCMTrainingManual,atp.5[LBEXLL652833].
6028InlaterSectionsofthisReport,theExaminerreferstoactivitycapturedinGCCMwhenLBHIactedas
central banker for affiliates, therebyreceiving or extending value on their behalf, as quasi
fundingactivity. See Section III.B.3.e of this Report, which discusses insider preferences against LBHI,
andSectionIII.B.6ofthisReport,whichdiscussesactivityoccurringinthethirtydaysbeforebankruptcy.
1555
subsequently posted to the DBS system via an automated daily batch process.6029
Typically, the receipt of funds by one Lehman entity for the benefit of another was
recordedasfollows:(1)thesourcesystemgeneratedanoticethatareceiptoffundswas
expected,whichwassenttoGCCM;(2)uponreceiptofthisnoticeGCCMtranslatedthe
InHouseaccountinformationassociatedwiththetransactiontotheNostroAccount;(3)
GCCMthennotifiedthebankthatareceiptofcashwasexpected;(4)thebankreceived
the funds in an External Bank Account; (5) the bank transmitted the wires SWIFT
data6030 to GCCM, which provided the details of the transaction; (6) GCCM then
compared the SWIFT data against the notice generated by the source system, and
transmittedanacknowledgementofareceiptoffundstothesourcesystem;and(7)the
transaction information recorded in GCCM and the source system was thereafter
recordedinDBS.6031
The following diagram illustrates the electronic transmissions that took place
betweenthesourcesystems,GCCMandbankinginstitutions,aswellasthesubsequent
recording ofthetransactioninformationinDBSinconnectionwiththereceiptofcash
byLBHIforthebenefitofanaffiliate.
6029JayChan,Lehman,GCCMTrainingManual,atpp.26[LBEXLL652833].
6030SWIFT (Society for Worldwide Interbank Financial Telecommunication) is the global standard by
whichbankingcustomersautomateandstandardizefinancialtransactionswithbanks.
6031SeeJayChan,Lehman,GCCMTrainingManual,atpp.35[LBEXLL652833].
1556

ThereceiptofcashbyoneLehmanentityforthebenefitofanotherwasrecorded
with one journal entry in the source system and two journal entries in GCCM, which
subsequentlypostedtoDBS.Thediagramsbelowillustratethejournalentriesmadein
GCCM,thesourcesystemandthegeneralledgerforthereceiptofcashbyLBHIforthe
benefit of LCPI, such as those received in connection with loan payments from third
partiesintheordinarycourseofbusiness.
1557

ReceiptofFundsbyLBHIfortheBenefitofLCPI
GCCMandSourceSystemJournalEntries

GCCM SourceSystem

Debit Credit Debit Credit

CashLBHI $100(a)

CashLCPI $100(b) $100(e)

ReceivableLCPI $100(f)

Intercompany
(DuefromLBHI) $100(c)

Intercompany
(DuetoLCPI) $100(d)

Total $200 $200 $100 $100
As shown in the diagram above, the journal entries in GCCM were as follows:
(a)adebittocashforLBHIcorrespondingtothereceiptofcashinLBHIsExternalBank
Account;(b)acredittocashforLCPIcorrespondingtotheallocationofcashtoLCPIs
InHouseAccount;(c)adebittoanintercompanyreceivabletoLCPIfromLBHIforcash
receivedbyLBHI;and(d)acredittoanintercompanypayablefromLBHItoLCPIfor
thecashowedbyLBHItoLCPI.
The diagram above also illustrates the following journal entries in the source
system:(e)adebittocashforLCPIforthereceiptofcashfromthethirdparty;and(f)a
credittoreceivablesforLCPIforareductionofthethirdpartysliabilitytoLCPI.
1558
Thesejournalentriesweresubsequentlyrecordedtothegeneralledgerinadaily
batch process. The diagram below illustrates the recording of these entries for LBHI
andLCPIinthegeneralledger.
ReceiptofFundsbyLBHIfortheBenefitofLCPI
LBHIandLCPIGeneralLedgerEntries

LBHIGeneralLedger LCPIGeneralLedger
Activity Activity

Debit Credit Debit Credit

CashLBHI $100(a)

CashLCPI $100(1) $100(2)

ReceivableLCPI $100(d)

Intercompany
(DuefromLBHI) $100(c)

Intercompany
(DuetoLCPI) $100(b)

Total $100 $100 $200 $200
Thistransactionwasrecordedinthegeneralledgerasfollows:(a)adebittocash
forLBHI,correspondingtothereceiptofcashinanLBHIExternalBankAccount;(b)a
credittoLBHIsintercompanypayablesowedtoLCPI,correspondingtotheallocation
of this cash to LCPIs InHouse Account; (c) a corresponding debit to LCPIs
intercompanyreceivablesreflectinganincreaseinintercompanyreceivablesfromLBHI;
1559
and (d) a credit to LCPIs receivables reflecting the receipt of cash from the third
party.6032
(4) BankAccountReconciliations
Bank account reconciliations were a critical component of LBHIs cash
management system, and were necessary for maintaining complete and accurate cash
records. A bank account reconciliation was performed by matching data from a
financial institution with data recorded in both LBHIs internal cash management
system and source systems to identify any inconsistencies or errors.6033 LBHI used a
thirdpartyvendor bank account reconciliation system, Global Smart Stream
Reconciliations (GSSR), which supplemented GCCM and automated the majority of
thebankreconciliationprocess.6034
GSSRperformedthefollowingtwokeycashreconciliationsonadailybasis:(1)
the reconciliation of Nostro Accounts against External Bank Accounts; and (2) the
reconciliation of InHouse Accounts against source system records.6035 Reconciliations
6032There is also an entry in the general ledger related to LCPI with corresponding debit and credit
amountsthatoffseteachother.Theseare:(1)adebittocashreflectingthereceiptofcashfromathird
party;and(2)acredittocashreflectingtheallocationofcashheldbyLBHItoLCPIsInHouseAccount.
6033See Yury Marasanov, Ernst & Young, Accounts Payable / Fixed Assets / NPE / Cash Mgmt. Process
Walkthrough(Nov.30,2008),atpp.1213[EYSECLBHICORPGAMX08056981].
6034JimMcMahon,Ernst&Young,BankReconciliationProcessWalkthrough(Nov.30,2008),atpp.912
[EYSECLBHIEEDGAMX08024858].
6035Inaddition,reconciliationsofNostroAccountandInHouseAccountbalancesinGCCMagainstDBS
were performed in GSSR. In some cases, reconciliations of source systems against External Bank
Accounts oragainst other source systems werealso performedin GSSR. SeeYury Marasanov, Ernst &
Young,AccountsPayable/FixedAssets/NPE/CashMgmt.ProcessWalkthrough(Nov.30,2008),atpp.
1213[EYSECLBHICORPGAMX08056981].
1560
of the Nostro Accounts against External Bank Accounts assessed the accuracy of the
balancesinanentitysExternalBankAccountsattheendoftheday.6036Reconciliations
oftheInHouseAccountsagainstsourcesystemrecordssubstantiatedthecashbalances
documentedineachentitysbooksandrecords.Inaddition,reconciliationsofNostro
AccountandInHouseAccountbalancesinGCCMagainstDBSrecordsensuredthatall
entriestoGCCMwerecorrect,servingasanadditionalsafeguardagainstinaccuracies
intheInHouseAccountandNostroAccountreconciliations.
As part of the reconciliation process, GSSR identified inconsistencies, or
breaks, between the data reported by financial institutions and the data reported in
LBHIscashmanagementsystem.6037Breakswerenotanunusualoccurrence.Abreak
report was created when listed items from either the bank system or GCCM did not
have a corresponding match in the other system.6038 Each break was investigated and
resolved by Treasury Group personnel.6039 For example, if an External Bank Account
receivedawiretransferfromathirdparty,butthecorrespondingdeposithadnotbeen
recordedinthecorrespondingNostroAccountwithinGCCMpriortothereconciliation,
thistransactionwaslistedonthebreakreport.Likewise,ifapaymenttoathirdparty
was recorded in a Nostro Account within GCCM, but the bank did not complete the
6036Seeid.atp.13.
6037Seeid.atp.12.
6038Seeid.
6039Seeid.atp.13.
1561
wire transfer until after the account reconciliation, the transaction would be listed on
thebreakreport.
d) EffectoftheBankruptcyontheCashManagementSystem
JustpriortotheLBHIbankruptcyfiling,financialinstitutionsincludingCitibank
and JPMorgan froze LBHIs bank accounts.6040 As a result, immediately following
LBHIs bankruptcy filing: (1) funds could not be withdrawn from these accounts; (2)
payments could not be made using funds in these accounts;6041 and (3) the Treasury
Group was unable to retrieve realtime account information. Nonetheless, the banks
continuedtoacceptpaymentsmadetotheseaccounts.
Because LBHIs bank accounts were frozen, the cash management processes of
LBHI affiliates were also disrupted. Funds were no longer transferred from LBHIs
External Bank Accounts to the External Bank Accounts of its subsidiaries and
affiliates.6042 In addition, LBHI stopped manually transferring cash from affiliate bank
accounts to its accounts, as it had done prior to the bankruptcy petition.6043 On
September19,2008,Lehmanregainedaccesstoitsbankaccounts.
6040Examiners Interview of David Forsyth, Oct. 29, 2009, at p. 3; Citigroup, Written Responses to
ExaminersInquiry(Jan.12,2010),atp.3.
6041Anexceptionwasapaymentof$23.5millionbyLBHItoWeilonSeptember15,2008.
6042The notable exception was passthrough principal and interest payments made to LCPI, which is
discussedbelowinthisSectionoftheReport.
6043Prior to the bankruptcy filing, LBHI treasury personnel transferred cash into LBHI accounts either
daily or intraday as needed. See Cash Management Motion, at pp. 67 ( 16), Docket No. 669, In re
LehmanBrothersHoldingsInc.,No.0813555(Bankr.S.D.N.Y.Oct.3,2008).
1562
Following the LBHI bankruptcy filing and the bankruptcy filings of LBHI
Affiliates,Lehmancontinuedtouseitscashmanagementsystem,honoredcertainpre
petition obligations related to the cash management system and maintained and used
certain existing External Bank Accounts.6044 In addition, the Debtors closed certain
External Bank Accounts and established new External Bank Accounts (New
Accounts),transferringcashintotheNewAccounts.Further,theDebtorsmaintained
certainprepetitionExternalBankAccounts(LegacyAccounts)becauseclosingthose
accountsandopeningnewaccountswouldhaverequiredreestablishingtheinterfaces
betweensuchaccountsandthevarioussystemsthatLehmanoperatedprepetition,and
would thus have involved significant costs. To the extent Legacy Accounts were not
maintained, monies slated for deposit into such accounts were redirected to New
Accounts. The Debtors continue to use New Accounts and Legacy Accounts for all
purposesoftheestate,includingcollectingmoniesandmakingpayments.6045
As an example of the changes described above, prior to September 15, 2008,
LBHIreceivedcertainloanpaymentsforthebenefitofLCPIfromthirdpartyborrowers
intheordinarycourseofbusiness.LBHIthentransferredthesefundsonbehalfofLCPI
directlytothethirdparties,LCPIinvestmentvehiclesorLehmannonDebtoraffiliates
6044See generally Cash Management Order, Docket No. 1416, In re Lehman Brothers Holdings Inc., No. 08
13555(Bankr.S.D.N.Y.Nov.6,2008).
6045LehmanBrothersHoldingsInc.,LBHIOperationalIssuesandChallenges(Nov.3,2008),atpp.1112
[LBEXOTS000866].
1563
that held the loans.6046 After the LBHI bankruptcy filing, funds received by LBHI on
behalf of LCPI could not be transferred because LBHIs External Bank Accounts were
frozen.
Consequently, on September 17, 2008, LCPI established new External Bank
AccountstocollectsuchfundsandLBHInolongerreceivedsuchfundsforthebenefit
of LCPI. LCPI subsequently made payments directly to thirdparty investors in
connectionwithsuchtransactions.OnSeptember18and19,2008,LBHItransferredthe
majorityofthefundsitpreviouslyreceivedforthebenefitofLCPItoanLCPIExternal
BankAccount.6047
e) CashTransfersGivingRisetoAdministrativeClaims
ThemethodologytheExaminerusedtoidentifycashtransfersconstitutingpost
petition extensions of credit that may give rise to administrative claims included a
reviewoftheDebtorsGCCMRecords,StatementsofFinancialAffairs,cashtransaction
reports for Legacy Accounts and New Accounts, bank statement data6048 and general
ledgerreports(collectively,theCashTransactionRecords).Inaddition,theExaminer
conductedinterviewswithcurrentandformerLehmanpersonnel.
6046GCCMIntercompanyReport,Sept.115,2008[LBEXLL2551231LBEXLL2564078].
6047SeeSectionIII.B.2.e.2ofthisReport,whichdiscussesthefundsthatremainintheLBHIExternalBank
Account.
6048Threeseparatedatafilesincluding(1)LegacyAccountdata(2)NewAccountdataand(3)aseparate
datafileforLCPILegacyAccountdatacomprisedthepopulationofbankstatementdata.
1564
Specifically, to identify (1) cash transfers from LBHI Affiliates to LBHI and (2)
cash received by LBHI for the benefit of any LBHI Affiliate, for the period from
September15,2008throughthedatethattheapplicableLBHIAffiliatecommencedits
Chapter 11 case, the Examiner created queries and analyzed reports generated from
Debtor bank statement data and GCCM. Transactions with common characteristics
were analyzed to determine whether such transactions met the definition of cash
sweeps.6049Finally,theExaminerreconciledthecashtransferinformationidentifiedin
the bank statement data against the GCCM funding report and intercompany report
data.
The Examiner analyzed bank statement data for approximately 65 accounts,
constituting the Debtors U.S. and foreign bank accounts.6050 The Examiners findings
basedonthemethodologydescribedaboveareasfollows:
(1) CashTransfersfromLBHIAffiliatestoLBHI
The Examiner has identified a transfer of $58,969,818 from LCPI to LBHI on
October1,2008.6051
6049See Section III.B.2.b of this Report, which discusses cash sweeps that give rise to administrative
claims.
6050TheDebtorsprovidedbankstatementdatafor:(1)U.S.bankaccountsofLBHI,EastDover,LB745,
LBCC,LBCS,LBDP,LBFP,LBSF,LCPI,LOTCandPAMIStatler;and(2)foreignbankaccountsofLBHI
(UK Branch), LBSF and LBCS. Email from Lauren Sheridan, Lehman, to Heather D. McArn, Jenner &
Block (Jan. 21, 2010) (noting that Lehman has provided the Examiner with the complete universe of all
transaction activity for Debtor entities); email from Lauren Sheridan, Lehman, to Heather D. McArn,
Jenner&Block,etal.(Jan.29,2010)(indicatingthatScottishFinance,CES,CESV,CESIX,Luxembourg
LLCandBNChadeitherminimalornobankingactivityduringtheStubPeriod).
6051SeeXOJetLCPIReceiptSupportAnalysis[LBEXAM5641494LBEXAM5641497].
1565
On September 30, 2008, LCPI received $58,969,818 from a third party in
connection with an aircraft lease.6052 These funds were subsequently transferred to
LBHI on October 1, 2008, three business days prior to the LCPI bankruptcy filing.
AccordingtoLehman,thistransferlikelyoccurredinordertoprotectthefundsfrom
beingseizedbyCitibank.6053ThesefundshavenotbeenremittedbyLBHItoLCPIasof
thedateofthisReport.6054TheExaminerhasdeterminedthatLCPImaybeentitledto
anadministrativeclaimagainstLBHIinconnectionwiththistransfer.
(2) CashReceivedbyLBHIonBehalfofLBHIAffiliates
The Examiner has identified cash received by LBHI for the benefit of LBHI
Affiliatesinthetotalamountof$264,944,535.6055
LBHIreceived$258,903,936ofthistotalamountforthebenefitofLCPI,relating
toprincipalandinterestpaymentsfromthirdparties.6056OnSeptember18and19,2008,
LBHI remitted a total of $258,745,279 to LCPI for these principal and interest
payments.6057 LBHI has not remitted the remaining balance of $158,657 to LCPI in
connection with these transactions, as of the date of this Report. The Examiner has
6052Seeid.
6053EmailfromLaurenSheridan,Lehman,toKenHalperin,Duff&Phelps(Jan.5,2010).
6054SeeXOJetLCPIReceiptSupportAnalysis[LBEXAM5641494LBEXAM5641497].
6055See Debtor Bank Statement Data [LBEXAM 5642100 LBEXAM 5642389]; see also GCCM
IntercompanyReport[LBEXLL2040576LBEXLL2041244].
1566
determined that LCPI may be entitled to an administrative claim against LBHI in
connectionwiththesetransactions.
LBHI also received a total amount of $6,038,929 for the benefit of LBSF during
theperiodfromOctober1throughOctober3,2008,relatedtointerestrateswapcoupon
payments from third parties.6058 During 2009, LBHI remitted a total amount of
$5,710,986toLBSFinconnectionwiththesetransactions.6059LBHIhasnotremittedthe
remainingbalanceof$327,943toLBSFasofthedateofthisReport.TheExaminerhas
determined that LBSF may be entitled to an administrative claim against LBHI in
connectionwiththesetransactions.
Inaddition,theExamineridentifiedtworeceiptsbyLBHIforthebenefitofLBCS
and LBSF, which were de minimis in amount. On September 15, 2008, LBHI received
$1,484forthebenefitofLBCSand$186forthebenefitofLBSF.6060Asofthedateofthis
Report, LBHI has not remitted these amounts to LBCS and LBSF. The Examiner has
determinedthatLBCSandLBSFmaybeentitledtoadministrativeclaimsagainstLBHI
inconnectionwiththesetransactions.
6058LBHIbankstatementdata[LBEXAM5642390].
6059Id.
6060See
Debtor Bank Statement Data [LBEXAM 5642100 LBEXAM 5642389]; see also GCCM
1567
(3) OtherRelevantTransactions
TheExamineridentifiedtwotransfersinthetotalamountof7,065,352NOKfrom
LBI(onbehalfofLBCC)toLBHI(forthebenefitofLBIE)onSeptember15,2008.6061
This transaction was the subject of a Bankruptcy Court decision dated May 12,
2009,concerningDnBNORBankASAs(DNB)entitlementtosetofffundsdeposited
toaLBHIbankaccountpostpetition.6062InitsdecisiondenyingDNBsrequestforrelief
from the automatic stay to effectuate setoff, the Court noted that the transaction
involvedatransferoffundsfromLBCCtoLBHI.TheCourtnotedthat:
[T]he current record fails to provide any explanation concerning the

reasonthatLBCCinitiatedthetransferoffundstoLBHI,theconsequence
of the transfer (other than as it relates to the setoff question) or whether
the transfer either satisfies or gives rise to an intercompany claim. The
Courtalsodoesnotknowwhetherthetransferisanexampleofordinary
courseprepetitioncashmanagementproceduresorrepresentsanisolated
transaction.6063
In investigating whether these NOK transfers constitute cash sweeps entitling
LBCCtoanadministrativeclaim,theExaminerreviewedtherecordbeforetheCourtas
well as Lehmans GCCM and RISC6064 records. These records provided additional
information regarding the entities involved in this transaction. Reflective of the
6061See GCCM transaction detail [LBEXLL 3356465 LBEXLL 3356471, LBEXLL 3356472 LBEXLL
3356479] (funds transfer by LBI (for LBCC) was to the UK branch of LBHI (for LBIE).) The 7,065,352
NorwegianKroner(NOK)isequivalenttoapproximately$1.2million.
6062See Memorandum Decision Denying Relief from the Automatic Stay to Effectuate Setoff Under 11
U.S.C.553(a),DocketNo.3551,InreLehmanBrothersHoldingsInc.,No.0813555,(Bankr.S.D.N.Y.May
12,2009).
6063Id.atp.15.
6064RISCstandsforRealtimeInformationSystemsforCommodities.
1568
complicated nature of Lehmans cash management system, this data revealed that the
transactioninvolvedcashtransfersmadeinsettlementofforeignexchangetransactions
between LBCC and LBIE to exchange NOK for U.S. dollars.6065 The transfers of NOK
originated from an LBI bank account at DNB (on behalf of LBCC) to an LBHI (UK
Branch) bank account at DNB (for the benefit of LBIE).6066 Based on available
information, the Examiner has determined that the corresponding U.S. dollar transfer
fromLBIEtoLBCCwasnotconsummated.6067
Becausethesecashtransfersweremadeinsettlementofexistingobligationsand
were not postpetition extensions of credit, they do not constitute cash sweeps as
defined in this Report.6068 Thus, any potential claims that may arise from this multi
entitytransactionareoutsidethescopeoftheExaminersinvestigation.
6065See RISC statement detail [LBEXAM 5641773, LBEXAM 5641774, LBEXAM 564177 and LBEXAM
564180](listingtheexecutionandscheduledsettlementdatesfortheseforeignexchangetransactions);see
also Francois ChuFong, Lehman, Written Responses to Examiner Inquiry Regarding DnB NOR
Transaction, attached to email from Lauren Sheridan, Lehman, to Heather D. McArn, Jenner & Block
(Jan.15,2010).
6066TheExaminerdeterminedthatbecauseLBCCdidnothaveforeigncurrencybankaccounts,LBIpaid
and received foreign currencies on its behalf. Likewise, in this transaction, LBHI UK served as LBIEs
agentforthereceiptofNOK.
6067See Debtor Bank Statement Data [LBEXAM 5642100 LBEXAM 5642389] (reflecting that the U.S.
dollaramountswerenottransferredtoLBCC).
6068The Examiners review of these transfers focused on potential administrative claims by LBCC (an
LBHIAffiliate)againstLBHIarisingfromcashsweeps.TheExaminerhasnotassessedwhetheranynon
Debtor affiliates including LBI and LBIE may have claims against any Debtor in connection with these
transfers.
1569
3. ExaminersInvestigationofPossibleAvoidanceActions(Third,Fourth
andEighthBullets)6069
a) Summary
This Section includes a discussion of (1) LBHI and LBHI Affiliate solvency
determinations, (2) unreasonably small capital determinations, (3) insider preferences
againstLBHI,and(4)potentialavoidanceclaimsavailabletoLBHIandLBHIAffiliates
againstfinancialparticipantsandpreChapter11lenders.
b) LBHISolvencyAnalysis
(1) Introduction
The analysis of LBHIs solvency is necessary as part of the Examiners
investigation into potential preferential and fraudulent transfers made by LBHI in the
timeleadinguptoitsbankruptcyfiling.6070TheBankruptcyCodedefinesinsolventas
afinancialconditionsuchthatthesumofsuchentitysdebtsisgreaterthanallofsuch
entitys property, at a fair valuation . . .6071 This definition of insolvency is the
traditionalbankruptcybalancesheettestofinsolvency:whetherdebtsaregreaterthan
assets, at a fair evaluation, exclusive of exempted property.6072 Although GAAP is
6069This Section of the Report includes data extracted from Lehmans source systems, including, for
example,GCCM,GSSR,andDBS.
6070Whether a debtor was insolvent at the time of a transfer affects the avoidability of that transfer as
either a preference or a fraudulent transfer under the Bankruptcy Code. See 11 U.S.C. 547(b)(3),
548(a)(1)(B)(ii)(I).
607111U.S.C.101(32)(A).
6072Akersv.Koubourlis(InreKoubourlis),869F.2d1319,1321(9thCir.1989).
1570
relevant to a solvency analysis, it is not determinative.6073 A court should ask: What
wouldabuyerbewillingtopayforthedebtorsentirepackageofassetsandliabilities?
Ifthepriceispositive,thefirmissolvent;ifnegative,insolvent.6074Whetheracompany
isinsolventisconsideredamixedquestionoflawandfact.6075
Valuation need not be exact:6076 indeed, the precise value of a company as a
goingconcernisfarfromcertain.6077TheSecondCircuit,inRoblin,explained:
The matrix within which questions of solvency and valuation exist in

bankruptcydemandsthattherebenorigidapproachtakentothesubject.
Because the value of property varies with time and circumstances, the
finder of fact must be free to arrive at the fair valuation defined in
101[32]bythemostappropriatemeans.6078
As explained in Iridium, [n]o rigid approach should be taken regarding the fair
valuation of a company within the context of [a] solvency analysis, but rather courts
should consider the totality of the circumstances.6079 Additionally, though not
6073Shubertv.LucentTech.,Inc.(InreWinstarCommc.,Inc.),348B.R.234,274(Bankr.D.Del.2005),affd
2007WL1232185(D.Del.Apr.26,2007),affdinpart,modifiedinpartonothergrounds,554F.3d382(3dCir.
2009).
6074Coveyv.CommercialNatlBankofPeoria,960F.2d657,660(7thCir.1992).
6075Travelers Intl AGv. Trans WorldAirlines, Inc.(In reTrans WorldAirlines, Inc.), 134 F.3d 188, 193(3rd
Cir.1998),cert.denied523U.S.1138(1998).
6076Bridenv.Foley,776F.2d379,382(1stCir.1985).
6077Wolkowitzv.Am.ResearchCorp.(InreDakIndus.,Inc.),170F.3d1197,1200(9thCir.1999);seealsoBrown
v.ShellCanada,Ltd.(InreTenn.Chem.Co.),143B.R.468,479(Bankr.E.D.Tenn.1992)(Exactnessisnot
requiredindeterminingsolvencyorinsolvency.),affd112F.3d234(6thCir.1997).
6078Lawsonv.FordMotorCo.(InreRoblinIndus.,Inc.),78F.3d30,38(2dCir.1996)(quotingPorterv.Yukon
NatlBank,866F.2d355,357(10thCir.1989)).
6079IridiumCapitalCorp.v.Motorola,Inc.(InreIridiumOperatingLLC),373B.R.283,344(Bankr.S.D.N.Y.
2007) (Peck, B.J.) (the Second Circuit has adopted a flexible approach to insolvency analysis); see also
Neuger v. Casgar (In re Randall Constr., Inc.), 20 B.R. 179, 184 (N.D. Ohio 1981) (determination of fair
valuationis,atbest,aninexactscience,andmayoftenbeimpossible.Asaresult,insolvencyfrequently
1571
dispositive,expertappraisalsandvaluationsshouldbeconsidered,whenpossible,ina
solvencyanalysis.6080
In order to perform this analysis, the Examiners financial advisors utilized an
approach based on the market prices for LBHI equity and debt. This approach was
complemented by (1) the utilization of the technique of retrojection; and (2) the
applicationofcurrentawareness,asexplainedbelow.
TheExaminersfinancialadvisorsdidnotperformeitheradiscountedcashflow
valuation (DCF) or a market comparable valuation of Lehman for several reasons.
First,suchanalyseswouldhaverequiredsignificanttimeandexpensetoperform,and
eachhassignificantshortcomingswithregardtoitsdependabilityandapplicabilityto
theExaminersanalyses.Second,Lehmansassetswerecomprisedmostlyoffinancial
assetsforwhichaprojectionofcashflowswouldhavebeenchallenging.Further,the
investigationdonebytheExaminersfinancialadvisorsincludednumerousdatesover
whichLehmansfinancialhealthwasfluctuatingwithsomeseverity.Asaresult,aDCF
performed on a single date would not necessarily be applicable to any other date,
causing the Examiners financial advisors to have to perform separate DCFs for each
date in which there was a potentially avoidable transaction. Finally, due to the
subjectivity necessary when projecting cash flows or determining appropriate
mustbedeterminedbyproofofotherfactsorconsiderationofotherfactorsfromwhichinsolvencymay
beinferred.)
6080Iridium,373B.R.at344.
1572
multiples,theExaminersfinancialadvisorsfounditmoreappropriateinthissituation
to rely on the contemporaneous analyses performed by all of the market participants.
The presentation of pricebook ratios, for example, indicates the collective,
contemporaneous analysis of all market participants with regard to an appropriate
discount that should be applied to Lehman relative to its peers. Any comparable
companyvaluationperformedbytheExaminersfinancialadvisorswouldmerelyserve
toreplicatethisanalysisayearlater.
Utilizing a marketbased approach, the Examiner first concluded that there is
sufficientevidencetosupportafindingofinsolvencyofLBHIbeginningonSeptember
8,2008.Adjustingthemarketbasedapproachpursuanttothetechniqueofretrojection
and the application of current awareness, which would factor in information in
existencebutnotknownbythemarket,theExaminerconcludedthatthereissufficient
evidencetosupportafindingofinsolvencyofLBHIbeginningonSeptember2,2008.
(2) MarketBasedValuationAnalysis
(a) BasisforUtilizationofaMarketBasedValuationAnalysis
Lehmanwasinanindustrywhereitwasrequiredtomarkmanyofitsassetsto
market every day. Although not all of Lehmans assets were marked with daily
frequency,6081thebookvalueofthefirmsequityistypicallyareasonablestartingpoint
6081GAAP does not require firms to mark fixed assets to market. Rather, it allows those assets to be
reportedatbookordepreciatedvalues.Further,GAAPrequiresfirmstoperformgoodwillimpairment
analyses,butitdoesnotrequirefirmstoreportappreciatingvaluesofgoodwillorintangibles.Finally,
GAAPdoesnotrequirefirmstomarkmostdebttomarket.
1573
fortheassessmentofthefirmstrueequity.DespitetheExaminersfinancialadvisors
determination that Lehmans valuation methodology for certain asset categories was
reasonable,6082thereisevidenceindicatingthatLehmansvaluationswereinaccurateor
didnotproperlyallowforfirmwideilliquidityand/ortheappropriatelevelsofcurrent
distress.6083 Although Lehmans internal marktomarket marking models have an
advantage over the market owing to their access to extensive private information, the
markings that are reported to the public occur relatively infrequently (quarterly), and
quickly become outdated. Quarterly marktomarket values depend on quarterly
accounting data and may not reflect the changing risk profile of the institution.
Moreover, during the time period relevant to the Examiners financial advisors
analyses, market values were declining rapidly and new information that impacted
pricing was released frequently. Thus, while fluid equity markets interpret public
informationandincorporatenewdataintopricesveryquickly,thequarterlyaccounting
marksofLehmanlackedsuchtimeliness.
An additional explanation for the discrepancy between the market values and
Lehmans book values is that the firms internal marktomarket models focus on the
riskiness ofthe individualassets,and thereforedo notnecessarilycorrectly reflectthe
overall riskiness of Lehman. Often, large firms are less risky than the sum of their
individual assets because of the benefit gained by diversification. In Lehmans case,
6082SeeSectionIII.B.3.(c)ofthisReport,whichdiscussesthisdetermination.
6083SeeSectionIII.A.5.iofthisReportforadiscussionofLehmansliquiditypool.
1574
where the liquidity of the firm was questionable, the firm as a whole may have been
seen as riskier than the sum of its individual assets. Thus, the aggregate value of the
firmsassetscouldbelessthantheirsum,makingitentirelyreasonableandrationalfor
thecompanysstocktotradebelowGAAPbookvalueofequity.
Moreover,whileLehmanscompetitorsandtheinvestmentbankingcommunity
ingeneralhadequitymarketpricetobookratios6084inexcessof1.0xthroughoutmostof
thesummerof2008,Lehmandidnot.Asdisplayedinthechartbelow,Lehmansprice
tobook ratio was wellbelow1.0xatalltimesbeginningJune1,2008,and for mostof
July,AugustandSeptember,itwasbetween0.4xand0.6x.
PricetoBookRatiosforLehmanandComps
June1,2008 September14,2008
2.0x
1.8x
1.6x
1.4x
1.2x
1.0x
0.8x
0.6x
0.4x
0.2x
0.0x
Jun2 Jun9 Jun16 Jun23 Jun30 Jul7 Jul14 Jul21 Jul28 Aug4 Aug11 Aug18 Aug25 Sep1 Sep8
LehmanBrothers MerrilLynch MorganStanley GoldmanSachs BankingIndex

6084PricetoBookratioismeasuredasthemarketcapitalizationofafirmdividedbythefirmsbookvalue
ofequity.
1575
Thus, reliance upon Lehmans balance sheet alone would be imprudent in an
insolvencyanalysis.
Ratherthanrelyingonacorporationsownbalancesheetvaluations,somecourts
have indicated that a market capitalization valuation methodology is the appropriate
solvency analysis for a large, publicly traded financial institution such as LBHI.6085
AccordingtothecourtinIridium,[a]companysstockpriceisanidealdatapointfor
determining value.6086 The advantage of such contemporaneous market evidence is
thatitisuntaintedbyhindsightorposthoclitigationinterests.6087TheThirdCircuit
inVFB,inaffirmingthedistrictcourtsprimaryrelianceonmarketbasedvaluations
asameasureofvalue,reasonedthat[e]quitymarketsallowparticipantstovoluntarily
take on or transfer among themselves the risk that their projections will be
inaccurate,6088 and that absent some reason to distrust it, the market price is a more
reliablemeasureofthestocksvaluethanthesubjectiveestimatesofoneortwoexpert
witnesses.6089
ItisforthesereasonsthattheExaminerandhisfinancialadvisorsbelievethata
marketbased approach to the valuation of LBHIs solvency is the most relevant, with
otherapproachesprovidingfurtheranalysis.
6085SeeIridium,373B.R.at346;VFBLLCv.CampbellSoupCo.,482F.3d624,63133(3rdCir.2007).
6086Iridium,373B.R.at346.
6087VFBLLCv.CampbellSoupCo.,2005WL2234606,at*13(D.Del.Sept.13,2005).
6088VFB,482F.3dat631.
6089Id.at663(citingInrePrince,85F.3d314,320(7thCir.1996)).
1576
(b) MarketValueofAssetsApproach
WhilethecourtsinIridiumandVFBfocusedprimarily,ifnotexclusively,onthe
marketvalueofequity,theExaminersfinancialadvisorshaveincludedintheiranalysis
the implication of solvency that results from an analysis of both the market value of
equityandthemarketvalueofdebt.
Itisimportanttoconsiderthemarketvalueofdebtalongwiththemarketvalue
ofequityforseveralreasons.First,inthecaseofabankruptcy,thevalueachievedfrom
sellingtheassetsofthecompanywouldhavetofundtherepaymentofbothdebtand
equity.Totheextentthatthecreditors(andthedebtmarketparticipants)feelthatthe
valueoftheassetswillnotbesufficienttorepayallofthedebt,theywillcausethedebt
totradeatadiscounttopar.ThiswasthecaseinthemonthsleadinguptoLehmans
bankruptcyfiling.
In addition to discounts in the debt markets, one must consider option value
embeddedintheequityprices.6090Asanillustrativeexample,thefollowingcharttracks
the stock price for CIT Group in the period up to and after its bankruptcy filing on
November1,2009:
6090Foramoredetaileddiscussionoftheoptionvalueembeddedinequityprices,seeAppendixNo.21,
Duff&Phelps,LBHISolvencyAnalysis(Feb.1,2010).
1577
CITGroup StockPrice
$2.50
$2.00
$1.50
November1
BankruptcyFiling
$1.00
$0.50
$0.00
9/1/2009 9/8/2009 9/15/2009 9/22/2009 9/29/2009 10/6/2009 10/13/200910/20/200910/27/2009 11/3/2009 11/10/200911/17/200911/24/2009 12/1/20

CIT Group was a company that was widely known to be insolvent; however
eventwodaysbeforethecompanyfiledforbankruptcy,itsstockwastradingabove$1
pershare.Thisphenomenonillustratesthefactthatequitybeingnonrecourse,which
definitively caps potential downside encourages speculative trading even at times
whereupsidepotentialishighlyunlikely.
(i) ImpliedAssetValue
Discounts in the bond market work in conjunction with optionality in the
equitiesmarket.Asolvencyanalysisconsistsofaviewofacompanyatasinglepointin
time.Atthatpointintime,assetanddebtpricesareessentiallyfixedand,asaresult,
thetotalexpectedpayouttoequityanddebtholdersisfixedaswell.Foragivenvalue
ofafirmsassets,anyincreaseinexpectedpayouttobondholderscomesattheexpense
1578
ofequityholdersandviceversa.Assuch,theExaminersfinancialadvisorsconsidered
boththeequityanddebtmarketsforLehmanintheiranalysisofimpliedassetvalue.
Thevaluationprincipalthatestablishestheframeworkforthisanalysisis,The
currentvalueofassetsminusthecurrentvalueofliabilitiesequalsthecurrentvalueof
thebusinessownersequity,6091or:
AssetsLiabilities=Equity
Rearrangingthatformula,thecurrentvalueofassetsequalsthecurrentvalueof
businessownersequityplusthecurrentvalueofliabilities,or:
Assets=Equity+Liabilities
Theexhibitbelowshows thatthepublicmarket (for debtand equity)indicated
that Lehman was insolvent on a balance sheet basis (1) between July 11 and July 15,
2008(aroundthetimeoftheIndyMaccollapse);(2)onJuly28,2008;(3)onseveraldates
betweenAugust19andAugust28,2008(duringcertainKDBrumorsandwhencertain
customers were leaving); (4) on September 4, 2008; (5) and on all dates on and after
September8,2008(FannieandFreddiefailedonSeptember7;6092theterminationofKDB
talks6093 became publicly known on September 9).6094 There is evidence, however, that
6091Shannon Pratt, Valuing a Business, Fifth Edition 350 (McGrawHill 5th ed. 2007) (1981). This
accountingformulaholdstrueregardlessofwhetheroneisreferringtobookvalueorfairmarketvalue
providedthatonemaintainsconsistencyacrosshisevaluation.
6092Office of Federal Housing Enterprise Oversight Press Release, (Sept. 7, 2008) (available at
http://www.treas.gov/press/releases/hp1129.htm). Given that September 7, 2008 was a Sunday,

September8,2008wasthefirsttradingdaythereafter.
6093SeeSectionIII.A.3.cforadiscussionoftheKDBnegotiations.
1579
the markets were not fully informed with regard to Lehmans true liquidity position,
becauseofissuessuchasRepo105andLehmansliquiditypool.6095Accountingforthis
potential for misinformation would result in findings of less solvency on all dates
impactedbythemisinformation.
Lehman ImpliedMVofAssetsRelativetoTotalLiabilities
20.00
10.00

May31,2008 June30,2008 July31,2008 August31,2008
SolvencyEquity($bil)
(10.00)
$6BNcapitalraisedon6/9,
including$4 billionincommonequity
and$2billioninpreferredequity.
(20.00)
(30.00)
(40.00)

(ii) SmallEquityCushion
As is true with many highly leveraged firms, Lehmans small margin of equity
relativetoassetsmeantitdidnotneedmuchlossofassetvaluetorenderitinsolvent.
6094For calculations supporting the exhibit below, see Appendix 21, Duff & Phelps, LBHI Solvency
Analysis(Feb.1,2010).
6095See Section III.A.4 of this Report which discusses Repo 105; see also Section III.A.5.i of this Report,
whichdiscussesLehmansliquiditypool.
1580
Beginning July 10, 2008, on all dates but one (August 5, 2008), the value of Lehmans
solvencyequity(computedasthemarketvalueofassetsminustheparvalueofdebt)
was less than 1% of the market value of assets. This implies a very low margin for
error. Thus, while it appears that Lehman was marginally solvent on several dates
throughoutAugust2008,afactfindermayconcludethat,givenLehmanssmallequity
cushionandthelowmarginforerror,LBHIwasinsolventonthosedatesaswell.
LehmanBrothersMarketValueofEquityasaPercentageofMarket
ValueofAssets
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%

(iii) LimitationsoftheMarketBasedApproach
A market value is not always a reliable measure of solvency, especially if the
market is not aware of circumstances in existence which, if known, would adversely
effectthemarketvalue.Forexample,theThirdCircuitnotedinVFBthatifthemarket
1581
capitalizationwasinflatedby[formerparent]smanipulationsitwasnotgoodevidence
ofvalue.6096
InAdlerI,thebankruptcycourtfortheSouthernDistrictofNewYorkheldthat
in determining the solvency or insolvency of a bankrupt securities clearing firm, the
court was not bound by the price at which the stock was trading at the time of the
challengedtransfers,totheextentthatthepricewasbeingmaintainedduetomassive
manipulation of the market.6097 Instead, the court relied on stock prices one business
dayafterthemarketmanipulatorclosed,February27,1995,asameasureofthemarket
priceofthestockonthedayofthechallengedtransfers,February16,1995.Theresult
wasastockpricemorethanseventyfivepercentlowerthanwhatithadbeentradingat
under manipulation.6098 Because a solvency analysis must ascribe a price to the stock
thatreflect[s]asnearlyaspossibleamarketuntaintedby[]manipulation,thecourt
held that the stock prices after the market manipulator had closed were a more
appropriatemeasureofvalue.6099TheSouthernDistrictofNewYorkinAdlerIIagreed,
holdingthatthemostaccuratereflectionofthestocksfairmarketworthasofFebruary
6096VFB,482F.3dat632.
6097Mishkinv.Ensminger(InreAdler,ColemanClearingCorp.),247B.R.51,110(Bankr.S.D.N.Y.1999)(Adler
I),affd263B.R.406(S.D.N.Y.2001)(AdlerII).
6098Id.
6099Id.at113.
1582
16wasthestockpriceonFebruary27,afterthemarketmanipulatorwasoutofbusiness
andthusunabletomanipulatethemarket.6100
In order to adjust for the limits of market knowledge, the Examiner and his
financialadvisorsanalyzedhowthevaluationofLBHImightbeaffectediftechniques
of retrojection and current awareness, described more fully below, were utilized to
ascertain a more accurate value of LBHI, given its market capitalization prior to the
filing.
a. ApplicationofRetrojection
Because of the difficulty in valuing the assets and liabilities of a debtor on the
exact date of a preferential or fraudulent transfer courts often utilize the well
establishedbankruptcyprinciplesofretrojectionandprojection...6101Therearetwo
typesofretrojection:(1)whereevidenceofinsolvencyatareasonabletimesubsequent
tothedateofatransfercanbeusedascompetentevidenceofthedebtorsinsolvencyon
the date of the transfer, and (2) where evidence of insolvency at an early date and
evidenceofinsolvencyatalaterdatecanbeusedascompetentevidenceofthedebtors
insolvency for all of the dates in between. For both types of retrojection, courts
6100AdlerII,263B.R.at466470.
6101Coated Sales, Inc. v. First E. Bank (In re Coated Sales, Inc.), 144 B.R. 663, 666 (Bankr. S.D.N.Y. 1992)
(citationsomitted).
1583
universallyrequireproofthatthedebtorsfinancialsituationdidnotchangematerially
duringtheinterveningperiod.6102
Accounting for the implied market value of LBHIs assets relative to its total
liabilities, the exhibit in Section III.B.3.b.2.(i) demonstrates that LBHI was insolvent
betweenJuly11andJuly15,2008,onJuly28,2008,onseveraldatesbetweenAugust19
and August 28, 2008, on September 4, 2008, and on all dates beginning September 8,
2008. In order to utilize retrojection, Lehmans financial situation must not have
materiallychangedintheinterveningperiods.Thus,theExaminerconcludesthatthe
earliest date to apply retrojection is September 2, 2008, the point at which KDB
indicatedthatitrelayeditsdecisionnottocontinuetalkswithLehman.6103
b. TheApplicationofCurrentAwareness
ThecourtinCoatedSalesemphasizedthatalthoughacompanysassetsmustbe
valuedatthetimeoftheallegedtransferandnotwhattheyturnedouttobeworthat
some time after the bankruptcy court intervened, it is not improper hindsight for a
court to attribute current circumstances which may be more correctly defined as
6102See,e.g.,Killipsv.Schropp(InrePrimeRealty,Inc.),380B.R.529,535(B.A.P.8thCir.2007)(recognizing
validity of retrojection, but refusing to apply where trustee did not establish that debtors financial
conditionhadnotsubstantiallychangedbetweenthetimeofthetransferandwhenitmayhavebecome
insolvent);Briden,776F.2dat382,38283(courtfounddebtorinsolventatthetimeofaMarchandApril
transfertosolestockholderwheredebtorsbalancesheetforApriloverstatedvalueofdebtorsinventory;
thecourtusedretrojectiontoinferinsolvencyinMarchaswell,givenslowstateofdebtorsbusiness).
6103ForamoredetailedaccountofcircumstancessurroundingtheKDBdeal,seeSectionIII.A.3.cofthis
Report.
1584
current awareness or current discovery of the existence of a previous set of
circumstances.6104AsdescribedbyCoatedSales:
Fair market or going concern value, although presumed to be

determined free of impermissible hindsight, is not determined in a
vacuum free of external stimuli. In fact, fair market value presumes
thatallrelevantinformationisknownbysellerandbuyer.Itfollows,that
a party purchasing assets at the time of the alleged preferential transfer
wouldbeawareofallrelevantfactors,whichwouldincludeknowledgeof
a massive businesswide fraud and environmental contamination:
otherwise, that party would be the victim of fraud. In sum, fair market
valuationentailsahypotheticalsale,notahypotheticalcompany.Thus,it
is not improper hindsight for a court to attribute current circumstances
which may be more correctly defined as current awareness or current
discoveryoftheexistenceofaprevioussetofcircumstances.6105
In order to apply such an analysis, described as a current awareness
methodology,theExaminersfinancialadvisorsidentifiedandevaluatedcircumstances
that existed, but were unknown to the investing public, and which would have
materiallyimpactedavaluationofLBHIiftheyhadbeenknown.Suchcircumstances
generally fall into one of two categories: (1) information that was made public by
Lehman or other parties but was known or knowable as of an earlier date; and
(2)information that was never made public, but hassince been discovered during the
courseoftheExaminersinvestigationeitherthroughwitnessinterviewsorthereview
ofeitherconfidentialorpreviouslyunreleaseddocuments.
6104Coated Sales, 144 B.R. at 668 (citing Cissel v. First Nat. Bank of Cincinnati, 476 F. Supp. 474, 484 (S.D.
Ohio1979));MutualSavings&LoanAssnv.McCants,183F.2d423,425(4thCir.1950)).
6105CoatedSales,144B.R.at668.
1585
For the first category, the Examiner has determined that there is sufficient
evidence to support a finding to apply current awareness to circumstances
surrounding the KDB deal. Following the Korean government officials statement
regarding the end of negotiations with Lehman, the cost of insuring Lehmans debt
surged by almost 200 basis points, Lehmans hedge funds pulled out, shortterm
creditors cut lending lines, JPMorgan required Lehman to execute Security and
Guaranty Agreements, and Citi sought a guarantee agreement to continue to clear in
Asia.6106BecauseLehmanwasinsolventonthedatethatthepublicwasinformedofthe
endofnegotiationsbetweenKDBandLehman,andbecausethisfactwasinexistenceas
ofSeptember2,2008(thepointatwhichKDBindicatedthatitrelayeditsdecisionnotto
continuetalkswithLehman),theExaminerconcludesthatthereissufficientevidenceto
supportafindingofinsolvencybeginningonSeptember2,2008.
For the second category of information, information that has not yet become
knowntothepublic(atleastpriortothepublishingofthisReport),theExaminerhas
determined that there is sufficient evidence to apply current awareness to the
circumstances of Repo 105 and issues of liquidity.6107 Applying a current awareness
methodologytosuchcircumstances,however,isinherentlycomplicatedbecauseofthe
difficultyinpredictinghowthestockmarketmightreacttoinformationthathasnever
6106ForamoredetailedaccountofcircumstancessurroundingtheKDBdeal,seeSectionIII.A.3.cofthe
Report.
6107SeeSectionIII.A.4ofthisReportforamoredetaileddiscussionofRepo105;seeSectionIII.A.5.iofthis
ReportforamoredetaileddiscussionofLehmansliquiditypool.
1586
become publicly known. Thus, this is an issue of fact that the Examiner has left
unresolved due to the difficulty in reliably quantifying the result that such
circumstances would have had on the fair market value of Lehman had they been
knowntothepublic.
(3) Conclusion
Utilizing a marketbased approach, the Examiner first concludes that there is
sufficientevidencetosupportafindingofinsolvencyofLBHIbeginningonSeptember
8,2008.Adjustingthemarketbasedapproachpursuanttothetechniqueofretrojection
and the application of current awareness, which would factor in information in
existencebutnotknownbythemarket,theExaminerconcludesthatthereissufficient
evidencetosupportafindingofinsolvencyofLBHIbeginningonSeptember2,2008.
c) LBHIAffiliateSolvencyAnalysis
(1) Summary
This Section of the Report addresses whether there is sufficient evidence to
supportafindingthatanLBHIAffiliatewasinsolvent,assuchtermisdefinedbythe
Bankruptcy Code and applicable state law, prior to the date that each LBHI Affiliate
commenced its Chapter 11 case.6108 The Bankruptcy Court has charged the Examiner
with determining, among other things: (1) whether any LBHI Affiliate has colorable
6108Consistentwith the Courts order, the Examiner has only addressed those LBHI Affiliates that
commenced their bankruptcy cases prior to the appointment of the Examiner. See Order Directing
AppointmentofanExaminerPursuanttoSection1104(c)(2)oftheBankruptcyCode,atp.3,DocketNo.
2569,InreLehmanBrothersHoldingsInc.,etal.,No.0813555(Bankr.S.D.N.Y.Jan.16,2009).
1587
claims against LBHI for potentially insider preferences arising under the Bankruptcy
Codeorstatelaw;and(2)whetheranyLBHIAffiliatehascolorableclaimsagainstLBHI
oranyotherentitiesforpotentiallyvoidabletransfersorincurrencesofdebt,underthe
Bankruptcy Code or otherwise applicable law.6109 In order to prevail on a preference
claim,theplaintiffmustestablishthatthedebtorentitywasinsolventatthetimeofthe
challengedtransfer.6110Withrespecttoconstructivelyfraudulenttransfers,theplaintiff
must establish that at the time of the transfer the debtor (1)wasinsolvent or became
insolventasaresultofthetransfer,(2)hadunreasonablysmallcapitalforthepurpose
of continuing to engage in its business, or (3)incurred debts that were beyond the
debtorsabilitytopayastheymatured.6111Accordingly,thedeterminationofwhether
there are colorable claims of either preferences or constructively fraudulent
conveyancesrequiresanexaminationofeachLBHIAffiliatessolvencyconditionasof
thedateachallengedtransferoccurred.6112
The Bankruptcy Code defines insolvent, for entities other than a partnership
andamunicipality,asthefinancialconditionsuchthatthesumofsuchentitysdebts
is greater than all of such entitys property, at a fair valuation.6113 Fair value is the
6109Seeid.
6110SeeAppendix1,LegalIssues,atSectionIV.D.
6111Id.,atSectionIV.A.2.
6112Id.,atSectionsIV.A.2,IV.A.D.
611311 U.S.C. 101(32)(A). The solvency analysis is undertaken exclusive of property transferred with
intent to hinder, delay or defraud the entitys creditors, and property exempt from the debtors estate
pursuanttoSection522oftheBankruptcyCode.Id.
1588
pricethatwouldbereceivedtosellanassetorpaidtotransferaliabilityinanorderly
transaction between market participants at the measurement date.6114 This Section of
theReportaddressesthegoingconcernvalueofeachLBHIAffiliate.6115
A debtor is presumed to be insolvent for purposes of a preferential transfer
analysisundertheBankruptcyCodeduringtheperiodbeginning90dayspriortothe
commencement of the debtors bankruptcy case.6116 The following table sets forth the
filingdatesforeachLBHIAffiliate,andthecorrespondingdatesunderSection547(b)(4)
of the Bankruptcy Code for the beginning of the 90day preference period for non
insidertransfersandfortheoneyearpreferenceperiodforinsidertransfers.6117
6114Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 157, Fair
ValueMeasurements,at6.SeealsoAppendix1,LegalIssues,atSectionIV.B.
6115An alternate means of valuation determines the liquidation value of the debtor. Courts in the
SouthernDistrictofNewYorkhaveappliedthisvaluationstandardwhenitisdeterminedthatthedebtor
isnominallyextantoronitsdeathbed,atthetimeinquestion.CoatedSales,Inc.v.FirstE.Bank(Inre
Coated Sales), 144 B.R. 663, 667 (Bankr. S.D.N.Y. 1992). The individual circumstances of each LBHI
Affiliate present questions of fact, to be determined by the Court, as to whether going concern or
liquidationvalueismostappropriateforanygivensolvencydetermination.However,becauseeachof
the LBHI Affiliates was able to continue daytoday operations in the months prior to commencing
theirbankruptcycases,theExaminerdeemsitmostappropriatetoconsidergoingconcernvalueforthe
purposeofthisanalysis.IridiumCapitalCorp.v.Motorola,Inc.(InreIridiumOperatingLLC),373B.R.283,
344(Bankr.S.D.N.Y.2007).
611611U.S.C.547(f).
6117TheseperiodsarecalculatedpursuanttoFederalRuleofCivilProcedure6(a)andthesimilarFederal
RuleofBankruptcyProcedure9006(a).
1589
DebtorEntity DateFiled 90DaysPrior OneYearPrior
LB745LLC 9/16/08 6/18/08 9/14/07
PAMIStatlerArmsLLC 9/22/08 6/24/08 9/21/07
LehmanBrothersCommodityServices 10/3/08 7/3/08 10/3/07
Inc.
LehmanBrothersSpecialFinancingInc. 10/3/08 7/3/08 10/3/07
LehmanBrothersOTCDerivativesInc. 10/3/08 7/3/08 10/3/07
LehmanBrothersDerivativeProducts 10/5/08 7/7/08 10/5/07
Inc.
LehmanCommercialPaperInc. 10/5/08 7/7/08 10/5/07
LehmanBrothersCommercial 10/5/08 7/7/08 10/5/07
Corporation
LehmanBrothersFinancialProducts 10/5/08 7/7/08 10/5/07
Inc.
LehmanScottishFinanceL.P. 10/5/08 7/7/08 10/5/07
CESAviationLLC 10/5/08 7/7/08 10/5/07
CESAviationVLLC 10/5/08 7/7/08 10/5/07
CESAviationIXLLC 10/5/08 7/7/08 10/5/07
EastDoverLimited 10/5/08 7/7/08 10/5/07
LuxembourgResidentialProperties 1/7/09 10/9/08 1/7/08
LoanFinanceS.a.r.l.
BNCMortgageLLC 1/9/09 10/10/08 1/9/08
Whileadebtorispresumedinsolventforthe90dayperiodidentifiedabove,this
presumption is rebuttable. The Second Circuit has explained that [a] creditor may
rebut the presumption by introducing some evidence that the debtor was not in fact
insolventatthetimeofthetransfer.Ifthecreditorintroducessuchevidence,thenthe
trustee must satisfy its burden of proof of insolvency by a preponderance of the
evidence.6118 A balance sheet showing that the debtor was solvent at the time of the
6118Lawsonv.FordMotorCo.(InreRoblinIndustries,Inc.),78F.3d30,34(2dCir.1996).
1590
transfer may be sufficient to rebut the presumption of insolvency.6119 A balance sheet
maybeparticularlyeffectiveifitsaccuracycanbeconfirmedbywitnesstestimonyfrom
experts or officers and directors of the debtor.6120 However, a court need not accept a
balancesheetatfacevalue,andabalancesheetdeemedtobeinaccuratewillnotsuffice
toovercomethepresumption.6121Accordingly,thisanalysisconsidersthenatureofthe
assetsheldbythedebtorentitiesandnoteswhenthepossibilityofmisstatementaffects
thesolvencydetermination.
ThisSectionaddressesthesolvencyofeachLBHIAffiliateinturn.Thefollowing
analysisassesseswhetherthefairvalueofeachLBHIAffiliatesassetsexceededtheface
valueofitsliabilitiesduringtheperiodpriortoitsbankruptcycase.TheExamineralso
consideredtheriskthatLehmansvaluationofeachLBHIAffiliateslessliquidassets
thoseidentifiedasFASBLevel2and3wasunreasonable,andwhetheranyreduction
in the value of such assets would impact the determination as to the solvency of the
LBHIAffiliate.Additionally,observationsareprovidedonotherfactorsimpactingthe
6119SeeJones Truck Lines, Inc. v. Full Service Leasing Corp., 83 F.3d 253, 258 (8th Cir. 1996) (A financial
statement showing positive net worth is sufficient to rebut the presumption of insolvency [under
547(f)].); cf. In re Ramba, Inc., 416 F.3d 394, 403 (5th Cir. 2005) (noting that balance sheet did address
issueofsolvency,butholdingthatpresumptionwasnotrebuttedbecausebalancesheetinquestiondid
notreflectstatusattimeoftransfer).
6120See Toy King Distributors Inc. v. Liberty Sav. Bank, FSB (In re Toy King Distributors, Inc.), 256 B.R. 1,
91(Bankr. M.D. Fla. 2000) (relying on balance sheets in conjunction with expert testimony in finding
rebuttal of 547(f) presumption); T.M. Sweeney & Sons v. Crawford (In re T.M. Sweeney & Sons, LTL
Services, Inc.), 120 B.R. 101, 103, 106(Bankr. N.D. Ill. 1990) (holding that presumption was rebutted by
balancesheetshowingsolvencyandtestimonyofdebtorsformerpresident).
6121SeeAppendix1,LegalIssues,atSectionIV.D.
1591
solvency of the debtor entities, including the credit ratings for the applicable LBHI
Affiliates.6122
TheExaminerhasreachedthefollowingconclusions:
1. ThereissufficientevidencetosupportafindingthatthreeLBHIAffiliates
LCPI, CES Aviation IX and CES Aviation V were balance sheet insolvent as of
May 31, 2008. Two of these entities, CES Aviation IX and CES Aviation V, remained
insolvent through the commencement of their bankruptcy cases. LCPI was balance
sheet insolvent through much of 2008, but received a $900 million capital infusion on
August29,2008,6123whichallowedittobecomeborderlinesolventasofAugust31,2008.
TheExaminerconcludesthatthereisinsufficientevidencetorebutthepresumptionof
insolvency for LCPI under Section 547(f) of the Bankruptcy Code after September 12,
2008,thelastbusinessdaypriortothecommencementofLBHIsbankruptcycase,for
thereasonssetforthinthefollowingparagraph.
2. ThreeLBHIAffiliatesLBSF,LBCSandCESAviationwereborderline
solventasofMay31,2008,meaningthattheirbalancesheetsshowedassetsjustslightly
in excess of liabilities such that a minimal write down of asset values or a small
unaccountedfor liability would render these entities insolvent. The small margin by
6122As will be explained in more detail, for certain entities, such as LBDP and LBFP, which were rated
independentlyofLBHI,ratingsofAAAwerereflectiveofthesolvencyoftheentity.Forotherentities,
suchasLBSFandLBCS,investmentgraderatingswerenotdispositiveofsolvency.LBHIwasratedA
atthetimeitfiledforbankruptcy.
6123EmailfromA.Jacob,Lehman,toKristieWong,Lehman,etal.(August28,2008)[LBEXSIPA005564].
1592
whichtheseentitiesweresolventcreatesafactualissuetoberesolvedbythecourtona
casebycase basis.6124 During the week following LBHIs bankruptcy and thereafter,
LBHI Affiliate counterparties terminated derivatives and other contracts at balance
sheetlossesestimated tobeinthetensofbillions of dollars;6125the securitiesinwhich
certain LBHI Affiliates held an interest at LBI were transferred to Barclays;6126 and
exchangetradedderivativespositionsclearedbyLBIforthebenefitofLBHIAffiliates
(suchasLBSFandLBCS)atclearingorganizationssuchastheCME6127andOCC6128were
liquidated. Moreover, after September 12, 2008, the collectability of intercompany
obligations reflected as assets on the balance sheets of LBHI Affiliates became
questionable. The LBHI Affiliates continued to update their balance sheets to reflect
suchactivity,butbaseduponinformationmadeavailabletohimtodate,theExaminer
concludes that there is insufficient evidence to rebut the presumption of insolvency
6124The Examiner did not conduct an assetbyasset valuation of each asset owned by LBHI Affiliates
becauseofthetimeandcostrequiredforsuchanexercise.Rather,positionsacrossanumberofdifferent
asset classes were reviewed for several Debtors. An entitys equitytototalassets ratio, as well as the
relative likelihood of a misstatement of the value of an entitys assets, is considered in determining
whether an entity that posted positive equity might nonetheless be borderline solvent. As the term is
used here, a low equitytototalassets ratio would make an entity borderline solvent unless the
compositionofitsassetswassuchthatmisstatementoftheirvaluewasveryunlikely.Inlightofthecost
andtimenecessarytoevaluatethevaluationofalloftheassetsofeachoftheborderlinesolvententities,
the Examiner determined that it would not be a prudent use of Estate resources to perform such an
exercise.ForpurposesofanalyzingwhethertheseLBHIAffiliateshavecolorableavoidanceclaims,the
Examinerassumedthattheborderlineentitieswereinsolvent.
6125SeeSectionIII.C.4ofthisReport.
6126SeeSectionIII.C.3.a.2.c.iofthisReport.
6127SeeSectionIII.B.3.g.5.hofthisReportforadescriptionoftheliquidationoftheCMEhousepositions.
6128SeeSectionIII.C.6.f.3.cofthisReport.
1593
underSection547(g)oftheBankruptcyCodeafterSeptember12,2008,withrespectto
anyoftheseLBHIAffiliates.
3. NineLBHIAffiliatesLOTC,LB745,LBDP,LBCC,BNCMortgageLLC,
LBFP,EastDoverLimited,LSFandLRPweresolventasofasMay31,2008,andthere
is insufficient evidence to support a finding that any of these LBHI Affiliates became
insolventduringtheperiodendingAugust31,2008.However,forthereasonssetforth
above, the Examiner concludes that there is insufficient evidence to rebut the
presumption of insolvency under Section 547(g) of the Bankruptcy Code after
September12,2008withrespecttoLOTCandLBCC.6129
4. Thereisinsufficientevidencetoreachadeterminationastothesolvency
ofdebtorentityPAMIStatlerArms.6130PAMIStatlerArmsisasubsidiaryofProperty
Asset Management, Inc. (PAMI), and its sole asset is an apartment complex in
6129 LB 745s principal asset was Lehmans headquarters building at 745 Seventh Avenue in New York.
See Section III.B.3.c.3.g of this Report. Following LBHIs bankruptcy, LBDP and LBFP continued to
maintaintheirAAAratings,andthebalancesheetsoftheseentitiescontinuedtoreflectpositiveequity.
See Section III.C.4 of this Report. BNC Mortgage LLCs principal assets, as of August 31, 2008, were
receivablesowingbynondebtorLehmansubsidiaries.SeeSectionIII.B.3.c.3.kofthisReport.EastDover
Limited, according to its August 31, 2008 balance sheet, had liabilities of $4 million and equity of
approximately $105.4 million. See Section III.B.3.c.3.l. LSF did not have anyliabilitiesaccording to its
May 31, 2008 and August 31, 2008 balance sheets. See Section III.B.3.c.3.m of this Report. LRP was
establishedinMay2008anddidnotpostabalancesheetuntilJune2008.LRPwassolventasofAugust
31, 2008, and its assets consisted of one corporate loan whose value was protected by price flex. See
SectionIII.B.3.c.3.eofthisReport.
6130A motion to dismiss PAMI Statler Arms LLCs bankruptcy petition was filed on May 26, 2009. See
Motion of Debtors Seeking Entry of an Order Pursuant to Section 1112(b) of the Bankruptcy Code
DismissingChapter11CaseofPAMIStatlerArmsLLC,DocketNo.3650,InreLehmanBros.HoldingsCo.,
No.0813555(Bankr.S.D.N.Y.May26,2009).Thehearingonthemotionhasbeenadjournedwithouta
date. See Notice of Adjournment of Motion of Debtors Seeking Entry of an Order Pursuant to Section
1112(b)oftheBankruptcyCodeDismissingChapter11CaseofPAMIStatlerArmsLLC,DocketNo.4060,
InreLehmanBros.HoldingsCo.,No.0813555(Bankr.S.D.N.Y.June20,2009).
1594
Cleveland, Ohio. Lehman did not maintain separate financial statements for PAMI
StatlerArmsinitsgeneralledgersoftwareprogram.
(2) DescriptionoftheExaminersAnalysis
TheExaminerinvestigatedthesolvencyofeachoftheLBHIAffiliates,takingasa
startingpointthebalancesheetsofeachentityasofMay31andAugust31,2008.6131The
Examinerdidnotperformanaudit,review,orexamination(asdefinedbytheAmerican
InstituteofCertifiedPublicAccountants)ofanyofthehistoricalfinancialinformation,
andthereforeexpressesnoopinionwithregardtosame.Thebalancesheetinformation
providedbelowforeachofthedebtorentitieswasobtainedfromLehmansHyperion
system,whichcontainsadjustedgeneralledgerinformation.LehmanalsousedtheDBS
general ledger system, accessed through EssBase, for internal management purposes,
buttheHyperionsystemwasthesourceforallpublicfinancialstatements.6132Balance
sheetinformationforLBHIAffiliatesthathadtheirownsubsidiariesispresentedona
consolidated basis. Information regarding the composition of each debtor entitys
financial inventory, and the SFAS 157 level of individual assets of the financial
inventory, is available on Lehmans Global Finance System (GFS), a positionlevel
database.However,theExaminersinvestigationhasrevealedthattheGFSdatabaseis
6131The Examiners analysis focuses on May 31, 2008 and August 31, 2008, because these were the end
dates of Lehmans second and third quarter reporting periods. Although Lehman did not file a 10Q
statement for the third quarter of 2008, its finance employees created financial statements for the third
quarterendingAugust31,2008.ExaminersInterviewofKristieWong,Dec.2,2009,atp.4.
6132ExaminersInterviewofKristieWong,Dec.2,2009,atp.4.
1595
incompleteandinaccuratewithrespecttomanyoftheassetsheldbyLBHIAffiliates.6133
Accordingly,informationfromtheGFSdatabaseisnotrelieduponinthisReportunless
ithasbeenreconciledtopubliclydisclosedfinancialstatementstoensureitsaccuracy.
Based on interviews with former and current Lehman financial personnel, as
wellastheExaminersanalysisofthesystemsandfinancialreportsthatwerecreatedby
Lehman prior to the bankruptcy filing, the Examiner has determined that there is
sufficientevidencetoconcludethattheLBHIAffiliatesbalancesheetsfairlyrepresent
thefinancialconditionofeachLBHIAffiliateasofMay31andAugust31,2008.6134
However, the Examiner has determined that the balance sheets of the LBHI
Affiliates created after August 31, 2008, which capture financial activity during the
remainingprepetitionperiodforeachLBHIAffiliate,arenotsufficientforpurposesof
making a determination of the solvency of each LBHI Affiliate during this period.6135
TheExaminerbasesthisconclusiononareviewoffinancialinformationobtainedfrom
various Lehman software systems. For example, in September 2008, the financial
systems lacked information technology support and, contrary to normal operation,
were not consistently receiving certain daily feeds between systems carrying pricing
6133Id.
6134TheExaminerdidnotconductaninvestigationofeachoftheliabilitiesreportedbytheLBHIAffiliates
and recognizes the possibility that there may be unreported or misstated liabilities which would be
consideredwhendeterminingthesolvencyofanygivenLBHIAffiliate.
6135Thisdeterminationdidnotimpacttheuseofbalancesheetinformationforthelimitedpurposesset
forthinSectionIII.C.3.b.
1596
and other information.6136 As a result, the financial statements produced by such
systemsarenotsufficientlyreliableforuseasthebasisofanysolvencydetermination.
Additionally, financial statements prepared by Lehman in the course of the
bankruptcy proceedings confirm that they differ materially from the public financial
statements that Lehman created in the ordinary course of its business prior to
bankruptcy. The Monthly Operating Reports (MOR), which are filed with the U.S.
BankruptcyCourt,specificallystatethat:
The Debtors have prepared [the MORs], as required by the Office of the
UnitedStatesTrustee,basedontheinformationavailabletoTheDebtors
atthistime,butnotethatsuchinformationmaybeincompleteandmaybe
materiallydeficientincertainrespects.ThisMORisnotmeanttoberelied
upon as a complete description of the Debtors, their business, condition
(financial or otherwise), results of operations, prospects, assets or
liabilities.TheDebtorsreserveallrightstorevisethisreport.6137
Among others, the MORs identify the following issues rendering the financials
reportedinsufficientforthepurposesofasolvencydetermination:
TheyarenotpreparedinaccordancewithU.S.GAAP.
They do not reflect normal quarterly adjustments that were generally

recordedbytheDebtor.
Certain items are under research and may be accounted for differently in
futuremonthlyreports(noupdateshavebeenfiledasofNovember2009).
CashandrestrictedcashmaynotbelongtotheDebtor.
6136ExaminersInterviewofKristieWong,Dec.2,2009,atp.4.
6137MonthlyOperatingReport,SelectedDebtorBalanceSheets,Docket3916,InreLehmanBros.Holdings
Inc.,etal.,No.0813555,atp.11(Bankr.S.D.N.Y.June15,2009).
1597
Securities and financial instruments are sometimes reported as of the last
valuationrecordedbyLehmananddonotreflectrealizablevaluesofassets
(i.e.,theyarenotFAS157compliant).6138
Giventheforegoing,andbecauseoftheextraordinarytimeandexpenserequired
to investigate the solvency of the LBHI Affiliates after August 31, 2008, the Examiner
expresses no view of the solvency of the LBHI Affiliates after August 31, 2008.
However, the Examiner notes that, of the evidence obtained, none suggests that the
solvency status of the borderline solvent or insolvent LBHI Affiliates materially
improved during the period beginning September 1, 2008, and ending on the
commencement of the respective bankruptcy cases. Furthermore, as noted above, the
Examiner finds that there is insufficient evidence to rebut the presumption of
insolvencyunderSection547(g)oftheBankruptcyCodeafterSeptember12,2008with
respecttoeachoftheborderlinesolventLBHIAffiliates,LOTC,andLBCC.
Becausethebalancesheetsolvencytestaskswhetherthefairvalueofadebtors
assets exceeds its liabilities, the solvency analysis performed is not based on GAAP.
CertainconceptsthatarenotaccountedforunderGAAP,butwhichimplicatethefair
value of the Debtors assets and its liabilities, are addressed here. For instance, the
Examiner has investigated whether any LBHI Affiliate held intangible assets.
Intangible assets are identifiable nonmonetary assets that are not physical in nature,
butcontributetothevalueofafirm.Theydonotappearonabalancesheetexceptin
6138Id.at4.
1598
certain circumstances, such as when an intangible asset is purchased in a transaction
andrecordedunderGAAPpurchaseaccountingrules.6139Examplesofintangibleassets
includecustomerlists,proprietarytechnology,internallydevelopedsoftware,andtrade
names.ForpurposesofthisSectionoftheReport,intangibleassetsarerelevanttothe
extentthattheywouldrenderanotherwiseinsolventdebtorsolvent,orimpairmentof
thebookvalueofintangibleassetswouldrenderasolventdebtorinsolvent.Therefore,
the analysis has focused on identifying intangible assets for insolvent or borderline
debtorsasidentifiedabove.
Addressing the LBHI Affiliates on a consolidated basis, the Examiner has
reviewed available documents and interviews with Legal Entity Controllers (LEC)
and identified intangible assets in the form of goodwill owned by LBSF and LBCS.
However, the existence of these assets, discussed below, does not change the
determinationofthoseentitiessolvency.Furthermore,basedontheanalysisprovided
in Section III.C.3 of this Report, it is possible that additional intangible assets may be
heldbycertainLBHIAffiliatesintheformofcustomerlists,proprietarytechnologyora
workforcerelatedasset,butsuchintangibleassetsarenotofmaterialvalueandwould
notchangethesolvencydeterminationforanyoftheLBHIAffiliates.
6139See
Financial Accounting Standards Board, Statement of Fin. Accounting Standards No. 141(R),
BusinessCombinations(2007).
1599
The following is a summary table of the Examiners conclusions regarding the
solvencyofLBHIAffiliatesasofMay31,2008:6140
Entity PrimaryBusiness Shareholder Shareholder BalanceSheet

Equity Equityas%of Solvencyasof
($million) TotalAssets6141 May31,2008
Lehman Originateandtrade (62.0) N/M Insolvent
CommercialPaper securedandunsecured (borderlineasof
Inc. loans;provide August2008)
warehouseloans
securedbymortgage
loansandotherassets
CESAviationIX Acquireandoperate (0.9) N/M Insolvent
LLC aircraftforLehman
CESAviationV Acquireandoperate (3.5) N/M Insolvent
LLC aircraftforLehman
LehmanBrothers LehmanBrothersInc.s 475.1 0.4% Borderline
SpecialFinancing principaldealerina
Inc. broadrangeof
derivativeproducts
includinginterestrate,
currency,creditand
mortgagederivatives
LehmanBrothers Tradepower,natural 26.0 0.4% Borderline
Commodity gas,oil,andstructured
ServicesInc. products
CESAviationLLC Acquireandoperate 0.1 0.6% Borderline
aircraftforLehman
Luxembourg Investmentand 2.6 0.4% Solvent
Residential financingvehicle,which
PropertiesLoan heldloans(typically
FinanceS.a.r.l. commercialloans
includingTermB
Archstoneloans)
LehmanBrothers Overthecounter 225.5 4.2% Solvent
OTCDerivatives derivativesdealer
Inc.
LB745LLC OwnerofLehmans 55.3 7.2% Solvent
headquarterslocatedat
745SeventhAvenuein
NewYork
6140Data is as of May 31, 2008, except in the case of Luxembourg Residential Properties Loan Finance
S.a.r.l.whosedataisasofAugust31,2008.FinancialdataisnotavailableforPAMIStatlerArmsLLC.
6141N/Mindicatesthattheratioisnotmeaningfulduetothefactthattheentityhadnegativeequity.
1600
LehmanBrothers AAAratedtermination 47.4 8.9% Solvent
Derivative derivativeproduct
ProductsInc. companythat
intermediatesinterest
rateandcurrencyswaps
betweenmarket
counterpartiesand
LehmanBrothers
SpecialFinancing
LehmanBrothers Dealerinoverthe 230.9 6.9% Solvent
Commercial counterforeign
Corporation currencyforwardsand
optionsandexchange
tradedfuturesand
futuresoptions
BNCMortgage Subprimemortgage 11.1 45.8% Solvent
LLC origination
LehmanBrothers AAAratedcontinuation 290.0 54.1% Solvent
FinancialProducts derivativeproduct
Inc. companythatengages
inoverthecounter
interestrateand
currencyswapsand
options,purchasingor
sellingexchangetraded
futuresandoptions,or
governmentbondsand
options
EastDover Historicallypurchased, 101.1 92.9% Solvent
Limited leasedandsoldaircraft
andrelatedequipment;
asofthebankruptcy
filing,nolonger
performedthese
activitiesbutheld
mostlyintercompany
receivablesand
payables
LehmanScottish Holdequitylinked 57.4 100% Solvent
FinanceL.P. notesofotherLehman
entities
1601
PAMIStatler OwnerofStatlerArms Unknown Unknown Unknown
ArmsLLC Apartments,a297suite
apartmentcomplexin
Cleveland
Asindicatedinthetableabove,whilemostofthe16debtorentitiesmaintained
somedegreeofpositiveGAAPequityasofMay31,2008,sixentitiespostednegativeor
verylowlevelsofcapitalinrelationtotheirlevelofassets.6142TheseentitieswereLCPI,
CESAviationVLLC,CESAviationIX,CESAviation,LBCS,andLBSF.
The following issues and concepts are common to the analysis of one or more
LBHIAffiliatesandarediscussedattheoutsetforclarity.
Fair Market Value of Balance Sheet Assets and SFAS 157 Assets. For the
purposeofdeterminingthebalancesheetsolvencyofLBHIAffiliates,theassetvalues
reported in financial statements must be representative of fair market value, or
adjustmentsmustbemadetoensurethatthefairvalueiscaptured.6143Inthecaseofthe
assets held by LBHI Affiliates, most reported values are representative of fair market
6142For the period May 31, 2008, through August 31, 2008, all of the Debtors, except one, posted net
payables to LBHI. The exception was LBDP, which posted a net $7.7 million receivable from LBHI in
May2008.However,thisaccountedforonly1.4%ofLBDPstotalassetsandevenwithacompletelossof
the receivable from LBHI, LBDP would remain solvent. Therefore, LBHIs potential failure to pay its
receivablesisnotanissueinregardtothesolvencyoftheLBHIAffiliates.
6143SeeInreRoblinIndus.,Inc.,78F.3dat36(Itisalsotruethatbookvaluesarenotordinarilyanaccurate
reflectionofthemarketvalueofanasset.);InreIridiumOperatingLLC,373B.R.at344(Whenabusiness
isagoingconcern,fairvalueisdeterminedbythefairmarketpriceofthedebtorsassetsthatcouldbe
obtained if sold in a prudent manner within a reasonable period of time to pay the debtors debts.)
(internalquotationmarksomitted).
1602
value.FollowingisalistofassettypesownedbyLBHIAffiliates,andtherelationship
ofthereportedvaluetofairmarketvalueforeach:
Asset RelationshiptoFairMarketValue
Cash PresumedtobeatFairMarketValue
AccountsReceivable PresumedtobeatFairMarketValueassumingnomaterial
changeinthefinancialhealthofcounterparties.
PrepaidandDeferred PresumedtobeatFairMarketValuependinginvestigation.
Expenses Theinstancesofdebtorsowningtheseassetsareaddressed
onacasebycasebasisbelow.
SecuritiesandOther PresumedtobeatFairMarketValueconsideringthe
FinancialInventory requirementtomarktheseassetstomarketunderSFAS157.
Theseassetsarediscussedfurtherbelow.
Plant,Propertyand UnlikelytobeatFairMarketValue.Otherthanland,these
Equipment assetsareassumedtobewastingassets,meaningthattheir
valuedecreasesovertime.Accordingly,FairMarketValue
fortheseassetswillgenerallybelessthanthepurchaseprice.
Duetocostandtimeconstraints,theExaminerdidnot
pursueanindependentvaluationoftheseassetsforany
LBHIAffiliate.Asdiscussedbelow,certainLBHIAffiliates
carriedsignificantamountsofPlant,Propertyand
Equipment,thoughinnocasewouldachangefrombook
valuetoFairMarketValuechangethefindingscontained
herein.
Goodwilland UnlikelytobeatFairMarketValue.Goodwilland
Intangibles Intangiblesaretheresultofpurchaseaccounting
requirementsanddonotnecessarilyreflectFairMarket
Value.
OffBalanceSheet Asthenamesuggests,theseareassetsthatdonotappearon
Assets thebalancesheet.BasedoninterviewswithLECs,nooff
balancesheetassetshavebeenidentifiedforanydebtor.
1603
In assessing the equity component of the LBHI Affiliates balance sheets, an
analysisofthecomponentsofeachentitysSecuritiesandFinancialInstrumentsOwned
hasbeenperformedinordertounderstandwheretheremayberisksofmisstatementof
the value of the entitys assets. Under SFAS 157, a firm is required to assess the fair
value of a financial instrument based on Level 1 (a market quoted price), Level 2
(measurement with no observable price, but based on observable inputs) and Level 3
(measurement using unobservable inputs).6144 Level 2 and 3 assets are at the greatest
risk of misstatement because their valuation is not based on a marketquoted price.
Data from Lehmans GFS system, modified by Lehmans finance team,6145 has been
assessed in order to identify the amount of Level 2 and 3 assets held by each debtor.
The ratio of equity to Level 2 and 3 assets is used as a measure of risk of possible
insolvencyasitrepresentstherelativesizeofanentitysequitycushionascomparedto
thevalueofitsassetssubjecttomisstatement.
CapitalInfusions.ThetaskofmonitoringtheequitylevelsofLehmansvarious
legalentitieswasperformedbyLECs.Whileeachlegalentityrequiredadifferentlevel
of attention based on its activity, each was assigned an LEC who was responsible for
6144StatementofFin.AccountingStandardsNo.157,FairValueMeasurements,atSFAS15710to12.
6145LehmanscontrollersindicatedthatGFSwasinaccurateand,onaquarterlybasis,GFSwasreconciled
to publicly filed financial statements for LBHI on a consolidated basis. When necessary, other source
systemswereconsideredtoprovidesupport.Nosuchexercisewasperformedatthelegalentitylevel.
ExaminersInterviewofKristieWong,Dec.2,2009,atp.4.
1604
monitoring and producing entity financials.6146 Unlike product controllers, whose
responsibilitieswereassignedalongproductand businesslines,LECsresponsibilities
weredeterminedbywhichlegalentitiestheywereassigned.TheLECswereacritical
part of the process whereby the financial data of each entity was assembled in a
reportableform.TheExaminerhasfoundnoevidenceofaformalwrittenpolicyprior
to 2008 or any consistent unwritten policy that LECs were to keep entities solvent.6147
However, when an operating entity did become balance sheet insolvent, LECs would
often respond by proposing that a capital infusion be made into that entity.6148 In
general,theLECsfornonregulatedentitiesaimedtomaintainenoughcapitalsoasto
avoidnegativecapital.6149
In 2008, however, Lehmans regulatory group markedly changed the way it
approachedcapitalizationrequirementsforcertainlegalentitiesbecausethoseentities,
orentitiesofwhichtheyweresubsidiaries,werethesubjectofheightenedscrutinyby
regulatorsandthirdpartiesasaresultoffallingassetprices.Atleastonewitnesshas
suggested that LBI, a broker/dealer, would be precluded from trading if one of its
subsidiaries failed to meet a particular capital requirement.6150 This is because a
broker/dealer was required to meet reporting requirements on a consolidated basis,
6146SeeExaminersInterviewofMichaelMontella,Oct.26,2009,atpp.27.
6147Id.atpp.45.
6148Id. In the case of LCPI, these infusions were, until August 2008, insufficient to actually establish
solvency.
6149Id.atpp.1011.
6150ExaminersInterviewofAdaShek,Nov.24,2009,atp.6.
1605
whichincludedthefinancialinformationofallitssubsidiaries.6151Moreover,LCPIhad
a triparty repo clearing agreement with JPMorgan, pursuant to which LCPI was
obligatedtomaintainaparticularequitytoassetorleverageratio.6152BeginninginMay
2008, therefore, the LECs would meet in the beginning or middle of each month to
identifyprojectedprofitsandlosses,writeoffs,andothermetrics.6153TheLECswould
thencomparethesefigurestothepreviousmonthsequityandattempttopredictfuture
equity levels and any capital infusion needs.6154 It was not uncommon for frontoffice
traderstosendemailsnotingcapitallevelsforcertainentities,suchasLCPI.6155
LCPI and LBSF, both subsidiaries of LBI, were of considerable concern to
Lehman,regulators,andthirdpartiesbecausetheywereforcedtotakesignificantwrite
downsduring2008. AlthoughtherewasaminorcapitalinfusioninFebruary2008of
$200,000,6156thefirstmajorcapitalinfusionoccurredinMay2008,whichwasinresponse
to a significant writedown of securities backed by real estate in California.6157 From
April through July 2008, LCPI continued to post negative equity levels and required
6151Id.
6152Id.atp.7.
6153Id.
6154Id.atpp.67.
6155Id.
6156Id.TheLECforLCPIwasunawareofanycapitalinfusionforLCPIbeforeFebruary2008.
6157Id.
1606
significant capital infusions. The following chart shows capital infusions (in millions)
receivedbyLCPI,LBSF,andLBDPduring2008inresponsetotheseconcerns:6158
Debtor Jan08 Feb08 Mar08 Apr08 May08 Jun08 Jul08 Aug08

LCPI 0.2 200.0 150.0 275.0 900.0
LBSF 100.0
LBDP 150.0
Intermsofmechanics,theExaminerhasidentifiedthreeinternalLehmanemails
thatdescribethecapitalinfusionsforLCPIandLBSFandprovidetherelevantjournal
entriesandwiretransfers.6159TheExaminerhasnotlocatedanyemailwithrespectto
the July 2008 capital infusion of LCPI. As for LCPI, LBI would first request a
paydown from LBHI to LBI, which was consummated by a wire transfer. LBHI
wouldrecordareductionincashandanincreaseinitsinvestmentassetinLBI.Second,
LBI wouldsend the money back to LBHI becauseLCPI,according to internalemails,
did not have a bank account.6160 In other words, LBHI accepted LCPIs money on its
behalf. Third, when LBHI received the money from LBI, it increased its cash account
and reduced its intercompany receivable from LCPI. Finally, LCPI reduced its debt
obligation to LBHI and credited its paidin capital account. LCPI did not record a
6158CapitalInfusionsaredeterminedbynotingthechangeinAdditionalPaidInCapital,asreportedin
LehmansHyperionfinancialsystem.
6159Email from Jeffrey Su, Lehman, to Arthur Hiller, Lehman, et al. (Mar. 27, 2008) [LBEXBARLEG
0000001to03];emailfromJeffreySu,Lehman,toArthurHiller,Lehman,etal.(May30,2008)[LBEX
BARLEG0000004];emailfromHuiWang,Lehman,toHelenChu,Lehman,etal.(Aug.28,2008)[LBEX
SIPA003320].
6160ThisisinconsistentwithobservationsofLCPIsbooksandrecords.DanJ.Fleming,Lehmansformer
Global Head of Cash and Collateral Management, also stated in an interview that LCPI did have bank
accounts.ExaminersInterviewofDanJ.Fleming,Dec.17,2009,atp.8.
1607
receivableonitsbooksandrecordswhenthemoneywasgivenbacktoLBHI.Inshort,
LCPIsliabilityinitsintercompanyaccountwithLBHIdecreasedandLBHIkepttheuse
ofthemoneyitoriginallytransferredtoLBI,causingnoimpacttoitsliquidity.Asfor
infusionsintoLBSF,theprocesswasidentical,exceptthatLBSFreceivedthefundson
its own behalf (they were not immediately remitted back to LBHI). The following
illustratesthestepsofthecapitalinfusionsreceivedbyLCPIandLBSF:
InfusionsintoLCPIMarch,MayandAugust2008

1608
InfusionintoLBSFMay2008
1609

(3) DebtorbyDebtorAnalysis
(a) LehmanCommercialPaperInc.
LCPIprimarilyengagedintheorigination,trading,andservicingofsecuredand
unsecuredloans.6161LCPIsmonthlybalancesheetsasofMay31,2008throughAugust
31,2008wereasfollows:6162
Lehman Commercial Paper, Inc
Balance Sheet Items at: May 31, 2008 June 30, 2008 July 31, 2008 August 31, 2008
CASH & CASH EQUIVALENTS 675,756,009 725,929,267 2,708,432,808 961,859,857
SEC. & OTHER FINANCIAL INSTRUMENTS OWNED 29,433,762,189 28,305,430,247 25,718,241,256 23,593,952,592
CASH & SECURITIES SEGR. AND ON DEPOSIT (31) (31) (74) (31)
SECURITIES PURCHASED UNDER AGREEMENT TO SELL 19,578,651,244 22,275,502,285 21,168,272,398 21,366,118,677
RECEIVABLES- BROKER/DEALER 464,902,039 622,970,642 583,521,985 434,533,107
RECEIVABLES- CUSTOMERS 2,101,522,190 2,698,515,924 1,406,513,724 1,421,687,767
RECEIVABLES- OTHER 13,160,040,651 7,493,297,900 7,764,947,048 8,246,411,601
PROPERTY, EQUIPMENT & LEASE IMPROVEMENTS 1,462,823 1,828,038 1,773,679 1,707,311
TOTAL BRIDGE ACCOUNTS 6 6 6 6
DEFFERED EXPENSE & OTHER ASSETS 328,525,248 330,203,124 371,986,965 285,342,973
TOTAL ASSETS 65,744,622,369 62,453,677,403 59,723,689,795 56,311,613,860
COMMERCIAL PAPER & S.T. DEBT 454,183,781 28,140,653 18,158,345 3,020,383,281
SEC.& OTHER INSTRUMENTS SOLD NOT YET PURCHASED 1,105,104,778 2,122,362,958 2,369,393,978 3,369,552,952
SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE 20,267,872,715 19,123,893,904 19,549,285,798 18,438,230,178
SECURITIES LOANED (8,857,059) (13,412,434) (15,791,168) (18,248,658)
OTHER SECURED FINANCING 6,684,055,232 6,745,696,751 6,430,902,517 6,729,268,740
PAYABLES- BROKER/DEALER 70,772,641 33,162,439 80,435,168 47,118,454
PAYABLES- CUSTOMERS 482,545,031 529,525,271 274,976,726 232,856,709
ACCD LIABILITIES & OTHER PAY. 36,750,913,611 34,026,234,430 31,177,301,584 24,285,597,683
SENIOR DEBT 0 0 0 0
TOTAL LIABILITIES 65,806,590,731 62,595,603,973 59,884,662,948 56,104,759,340
COMMON STOCK 10,000 10,000.00 10,000.00 10,000
F/X TRANSLATION ADJUSTMENT 22,422,006 18,600,078.01 22,624,113.30 45,165,409
RETAINED EARNINGS (940,598,231) -1,016,734,510.84 -1,314,805,129.27 (1,869,518,752)
TOTAL ADDITIONAL PAID IN CAPITAL 856,197,863 856,197,863.00 1,131,197,863.00 2,031,197,863
TOTAL STOCKHOLDER'S EQUITY (61,968,362) (141,926,570) (160,973,153) 206,854,520
TOTAL LIABILITIES & STOCKHOLDER'S EQUITY 65,744,622,369 62,453,677,403 59,723,689,795 56,311,613,860
CAPITAL INFUSION 150,000,000 275,000,000 900,000,000
6161Lehman,LCPICorporateDescription[LBEXBARLCT0000723].However,LCPIwasnotalwaysused
forthispurposeasitformerlytradedincommercialpaper.
6162AllbalancefiguresarepresentedonaconsolidatedLCPIbasis.
1610

As this table shows, from May through July 2008, LCPI reported negative equity by
amountsrangingfrom$62millionto$161million.InAugust2008,LCPIreported$207
millioninpositiveequity.
AsofMay31,2008,LCPIheldapproximately$29.4billioninfinancialinventory,
with the remaining assets on its balance sheet comprised largely of reverse repos and
intercompanyreceivables.Followingisatableofthefinancialinventorydirectlyheld
byLCPIasofMay31,2008andAugust31,2008.6163
Lehman Commercial Paper, Inc.

Total Financial Instruments Owned (Assets)
GAAP Asset Class as of 5/31/08 % of Total as of 8/31/08 % of Total
Commercial Paper & Money Market 1,500,606,326 5.10% 1,742,658,697 7.55%
Third Party Derivatives 274,401,594 0.93% 203,889,227 0.88%

Intercompany Derivatives 712,018,593 2.42% 2,831,028,078 12.26%
Total Derivatives 986,420,187 3.35% 3,034,917,305 13.15%
Corporate Debt 17,332,854,996 58.89% 12,442,838,192 53.90%
Corporate Equity 1,034,329,176 3.51% 88,723,365 0.38%
Governments & Agencies 19,658,550 0.07% 80,840,327 0.35%
Real Estate Held for Sale 5,090,122,271 17.29% 3,863,492,546 16.74%
Mortgages & Mortgage Backed 3,469,770,683 11.79% 1,831,526,818 7.93%
29,433,762,189 100.00% 23,084,997,251 100.00%

Source: Hyperion.
6163InformationregardingthefinancialinventoryheldbyeachDebtorentityisobtainedfromLehmans
Hyperion reporting system. Note that there is an irreconcilable variance between the sum of the
individual line items for financial instruments owned in this table and the total stated in Hyperion for
August.
1611
As of May 2008, approximately $17.3 billion, or 59%, of LCPIs financial
instrumentpositionswerecorporateloans,droppingtoapproximately$12.4billion,or
53%, by August 2008. At the same time, the value of intercompany derivatives
increased significantly from approximately $710 million, or 2.4% of total financial
instrumentsinMay2008,to$2.8billion,or12.3%,inAugust2008.
As of August 31, 2008, LCPI held approximately $23.6 billion in financial
inventory, withtheremaining assetsonits balancesheet comprised largely of reverse
repos and intercompany receivables. Because over 99% of Corporate Debt and
Mortgage and Mortgage Backed securities are SFAS levels 2 and 3, the Examiner
estimatesthatapproximately60%ofLCPIsfinancialinventorywasFASB157levels2
and3.6164Themarksassignedtheseassetsarenotsupportedbyamarketquotedprice
andtheyhaveahighriskofmisstatement.
SectionIII.C.3ofthisReportanalyzedpotentialintangibleassetsheldbyLCPIon
astandalone(i.e.,unconsolidated)basis.Whileitispossiblethatadditionalintangible
assets may exist in LCPI in the form of customer lists, proprietary technology and
human capital, the Examiner has determined that such intangible assets are not of
materialvalueandwouldnotchangethesolvencydeterminationofLCPI.6165
6164Lehman Brothers Holdings Inc., Quarterly Report as of May 31, 2008 (Form 10Q) (filed on Jul. 10,
2008).
6165Duetothecostandtimerequiredbysuchanexercise,theExaminerdidnotperformaninvestigation
intothepossibleintangibleassetsineachofLCPIssubsidiaries.
1612
The majority of LCPIs Deferred Expenses and Other Assets relate to its
investmentof$225millioninitssubsidiaryLeveragedLoanTradingHoldingsPartners
(LLTHP). Based on a review of the consolidated balance sheets of LLTHP, the
ExaminerhasconcludedthatthevalueofLCPIsinvestmentinLLTHPshouldnothave
beenimpaired.6166
LCPICapitalInfusions.LCPIwassignificantlyleveragedandpostednegative
equityfromApril2008throughJuly2008.InFebruary,March,May,JulyandAugust
2008, LCPI obtained capital infusions from LBI in an attempt to post positive equity.
Accordingtointernaldocuments,thenegativeequityinJulywasaresultof$1billionin
losses in, among others, SunCal and TXU Energy positions.6167 Losses in August 2008
weretheresultofwritedownsinmortgageresidualpositionsaswellaswritedownsof
certain corporate loans.6168 Interviews with Lehman finance personnel revealed that
there was an effort to keep LCPI, as the subsidiary of LBI, balance sheet solvent.6169
6166LLTHPs consolidated balance sheets showed a level of assets that remained relatively steady
throughoutfiscalyear2008.ItslargestassetwasitsinvestmentinLuxembourgTradingFinanceSARL,
which,inturn,holdsArchstoneTermBloans.Becauseofthepriceflexfeatureoftheseloans,theirvalue
would not be impaired. Furthermore, LLTHP posted steady increases in retained earnings throughout
fiscalyear2008,and,withfewliabilities,postedsignificantpositiveequity.
6167EmailfromKristieWong,Lehman,toAnthonyStucchio,Lehman,etal.(July29,2008)[LBEXSIPA
005520].
6168EmailfromKristieWong,Lehman,toPaoloTonucci,Lehman(August27,2008)[LBEXSIPA005564].
6169Examiners Interview of Kristie Wong, Dec. 2, 2009, at p. 2; Examiners Interview of Joselito Rivera,
Oct. 13, 2009, at pp. 56. However, LEC Mike Montella stated that LECs may in some circumstances
allow a nonregulated entity to post negative equity at month end. Examiners Interview of Michael
Montella,Oct.26,2009,atp.1012.ThiscontradictionmaybeexplainedbythefactthatWong,whowas
headLEC,alsostatedthatthecapitalinfusionsLCPIreceivedinMayandJulyof2008wereintendedto
allow it to post positive equity, but that the amount of capital necessary to do so was underestimated.
1613
While there were no capital guidelines other than the principle of avoiding negative
equity,LECswereawareofthefactthatanentitysuchasLCPIwouldbereviewedand
questionedbyregulators.6170
LCPI became balance sheet insolvent for the first time in February 2008. It
posted positive equity by a small margin in March 2008, but then posted negative
equity until August, despite the capital infusions it received during this time.6171 In
August 2008, LCPI received a $900 million capital infusion from LBI which was
sufficienttoallowittomaintainborderlinebalancesheetsolvencyapparentlyuntilits
bankruptcy filing. Below is a table of LCPIs monthly equity in the year prior to its
bankruptcy filing, along with its ratio of equitytototalassets, and the Examiners
solvencydeterminationasofeachmonth.
ExaminersInterviewofKristieWong,Dec.2,2009,atp.3.Thus,LECsattemptedtomaintainpositive
equityinLCPI,butwereoccasionallyunabletodoso.
6170ExaminersInterviewofMichaelMontella,Oct.26,2009,atpp.1012;ExaminersInterviewofKristie
Wong,Dec.2,2009,atp.2.
6171Wong stated that she did not know why this would be so. She surmised that the capital infusions
weresimplyinadequate.ExaminersInterviewofKristieWong,Dec.2,2009,atp.3.
1614
Ratio of
Solvency Equity to
Equity Determination Total Assets
September 30, 2007 $372,928,608 Borderline 0.61%
October 31, 2007 $484,906,910 Borderline 0.74%
November 30, 2007 $310,007,656 Borderline 0.53%
December 31, 2007 $302,649,926 Borderline 0.51%
January 31, 2008 $132,490,100 Borderline 0.20%
February 29, 2008 ($6,669,838) Insolvent N/M
March 31, 2008 $255,994,138 Borderline 0.41%
April 30, 2008 ($159,512,650) Insolvent N/M
May 31, 2008 ($61,968,362) Insolvent N/M
June 30, 2008 ($141,926,570) Insolvent N/M
July 31, 2008 ($160,973,153) Insolvent N/M
August 31, 2008 $206,854,520 Borderline 0.37%
Note: N/M signifies "Not Meaningful" due to negative values of equity.

Source: Hyperion.
(b) CESAviation,CESAviationVLLC,CESAviationIX
The CES Aviation entities CES Aviation, CES Aviation V LLC, and CES
Aviation IX were established for the purpose of acquiring and operating aircraft for
Lehman.TheirbalancesheetsasofMay31,2008andAugust31,2008areasfollows:
CES Aviation
Balance Sheet Items at: May 31, 2008 August 31, 2008
CASH & CASH EQUIVALENTS 665,422 354,419
PROPERTY, EQUIPMENT & LEASE IMPROVEMENTS 21,873,360 21,467,298
DEFFERED EXPENSE & OTHER ASSETS 49,778 19,911
TOTAL ASSETS 22,588,560 21,841,628
ACCRUED LIABILITIES & OTHER PAYABLES 22,456,891 21,913,826
TOTAL LIABILITIES 22,456,891 21,913,826
RETAINED EARNINGS (6,868,331) (7,072,197)
TOTAL ADDITIONAL PAID IN CAPITAL 7,000,000 7,000,000
TOTAL STOCKHOLDER'S EQUITY 131,669 (72,197)
TOTAL LIABILITIES & STOCKHOLDER'S EQUITY 22,588,560 21,841,628

1615

CES Aviation V LLC
RECEIVABLES- OTHER 38,622 38,622
TOTAL ASSETS 4,500,447 4,450,756
ACCD LIABILITIES & OTHER PAY. 7,954,035 8,003,875
TOTAL STOCKHOLDER'S EQUITY (3,453,588) (3,553,119)

CES Aviation IX
RECEIVABLES- OTHER 7,934 7,934
TOTAL ASSETS 8,144,451 7,955,833
ACCRUED LIABILITIES & OTHER PAYABLES 9,001,137 8,952,961
RETAINED EARNINGS (856,686) (997,128)
TOTAL STOCKHOLDER'S EQUITY (856,686) (997,128)

Theseentitiesassetsconsistedlargelyofaircraft,cashandprepaidinsuranceon
aircraft.Liabilitiesarerelatedtotheuseoftheaircraft,suchastransportationcosts,and
intercompany payables to LBHI and LBI. Because of the nature of their business, all
threeCESentitiesheldexclusivelyfixedassets,andtheExaminerconcludesthatnone
heldsignificantintangibleassets.
1616
Withnointangibleassetsassociatedwiththeseentities,CESAviationVLLCand
CESAviationIXwerebalancesheetinsolventasofMay31,2008,andAugust31,2008.
Theentitiesbookvalueforproperty,equipmentandleaseimprovements(PEL)takes
into account depreciation and does not reflect the fair market value of these entities
aviation equipment. However, even assuming the PEL was worth its purchase price
($8.7million),theentitiesequitydeficitistoosignificanttoovercomeanyincreasefrom
thebookvalueoftheassets.
AsofMay31,2008,CESAviationpostedpositiveshareholdersequitybyavery
slim margin. Accordingly, the Examiner concludes that CES Aviation was borderline
solventasofMay31,2008.InJuly2008,CESAviationpostednegativeequityanddid
sothroughAugust31,2008.However,becauseitsmarginofnegativeequitywasvery
small$15,813and$72,197inJulyandAugust2008,respectivelyitispossiblethatthe
fairmarketvalueofPELinthisentitywouldbesufficientlyabovethevaluereportedon
itsbalancesheettopushCESintopositiveequity.Accordingly,giventheuncertainty
of the market value of certain aviation assets in this entity, and their impact on the
solvencyoftheentity,theExaminerconcludesthatCESAviationremainedborderline
solvent as of August 2008. In light of the time and expense to the Debtors estates
required to conduct an independent valuation of these assets, the Examiner has
determinedthatitwouldbeanimprudentuseoftheEstatesresourcestodoso.The
tablebelowprovidesthemonthlyequitypositionsofeachentity.
1617
CES Aviation CES Aviation V CES Aviation IX
Solvency Solvency Solvency
Equity Determination Equity Determination Equity Determination
September 30, 2007 $917,722 Borderline ($2,841,129) Insolvent ($465,808) Insolvent
October 31, 2007 $770,068 Borderline ($2,939,739) Insolvent ($524,954) Insolvent
November 30, 2007 $765,759 Borderline ($2,953,150) Insolvent ($589,790) Insolvent
December 31, 2007 $626,549 Borderline ($3,026,449) Insolvent ($648,527) Insolvent
January 31, 2008 $444,105 Borderline ($3,059,305) Insolvent ($701,748) Insolvent
February 29, 2008 $331,361 Borderline ($3,148,726) Insolvent ($720,203) Insolvent
March 31, 2008 $237,230 Borderline ($3,220,516) Insolvent ($761,657) Insolvent
April 30, 2008 $49,335 Borderline ($3,401,644) Insolvent ($802,240) Insolvent
May 31, 2008 $131,669 Borderline ($3,453,588) Insolvent ($856,686) Insolvent
June 30, 2008 $49,067 Borderline ($3,446,161) Insolvent ($909,705) Insolvent
July 31, 2008 ($15,813) Borderline ($3,494,369) Insolvent ($1,013,850) Insolvent
August 31, 2008 ($72,197) Borderline ($3,553,119) Insolvent ($997,128) Insolvent
Source: Hyperion.
(c) LBSpecialFinancing
LBSFwasLehmanBrothersInc.sprincipaldealerinabroadrangeofderivative
products, including interest rate, currency, credit and mortgage derivatives. For the
reasonsdescribedbelow,theExaminerdeemsLBSFtohavebeenborderlinesolventas
of May 31, 2008, and August 31, 2008. LBSFs balance sheets as of April 30, 2008,
throughAugust31,2008areasfollows:6172
6172NotethatallbalancefiguresarepresentedonaconsolidatedLBSFbasis.
1618
LB Special Financing Inc.
Balance Sheet Items at: April 30, 2008 May 31, 2008 June 30, 2008 July 31, 2008 August 31, 2008
CASH & CASH EQUIVALENTS 32,268,168 39,695,084 40,170,990 38,978,054 54,277,418
CASH & SEC.SEGR. & ON DEPOSIT 0 121,898,763 130,804,614 142,211,812 158,859,102
SEC. & OTHER FININANCIAL INSTRUMENTS OWNED 78,574,785,243 71,822,087,467 81,038,596,170 77,021,236,554 66,005,066,729
SECURITIES PURCHASED UNDER AGREEMENT TO SELL 4,799,272,249 5,579,013,493 3,117,305,188 3,213,698,449 3,253,884,281
SECURITIES BORROWED 43,783,917,364 26,365,338,267 34,440,447,484 36,632,787,111 26,565,362,945
RECEIVABLES- BROKER/DEALER 4,553,931,571 6,946,351,256 3,907,417,323 6,618,862,372 4,083,561,521
RECEIVABLES- CUSTOMERS 1,462,805,597 1,584,409,453 1,503,468,998 2,306,493,702 2,230,283,390
RECEIVABLES- OTHER 2,581,362,126 2,159,122,186 2,162,547,954 2,394,986,043 3,549,323,316
GOODWILL & INTANGIBLES 284,765,999 284,763,199 287,253,790 287,250,990 291,248,190
PROPERTY, EQUIPMENT & LEASE IMPROVEMENTS 11,460,586 10,919,044 12,549,216 12,328,440 10,108,220
DEFFERED EXPENSE & OTHER ASSETS 219,240,440 199,515,090 391,189,073 448,445,623 430,075,277
TOTAL BRIDGE ACCOUNTS 31 3 1 4 2
TOTAL ASSETS 136,303,809,375 115,113,113,305 127,031,750,801 129,117,279,154 106,632,050,391
COMMERCIAL PAPER & S.T. DEBT 188,128,111 184,568,237 185,291,739.29 190,472,213.47 176,893,415
SEC.& OTHER INSTRUMENTS SOLD NOT YET PURCHASED 55,595,965,409 40,456,549,211 45,632,121,885.11 45,395,025,250.05 33,540,848,955
SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE 4,347,510,621 2,936,970,849 2,887,343,577.67 3,698,729,925.45 4,249,528,937
SECURITIES LOANED 43,991,644,009 40,672,680,943 43,011,801,476.53 44,678,811,748.63 35,540,001,644
OTHER SECURED FINANCING 2,429,178,131 1,918,859,123 1,906,166,762.30 1,414,153,886.91 1,074,702,425
PAYABLES- BROKER/DEALER 3,696,490,806 3,304,690,852 3,956,473,979.96 4,240,558,371.16 5,253,116,854
PAYABLES- CUSTOMERS 3,689,374,176 4,268,820,487 3,154,191,489.04 2,980,868,156.83 2,657,840,130
ACCD LIABILITIES & OTHER PAY. 21,622,506,426 20,211,734,488 25,187,338,234.46 25,373,700,109.15 23,040,698,961
SENIOR DEBT 695,725,691 683,144,683 659,429,677.75 640,889,783.27 630,005,545
TOTAL LIABILITIES 136,256,523,382 114,638,018,874 126,580,158,822 128,613,209,445 106,163,636,866
COMMON STOCK 1,000 1,000 1,000 1,000 1,000
F/X TRANSLATION ADJUSTMENT (26,146) (55,861) (23,322) (15,863) (16,532)
RETAINED EARNINGS (202,688,861) 125,149,292 101,614,301 154,084,572 118,429,057
TOTAL ADDITIONAL PAID IN CAPITAL 250,000,000 350,000,000 350,000,000 350,000,000 350,000,000
TOTAL STOCKHOLDER'S EQUITY 47,285,993 475,094,431 451,591,979 504,069,709 468,413,525
TOTAL LIABILITIES & STOCKHOLDER'S EQUITY 136,303,809,375 115,113,113,305 127,031,750,801 129,117,279,153 106,632,050,391
CAPITAL INFUSION 0 100,000,000 0 0 0
EQUITY AS % OF TOTAL ASSETS 0.03% 0.41% 0.36% 0.39% 0.44%

AsofMay31,2008,LBSFheldapproximately$72billioninfinancialinventory,
with the remaining asset balance made up largely of receivables, reverse repos and
securitiesborrowed.Ofthefinancialinventory,nearly80%iscomprisedofderivatives
and government and agency securities, including 15% allocated to intercompany
derivatives.FollowingisatableoftheinventorydirectlyheldbyLBSFas ofMay31,
2008andAugust31,2008.
1619
Lehman Brothers Special Financing
Commercial Paper & Money Market 87,851,674 0.12% 38,050,077 0.06%
Third Party Derivatives 21,490,667,702 29.92% 22,267,378,700 33.74%

Intercompany Derivatives 11,124,364,636 15.49% 10,977,690,112 16.63%
Total Derivatives 32,615,032,338 45.41% 33,245,068,813 50.37%
Physical Commodities 526,763,622 0.73% 413,833,886 0.63%

Corporate Debt 3,279,571,273 4.57% 5,215,184,322 7.90%
Corporate Debt & Other 3,806,334,896 5.30% 5,629,018,208 8.53%
Corporate Equity 9,379,851,772 13.06% 9,113,820,996 13.81%
Governments & Agencies 24,877,048,749 34.64% 17,668,641,729 26.77%
Mortgages & Mortgage Backed 1,055,968,037 1.47% 310,466,906 0.47%
71,822,087,467 100.00% 66,005,066,729 100.00%
AssetforthinSectionIII.A.2ofthisReport,theExaminerhasdeterminedthatthereis
insufficient evidence to support a finding, for purposes of a solvency analysis, that
Lehmans derivative instruments or corporate debt and equity positions were
unreasonablymarked.
LBSF was a warehouse for derivative positions and did not originate business
activityorperformsignificantbusinessoperations.However,goodwilldidappearon
its consolidated balance sheet as of June 2007 in the amount of approximately $285
millionduetotheacquisitionofEagleEnergy.Duetothecostandtimerequired,the
Examiner did not conduct an investigation of the reasonableness of the magnitude of
the goodwill and intangibles; even if the goodwill was written off completely, LBSF
would continue to post positive equity for all months in 2008 other than March and
1620
April. Moreover, Section III.C.3 of this Report analyzes potential intangible assets in
LBSFona standalone(i.e., unconsolidated)basis.Whileit is possiblethatadditional
intangibleassetsmayexistintheformofcustomerlists,proprietarytechnologyand/or
humancapital, suchintangibleassetsarenotofmaterial valueandwould notchange
thesolvencydeterminationofLBSF.6173BelowisatableofLBSFsmonthlyequityinthe
yearpriortoitsbankruptcyfiling,alongwithitsratioofequitytototalassets,andthe
Examinerssolvencydeterminationasofeachmonth.
Ratio of
Solvency Equity to
February 29, 2008 $953,503,304 Borderline 0.73%
April 30, 2008 $47,285,993 Borderline 0.03%
May 31, 2008 $475,094,431 Borderline 0.41%
June 30, 2008 $451,591,979 Borderline 0.36%
July 31, 2008 $504,069,709 Borderline 0.39%
Source: Hyperion.
As with other LBHI Affiliates, LECs attempted to make sure that LBSF had
positive equity. Accordingly, while in February and March of 2008, LBSF paid
dividendsof$300millionand$500milliontoLBI,justtwomonthslater,inMay2008,
6173Due to the cost and time required, the Examiner did not perform an investigation into the possible
intangibleassetsineachofLBSFssubsidiaries.
1621
LBSFreceivedacapitalinfusionof$100millionfromLBI.Withoutthisadditional$100
million,LBSFwouldhavebeenbalancesheetinsolventasofMay2008.
Asillustratedabove,LBSFmaintainedanequitytototalassetsratioofnomore
than 0.44% from March through August 2008. Even though the Examiner concludes
that there is insufficient evidence to support a finding, for purposes of a solvency
analysis,thattheassetsheldbyLBSFwereunreasonablymarked,LBSFsassetswould
onlyneedtolose0.45%oftheirvalueinordertorenderLBSFbalancesheetinsolvent.
Becauseofitssmallequitycushion,theExaminerdeemsLBSFtohavebeenborderline
solventasofMay31,2008,andAugust31,2008.
(d) LBCommodityServices
LBCSs principal business was the trading of power, natural gas, oil, and
structured products. The following table details LBCSs balance sheets as of May 31,
2008,andAugust31,2008:6174
6174NotethatallbalancefiguresarepresentedonaconsolidatedLBCSbasis.
1622
LB Commodity Services Inc.
CASH & CASH EQUIVALENTS 6,850,371 22,550,284
SEC. & OTHER FININANCIAL INSTRUMENTS OWNED 5,488,309,683 4,340,355,972
SECURITIES PURCH. UNDER AGREEMENT TO SELL 0 4,155,555
RECEIVABLES- BROKER/DEALER 1,263,880,051 1,085,836,004
RECEIVABLES- CUSTOMERS 265,921,188 86,194,370
RECEIVABLES- OTHER 106,985,698 280,851,379
DEFFERED EXPENSE & OTHER ASSETS 145,476,400 0
GOODWILL & INTANGIBLES 284,763,199 291,248,190
TOTAL BRIDGE ACCOUNTS 0 378,237,034
TOTAL ASSETS 7,569,905,106 6,496,463,763
SEC.& OTHER INSTRUMENTS SOLD NOT YET PURCHASED 3,538,571,157 2,058,364,215
COMMERCIAL PAPER & ST DEBT 152 79,068
PAYABLES- BROKER/DEALER 145,550,384 8,834,794
PAYABLES- CUSTOMERS 207,624,790 115,438,486
ACCD LIABILITIES & OTHER PAY. 2,974,541,324 3,485,452,763
SENIOR DEBT 677,617,075 624,483,872
TOTAL LIABILITIES 7,543,904,882 6,292,653,199
COMMON STOCK 100 100
F/X TRANSLATION ADJUSTMENT (116,705) (47,837)
RETAINED EARNINGS (4,883,170) 172,858,302
TOTAL STOCKHOLDER'S EQUITY 26,000,224 203,810,565
TOTAL LIABILITIES & STOCKHOLDER'S EQUITY 7,569,905,106 6,496,463,763
EQUITY AS % OF TOTAL ASSETS 0.34% 3.14%
TheincreaseinstockholdersequityfromMaytoAugustwasduetoanincrease
of approximately $117 million in retained earnings between May and June 2008, and
another$60millionincreasebetweenJuneandJuly2008.LBCSalsopostedareceivable
fromLBIof$1.3billiononMay31,2008,and$1.1billiononAugust31,2008.Giventhe
pendingfailureofLBIandLBHI,itispossiblethattheAugust31valueofthereceivable
fromLBIshouldbevaluedatlessthanbookvalue.However,inlightofthecostand
1623
expense of examining this issue, and because the Examiner deems LBCS to be
borderline solvent even if the receivable from LBI is valued at full book value, the
Examinerhasdeterminedthatitwouldnotbeaprudentuseofresourcestoinvestigate
thisissuefurther.
Asshownabove,asofMay31,2008,LBCSsbalancesheetshowed$5.5billionin
financialinventory,decreasingto$4.3billionbyAugust31,2008.Followingisatableof
theinventorydirectlyheldbyLBCSasofMay31,2008,andAugust31,2008.
LB Commodity Services
Commercial Paper & Money Market 3,016,437 0.05% 2,343,645 0.05%
Third Party Derivatives 3,982,759,627 72.57% 2,763,758,194 63.68%

Intercompany Derivatives 914,611,931 16.66% 1,009,617,031 23.26%
Total Derivatives 4,897,371,558 89.23% 3,773,375,225 86.94%
Physical Commodities 526,763,622 9.60% 413,833,886 9.53%

Corporate Debt 61,158,066 1.11% 150,801,915 3.47%
Corporate Debt & Other 587,921,688 10.71% 564,635,801 13.01%
Governments & Agencies (0) 0.00% 1,301 0.00%
5,488,309,683 100.00% 4,340,355,972 100.00%
OfLBCSsfinancialinventoryportfolio,almost90%pertainstoderivatives,with
17% and 23% allocated to intercompany derivatives in May and August, respectively.
TheExaminersvaluationanalysisofderivativepositions,describedinSectionIII.A.2of
the Report, indicates that there is insufficient evidence to support a finding, for
purposes of a solvency analysis, that they were unreasonably marked. Also, while
LBCSdidperformbusinessoperationsand,asdiscussedinSectionIII.C.3,itispossible
1624
that additional intangible assets may exist in the form of customer lists, proprietary
technologyandhumancapital,theExaminerhasdeterminedthatsuchintangibleassets
arenotofmaterialvalue.6175However,asnotedaboveforLBSF,LBCSsparententity,
approximately$285millioningoodwillandintangiblesdidexistbeginninginJune2007
due to the acquisition of Eagle Energy. These same goodwill assets are reflected on
LBCSsconsolidatedbalancesheet.TheExaminerhasdeterminedthatifthisgoodwill
were entirely written off, LBCS would become balance sheet insolvent as of May and
August 2008. However, due to the expense and time required, the Examiner has not
engagedinaninvestigationofthereasonablenessofthemagnitudeofthegoodwilland
intangibles.6176
Below is a table of LBCSs monthly equity in the year prior to its bankruptcy
filing, along with its ratio of equitytototal assets, and the Examiners solvency
determinationasofeachmonth.
6175Asnoted above, the analysis in Section III.C.3 was performed on LBCS on a standalone (i.e.,
unconsolidated)basis.Duetothecostandtimerequired,theExaminerdidnotperformaninvestigation
intothepossibleintangibleassetsineachofLBCSssubsidiaries.
6176LBHIguaranteedcertainoftheobligationsofLBCS,LBCC,LOTCandLBSF,pursuanttoaLehman
Executive Committee Order dated June 9, 2005. See Lehman, Unanimous Written Consent of the
ExecutiveCommitteeoftheBoardofDirectorsofLehmanBrothersHoldingsInc.(June9,2005)[LBEX
AM 003415003417]. LCPI and LOTC also received guaranties from LBHI for their activity with
JPMorganChaseonAugust26,2008.JPMorgan,Guaranty[JPM200400058790005884].TheExecutive
Committee Order stated that LBHI would guarantee payment of all liabilities, obligations and
commitmentsofthesubsidiaries.JPMorgan,Guaranty[JPM200400058790005884].Assumingthatthe
guarantyisalegallyenforceableobligation,itisnotanassetoftheDebtorentity,nordoesitcontributeto
the solvency of the LBHI Affiliates. See Section III.A.5 and III.B.3.g of this Report for additional
informationonLBHIguaranties.
1625
Ratio of
Solvency Equity to
February 29, 2008 $83,838,341 Borderline 1.81%
April 30, 2008 $25,662,935 Borderline 0.38%
May 31, 2008 $26,000,224 Borderline 0.34%
June 30, 2008 $143,082,271 Borderline 1.46%
July 31, 2008 $203,052,519 Borderline 2.58%
Source: Hyperion.
LBCSs equitytototalassets ratio of 0.3% in May 2008 and 3.14% in August of 2008,
rendered it vulnerable to small writedowns or unforeseen liabilities.6177 Accordingly,
althoughLBCSsbalancesheetindicatesthatitwassolventasofMay31andAugust31,
2008,theExaminerhasdeterminedthatLBCSwasborderlinesolventduringtheperiod
notedinthetableabove.6178
6177ThereisevidencethatoneofLBCSssubsidiaries,EagleEnergyPartners1L.P.(EagleEnergy)may
have been overvaluedas of May and August of 2008. In May 2008, Eagle Energys shareholder equity
was $354 million. Hyperion report [LBEXBARHYP 00000380000049]. In August, Eagle Energys
shareholder equity was $363 million. Id. The magnitude of Eagle Energys book value of shareholder
equityisrelevantbecauseinOctober2008,LBCSsoldEagleEnergytoElectricitedeFranceSAfor$230.5
million, over $100 million less than book value of the equity. Edvard Pettersson, Lehman to Sell Eagle
Energy Unit to EDF for $230.5 Million, Bloomberg, October 1, 2008; Federal Energy Regulatory
Commission,FERCAuthorizesLehmanEDFTransaction,October30,2008.Becauseofthenarrowmargin
by which LBCS was balance sheet solvent in May 2008, a significant decrease in the equity of Eagle
Energy,aLevel2asset,wouldhaverenderedLBCSinsolvent.
6178TherewerefourDebtorentitiesthatwerereviewedandratedbyratingagencies:LBCS,LBFP,LBDP
and LBCC. Each entity obtained credit ratings of at least A. In light of the applicable precedent, the
Examinerdoesnotconsidertheratingitselftobedispositiveofsolvency.
1626
(e) LuxembourgResidentialPropertiesLoanFinanceS.A.R.L.
LRPwasestablishedinMay2008asaninvestmentandfinancingvehicletohold
primarily commercial loans.6179 Balance sheet information was not available for this
entityuntilJuneanditsbalancesheetasofAugust31,2008,isstatedasfollows:
Luxembourg Residential Properties

Balance Sheet Items at August 31, 2008
CASH & CASH EQUIVALENTS 20,000
SEC. & OTHER FININANCIAL INSTRUMENTS OWNED 596,624,913
TOTAL ASSETS 596,644,913
ACCD LIABILITIES & OTHER PAY. 593,998,140
TOTAL LIABILITIES 593,998,140
COMMON STOCK 20,000
RETAINED EARNINGS 2,626,773
TOTAL STOCKHOLDER'S EQUITY 2,646,773
Total Liabilities & Stockholder's Equity 596,644,913
LRPsassetsconsistentirelyofonecorporateloan;anArchstoneTermBloanin
the principal amount of $597 million. As noted in Section III.A.2, the Examiner has
determined that it was reasonable for Lehman to value its Archstone Term B loan at
99%ofstatedprincipalduetopriceflex.
BasedonthefactthattheArchstoneTermLoanBwastheonlyassetofLRP,and
becausethereisnobasistoexpectanydeteriorationinthevalueofthatasset,thereis
insufficientevidencetosupportafindingthatLRPwasinsolventasofAugust31,2008.
6179ExaminersInterviewofGeraldHaupt,Oct.13,2009,atpp.23.LRPisadistinctandseparateentity
fromLuxembourgFinance,S.a.r.l.,whichisnotaDebtorLBHIAffiliate.
1627
(f) LBOTCDerivatives
LOTCisanoverthecounterderivativesdealeranditsbalancesheetsasofMay
31,2008andAugust31,2008arestatedasfollows:
LB OTC Derivatives
CASH & CASH EQUIVALENTS 0 31,661
SEC. & OTHER FININANCIAL INSTRUMENTS OWNED 2,006,960,062 1,760,363,783
SECURITIES PURCHASED UNDER AGREEMENT TO SELL 99,617,347 759,230,174
SECURITIES BORROWED 99,412,565 53,742,524
RECEIVABLES- BROKER/DEALER 1,531,638,380 944,631,818
RECEIVABLES- CUSTOMERS 1,605,884,195 1,095,052,703
DEFERRED EXPENSE & OTHER ASSETS 0 2,559,784
TOTAL BRIDGE ACCOUNTS (0) 0
TOTAL ASSETS 5,391,246,062 4,669,751,382
COMMERCIAL PAPER & S.T. DEBT 187,220,440 1,013,982,923
SEC.& OTHER INSTRUMENTS SOLD NOT YET PURCHASED 3,900,934,006 2,274,803,899
SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE 3,024,306 129,388
SUBORDINATED INDEBTEDNESS 250,000,000 250,000,000
RETAINED EARNINGS 125,544,736 115,106,863

Ofits$5billionintotalassetsasofMay31,2008,approximately$2billionwasin
the form of financial instruments owned by LOTC. Almost 40% of the financial
inventory was derivatives, with the other 60% comprised of corporate equity and
corporatedebtpositions.TheExaminersvaluationreviewoftheseassetssuggeststhat
1628
there is insufficientevidenceto supportafinding that theseassetswereunreasonably
marked.6180ThefollowingisatableofthefinancialinventorydirectlyheldbyLOTCas
ofMay31,2008andAugust31,2008:
LB OTC DERIVATIVES
% of
GAAP Asset Class as of 5/31/08 % of Total as of 8/31/08
Total
Commercial Paper & Money Market (1,037,563) -0.05% (737,700) -0.04%

Intercompany Derivatives 263,105 0.01% 51,169 0.00%
Total Derivatives 792,948,439 39.51% 664,109,703 37.73%
Corporate Debt 911,345,248 45.41% 775,426,806 44.05%
Corporate Equity 303,715,608 15.13% 321,564,974 18.27%
Governments & Agencies (11,670) 0.00% (0) 0.00%
2,006,960,062 100.00% 1,760,363,783 100.00%
Based on the positive equity cushion reflected on its balance sheet and the
reasonableness of the value of the financial assets it owned, there is insufficient
evidencetosupportafindingthatLOTCwasinsolventasofMay31,2008andAugust
31,2008.
(g) LB745LLC
LB 745 is an entity established for the primary purpose of acquiring Lehmans
headquarters building at 745 Seventh Avenue in New York. As of May 2008, the
entityscoreassetsincludedapproximately$193millioninreceivablesand$576million
6180SeeSectionIII.A.2ofthisReport.
1629
forthepropertyandrelatedequipment.6181Thesevalueshadnotvariedsignificantlyby
August31,2008. Althoughthe valueof the property onLB 745sbalancesheet is not
fair market value, the value of commercial real estate property in New York would
likelyhaveexperiencedsignificantappreciationfromitspurchasein2001toMay2008
or August 2008.6182 The entitys largest liability is comprised of intercompany debt of
approximately$600million.LB745sbalancesheetsasofMay31,2008andAugust31,
2008areasfollows:
LB 745 LLC
DEFFERED EXPENSE & OTHER ASSETS 1,206,427 6,028,918
TOTAL ASSETS 771,144,269 771,814,675
SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE 4 4

Based on the assets held by LB 745, there is insufficient evidence to support a
findingthatLB745wasinsolventasofMay31,2008andAugust31,2008.
6181Notethatapproximately$25millionoftotalreceivableswasanintercompanyreceivablefromLCPI
and$8millionfromLBSF.
6182SeeMoodys/REALCommercialPropertyPriceIndex,NewYorkCityMetroArea,Q42000Q22009,
availableat,http://web.mit.edu/cre/research/credl/rca.html.
1630
(h) LBDerivativeProducts
LBDP is a termination derivative product company that intermediates interest
rate and currency swaps between market counterparties and LBSF. In order for
investmentbankslikeLehman,whichareratedbelowAAorAAA,totradewithcertain
highly rated counterparties, banks establish derivative product companies that can
maintain a high rating from the rating agencies. In general, these AAA ratings are
dependent on certain criteria, the most visible of which are: (1) hedging market risk
through backtoback transactions or mirror transactions with another corporate
entity; (2) minimizing counterparty credit risk with the hedging counterparty by
requiringcollateralonnegativemarktomarketexposurestothecounterparty;and(3)
maintainingstrictcapitalrequirements.6183
LBDP entered into a variety of derivative transactions and eliminated market
riskbyenteringintomirrortransactionswithLBSF,whichwereguaranteedbyLBHI.
As a termination structure, LBDP would provide for the acceleration and cash
settlement of all contracts before their maturity upon certain events.6184 Furthermore,
LBDP purchased a surety bond from Ambac Assurance Corp., which guaranteed that
itsobligationstocounterpartieswouldbefulfilled.6185
6183Standard&PoorsRatingsDirect,LehmanBrothersDerivativeProductsInc.(Feb.4,2000).
6184Lehman, Lehman Brothers Derivatives Products Operating Guidelines, Article X (July 16, 1998)
[LBEXBARLEG00018240001885];ExaminersInterviewofMichaelMontella,Oct.26,2009,atp.5.
6185Standard&PoorsRatingsDirect,LehmanBrothersDerivativeProductsInc.,atp.2(Feb.4,2000).
1631
LBDPsassetsconsistedalmostentirelyofinterestrateswapsandmoneymarket
instruments.ItsbalancesheetsasofMay31,2008,andAugust31,2008,areasfollows:
LB Derivative Products Inc
SEC. & OTHER FININANCIAL INSTRUMENTS OWNED 432,292,498 756,349,084
RECEIVABLES- CUSTOMERS 7,600,000 0
RECEIVABLES- BROKER/DEALER 0 0
RECEIVABLES- OTHER 7,720,095 99
TOTAL ASSETS 534,666,190 762,769,292
SEC.& OTHER INSTRUMENTS SOLD NOT YET PURCHASED 375,222,833 488,716,675
PAYABLES- CUSTOMERS 10,266,440 0
SUBORDINATED INDEBTEDNESS 10,000,000 10,000,000

TheincreaseinLBDPsstockholderequitybetweenMay31,2008,andAugust31,
2008, waslargely duetoa capitalinfusion of $150millionreceived from LBI,through
LBHI, on June 12, 2008.6186 This capital infusion was in response to the downgrade of
Ambac,LBDPsinsurer,andwasrequiredinordertomaintainLBDPsAAArating.6187
6186Lehman,DailyTreasuryMISasof6/12/08[LBEXDOCID552032].
6187EmailfromJ.Palumbo,Ernst&Young,toW.SchlichandJenniferJackson,Ernst&Young,(Jun.8,
2008) [EYLELBHIKEYPERS 257754]; email from J. Goodman, Lehman, to C. OMeara and V.

DiMassimo,Lehman(June6,2008)[LBHI_SEC07940_781486].
1632
LBDP was consistently rated AAA by S&P until it was placed on CreditWatch
with negative implications on September 25, 2008. The entitys operating guidelines
provide for the termination of all outstanding swaps should the following events
occur:6188
LBDPceasedtomaintainanArating;
LBSF fails to deliver the required collateral under the backtoback

transactionswithinatwodaycureperiod;
LBDPfailstomaintainthecapitalrequired;or
LBHIorLBSFfileforbankruptcyprotection.
In this case, the termination trigger was the bankruptcy filing of LBHI on
September15,2008.
Because the Examiner finds, for purposes of a solvency analysis, that there is
insufficient evidence to conclude that LBDPs derivative assets were marked
unreasonably, there is also insufficient evidence to support a finding that LBDP was
insolvent during the period in question. The Examiner concludes that LBDP was
balancesheetsolventonMay31,2008,andAugust31,2008.
(i) LBFinancialProducts
LBFP was established for the purpose of engaging in overthecounter interest
rate and currency swaps and options, as well as trading exchangetraded futures and
options,andgovernmentbondsandoptions.SimilartoitssistercompanyLBDP,LBFP
6188Lehman, Lehman Brothers Derivatives Products Operating Guidelines, Article X, at p. 25 (July 16,
1998)[LBEXBARLEG00018240001885].
1633
wasaderivativeproductcompany.Assuch,iteliminatedmarketriskbyenteringinto
offsettingmirrortransactionswithLBSF,whichwasunconditionallybackedbyLBHI,
and was bound by strict capital requirements. However, unlike LBDP, which had a
terminationstructure,LBFPwasacontinuationderivativeproductcompanythatwould
maintainitsderivativepositionsthroughmaturity,evenuponatriggerevent.6189
LBFPsassetsconsistedalmostentirelyofinterestrateswapsandmoneymarket
instruments.ItsbalancesheetsasofMay31,2008,andAugust31,2008,areasfollows:
LB Financial Products Inc.
CASH & CASH EQUIVALENTS (56,027) 1,430,613
RECEIVABLES- OTHER 106 3,504
DEFFERED EXPENSE & OTHER ASSETS 5,889,140 5,779,137
TOTAL ASSETS 536,002,370 556,111,126
SEC.& OTHER INSTRUMENTS SOLD NOT YET PURCHASED 220,854,048 237,596,839
COMMON STOCK 10 10

LBHIs bankruptcy filing automatically placed LBFP into continuation mode,
forcingLBFPintoawinddownphaseastheentitieswereintertwinedtoagreatextent,
6189Lehman, Lehman Brothers Financial Products Inc. Operating Guidelines [LBEXBARLEG 0001886
0001933];ExaminersInterviewofMichaelMontella,Oct.26,2009,atp.5.
1634
withLBHIplayingbothoperationalandfinancialrolesforLBFP.6190LBFPsassetswere
primarily interest rate swaps and money market instruments. As a continuation
structure, LBFP would not terminate these positions with counterparties upon a
triggeringevent.Instead,acontingentmanagerwouldassistinmanagingtheportfolio
untilfinalmaturityandtakeresponsibilityforhedgingtheportfolioagainstinterestrate
movements.AtthetimeofLBFPsvoluntarybankruptcyfiling,however,thestatusof
theoutstandingderivativespositionswasunclear.6191
TheExaminerfindsinsufficientevidencetosupportafinding,forpurposesofa
solvencyanalysis,thattheassetsheldbyLBFPwereunreasonablymarked.Therefore,
the Examiner concludes that LBFP was balance sheet solvent on May 31, 2008, and
August31,2008.
(j) LBCommercialCorporation
LBCC actedprimarilyasa dealerinoverthecounter(OTC) foreigncurrency
forwards and options and exchangetraded futures and futures options. LBCCs
balancesheetsasofMay31,2008,andAugust31,2008,wereasfollows:
6190ExaminersInterview of Michael Montella, Oct. 26, 2009, at p. 5; Standard & Poors, Lehman Bros
FinancialProdRatingsPutonWatch;LehmanBrosDerivativeProdRatingsAffirmed,Sept.25,2008.
6191Lehman, Lehman Brothers Financial Products Inc. Operating Guidelines, [LBEXBARLEG 0001886
0001933]; Standard & Poors, Lehman Bros Derivative Product Rts Cut, Put on Watch Neg; Lehman Bros
FinancialProductRtsCut,Oct.6,2008.
1635
LB Commercial Corp.
SEC. & OTHER FININANCIAL INSTRUMENTS OWNED 1,356,600,864 912,862,084
RECEIVABLES- BROKER/DEALER 1,250,349,674 1,264,899,973
RECEIVABLES- CUSTOMERS 13,541,462 1,716,562
DEFFERED EXPENSE & OTHER ASSETS (803) (803)
TOTAL ASSETS 3,323,986,094 3,119,088,646
SEC.& OTHER INSTRUMENTS SOLD NOT YET PURCHASED 773,420,701 1,301,089,939
COMMERCIAL PAPER & S.T. DEBT 0 9,402,088
ACCD LIABILITIES & OTHER PAY. 1,631,146,162 1,058,172,121
COMMON STOCK 1,000 1,000
RSU MTM APPRECIATION (211,560) (211,560)

A reviewof LBCCs balancesheet revealsthatLBCCsfinancial inventoryas of
May31,2008,andAugust31,2008,wascomprisedentirelyofderivatives.Asampleof
thesederivativeswasreviewedandaresummarizedbelow.TheremainderofLBCCs
assetsasofthesedateswaslargelyreceivables.
1636
LB Commercial Corporation
Commercial Paper & Money Market (27,625,745) -2.04% (48,950,953) -5.36%

Intercompany Derivatives 623,334,582 45.95% 568,535,577 62.28%
Total Derivatives 1,383,886,004 102.01% 961,813,234 105.36%
Corporate Debt 887 0.00% - 0.00%
Governments & Agencies 204,987 0.02% - 0.00%
Mortgages & Mortgage Backed 134,731 0.01% (197) 0.00%
1,356,600,864 100.00% 912,862,084 100.00%
AsdescribedinSectionIII.A.2,theExaminerhasfoundinsufficientevidenceto
support a finding that Lehmans derivatives positions, as an asset class, were
unreasonablymarked.Additionally,theExaminerevaluatedthereasonablenessofthe
valuation of twelve option positions held by LBCC as of May 31, 2008.6192 Lehmans
GFS quotes for price and total dollar value for these positions were evaluated by
comparisontopricequotesfromeitherBloombergorMarketWatch.TheExaminerhas
determinedthatLehmanspricesforthesepositionswerereasonable.
Given the makeup of its assets and the reasonableness of their marks, the
Examiner concludesthatthere isinsufficientevidence tosupport afinding thatLBCC
wasbalancesheetinsolventasofMay31,2008andAugust31,2008.
6192TheExaminerevaluatedcallandputoptionsonAmericanInternationalGroup,AppleInc.,BPPLC,
Citigroup, Google Inc., and the S&P 500. The GFS ticker symbols for the positions investigated were
QWAPMG, QAPVAP, QQAAAR, QBPAN, QBPMM, QSXYUO, QBPMN, QSXYFS, QCIT, QBPSL,
QGOOFN,andQVAFAO.
1637
(k) BNCMortgageLLC
BNC Mortgage LLC was a subprime mortgage originator. As of May 31, 2008,
andAugust31,2008,itsbalancesheetswereasfollows:
BNC Mortgage LLC
TOTAL ASSETS 24,281,373 20,764,794
COMMON STOCK 25,000,000 25,000,000

As detailed above, 98% of BNCs assets consisted of intercompany receivables,
split between receivables from Lehman Brothers Bank and Aurora Loan Services.
Given BNCssubstantialequity cushion,as wellasthefact thatitslargestassets were
receivables from nondebtor entities, its balance sheet was relatively strong.
Accordingly, the Examiner concludes that there is insufficient evidence to support a
findingthatBNCwasbalancesheetinsolventasofMay31,2008andAugust31,2008.
(l) EastDoverLimited
East Dover Limited was established for the sole purpose of purchasing, leasing
and selling aircraft and related equipment. However, at the time of its bankruptcy
filing, this entity was no longer used for this purpose and held mostly intercompany
1638
receivables and payables. Its balance sheets as of May 31, 2008, and August 31, 2008,
wereasfollows:
East Dover Ltd
CASH & CASH EQUIVALENTS 59,605,203 100,373
SEC. & OTHER FININANCIAL INSTRUMENTS OWNED (34) (0)
TOTAL ASSETS 108,857,921 109,704,246
COMMERCIAL PAPER S.T. DEBT 32,513 30,817

AsofMay31,2008,over50%ofEastDoversassetswerederivedfromcash.The
remainingassetsconsistedlargelyof$46millionofintercompanyreceivablesfromLBI
and LCPI. An intercompany receivable from LCPI of $39.1 million comprised 37% of
East Dovers total assets. However, even if LCPI were unable to repay its obligation,
EastDoverhadsufficientequity,$101million,tocoveritsloss.
By August 31, 2008, East Dovers cash had decreased to less than 1% of total
assets and was replaced by a $99 million intercompany receivable from LCPI.
However,inthisinstanceaswell,evenifLCPIwereunabletorepayitsobligation,East
Doverhadsufficientequity$105milliontocoveritsloss.
1639
ThereisinsufficientevidencetosupportafindingthatEastDoverwasinsolvent
and the Examiner concludes that East Dover was balance sheet solvent as of May 31,
2008,andAugust31,2008.
(m) LehmanScottishFinance
LSFwasestablishedforthesolepurposeofholdingequitylinkednotesofother
Lehman entities. Its balance sheets as of May 31, 2008, and August 31, 2008, were as
follows:
Lehman Scottish Finance LP
TOTAL ASSETS 57,368,026 62,723,454
TOTAL LIABILITIES - -
COMMON STOCK 50,000,000 50,000,000

LSFdidnotpostanyliabilitiesonitsbalancesheetasofMay31,2008,orAugust
31,2008.Thisisconsistentwithitsroleasanonoperatingentitythatwasnotinvolved
in transactions and which was created for the sole purpose of holding equitylinked
notes of other Lehman entities. At the same time, on May 31, 2008, LSFs assets
consisted of $2.8 million in U.S. equities and $53 million in intercompany receivables.
By August 31, 2008, its financial inventory, still consisting entirely of derivatives,
1640
increasedto$7.2million.ThereceivablesreportedbyLSFareprimarilycomprisedof
$9millioninLuxembourgFinance,S.a.r.l.redeemablecommonstockand$40millionin
subordinatedebtpurchasedfromLuxembourgFinance,S.a.r.l.in2007.
Given the lack of any liabilities and the composition of its assets, 93% being
redeemablecommonstockandasubordinateloan,theExaminerconcludesthatthereis
insufficient evidence to support a finding that LSF was balance sheet insolvent as of
May31,2008,andAugust31,2008.
(n) PAMIStatlerArms
PAMIwasa Lehmanentitycreated to ownandmanage avarietyofrealestate
properties.Oneofitssubsidiaries,PAMIStatlerArms,wasestablishedtoholdtitleto
theStatlerArmsApartments,a297suiteapartmentcomplexinCleveland,Ohio.PAMI
StatlerArmstookownershipofthebuildinginMay2008.
According to the Chapter 11 petition filed by PAMI Statler Arms, it had $20
millioninassetsand$38.5millioninliabilitiesatthetimeofitsbankruptcyfiling.6193No
financialinformationisavailableforPAMIStatlerArmsinLehmansfinancialsystems.
Given the lack of data available on this entity, as well as the immaterial amount of
assetsinvolved,theExaminerisunabletodrawanyconclusionregardingthesolvency
ofthisentity.
6193Exhibit
A to Voluntary Petition, Docket 1, In re PAMI Statler Arms LLC, No. 0813664 (Bankr.
S.D.N.Y.Sept.22,2008).
1641
d) UnreasonablySmallCapital
As set forth supra, the avoidance of a prepetition transfer as constructively
fraudulent requires, among other things, one of three measuresof a debtors financial
condition to be satisfied: insolvency, unreasonably small capital, or an inability to
pay debts as they come due.6194 This Section addresses whether, and as of what date,
there is evidence sufficient to establish a finding that LBHI or an LBHI Affiliate had
unreasonablysmallcapital.Becauseofthefactintensivenatureoftheunreasonably
smallcapitaltest,thisSectiondrawsextensivelyuponthefactsandfindingssetforth
more fully in other Sections of this Report, but repeats those facts to the extent
necessarytoprovideclaritytothediscussionofundercapitalization.
Giventherelativelylimitednumberofreportedcasesapplyingtheunreasonably
smallcapitaltest,ascomparedtotheinsolvencytest,theunreasonablysmallcapitaltest
canfairlybecharacterizedasanalternativetestthatacourtmayconsiderintheevent
that it determines that the debtor was not insolvent as of the date of the challenged
transfer. As noted by Judge Richard Posner in a recent Seventh Circuit decision, the
unreasonably small capital test allows a court to assess the avoidability of a given
prepetitiontransferwithoutnecessarilyhagglingoverwhetheratthemomentofthe
6194See11U.S.C.548(a)(1)(B)(ii).
1642
transferthecorporationbecametechnicallyinsolvent,aquestionthatonlyaccountants
couldrelishhavingtoanswer.6195
This test seems particularly apt in the Lehman matter, as the unreasonably
smallcapitaltestcanallowafactfindertotakeabroaderviewofcertainrisks,suchas
liquidityrisk,thatarenotnecessarilyreflectedonabalancesheet.Financialinstitutions
such as Lehman have a relatively greater risk of failure due to a lack of liquidity, as
comparedtoariskoffailureduetothevalueoftheirliabilitiesexceedingthefairvalue
oftheirassets.AsnotedbyPaulShotton,LehmansGlobalHeadofRiskControl,inthe
aftermath of the near collapse of Bear Stearns, [l]iquidity is more important than
capital; most entities which go bankrupt do so because they run out of financing, not
becausethevalueoftheirassetsfallsbelowthevalueoftheirliabilities.6196
Accordingly,andinlightofthepurposeofthefraudulentconveyancelawsto
ensurethatpropertytransferredbythedebtorforlessthanreasonablyequivalentvalue
duringtheapplicableperiodisavailablefordistributiontothedebtorscreditorsthe
Examinerhasdeterminedthatitisprudenttoaddresstheunreasonablysmallcapital
test.
The Examiner emphasizes that a finding of unreasonably small capital is
germane only to the narrow question of evaluating the viability of certain claims to
6195Boyerv.CrownStockDistrib.,Inc.,587F.3d787,794(7thCir.2009).
6196See
Email from Paul Shotton, Lehman, to Christopher OMeara, Lehman (Apr. 15, 2008)
[LBHI_SEC07940_768467].
1643
avoid transfers as constructively fraudulent under Section 548(a)(1)(B) of the
Bankruptcy Code or under analogous sections of applicable state law. As
unreasonablysmallcapitaldenotesafinancialconditionshortofinsolvency,afinding
of unreasonably small capital is not relevant to evaluating claims that require a
finding of insolvency as one of their essential elements.6197 Moreover, a finding that a
transferisconstructivelyfraudulentdoesnotrequireorimplyafindingthatapartyto
thetransfercommittedanybadacts.6198Rather,thepurposeoffraudulentconveyance
lawistoprotectcreditorsfromlastminutediminutionsofthepoolofassetsinwhich
theyhaveinterestsandnottoidentifyorpunishbadactors.6199Forthesereasons,the
Examiners application of the unreasonably small capital test is relevant only to his
consideration of constructively fraudulent avoidance claims and is discussed only in
thatcontext.
As set forth in detail below, the Examiner has identified evidence that would
supportadeterminationbyafinderoffactthatLBHI,andeachoftheLBHIAffiliates
that relied on LBHI to provide funding or credit support, had unreasonably small
capital beginning early in the third quarter of 2008 and continuing through to the
applicablepetitiondate.TheExaminerhasalsoidentifiedevidencethatwouldsupport
6197 See Pereira v. Farace, 413 F.3d 330, 343 (2d Cir. 2005) (holding that a cash flowbased analysis that
projectsintothefuturetodeterminewhethercapitalwillremainadequateovertimeisnotrelevantto
determiningwhetheracorporationisinsolventundertheapplicableDelawarelaw.);butseeASARCO
LLCv.AmericasMiningCorp.,396B.R.278,395(Bankr.S.D.Tex.2008).
6198SeeInreFBNFoodServs.,Inc.,82F.3d1387,1394(7thCir.1996).
6199BondedFin.Servs.,Inc.v.EuropeanAmericanBank,838F.2d890,892(7thCir.1988).
1644
a contrary finding. As such, a future finder of fact would need to weigh carefully all
evidence to determine whether the unreasonably small capital element is satisfied.
Becauseconflictingevidenceexistsandbecausetheunreasonablysmallcapitaltestis
fuzzy6200andinfrequentlyconsideredbycourts,theExaminerexpressesnoopinionas
tohowsuchafinderoffactwouldfind.
(1) Summary
The unreasonably small capital test is a forwardlooking analysis that
considerswhether,andatwhatpoint,adebtorcouldhavereasonablyprojectedthatit
faced an unreasonable risk of insolvency given its business model and financial
condition.6201 As a highly leveraged investment bank that required tens of billions of
dollarsinovernightfunding,Lehmansprimaryinsolvencyriskwasthatitwouldnot
have sufficient funds to satisfy its debts asthey came due.6202 Thisrisk, referred to as
liquidityrisk,differsfrombalancesheetinsolvency,theconditionwherethefairvalue
oftheentitysassetsislessthanitsliabilities.
6200Boyerv.CrownStockDistribution,Inc.,587F.3d787,794(7thCir.2009).
6201SeeBoyerv.CrownStockDistrib.,Inc.,No.1:076CV409RM,2009WL418275,at*11(N.D.Ind.Feb.17,
2009) (describing the unreasonably small capital test as forwardlooking, requiring consideration of
liabilities the debtor would incur or contemplated transactions for which the remaining assets were
unreasonablysmall),affdinpart,revdinpart,Boyer,587F.3dat787;seealsoBrandtv.Hicks,Muse&Co.,
Inc. (In re Healthco Interl), 208 B.R. 288, 302 (Bankr. D. Mass. 1997) (describing unreasonably small
capitalasanunreasonableriskofinsolvency,notnecessarilyalikelihoodofinsolvencythatissimilar
to the concept of negligence, which is conduct that creates an unreasonable risk of harm to anothers
personorproperty);cf.InreVadnaisLumberSupply,Inc.,100B.R.127,137(Bankr.D.Mass.1989)(noting
thatunreasonablysmallcapital...encompassesdifficultieswhichareshortofinsolvencyinanysense
butarelikelytoleadtoinsolvencyatsometimeinthefuture).
6202Although Lehman and other investment banks measured their capital adequacy according to
metrics such as net leverage ratios and CSE Capital Ratios, as discussed below, these metrics do not
adequatelymonitororaddressaninvestmentsbanksliquidityrisk.
1645
Lehmanrelieduponrepofundingaformofshorttermsecuredfinancingto
support a substantial part of its less liquid assets.6203 After the near collapse of Bear
Stearns, Lehman recognized that its ability to obtain such financing was more
dependentonthemarketsconfidenceinLehmansviabilitythantheactualvalueofthe
underlyingassetbeingfinanced.6204Afterhavingengagedinacountercyclicalstrategy
ofincreasingitsrealestateassetsaswellasincreasingitspositionsinleveragedloans,
privateequityandotherlessliquidassets,bylate2007,Lehmanrecognizedtheneedto
reduce its firmwide leverage. By January 2008, Fuld had ordered Lehman to cut its
balancesheetinhalf,andbythesecondquarterof2008,Lehmanreversedcourseand
executedadeleveragingplaninthesecondquarterof2008towinbacktheconfidence
of the market and Lehmans lenders.6205 Notwithstanding Lehmans execution of this
plan, the market did not respond as Lehman had anticipated.6206 As discussed below,
sufficientevidenceexiststosupportadeterminationthatLehmankneworshouldhave
known that, beginning early in the third quarter of 2008, there was a reasonable
6203Lehman defined less liquid inventory positions as including derivatives, private equity
investments,certaincorporateloans,certaincommercialmortgagesandrealestatepositions.Lehman
BrothersHoldingsInc.,QuarterlyReportasofFeb.29,2008(Form10Q),atp.68(filedonApr.9,2008)
[LBEXDOCID1024435](LBHI10Q(Apr.9,2008)).
6204See, e.g., Email from Paul Shotton, Lehman, to Chris OMeara, Lehman (Apr. 15, 2008)
[LBHI_SEC07940_768467].
6205ErinCallan,Lehman,LeverageAnalysis[Draft](Apr.7,2008),atp.1[LBEXDOCID1303158].
6206StartinginJune2008,Lehmanssharepricewasapproachingits52weeklow,wouldsoonfallbelow
$30pershareandwouldnotagainreturntothatlevel.SeealsoBenLevisohn,Lehman:IndependentforHow
Long? The diversified investment bank does not have the requisite strength or size for the current environment.
But suitors are holding back for now, Business Week, June 11, 2008, available at
http://www.businessweek.com/investor/content/jun2008/pi20080610_650233.htm) (The market believes
Lehman hasnt fully cleaned up its balance sheet and that the worst is still to come, managements
assurancesnotwithstanding.).
1646
possibility,orrisk,thatLehmanwouldsufferamateriallossofmarketconfidenceinits
nearfuture,andthatthislossofconfidencewouldmanifestitselfasalossofabilityto
financeitslessliquidassetsthroughtherepomarket.
ThenextstepistoassesswhetherLehmanwasreasonablypreparedtoabsorbor
addressthisreasonablyforeseeablerisk.FollowingtheBearStearnsevent,theSECand
theFRBNYrequestedthateachoftheCSEsdevelopliquiditystressteststhataddressed,
among other things, a significant loss of repo financing of less liquid assets.6207
AlthoughLehmanprojectedthatitcouldsurvivesuchastressevent,thereissufficient
evidence to support a determination that certain of these projections were based on
assumptionsthatfailedtotakeintoaccountfactorsthatLehmanknew,orshouldhave
known, would directly impact its liquidity position in a stress event. In particular,
Lehman assumed that its clearing banks would provide unsecured credit on an intra
daybasisandthatoperationalfrictionwouldnothaveamaterialimpactonitsliquidity,
ineachcaseduringtheprojectedstressevent.
For the reasons discussed below, the Examiner finds that sufficient evidence
existstosupportafindingthat,beginninginthethirdquarterof2008andatalltimes
througheachapplicablepetitiondate,LBHIandeachoftheLBHIAffiliatesthatrelied
on LBHI to provide funding or credit support had unreasonably small capital to
engageintheirbusinesses.
6207Joint
Request of SEC and FRBNY: Liquidity Scenarios for CSEs (May 20, 2008),
[LBHI_SEC07940_505195].
1647
(2) AnalysisoftheUnreasonablySmallCapitalTest
(a) SummaryofLegalStandard6208
Courts and commentators have recognized that the criteria for determining
whetheracompanyhasunreasonablysmallcapitalarenotclearlydefined.6209There
isagreement,however,thattheunreasonablysmallcapitaltestisaforwardlooking
analysisthatexaminesnotonlyhowacompanyisperformingatagivenpointintime,
but also whether the company had sufficient resources to withstand reasonably
foreseeable downturns in its performance or in the broader market in which it
operates.6210
Todeterminewhetheracompanyhasunreasonablysmallcapital,courtshave
assessedboththenatureoftheenterpriseitselfandtheextentoftheenterprisesneed
forcapitalduringtheperiodinquestion.6211Inconductingthisanalysis,courtslookat
6208The legal standard for unreasonably small capital is discussed more fully in Appendix 1, Legal
Issues,atSectionIV.A.2.b.
6209In re Best Products Co., Inc., 168 B.R. 35, 54 (Bankr. S.D.N.Y. 1994) (noting that the test is far from
clear). There is no statutory definition of the term unreasonably small capital (or its equivalent,
unreasonably small assets) under the Bankruptcy Code or applicable state law. The unreasonably
small capital test requires judicial consideration of the overall state of affairs surrounding the
corporationandthechallengedtransferitself,andthusisgenerallyanalyzedandappliedonacaseby
casebasis.InreSuburbanMotorFreight,Inc.,124B.R.984,99899(Bankr.S.D.Ohio1990);seealsoCredit
Managers Assn of So. Cal. v. Federal Co., 629 F. Supp. 175, 183 (C.D. Cal. 1985) (describing the
unreasonablysmallcapitaltestasaquestionoffactthatmustbeascertainedonacasebycasebasis);
Barrettv.ContinentalIll.NatlBank&TrustCo.,882F.2d1,4(1stCir.1989)(Unreasonablyisclearlya
relativetermanddemands,forthepurposesof[Section5oftheUFCA],thesortofrelative,contextual
judgment which looks to both the ends served by 5 and the overall state of affairs surrounding the
transferorcorporationandthechallengedtransferitself.).
6210Moody v. Sec. Pacific Bus. Credit, Inc., 971 F.2d 1056, 1074 (3d Cir. 1992) (The critical question is
whetherthepartiesprojectionswerereasonable.);seealsoBoyer,2009WL418275,at*11;InreHealthco
Intl,208B.R.at302.
6211Barrett,882F.2dat4.
1648
allreasonablyanticipatedsourcesofoperatingfunds,whichmayincludenewequity
infusions, cash from operations, or cash from secured or unsecured loans over the
relevanttimeperiod.6212Inaddition,acompanymustaccountfordifficultiesthatare
likelytoarise,6213andotherwiseincorporatesomemarginforerror.6214Theobjectof
an unreasonably small capital analysis is to determine the moment . . . that
bankruptcyisaconsequencebothlikelyandforeseeable.6215
Application of the unreasonably small capital test to Lehman involves a fact
intensive twostep analysis. The first inquiry is whether and at what point it was
reasonably foreseeable that Lehman was at risk of losing access to the financing it
required to operate its business and to satisfy its obligations as they came due. The
secondinquiryiswhetherLehmansliquiditystresstests,whichprojectedthatLehman
couldsurviveaperiodduringwhichitwouldobtainreducedlevelsoffinancing,were
reasonablyconstructed.
6212Moody,971F.2dat1072n.24.
6213Id;InreTOUSA,Inc.,B.R.,Bankr.No.0810928,Adv.No.081435JKO,2009WL3519403,at*74
(Bankr. S.D. Fla. Oct. 30, 2009) (describing the test as whether a company has sufficient capital to
support operations in the event that performance is below expectations) (emphasis added); Carpenter v.
Roe,10N.Y.227,232(1851)(invalidatingaprebankruptcytransfermadeatatimewhenthedebtorwas
indebted,andhadreasontobelievethatinsolvencywouldbetheinevitableorprobableresultofwantof
success in the business in which he was engaged); In re Iridium Operating LLC, 373 B.R. at 344 (Bankr.
S.D.N.Y.2007).
6214Moody,971F.2dat1073.
6215Boyer,587F.3dat794.
1649
(b) LehmansCountercyclicalStrategy
InAugust2006,Lehmandecidedtopursueastrategytosignificantlyincreaseits
subprime lending and commercial real estate financing businesses.6216 In 2007, as the
subprime residential mortgage market deteriorated, Lehman made a countercyclical
betoncommercialrealestateontheassumptionthatthesubprimecrisiswouldnotspill
overintothecommercialmarket.6217AsignificantelementofLehmansstrategywasto
monetize certain of these assets through syndication or securitization.6218 Lehman
described itself in itsForm10Q forthethird quarterof2006asthemarketleaderin
mortgage and asset backed securitizations and other structured financing
arrangements.6219
6216SeeEmail from Jeffrey Goodman, Lehman, to Madelyn Antoncic, Lehman, et al. (Aug. 23, 2006)
[LBEXDOCID 1368052]; see also Ronald Marcus, U.S. Department of the Treasury, Office of Thrift
Supervision,ExaminersReportofLehmanBrothersHoldingsInc.(July7,2008),atpp.12(describingthe
strategicdecisiontogrowthebalancesheetasanoutsizedbetonrealestate.).
6217 Examiners Interview of Richard S. Fuld, Jr. Sept. 30, 2009, at pp. 1415; Examiners Interview of
JosephGregory,Nov.13,2009,atpp.78;ExaminersInterviewofMarkA.Walsh,Oct.21,2009,atpp.7
9.
6218SeeLehmanBrothersHoldingsInc.,AnnualReportforFY2007asofNov.30,2007(Form10K)(filed
onJan.29,2008),atp.104(LBHI200710K)(describingLehmansintenttosellthroughsecuritization
orsyndicationactivities,residentialandcommercialmortgagewholeloansweoriginate,aswellasthose
weacquireinthesecondarymarket);seealsoBinyaminAppelbaum,etal.,Fedsapproachtoregulationleft
banks exposed to crisis, Wash. Post, Dec. 21, 2009, available at http://www.washingtonpost.com/wp
dyn/content/article/2009/12/20/AR2009122002580.html (Rather than wait for borrowers to repay loans,
banks were adopting a technique called securitization. The banks created pools of loans and sold
investors the right to collect portions of the inflowing payments. The bank got its money upfront.
Equally important, under accounting rules it was allowed to report that the loans had been sold, and
thereforeitdidnotneedtoholdanyadditionalcapital.Butinmanycases,thebankstillpledgedtocover
lossesifborrowersdefaulted.).
6219LehmanBros.HoldingsInc.,QuarterlyReportasofAug.31,2006(Form10Q)(filedonOct.10,2006),
atp.18.
1650
TimothyGeithner,thethenPresidentoftheFRBNY,describedsecuritizationina
June9,2008speechasa$2.2trillionparallelfinancialsystemoutsideofthetraditional
bankingsystem.6220 The assets sofinancedwereassumed to bereadily saleable at fair
values, and the liquidity supporting them was assumed to be continuous and
essentiallyfrictionless,becauseithadbeensoforalongtime.6221
In 2007, it became apparent that the market for assetbacked securities (ABS)
begantobecomemoreilliquidinlightoftheweakperformanceofsuchsecuritiesthat
werebackedbysubprimemortgages:
Assetbacked securities . . . experienced the greatest degree of stress in

2007. The loss of the value of subprime mortgages throughout the year
ledtogrowinguncertaintyaboutthevalueofcreditinstruments suchas
collateralizeddebtobligations(CDOs)thatoftenincludedsuchsubprime
mortgages in what investors and ratings agencies had previously
consideredhighqualityassets.6222
FRBNY President Geithner described the state of the securitization markets
beginning in late 2007 as follows: The funding and balance sheet pressures on banks
were intensified by the rapid breakdown of securitization and structured finance
markets. Banks lost the capacity to move riskier assets off their balance sheets, at the
6220FRBNY President Timothy F. Geithner, Reducing Systemic Risk In A Dynamic Financial System,
Transcript of Remarks to The Economic Club (June 9, 2008), available at
http://www.newyorkfed.org/newsevents/speeches/2008/tfg080609.html (In early 2007, assetbacked
commercialpaperconduits,instructuredinvestmentvehicles,inauctionratepreferredsecurities,tender
optionbondsandvariableratedemandnoteshadacombinedassetsizeofroughly$2.2trillion.).
6221Id.
6222Senior Supervisors Group, Observations on Risk Management Practices during the Recent Market
Turbulence(Mar.6,2008)atp.1,availableathttp://www.newyorkfed.org/newsevents/news/banking/2008/
SSG_Risk_Mgt_doc_final.pdf.
1651
sametimetheyhadtofund,ortopreparetofund,arangeofcontingentcommitments
overanuncertaintimehorizon.6223
Thedisruptionsinthesecuritizationmarketputpressureonthebalancesheetsof
majorinvestmentbanks,asnotedbyS&PinaNovember2007report:
Recent disruptions in the subprime market and its contagion effects into
the leveraged finance, assetbacked commercial paper (ABCP), and CDO
spaces have substantially curtailed market liquidity. The sudden loss of
appetite for subprime and other highyield exposure has significantly
narrowedthesemarkets,whileuncertaintyregardingassetvaluationsleft
manyinstitutionsunabletounwindexposuresatfairmarketprices...As
aresult,themarketsfortheseassetshaveconsiderablyshrunk,whilethe
spiral effects have led to concerns with respect to the brokerdealers
fundingliquidityrisk.6224
Lehman,inaSeptember2007presentationtotheFinanceCommitteeofitsBoard
ofDirectors,observedthatthecommercialpaper,structuredfinanceandotherfinancial
markets had experienced significant turmoil in 2007.6225 Such turmoil began with
initial tremors in the subprime mortgage market at the end of 2006, and then spread
withthefailureoftwohedgefundsoperatedbyBearStearnsthatwereheavilyexposed
tosubprimemortgageloansinJune2007.6226Lehmanobservedthat,byJuly2007,the
fearofcontagionhadspreadtoothermarketscausingaroutinallcreditproducts,of
6223FRBNYPresidentTimothyF.Geithner,TranscriptofRemarkstoTheEconomicClub,NewYorkCity,
New York, Reducing Systemic Risk In A Dynamic Financial System, (June 9, 2008), available at
http://www.newyorkfed.org/newsevents/speeches/2008/tfg080609.html.
6224Diane Hinton, S&P, Liquidity Management In Times Of Stress: How The Major U.S. BrokerDealers Fare,
S&PRatingsDirect,Nov.8,2007,atpp.23[LBHI_SEC07940_439424].
6225Lehman,PresentationtotheFinanceCommitteeoftheBoardofDirectors,Risk,Liquidity,Capital&
BalanceSheetUpdate:RiskUpdate(Sept.11,2007),atp.4[LBEXDOCID505941].
6226Id.
1652
every rating including all the way up to AAAbonds.6227 Lehman concluded that the
assetbacked commercial paper market was facing challenging conditions, with very
little liquidity and that [f]unding for almost any type of mortgage or ABS product
driedup.6228
As Lehman executed its countercyclical strategy and the securitization and
structuredfinance markets deteriorated, the size of Lehmans balance sheet increased.
Lehmans reported gross assets grew from $504 billion at the end of FY 2006 to $691
billion by the end of FY 2007,6229 and its net assets grew by a similar proportion, from
$269billionto$373billionoverthesametimeperiod.6230Althoughbylate2007certain
senior Lehman personnel identified the need for Lehman to reduce the firmwide
leverage,Lehmansbalancesheetcontinuedtogrowthroughtheendofthefirstquarter
of2008,withgrossassetsofapproximately$786billionandnetassetsofapproximately
$397billion.6231Lehmansnetleverageratio,whichmeasuredtheratioofLehmansnet
assetsagainstitstangibleequitycapitalbase,6232increasedfrom14.5xattheendoffiscal
6227Id.
6228Id.
6229LBHI200710K,atp.29.
6230Id.Lehmancalculatednetassetsbystartingwithtotalassetsandexcludingfromthatamountthe
following three categories: (i) cash andsecuritiessegregatedandon deposit for regulatoryreasons and
otherpurposes;(ii)collateralizedlendingagreements;and(iii)identifiableintangibleassetsandgoodwill.
Id.atp.30n.3.
6231LBHI10Q(Apr.9,2008),atp.72.
6232Lehman defined tangible equity capital as stockholders equity and junior subordinated notes
minusidentifiableintangibleassetsandgoodwill.Tangibleequitycapitalwasusedasthedenominator
inLehmansnetleverageratiocalculation.LBHI200710K,atp.29.
1653
year2006to16.1xbytheendoffiscalyear2007.6233Lehmannotedthatitsnetleverage
ratiohadcreptbacktowardthehigherendofthepeergroupinrecentyears.6234
At the end of the second quarter of 2008, Lehman reported a quarterover
quarterreductionof$146.6billionofgrossassets,and$68.9billionofnetassets.6235The
asset reductions, together with the issuance of equity capital, contributed to the
reductioninLehmansgrossleverageratioto24.3xanditsnetleverageratioto12.06x
as ofthe end ofthe second quarterof 2008.6236Asdiscussed elsewhere in this Report,
Lehmansreported leverageratioswere enhanced(thatislowered)byits useofRepo
105 transactions.6237 At the end of the second quarter of 2008, Lehman proclaimed,
basedonitsreportednumbers,thatithaditslowestnetleverageratioinitshistoryas
a public company,6238 and Lehman CEO Richard Fuld stated that Lehmans capital
positionhadneverbeenstronger.6239
(c) LehmansRepoBookandLiquidityRisk
ThereporteddeleveragingofLehmansbalancesheetduringthesecondquarter
of 2008 allowed Lehman to project the appearance of capital adequacy to the extent
6233Id.
6234ErinCallan,Lehman,LeverageAnalysis[Draft](Apr.7,2008),atp.5[LBEXDOCID1303158].
6235Lehman Brothers Holdings Inc., Quarterly Report as of May 31, 2008 (Form 10Q) (filed on July 10,
2008),atpp.56,86(LBHI10Q(July10,2008)).
6236Id.atpp.55,56,89.
6237SeeSectionIII.A.4,whichdiscussesLehmansuseofRepo105/108transactions.
6238Lehman, Capital Adequacy & Liquidity Update (June 4, 2008), at p. 7, [LBHI_SEC07940_513590]

(DespiteaforecastlossinQ208,theactionstakenbyLehmaninthequarterwillresultinthestrongest
capitalandliquiditypositionstheFirmhaseverhad.).
6239FinalTranscriptofLehmanBrothersHoldings,Inc.SecondQuarter2008EarningsCall(June16,2008),
atp.4[LBHI_SEC07940_519082].
1654
measuredintermsoftheratioofitsassetstoitstangibleequitycapitalbase.Asnoted
above,however,LehmansGlobalHeadofRiskControlstatedthat[l]iquidityismore
importantthancapital,6240andLehmanrecognizedthat[l]iquidity,thatisreadyaccess
tofunds,isessentialtoourbusinesses.6241Lehmanwas,likeotherinvestmentbanks,
heavily reliant upon wholesale funding sources to finance the inventory on its
balance sheet.6242 Callan, in an interview after the Bear Stearns event, stated that
[l]iquidityisthethingthatwillkillyouinamoment.6243
Accordingly, the analysis as to whether Lehman had unreasonably small
capitalmustbeginwithLehmansexposuretoliquidityrisk,whiletakingintoaccount
other metrics of capital adequacy. Lehmans liquidity risk arose primarily from its
relianceuponshorttermrepofundingtosupportassetsthatwouldtakelongertosellif
theycouldnotbefinanced,particularlyinastressedenvironment.6244Theothermetrics
of capital adequacy that Lehman measured, such as Lehmans reported cash capital
6240See Email from Paul Shotton, Lehman, to Chris OMeara, Lehman (Apr. 15, 2008)
[LBHI_SEC07940_768467].
6241LBHI200710K,atp.17.
6242Diane Hinton, S&P, Liquidity Management In Times Of Stress: How The Major U.S. BrokerDealers Fare,
S&PRatingsDirect,Nov.8,2007,atp.2[LBHI_SEC07940_439424].
6243Maria Bartiromo, Lehman CFO Erin Callan: Back from Ugly Monday, Business Week, Mar. 20, 2008,
availableathttp://www.businessweek.com/magazine/content/08_13/b4077023363140.htm?chan=
magazine+channel_the+business+week.
6244See, e.g, Tobias Adrian, et al., The Federal Reserves Primary Dealer Credit Facility, 15 Current Issues In
Economics and Finance, at pp. 34 (Aug. 2009) available at

http://www.newyorkfed.org/research/current_issues (Originally focused on the highest quality
collateralTreasuryandagencydebtrepotransactionsby2008weremakinguseofbelowinvestment
gradecorporatedebtandequitiesandevenwholeloansandtrustreceipts.Thisshifttowardlessliquid
collateral increased the risks attendinga crisis in the market since, in the event of a crisis,selling these
securitieswouldlikelytaketimeandoccuratasignificantloss.).
1655
surplus, its Equity Adequacy Framework and its CSE Capital Ratios, did not fully
account for the nature and extent of Lehmans liquidity risk, especially following the
BearStearnsevent.
(i) BearStearnsDemonstratestheLiquidityRisk
AssociatedwithRepoFinancing
Lehmanwashighlydependentuponrepofunding,6245aformofsecuredlending
structured as a sale of assets and forward commitment to repurchase the same or
similarassetswithaslightmargin.6246Becauserepofundingistypicallyshortterm,and
creditisdesignedtobeprovidedonanoversecuredbasis,6247itwasgenerallyviewedas
a reliable form of shortterm financing, even in a stressed environment.6248 Robert
Azerad,LehmansGlobalHeadofAssetandLiabilityManagement,statedthat,priorto
theBearStearnsevent,liquidity riskmanagerswereconcernedthattheirfirmswould
6245LBHI200710K,atp.17(discussingLehmansrelianceoncontinuousaccesstotherepomarket).
6246FRBNY, Repurchase and Reverse Repurchase Transactions, Fedpoint, available at

http://www.newyorkfed.org/aboutthefed/fedpoint/fed04.html. The repo market has a long pedigree,
datingbacktotheearly20thcenturywhentheFederalReserveusedreposingovernmentsecuritiesto
eitherdrainoraddliquiditytothebankingsystem.SeeMooradChoudhry,TheRepoHandbook6(2002).
6247For each class or type of asset, there is a haircut provided by the liquidity provider. For lesser
quality collateral, the haircut would be larger. In this manner, the repo counterparty in the event of a
defaultwasabletosellthecollateralsuchthatevenifitwassoldatlessthanpar,solongasitwasnot
soldforlessthanhaircut,therepocounterpartywouldnotsufferaloss.
6248See Lehman, Liquidity Stress Scenario Analysis (Apr. 21, 2008), at p. 8 [LBEXDOCID 008608]
(assertingthat[l]iquidityriskatthebrokerdealersisthoughttobelessofanissuebecausethe[r]epo
marketisthoughttobemuchmorereliablethanunsecuredmarketwitha[l]owcreditriskbecauseof
thecollateralreceivedbythelenderandthehaircutandalsoduetothe[s]ophisticatednatureofmost
lenders.).
1656
lose access to unsecured forms of financing, but not necessarily access to repo
funding.6249
The near collapse of Bear Stearns in March 2008 was a paradigmatic event
because it demonstrated that repo funding, even when supported by relatively high
qualityassets,couldproveunreliableinacrisis.Inanumberofpresentations,Lehman
quotedthenSECChairmanChristopherCoxsobservationsandconclusionsregarding
theliquiditylessonslearnedfromtheBearStearnsevent,wherehedescribedthecause
ofthenearcollapseofBearStearnsasbeginningwithareluctancetodealwithBearon
anunsecuredbasis,whichextendedtosecuredlendingonlessliquidandlowerquality
assetsandlater,aninabilityofBearStearnstoobtainsecuredfinancingevenonhigh
quality agency securities. 6250 Chairman Cox also observed that [t]he Bear Stearns
experiencehaschallengedthemeasurementofliquidityineveryregulatoryapproach,
notonlyhereintheUnitedStatesbutaroundtheworld.6251AzeradtoldtheExaminer
that the Bear Stearns event shattered commonly held assumptions about the
market.6252
6249ExaminersInterviewofRobertAzerad,Sept.23,2009(secondinterview),atp.4.
6250Lehman,LiquidityManagementAtLehmanBrothers,PresentationtotheS&P(May15,2008),atp.20
[LBEXDOCID008669].
6251Id.;seealsoLehman,Leverage,andLiquidity,PresentationtotheFederalReserveUpdateonCapital,
(May 28, 2008), at p. 6 [LBHI_SEC07940_062581]; Lehman, Project Green: Liquidity & Liquidity
Management[Draft](June2008),atp.19[LBHI_SEC07940_844120].
1657
(ii) QualityandTenorofLehmansRepoBook
ThenatureandextentofLehmansliquidityriskisdemonstratedthroughabasic
analysis of the composition of Lehmans repo book. Two key criteria that Lehman
monitored were the quality of the repo collateral and the tenor, or term, of the repo
agreements(e.g.,overnight).Lehmandisclosedinitsquarterlyreport,orform10Q,for
the second quarter of 2008 that it had $188 billion of repo financing, $105 billion of
whichwas secured bynongovernment,nonagency collateral.6253Lehman specifically
trackeditsrepocollateralthatwasnotgovernmentandagencyfixedincomesecurities
governmentandagencysecuritieswereperceivedashighlyliquidformsofcollateral
invirtuallyanymarketcondition.6254AsofMay30,2008,thecompositionofLehmans
nongovernment,nonagencyrepobookwasasfollows:6255
CollateralType Amount($billion)
AssetBacksInvestmentGrade 25.4
AssetBacksNonInvestmentGrade 2.0
C1InvestmentGradeConvertibles 1.5
C2NonInvestmentGradeConvertibles 2.3
6253LBHI 10Q (Apr. 9, 2008), at pp. 8485. Lehman thus had $83 billion of government and agency
inventorythatwasusedtogenerateshorttermfundingthroughtherepomarket,although$71billionof
this funding was used in matched book transactions to provide financing to Lehmans prime broker
clients(throughreverserepotransactions).Theremaining$12billionofcashgeneratedthroughtherepo
marketwascashforLehmansliquiditypool.SeeEmailfromRobertAzerad,Lehman,toThomasLuglio,
Lehman,etal.(June26,2008)[LBHI_SEC07940_522788].
6254See FRBNY, System Open Market Account, Fedpoint (Mar. 2009), available at
http:/www.newyorkfed.org/aboutthefed/fedpoint/fed27.html (describing how the New York Fed uses
Open Market Operations to control the money supply by lending money to primary dealers in
governmentsecuritiesinexchangeforhighqualitysecuritiesasgeneralcollateralagainsttherepofunds);
see also FRBNY, Understanding U.S. Government Securities Quotes, Fedpoint (Aug. 2007), available at
http://www.newyorkfed.org/aboutthefed/fedpoint/fed07.html(BecausethemarketforU.S.Government
securitiesisbothglobalandhighlycompetitive,pricestendtobesimilarthroughouttheworld.).
6255Lehman,GlobalLiquidityMIS(May30,2008)atp.20[LBEXDOCID1058911].Notethetotaldiffers
slightlyfromthesumoftheparts,whichwebelieveisduetorounding.
1658
CorporatesInvestmentGrade 12.8
CorporatesNonInvestmentGrade 8.2
EMG(EmergingMarketsbonds) 7.1
Equities 23.4
MoneyMarkets 7.3
Muni 2.2
PrivateLabelsHighYield 2.3
PrivateLabelsInvestmentGrade 9.9
ResidentialWholeLoan 1.1
Total 105.3
Lehman, for internal reporting purposes, divided its nongovernment, non
agency repo book into two categories: assets that were eligible to be funded by the
FederalReserveandEuropeanCentralBank(ECB),andnoncentralbankeligibleassets.
According to its internal analysis, from May 30, 2008 to July 3, 2008, Lehmans non
government,nonagencyrepobookrangedbetween$105billionand$112billion,and
its nongovernment, nonagency repo book that was also noncentral bank eligible
rangedbetween$60billionand$67billion.6256Inotherwords,approximately60percent
of its nongovernment, nonagency repo book was composed of noncentralbank
eligible assets assets that are less liquid, by definition, because central banks would
notacceptthemascollateral.
Basedonthecategorizationofitsnongovernment,nonagencyrepobookinthe
abovetable,Lehmanwasrelyinguponrepofundingtofinancecertainofitslessliquid
noninvestment grade and high yield assets. Further, by the fall of 2007, Lehman
understoodthatthemarketwasbecominglessliquidforcertainofitsinvestmentgrade
6256Lehman,LiquiditySlides(July29,2008),atp.8[LBEXDOCID1300268].
1659
assets.InaSeptember11,2007presentationtotheFinanceCommitteeoftheBoardof
Directors, Lehman noted that the fear of contagion had spread from subprime
mortgage loans to other credit products of every rating including all the way up to
AAA bonds.6257 In February 2008, it was reported that [t]he seizure in the credit
marketscausedbythecollapseofsubprimemortgagesismakinginvestorsdoubteven
theAAAratedsecuritiesofcompanieswithinvestmentgradecredentials.6258
To the extent that repo funding, which is shortterm in nature, was used to
financelongerterm,lessliquidassets,therewasamaturitymismatchthatcouldexpose
Lehman to liquidity risk. Lehman monitored the tenor of its nongovernment, non
agencyrepofunding,andinaninternalpresentationnotedthat,asoftheendofthefirst
quarter2008,56%ofitsrepofundingwasovernight,andanadditional18%hadaterm
oflessthanoneweek.6259Lehmanacknowledgedthat[d]ailyrefinancingriskishigher
than we would want.6260 By the end of the second quarter of 2008, of its $105 billion
nongovernment,nonagencyrepobook,Lehmanwasfunding42%($43.9billion)onan
6257Lehman, Risk, Liquidity, Capital & Balance Sheet Update: Risk Update, Presentation to the Finance
CommitteeoftheBoardofDirectors(Sept.11,2007)at4[LBEXDOCID505941].
6258AbigailMoses,InvestmentGradeDefaultstoRise,CreditModelsShow(Update2),Bloomberg.com(Feb.
15, 2008), available at http://www.bloomberg.com/apps/news?pid=20601087&sid=aIy82dumycXg&refer=

home.
6259Lehman,FundingLehmanBrothers,(Sept.10,2008),atp.13[LBHI_SEC07940_739985].
6260Lehman,LiquidityUpdate(Apr.1,2008),atp.6[LBEXDOCID1300141].
1660
overnight basis, and an additional 19% ($19.7 billion) with a term of less than two
weeks.6261
Theriskaccompanyingrelianceuponshorttermfunding tosupportlongterm,
illiquid assets was well recognized, particularly in the aftermath of the Bear Stearns
crisis.Forexample,FRBNYPresidentGeithnernotedinhisJune2008speech:
Thescaleoflongtermriskyandrelativelyilliquidassetsfinancedbyvery
shortterm liabilities made many of the vehicles and institutions in this
parallel financial system vulnerable to a classic type of run, but without
the protections such as deposit insurance that the banking system has in
place to reduce such risks. Once the investors in these financing
arrangementsmany conservatively managed money fundswithdrew
or threatened to withdraw their funds from these markets, the system
became vulnerable to a selfreinforcing cycle of forced liquidation of
assets, which further increased volatility and lowered prices across a
varietyofassetclasses.6262
Lehman internally measured and monitored its repo book at risk, which
assessed its repo book in terms of asset quality and tenor of funding in order to
determinehowmuchsecuredfundingLehmancouldexpecttoloseinacrisis.6263Asof
6261Lehman,2008Q2LiquidityMetrics,Version2,(June14,2008),atp.18[LBHI_SEC07940_601022].
6262FRBNY President Timothy F. Geithner, Reducing Systemic Risk In A Dynamic Financial System,
Transcript of Remarks to The Economic Club (June 9, 2008), available at
http://www.newyorkfed.org/newsevents/speeches/2008/tfg080609.html.
6263ShortlyaftertheBearStearnsevent,Lehmanrecognizedthatinastressevent,asubstantialportionof
its repo book would be at risk, and Lehman modeled this impact. Lehman, Liquidity Stress Scenario
Analysis(Apr.21,2008),atp.5[LBEXDOCID008608](showing$25.3billionnetlossofsecuredfunding
onthefirstdayofastressevent).AsofJune2008,Lehmanbeganinternallymeasuringitsrepobookat
riskinitsperformanceofstresstests.See,e.g.ApocalypseNowliquidityscenarioasofJune12,2008
[LBEXDOCID 022363]; Apocalypse Now Liquidity Scenario as of July 10, 2008 [LBEXDOCID
1300118].AsofAugust1,2008,LehmanbeganinternallytrackingrepoatriskinitsdailyliquidityMIS
reports.See,e.g.,Lehman,GlobalLiquidityMIS(Aug.1,2008),atp.14[LBEXDOCID1058944](showing
$55.7 billion of repo at risk); Lehman, Global Liquidity MIS (Aug. 4, 2008), at p. 14 [LBEXDOCID
1058945] (showing $56.9 billion of repo at risk). Lehman continued to track this repo book at risk
1661
June12,2008,forexample,Lehmanprojecteditcouldlose,inastressedenvironment,
approximately$56.7billionofrepocapacityoutofits$107.9billiontotalrepobookfor
nongovernment,nonagencycollateral.6264Thus,aftertheBearStearnsevent,Lehman
wasincreasinglyawareofthenatureandextentofitsliquidityrisk,bothintermsofthe
qualityoftherepobookandthematuritymismatch.
(d) DeleveragingtoWinBackMarketConfidence
Notwithstandingthetechnicalcomplexityoftheirdaytodaybusiness,financial
institutions cannot operate absent the fundamental ability to trade with third parties.
That ability, in turn, requires those potential counterparties to have confidence in the
financialinstitutionspecifically,theinstitutionsabilitytosatisfyitsobligationstoits
counterparties.Inthismanner, asS&PnotedinaMay2008report,investmentbanks
relyontheirreputationsinallaspectsoftheirbusiness,fromfacilitatingtradingand
financialadvisorywork,tofindingnewinvestments,toborrowingcapital.6265Thus,the
most troublesome crisis that these firms can face is a crisis of confidence in the
firm.6266TheimportanceofconfidenceandcredibilitytoLehmansfranchiseisevident
inthematerialsLehmanusedtotrainitstraders,whichemphasizedthat[c]redibility
metric through the week leading up to its bankruptcy filing on September 15, 2008. See, e.g., Lehman,
LiquidityManagementMIS(Sept.8,2008),atp.2[LBEXDOCID022279](showing$56.5billionrepoat
risk);Lehman,LiquidityUpdate(Sept.10,2008),[LBHI_SEC07940_845894],atp.8.
6264ApocalypseNowliquiditystressscenarioasofJune12,2008[LBEXDOCID022363].
6265MatthewAlbrecht,S&P,InvestmentServicesIndustrySurvey(May29,2008),atp.1.
6266Id.
1662
takesyearstoearn,andonedaytolose.6267Azeradconfirmedthatconfidenceisavery
fleetingconceptthatcoulddisappearinaday.6268
Giventhe natureandtheextentofLehmansliquidityrisk,the nextstep inthe
unreasonably small capital analysis is to assess whether (and if applicable, when)
Lehman could or should have anticipated that it could be facedwith a loss of market
confidencethatwouldmateriallyimpairitsabilitytoobtainfinancing.
Immediately following the near collapse of Bear Stearns, Lehman was widely
viewedasoneofthenextmostvulnerableinvestmentbanks.6269EricFelder,Lehmans
US head of Global Credit Products, in a March 26, 2008 email to Herbert Bart
McDade,thethenGlobalHeadofLehmansCapitalMarketsEquitiesGroup,explained
the risk facing Lehman in light of Lehmans repo funding maturity mismatch and the
sizeandilliquidityofLehmansrealestaterelatedinvestments:
6267KentaroUmezaki,Lehman,LehmanBrothers1998LiquidityRiskCaseStudy,atp.13[LBEXDOCID
251244].
6269The assessment that Lehman was seen as the next most vulnerable was noted by Federal Reserve
chairman Ben S. Bernanke, former Treasury Secretary Henry M. Paulson, Jr., and present Treasury
Secretary and former FRBNY President Timothy F. Geithner in their interviews with the Examiner.
Examiners Interview of Ben S. Bernanke, Dec. 23, 2009, at p. 3; Examiners Interview of Timothy F.
Geithner, Nov. 24, 2009, at p. 3; Examiners Interview of Henry M. Paulson, Jr., June 25, 2009, at p. 11.
This view reflects reports in the financial press immediately following Bear Stearns. For example, on
March20,2008,an articleappeared onPortfolio.comstating, After the [near] collapse[ofBearStearns],
Wall Streets attention naturally turned to the other investment banks, especially Lehman Brothers,
perceivedasthemostvulnerable.JesseEisinger,TheDebtShuffle:WallStreetcheeredLehmansearnings,
but there are questions about its balance sheet, Portfolio.com (Mar. 20, 2008), available at
http://www.portfolio.com/newsmarkets/top5/2008/03/20/LehmansDebtShuffle.EricFelderforwarded
thearticletoIanLowitt,withthenote,bunchofpeoplelookingatthisarticle.EmailfromEricFelder,
Lehman, to Ian Lowitt, Lehman (Mar. 23, 2008) [LBHI_SEC07940_625905]. Lowitt responded, Doesnt
help.EmailfromIanLowitt,Lehman,toEricFelder,Lehman(Mar.23,2008)[LBHI_SEC07940_625905].
1663
Everyfinancialfailurehasbeentheresultofnotbeingmatchfunded.Im
scared our repo is going to pull and our 7b over overnight [commercial
paper] is going to go away mid april. . . . We need to set up for
[commercialpaper]goingtozeroandameaningfulportionofoursecured
repofading(notbecauseitmakessensebutjustbecause)....Thereality
of our problem lies in our dependence on repo and the scale of the real
estaterelatedpositionswhichwilltakelongertosell.6270
In response to Felders warnings, Ian Lowitt, who was then Lehmans cochief
administrativeofficer(andwhowouldlaterbecomeLehmansCFO),reassuredFelder
by emphasizing the availability of the liquidity pool, Lehmans expectation that it
would be able to obtain temporary funding from central banks, as well as ongoing
effortstodeleveragethebalancesheet:
The[commercialpaper]fadingwilljustcomeoutoftheexcessliquidityin
holdingcompanyliquiditypoolso32bngoesto24.LBIwillbeableto
funditselfviathefedwindowinonewayoranothertogetflatcash.LBIE
is getting securities into form can pledge via bankhaus to the [European
CentralBank],tothetuneof4bnorsobymidApril.Thereisalotofterm
in thesecuredfunding book.Thedeleveragingfocusisnowreal. Itwill
betoughbutwearemuchmoreactivethantheothers....Peopleareon
it.Agreetherewillbeanotherrun,butbelieveitwillbeindustrywidenot
Lehmanspecific. You arenot Cassandra, cursedbyApollotobe ableto
seethefuturebuthavenoonebelieveyou!!6271
Lehmansbalancesheet,intermsofitssizeandcomposition,wasamainfocusof
the market in late 2007 and early 2008, and Lehman was focused upon reducing its
leveragenumbersbyraisingequityandsellingorotherwisetransferringassetsoffofits
balancesheetinordertoengendermarketconfidence.Forexample,Callan,Lehmans
6270Email from Eric Felder, Lehman, to Herbert Bart McDade, Lehman (Mar. 26, 2008)
[LBHI_SEC07940_32640001].
6271EmailfromIanLowitt,Lehman,toEricFelder,Lehman(Mar.26,2008)[LBHI_SEC07940_326400].
1664
CFOatthetime,statedinaninternalApril7,2008presentationthatdeleveragingwas
designed to win back the confidence of the market, lenders and investors.6272 The
presentationdemonstratesthat,asofApril2008,Lehmanrecognizedthatithadalready
lostsomemeasureofmarketconfidence,andinparticular,theconfidenceofLehmans
lenders.
(e) BeginningintheThirdQuarterof2008,LehmanCould
HaveReasonablyAnticipatedaLossofConfidenceWhich
WouldHaveTriggeredItsLiquidityRisk
Prior to Lehmans earnings announcement for the second quarter of 2008, on
June 2, 2008, S&P downgraded Lehmans longterm rating from A+ to A,
expressingconcernaboutpersistentdislocationsinglobalcapitalmarkets[that]could
furtherweighoncoreoperatingperformanceforthesecuritiesindustryasawhole.6273
Although S&PacknowledgedLehmans stable fundingprofileand excessliquidity
position,S&PnotedthatLehmansrepocapacitycouldbeadverselyaffectedifthere
isachangeinmarketperceptionofthefirm,howeverillfounded.6274
LehmannotedthatinaJune3,2008conferencecallwithS&P,theratingsagency
referredtoLehmanscapitalraisesduringthequarterandstatedthatLehmandoesnot
6272Erin Callan, Lehman, Leverage Analysis [Draft] (Apr. 7, 2008), at p. 1 [LBEXDOCID 1303158]. She
alsonotedthat,inadditiontodeleveraging,Lehmanneededtousemoreconservativetermstructuresto
fundlessliquidsecurities(EMG,highyield,E2andE3equities).Id.atp.14.
6273SeeDianeHinton,S&P,ResearchUpdate:LehmanBrothersHoldingsInc.RatingLoweredToAFromA+;
Outlook Negative, S&P RatingsDirect, June 2, 2008, at p. 2 [LBHI_SEC07940_512922], available at

http://www2.standardandpoors.com/spf/pdf/events/fiart56308.pdf.
6274Id.
1665
have a capital issue at this time.6275 Lehman also stated its belief that the S&P
downgradedidnotfullyreflect oracknowledgeLehmans materialimprovement[s]
initsalltimelowfornetleverageoritssignificantreductioninitsexposuretohigh
riskassets.6276
Lehmanrecognizedandanticipatedtheimpactofthisdowngrade,andonJune
4,2008, responded bypreparing awritten presentationentitled, Capital Adequacy &
Liquidity,whichwasintendedforLehmanssignificantrepocounterparties6277andin
which Lehman downplayed the anticipated action as reflecting industry concerns,
insofaritsratingsrelativetomostofitsdirectpeersdidnotchange.6278
Prior to the opening of business on June 9, 2008, Lehman announced that it
intended to raise $6 billion through offerings of common stock and noncumulative
mandatoryconvertiblepreferredstock,andthatitexpectedtoreportanetearningsloss
of $2.8 billion for the second quarter of 2008.6279 These announcements were reported
upon shortly before 7:00 a.m. EST on June 9, 2008 by the Wall Street Journal
6275Lehman,CapitalAdequacy&Liquidity(June4,2008),atp.19[LBHI_SEC07940_513590].
6276Id.
6277Id.atp.18.
6278SeealsoDianeHinton,S&P,ResearchUpdate:LehmanBrothersHoldingsInc.RatingLoweredToAFrom
A+; Outlook Negative, S&P RatingsDirect (June 2, 2008), at p. 2 [LBHI_SEC07940_512922], available at

http://www2.standardandpoors.com/spf/pdf/events/fiart56308.pdf(statingthatratingswerealsolowered
forMorganStanleyandMerrillLynch&Co.,Inc.).
6279Lehman,PressRelease:LehmanBrothersAnnouncesExpectedSecondQuarterResults(June9,2008),
at p. 1 [LBHI_SEC07940_035278287]; Lehman,Press Release:Lehman Brothers AnnouncesOfferings of

Common Stock and Mandatory Convertible Preferred Stock (June 9, 2008), at p. 1
[LBHI_SEC07940_221826263].
1666
MarketWatch.6280 This loss was Lehmans first as a public company.6281 Although the
markethadanticipatedaloss,itssizewasnearly10timeswhatmanyanalystshadbeen
predicting for Lehman.6282 At 10:00 a.m., Lehman, led by its thenCFO Erin Callan,
hosted a preliminary earnings call regarding its second quarter performance and
financialcondition.6283Tooffsetthenegativeearningsreport,Lehmanemphasizedthat
it had engaged in and successfully executed an aggressive deleveraging effort over
the courseof thesecondquarterof2008,thatalargepart of the reduction occurred
with less liquid asset categories, and that it had raised $6 billion in new equity. 6284
Lehman also stated that the effect of these efforts was to reduce Lehmans gross
leverage ratio to less than 25 times equity, and its net leverage ratio to less than 12.5
timesequity.6285Notwithstandingtheearningsloss,Lehmanspositionwasthatitsgoal
for the quarter was to bring down gross and net leverage, and that Lehman had
6280SteveGilsi,LehmanBrotherstopost$3blnloss;sets$6blnstocksale,WallStreetJournalMarketWatch,
June 9, 2008, available at http://www.marketwatch.com/story/lehmanbrotherstopost3blnlosssets6

blnstocksale?siteid=bnbh.
6281Ben White, et al, Lehman targets up to $6bn in fresh capital, Financial Times (June 6, 2008), available at
http://www.ft.com/cms/s/0/51c1624c341711dd869b0000779fd2ac.html.
6282SusanneCraig,LehmanSettoRaise$5BillionAmidLosses,WallStreetJournal,June9,2008,availableat
http://online.wsj.com/article/SB121296377617855623.html?mod=djemalertMARKET(Untilrecently,most
analystswhofollowLehmanhavebeenpredictingalossofabout$300million.).
6283TranscriptofLehmanBrothersHoldingsInc.SecondQuarter2008PreliminaryEarningsCall(June9,
2008)[LBHI_SEC07940_592160].
6284Id.atp.2.
6285Id.
1667
accomplishedthisgoal.6286Thus,Lehmanmadeitscaseforwhythemarketshouldnot
loseconfidenceinitscorefranchiseorcapitalposition.
However, notwithstanding this presentation, on June 9, 2008, Fitch Ratings
issued a ratingsdowngradefor Lehman,citingincreasedearningsvolatility, changes
initsbusinessmixduetocontractioninthesecuritizationandstructuredcreditmarkets
andthelevelofriskyassetsexposingearningstochallengesinhedgeeffectiveness.6287
Fitch noted that [d]espite [its] asset sales, Lehmans exposure to higher risk asset
categoriesasapercentofFitchcorecapitalishigherthan[its]peers.6288Further,Fitch
expressed concern that Lehmans deleveraging was removing its most attractive
assetsfrom its balance sheet, leaving a concentrated level of least desirable or more
problematic assets.6289 Moodys similarly changed Lehmans outlook from stable to
negative on June 9, despite Lehmans June 6 announcement of its $6 billion equity
raise.6290Moodysstatedthatitsdecisionreflecteditsconcernaboutriskmanagement
decisions that resulted in elevated real estate exposures and the subsequent
ineffectivenessofhedgestomitigatetheseexposuresintherecentquarter.6291
6286Id.atp.3.
6287FitchRatingsPressRelease:FitchDowngradesLehmanBrothersLT&STIDRstoA+/F1;Outlook
Negative (June 9, 2008), available at http://www.prinside.com/fitchdowngradeslehmanbrotherslt

r633111.htm.
6288Id.
6289Id.
6290RubyMcDermid,MoodysdowngradesLehmantonegativefromstable,WallStreetJournalMarketWatch
June 9, 2008, available at http://www.marketwatch.com/story/moodysdowngradeslehmantonegative

fromstable.
6291Id.
1668
Following the preliminary earnings call on June 9, the market had an
opportunitytoreflectontheearningsannouncement,Lehmansreporteddeleveraging
and Lehmans $6 billion equity raise. There is evidence sufficient to support a
determinationthat,notwithstandingLehmansplantowinbacktheconfidenceofthe
market,itsplanhadnotsucceeded.
The price of Lehmans common stock could support a determination that the
stepstakenbyLehmanthroughoutthesecondquarterandthefirstpartofJunedidnot
resultinincreasedmarketconfidence.Fromthebeginningof2008throughtheendof
thesecondquarterof2008,Lehmanscommonstocktradedinrangebetweenahighof
$66 per share on February 1, 2008 to a low of $31.75 on March 17, 2008, immediately
afterthenearcollapseofBearStearns.StartinginJune2008,Lehmanssharepricewas
approachingits52weeklow,wouldsoonfallbelow$30pershareandwouldnotagain
return to that level.6292 On June 12, 2008, Lehmans stock opened at $21.35/share, and
closed at $21.17/share lows that Lehman had not reached since 1996 and the
volumeontradingofLehmanssharesreachedanalltimehighofover173milliona
level of trading that would only be eclipsed in Lehmans final week prior to the
bankruptcyfiling.6293
6292ThelasttimeLehmansstockhadtradedbelow$30/sharewasinSeptemberandOctober1998in
theaftermathofthecollapseofLongTermCapitalManagementandtheRussianSovereignDebtCrisis.
AllhistoricalpricinginformationispubliclyavailablefromsitessuchasYahoo!Finance.
6293Id.
1669
Press reports at that time are also an indicator of the declining confidence in
Lehman. On June 11, 2008, Robert Azerad forwarded to Paolo Tonucci two articles
fromthatday.6294ThefirstarticlefromBusinessWeek,entitled,Lehman:Independent
forHowLong?concludedwithaquotefromananalyst:Lehmanisnext.Whenyou
have a pack of dinosaurs, the slowest gets picked off.6295 The second article, a
commentaryfromJonathanWeilofBloomberg.com,stated:
Lehman reported a $2.8 billion quarterly loss on June 9, the same day it
saidithadraised$6billioninfreshcapital.Investorsseemedsurprised,
judgingbythestocks15percentdeclinesincethen.Theyshouldnthave
been.WallStreetstockanalystswerepredictingamuchsmallerloss.Yet
Lehmans market capitalization, at $19.2 billion, is now almost $7 billion
lessthanthecompanys$26billionbookvalue,orassetsminusliabilities.
ThatsuggeststhatthemarketbelievesLehmanhasntfullycleanedupits
balancesheetandthattheworstisstilltocome,managementsassurances
notwithstanding.6296
InhisemailtoTonucci,Azeraddescribedthesearticlesas[r]epresentativeofthetone
ofthemarket.6297
OnJune12,LehmanannouncedthatitwasreplacingitslongstandingPresident
andCOO,JosephGregory,aswellasCallan.6298AsdescribedinofficialLehmantalking
6294Email from Robert Azerad, Lehman, to Paolo Tonucci, Lehman (June 11, 2008)
[LBHI_SEC07940_517806809].
6295Ben Levisohn, Lehman: Independent for How Long? Business Week, June 11, 2008, attached to email
fromRobertAzerad,Lehman,toPaoloTonucci,Lehman(June11,2008)[LBHI_SEC07940].
[LBHI_SEC07940_517806809] (Jonathan Weil, Lehmans Greatest Value Lies In Lessons Learned,

Bloomberg.com (June 11, 2008), attached to email from Robert Azerad, Lehman, to Paolo Tonucci,
Lehman(June11,2008)[LBHISEC07940].
[LBHI_SEC07940_517806].
1670
points distributed to Lehman managers for internal distribution, these senior
management changes were made in an effort to regain the confidence of investors
anditsbusinesspartners,andtorepairthefirmserodedcredibility.6299
Also,onJune12,2008,oneofLehmansclearingbanks,Citigroup,requestedthat
LehmanprovideitwithasubstantialcashdeposittocoveritsexposuretoLehmanon
anintradaybasis,inaninitialamountofbetween$3billionand$5billion,whichwas
laternegotiateddowntoa$2billioncomfortdeposit.6300Inanemailsentinternally
between Citigroup personnel on that date, Citigroup risk manager Thomas Fontana
stated:
6298SeeAlistairBarr,et.al,LehmanCFOCallan,COOGregoryoustedfromposts,MarketWatch,June12,2008,
available at http://www.marketwatch.com/story/lehmanscfoandcoooustedasturmoiltakesanew
turn2008612111300.
6299Lehman,President,COO,CFOChanges:InternalTalkingPoints(June12,2008),atp.1[LBEXDOCID
362070], email from George Creppy, Lehman, to Steven Hash, Lehman, et al. (June 12, 2008) [LBEX
DOCID362233](subjectline:ForInternalUsebyManagers:TPs/FAWsonSeniorMgmtChanges.).
6300See Email from Thomas Fontana, Citigroup, to Christopher Foskett, Citigroup, et al. (June 12, 2008)
[CITILBHIEXAM00074930](AfterspeakingwiththeCFOandTreasurer,wemadearequestfor$5Bin
a cash deposit.); see also email from Christopher Foskett, Citigroup, to John Havens, Citigroup, et al.
(June 12, 2008) [CITILBHIEXAM 00074930] (I have been on the phone this morning with Ian Lowitt,
newCFOofLehmanandPaoloTonucci,globalTreasurer.Inordertokeepourclearingcapabilitiesat
levelstheyrequiretoefficientlyoperate,IhaveaskedthemtoputupacashdepositaswedidwithBear
Stearns last summer to offset any intraday or end of day shortages that may occur. While
disappointed, they have directed their team to put it in place.); cf. email from Daniel J. Fleming,
Lehman,toIanLowitt,Lehman(June12,2008)[LBEXAM008609008610](Citibankisaskingfora$3bn
cash deposit tonight to cover intraday exposures.). Ultimately, Lehman provided and Citigroup
accepted a deposit in the amount of $2 billion. See Email from Thomas Fontana, Citigroup, to Richard
Blaszkowski,Citigroup,etal.(June12,2008)[CITILBHIEXAM00051023](AlotofstressontheLehman
nameinthemarkettoday.Wetookina$2Bdepositandresizedtheclearinglines.);emailfromDaniel
J.Fleming,Lehman,toIanLowitt,Lehman,etal.(June12,2008)[LBEXAM008608](Willbedepositing
$2bnwithCititonight.Nolienorrightofoffset,astraightovernightfedfundsdeposit.).
1671
Fuldoust[edthe]CFOandCOO....Wehavecutbackclearinglinesin
Asia . . . .This is bad news. Market is saying Lehman can not make it
alone.Lossofconfidenceishugeatthemoment.6301
Onthesamedate,DonaldKohn,theFederalReserveBankViceChairman,wrote
toFederalReserveBankChairmanBenBernanke,notingthatwhileLehmanhadraised
$6billionthroughanequityofferingthatday,theadditionalinjectionofequitydidnot
restorethemarketsconfidenceinLehman,andthattherewasapossibilitythatthis
isThursdayofBS[BearStearns]weekend,andequityholderscouldwakeupMonday
with no value.6302 Kohn also noted that Fuld really [had] no alternative plan at this
point.6303 Kohn provided Bernanke with a report of a joint call between the Federal
Reserve,TreasuryDepartmentandtheSECthatoccurredontheafternoononJune12,
2008 regarding Lehman, and noted that the discussion turned to thinking about
options in the eventthe slowerosion ofconfidence [inLehman] turns into aroutand
6301EmailfromThomasFontana,Citigroup,toChristopherFoskett,Citigroup,etal.(June12,2008)[CITI
LBHIEXAM00081606].
6302EmailfromDonaldKohn,FRBNY,toBenS.Bernanke,FederalReserve,etal.(June12,2008)[FRBto
LEHExaminer00073].
6303Id.Coincidentally,onJune12,2008,theEconomist magazinepublishedanarticletitled,Litterbinof
LastResort,criticizingtheECBforallowinginvestmentbankstodumpassetbackedsecurities,likeso
muchradioactivewaste,andforstickingtoitsprecrisisacceptancerulesthatwerebeinggamedor
arbitragedbyinvestmentbanks,whowerecreatingassetbackedsecuritiesthathadnopubliclytraded
valuebutweredesignedsolelyforpledgingtoECBwindows.SeeEmailfromRobertAzerad,Lehman,to
Paolo Tonucci, Lehman, et al. (June 12, 2008) [LBEXDOCID 008040]. Lehman had been internally
concernedaboutitsincreasingrelianceonitsstrategyofcreatingABSsolelyforthepurposeofpledging
totheECB,evendiscussingthepossiblereputationalissueiftheextentofitsreliancebecamepublic.
See email from Carlo Pellerani, Lehman, to Robert Azerad, Lehman (May 12, 2008)
[LBHI_SEC07940_336321]; cf. Carlo Pellerani, Lehman, ECB Strategy (June 2008)
[LBHI_SEC07940_345777786].Atthesametime,however,Lehmanscontingencyplanintheeventofa
loss of repo funding relied upon increased funding through the ECB. See Lehman, Presentation to the
Federal Reserve: Update on Capital, Leverage, and Liquidity (May 28, 2008), at pp. 7, 16
[LBHI_SEC07940_062581].
1672
liquidityfledquickly.6304KohnconcludedthattheFederalReservedidnothaveany
optionstoprovideconfidenceinthefirm.6305
After the release of its second quarter 2008 financials, Fuld was receiving
increasingly blunt pressure from Secretary Paulson and FRBNY President Geithner to
sell Lehman or find a strategic partner.6306 Secretary Paulson told the Examiner that
Lehmans devastating announcement of its firstever earnings loss in the second
quarterof2008convincedFuldthatdramaticactionwasnecessarytosaveLehman.6307
AccordingtoSecretaryPaulson,thereleaseofthenumbersservedasawakeupcall
toFuldwho,atthatpoint,appreciatedLehmansfragilityandcomprehendedthatthe
futureportendednothingbetter.6308
The Examiner finds that there is evidence sufficient to support a determination
that,beginningearlyinthethirdquarterof2008,therewasareasonablelikelihood of
Lehman losing the confidence of the markets in the near term, such that its ability to
6304EmailfromDonaldKohn,FRBNY,toBenS.Bernanke,FederalReserve,etal.(June12,2008)[FRBto
LEHExaminer00073].
6305Id.
6306Examiners Interview of Treasury Secretary Henry Paulson, June 25, 2009, at p. 14; Examiners
InterviewofTreasurySecretaryTimothyF.Geithner,Nov.24,2009,atp.6.However,FederalReserve
Chairman Ben S. Bernanke told the Examiner that he was not of the view in the summer of 2008 that
Lehmansfailurewasinevitable.ExaminerInterviewofChairmanBenS.Bernanke,Dec.22,2008,atp.
7.
6307ExaminersInterviewofTreasurySecretaryHenryPaulson,June25,2009,atpp.1314.
6308Id.atp.14.
1673
obtain financing to support its nongovernment, nonagency asset classes through the
repomarketwasatrisk.6309
Government,NonAgencyRepoFunding
The next step of the analysis is to determine whether Lehman was adequately
prepared to manage the liquidity risk posed by the reasonably foreseeable loss of
market confidence. After the Bear Stearns event, Lehman conducted liquidity stress
tests that assumed Lehman would lose a certain measure of repo funding for non
government,nonagencyassetsoverafourweekperiod.EachofLehmansstresstests,
other than one, predicted that they would survive.6310 If these stress scenarios were
foundeduponreasonableandprudentassumptions,theresultssupporttheconclusion
that Lehman was adequately prepared to handle such risks and it did not have
unreasonably small capital. Conversely, if Lehman was only able to project survival
under these stress scenarios through the use of assumptions that were imprudent or
6309Selectingaprecisedatethatacompanyhasunreasonablysmallcapitalisamatterofjudgment.As
a matter of law, such precision is unnecessary: a factfinder can examine the financial condition of the
companyforareasonableperiodoftimebothbeforeandafterthedateofthetransferinquestion.See,
e.g.,Barrettv.ContinentalIll.NatlBank&TrustCo.,882F.2d1,4(1stCir.1989).TheExaminerhasfocused
onJuneof2008inlightoftheapplicablefactsandgoverninglaw.
6310TheApril21stresstest,whichwasthefirstthatLehmanpresentedtotheFederalReserveandSEC,
showedLehmansurvivingafourweekstressscenariowithlessthan$500millionofliquidity.Lehman,
LiquidityStressScenarioAnalysis (Apr.21,2008),at p. 5 [LBEXDOCID 008608]. Lehmans next stress
test,presentedtotheFederalReserveandSEConMay28,2008,showedLehmansurvivingthefourweek
stress event with more than $20 billion left in its liquidity pool. Lehman, Presentation to the Federal
Reserve: Update on Capital, Leverage & Liquidity (May 28, 2008), at p. 13 [LBHI_SEC07940_062581].
However,LehmanBrotherswasaskedtorestateitsMay28thstresstestresultsusingmoreconservative
assumptions, andas restated, LehmanBrothers would have shown failure byapproximately $6 billion.
SeeLehman,LiquidityStressTestsAtLehmanBrothers(Aug.8,2008),atp.3[LBEXDOCID3211633].
1674
unreasonable,thentheresultofthesestresstestsdonotprecludeadeterminationthat
Lehmanwasoperatingwithunreasonablysmallcapital.Furthermore,notwithstanding
theliquiditystresstests,theExaminerhasevaluatedothermetricsofcapitaladequacy
thatLehmanmonitoredandthatpurportedtoshowLehmansstrongcapitalpositionto
determine whether these metrics preclude a conclusion that Lehman was operating
withunreasonablysmallcapital.
(i) LehmansLiquidityPool
As noted above, Lehman was well aware that a loss of shortterm financing
could impair its ability to continue operations. Lehman had experienced a liquidity
crisisin1998followingtheRussianSovereignDebtCrisisandthecollapseofthehedge
fund, LongTerm Capital Management.6311 In response, Lehman adopted a three
dimension[al] funding framework to guide its funding of assets and mitigate its
liquidity risk (the Funding Framework).6312 One of the principal components of
6311See
Kentaro Umezaki, Lehman Brothers, 1998 Liquidity Risk Case Study, at p. 7 [LBEXDOCID
251244], attached to email from Kentaro Umezaki, Lehman, to Rebecca Miller, Lehman (Sept. 5, 2007)
[LBEXDOCID427653].
6312Lehman, Project Green Liquidity & Liquidity Management [Draft] (June 2008), at p. 2
[LBHI_SEC07940_844120]. The principal components of Lehmans Funding Framework were the

liquiditypool,thecashcapitalsurplus,andthereliablesecuredfundingmodel.Thethreecomponents
weredesignedtoworkinconjunctionwitheachother.SeeLBHI10Q(July10,2008),atpp.8182.The
reliable secured funding model was designed to address the risk of a loss of repo funding through a
relationshipbased strategy of Lehman obtaining a certain level of financing from counterparties the
relationshipsofwhichwithLehmanweresufficientlystrongsuchthatLehmanprojectedthatthesefirms
wouldcontinuetotradewithLehmanduringastressevent.SeeLehman,SecuredLiquidityRiskModel
(Jan.2006)[LBEXDOCID1313333].Thecashcapitalsurplusprincipallymeasuredtheamountbywhich
thesumofLehmanslongtermdebtandequitycapitalexceededLehmansestimatesofitslessliquidand
illiquid assets as well as the aggregate haircuts applied to such assets. In this sense, the cash capital
model built upon the assumptions of the reliable secured funding model, insofar as the assessment of
1675
LehmansFundingFrameworkwastheLBHIliquiditypool.6313Theliquiditypoolwas
designedtocoverthelossofunsecureddebt,specifically,therollingoffofcommercial
paperandthematurityofthecurrentportionoflongtermdebt.6314Lehmanreporteda
recordliquiditypoolof$44.6billionandarecordcashcapitalsurplusof$15.0billionas
ofMay31,2008.6315
However, Lehmans liquidity pool was not, at least prior to the Bear Stearns
event, primarily designed or sized to address a loss of repo funding. In its Annual
Report for fiscal year 2007, Lehman disclosed that [e]ven within the oneyear time
frame contemplated by our liquidity pool, we depend on continuous access to secured
financing in the repurchase and securities lending markets, which could be impaired by
factors that are not specific to Lehman Brothers, such as a severe disruption of the
financialmarkets.6316InaMarch2008presentationtotheFederalReserveandtheSEC,
Lehman noted that the liquidity pool was primarily designed to cover the inability to
which assets were less liquid (and therefore needed to be matchfunded with cash capital). The
liquiditypoolwasdesignedtocoverthelossofunsecureddebt,specifically,therollingoffofcommercial
paperandthematurityofthecurrentportionoflongtermdebt.SeeLehman,LiquidityManagementAt
LehmanBrothers,PresentationtotheChicagoMercantileExchange,[Draft](June5,2008),atp.10[LBEX
DOCID1300305](describingtheMCOormaximumcumulativeoutflowassumptions).
6313Lehman, Project Green Liquidity & Liquidity Management [Draft] (June 2008), at p. 2
[LBHI_SEC07940_844120].
6314Lehman, Presentation to the Chicago Mercantile Exchange, Liquidity Management At Lehman
Brothers [Draft] (June 5, 2008), at p. 10 [LBEXDOCID 1300305] (describing the MCO or maximum
cumulativeoutflowassumptions).
6315LBHI10Q(July10,2008),atpp.8182.
6316LBHI200710K,atp.17(emphasisadded).
1676
roll maturing, unsecured debt for one year, not the loss or reduction of repo funding,
whichwastobeaddressedwith[o]verfundingoflessliquidassetclasses.6317
FollowingtheBearStearnsevent,Lehmanmadeaseriesofmodificationstoits
funding framework to bolster its liquidity fortress and to manage the liquidity risk
presented by short term secured funding.6318 Although Lehman acknowledged that a
lossofshorttermsecuredfundingcouldresultinanimpairmentofthefranchise,its
liquidity pool was not part of its risk mitigation plan against the potential loss of
securedfunding:LehmanBrothersmanagesitssecuredliquidityusingafourpronged
risk mitigation strategy, which conservatively assumes: (a) no reliance on Holdings
liquidity;(b)norelianceoncustomercollateralorfreecredits.6319
6317Lehman, Presentation to Federal Reserve & SEC: Liquidity Management At Lehman Brothers (Mar.
26,2008),atp.10[LBHI_SEC07940_057097].Lehmanwouldlaterdescribeoverfundingastheability
to absorb adverse changes in secured funding capacity in times of stress by reducing total collateral
borrowedinorreallocatingthehigherquality,easytofundtreasuryoragencysecurities.SeeLBHI10Q
(July10,2008),atp.84.
6318Lehman, Liquidity Management At Lehman Brothers (May 15, 2008), at pp. 12, 23 [LBEXDOCID
008669].Lehmanstatedthatitwouldmitigateitssecuredfundingriskbyincreasingoverfundingofless
liquid asset classes, increasing its use of its captive banking entities, especially Lehman Brothers
Bankhaus, and transforming its balance sheet through the use of securitization to create liquid,
investment grade securities out of a pool of less liquid collateral. Id at p. 12. Of these three
modifications, overfunding was a major part of Lehmans postBearStearns funding framework. Inits
Form 10Q for the second quarter of 2008, Lehman reported that it had an overfunding cushion of $27
billion. LBHI 10Q (July 10, 2008), at p. 84. By comparison, Lehman estimated that it could fund
approximately$3billionofitslostrepocapacitythroughitscaptivebankingentities,whichisafraction
of the amount of overfunding it projected. See Lehman, Liquidity Management At Lehman Brothers
(May 15, 2008), at pp. 12, 14 [LBEXDOCID 008669]. Lehman noted that its ability to transform the
balance sheet through the securitization and structured finance markets (which were largely moribund
bysummer2008)wouldtake1to2weeks.Id.at24.
6319Lehman, Presentation to Federal Reserve & SEC: Liquidity Management At Lehman Brothers (Mar.
26,2008),atp.11[LBHI_SEC07940_057097](emphasisadded);seealsoLehman,LiquidityManagementAt
LehmanBrothers(May15,2008),atp.12[LBEXDOCID008669].
1677
However, in its quarterly report for the second quarter of 2008, Lehman
disclosed,forthefirsttime,thattheLBHIliquiditypoolcouldbeavailable,[a]salast
resort, as a mitigant against the loss of secured funding capacity.6320 Lehman
providedanassessmentofitsrepobookatrisk,startingwithitsnongovernment,non
agencyrepobookof$105billion,andexcludingcertainassetclassesthatitconsidered
to be relatively liquid even under stressed conditions, and disclosed that its projected
lossof$32billionofrepocapacitymaybemitigatedbytheliquiditypoolavailableto
theCompany.6321
(ii) LiquidityStressTests
FollowingtheBearStearnsevent,LehmanmetwiththeFRBNYandtheSECon
several occasions to discuss the results of successive versions of its liquidity stress
tests.6322Withoneexceptionnotedbelow,Lehmanreportedthatitsurvivedthestress
tests, and beginning with its May 28, 2008 stress test report, Lehman reported that it
6320LBHI 10Q (July 10, 2008), at p. 84. Previously, Lehman had only made general statements that its
liquidity pool was sized to cover expected cash outflows associated with an anticipated impact of
adversechangesonsecuredfunding,eitherintheformofagreaterdifferencebetweenthemarketand
pledge value of the assets (also known as haircuts) or in the form of reduced borrowingavailability.
See,e.g.,LBHI200710K,atp.56;LBHI10Q(Apr.9,2008),atp.65.
6321LBHI10Q(July10,2008),atpp.8485.
6322Email from Michael Hsu, SEC, to Paolo Tonucci, Lehman, et al. (Apr. 9, 2008)
[LBHI_SEC07940_477096](notingthattheSECwaslookingforLehmananditspeerstoagreeuponthe
principle of a new liquidity standard which he described as a 30day bulletproof liquidity survival
window); Joint Request of SEC and FRBNY: Liquidity Scenarios for CSEs (May 20, 2008)
[LBHI_SEC07940_505195]; see also Lehman, Liquidity Stress Scenario Analysis (Apr. 21, 2008), at p. 5
[LBEXDOCID 008608]; Lehman, Presentation to the Federal Reserve Update on Capital, Leverage &
Liquidity(May28,2008),atp.13[LBHI_SEC07940_062581];Lehman,PresentationtotheFederalReserve
& SEC: Updated Stressed Liquidity Scenario (July 2, 2008), at p. 10 [LBEXDOCID 1300104]; Lehman,
LiquidityStressTestsAtLehmanBrothers(Aug.8,2008),atp.3[LBEXDOCID3211633].
1678
survivedthestresstestsbyamarginexceeding$10billionattheendofthefourweek
projectionperiod.6323
These stress tests were based on Lehmans own projections, and in substantial
part,employedassumptionsdeterminedbyLehman.6324Courtshaverecognizedthata
companysownprojectionstendtobeoptimistic,andtherefore,afactfindershould
not simply take them at face value.6325 Accordingly, the key inquiry is whether the
projectionitselfwasbaseduponprudentandreasonableassumptions.6326
Theassumptionsemployedbythestresstestshadamaterialimpactonthetest
results.Forexample,LehmansstresstestpresentedtotheFRBNYandtheSEConMay
28, 2008, assumed that Lehmans liquidity position would benefit over the fourweek
projection period due to the positive impact of $16.0 billion of balance sheet
reduction, and a $10.0 billion reduction in prime broker customer funding.6327 This
6323TheApril21stresstest,whichwasthefirstthatLehmanpresentedtotheFederalReserveandSEC,
showed Lehman surviving a fourweek stress scenario with less than $500 million left of its original
liquidity position. Lehman, Liquidity Stress Scenario Analysis (Apr. 21, 2008), at p. 5 [LBEXDOCID
008608].Lehmansnextstresstest,presentedtotheFederalReserveandSEConMay28,2008,showed
Lehman surviving the fourweek stress event with more than $20 billion left in its liquidity pool.
Lehman,PresentationtotheFederalReserveUpdateonCapital,Leverage&Liquidity(May28,2008),at
p.13[LBHI_SEC07940_062581].However,LehmanBrotherswasaskedtorestateitsMay28thstresstest
results using more conservative assumptions, and as restated, Lehman Brothers would have shown
failure by approximately $6 billion. See Lehman, Liquidity Stress Tests At Lehman Brothers (Aug. 8,
6324Examiners Interview of Irina Veksler, Sept. 11, 2009, at. p. 6; Examiners Interview of Laura M.
VecchioApr.16,2009,atp.5.
6325Moodyv.SecurityPac.Bus.Credit,Inc.,971F.2d1056,1073(3rdCir.1992).
6326MFS/Sun Life TrustHigh Yield Series v. Van Dusen Airport Servs. Co., 910 F. Supp 913, 944 (S.D.N.Y.
1995);seealsoInReIridiumOperatingLLC,373B.R.at347.
6327Lehman,PresentationtotheFederalReserveUpdateonCapital,Leverage&Liquidity(May28,2008),
atpp.1314[LBHI_SEC07940_062581].
1679
stress test projected that Lehman would survive a liquidity stress event with $20.7
billionofitsavailableliquidityattheendofthefourweekperiod.6328Attherequestof
the regulators, Lehman subsequently conducted the stress test without these
assumptions.6329 Without the benefit of these assumptions, the restated stress test
demonstrated that Lehman would have failed the May 28, 2008 stress test by $6
billion.6330 In this manner, altering two assumptions had a $26.7 billion effect on the
testsresult.
Aseconddemonstrationoftheimpactofaliquiditystresstestsassumptionson
the result can be found in the independent stress tests developed by the FRBNY. In
May2008,theFRBNYgeneratedtwostresstestscenarioswhichmodeledhowLehman
would respondtoa BearStearns andBear Light scenarios.6331TheBearStearns
scenarioassumedarunonthebankinallbusinessareas,andtheBearLightscenario
assumedthattherunwas35percentasstrongastheBearStearnsscenario.6332These
stresstestsprojectedthatLehmanwouldfailtheBearStearnsscenarioby$84billion
and the Bear Light scenario by $15 billion.6333 In June 2008, the FRBNY ran another
6328Id.atp.13.
6329Lehman,LiquidityStressTestsAtLehmanBrothers(Aug.8,2008),atp.3[LBEXDOCID3211633];see
also email from Robert Azerad, Lehman, to Laura M. Vecchio, Lehman, et al. (Aug. 8, 2008) [LBEX
DOCID3207542](notingthattherestatedstresstestwasthefollowuptolastweeksmeetingwiththe
Fed.).
6330Lehman,LiquidityStressTestsAtLehmanBrothers(Aug.8,2008),atp.1[LBEXDOCID3211633].
6331BillBrodows,FRBNY,etal.,PrimaryDealerMonitoring:InitialAssessmentofCSEs(May12,2008),at
p.9[FRBNYtoExam000017].
6332Id.
6333Id.atp.11.
1680
stress test with assumptions that were generally consistent with the May 2008 Bear
Light scenario.6334 According to the FRBNYs projections, the June 2008 stress test
showedthatLehmanwouldfailinareasonablyforeseeablestresseventbyamarginof
$15billion.6335
There is sufficient evidence to support the determination that certain of the
material assumptions employed in Lehmans tests were not reasonable. For example,
Lehman assumed that it would not be able to issue any unsecured commercial paper
during the term of the fourweek stress event. This assumption was based on the
reasonable determination that Lehman would not be able to obtain unsecured debt
during a liquidity stress event. Lehman, however, did not apply this determination
consistentlythroughoutthescenario.AsdiscussedinSectionIII.A.5.iofthisReport,at
thetimethestresstestswereconducted,Lehmansclearingbanksprovidedameasure
of unsecured credit on an intraday basis.6336 Given that Lehman deemed the loss of
unsecured financing a reasonable and necessary assumption under its stress
scenarios,6337 it was inconsistent not to apply that assumption to the unsecured credit
providedbytheclearingbanks.
6334FRBNY,Primary DealerMonitoring:LiquidityStress Analysis(June 25,2008, revisedJune 26,2008)
[FRBNYtoExam000033].
6335Id.atp.2.
6336See Section III.A.5.b.1.b, noting that the Net Free Equity metric was the market value of Lehman
securitiespledgedtoJPMorganplusanyunsecuredcreditlineJPMorganextendedtoLehmanminuscash
advancedbyJPMorgantoLehman.
6337See, e.g., LBHI 10Q (July 10, 2008), at p. 85. (Most of the Companys [stress] scenarios assume
completedisruptionofunsecuredfundingmarkets(i.e.theinabilitytoissuenewunsecureddebt).)See
1681
Furthermore,therearesufficientfactstodemonstratethatitsassumptionthatits
clearingbankswouldcontinuetoprovideunsecuredcreditonanintradaybasisduring
a stress event was unreasonable. By February 2008, Lehmans primary clearing bank
JPMorganhadexpressedconcerntoLehmanaboutitsintradayexposuretoLehman.6338
Additionally, as noted above, on June 12, 2008, Lehmans foreign exchange clearing
bank, Citigroup, initially requested that Lehman provide it a comfort deposit of
between $3 billion and $5 billion to mitigate Citigroups perceived intraday
exposure.6339 Further, on June 19, 2008, Lehman provided $5.4 billion in collateral to
alsoLehman,LiquidityStressScenarioAnalysis(Apr.21,2008),atp.3[LBEXDOCID008608](notingthat
lossofunsecuredfundingisakeyassumption.);Lehman,PresentationtotheFederalReserveUpdate
on Capital, Leverage & Liquidity (May 28, 2008), at p. 6 [LBHI_SEC07940_062581] (distinguishing the
BearStearnseventbynotingthatLehmanhad[n]orelianceonshorttermunsecuredfundingandthat
its liquidity framework assumes that unsecured debt cannot be rolled in a liquidity event); Lehman,
Presentation to the Federal Reserve & SEC: Updated Stressed Liquidity Scenario (July 2, 2008), at p. 5
[LBEXDOCID1300104](notingacompleteinabilitytorollunsecureddebtsuchascommercialpaperand
lettersofcreditatmaturity).
6338Email from Janet Birney, Lehman, to Daniel J. Fleming, Lehman, et al. (Feb. 26, 2008)
[LBHI_SEC07940_436414].JPMorganwasspecificallyconcernedthatLehmansrepocounterpartieswere
not valuing the collateral correctly, and assessed increasing haircuts against the repo collateral in the
tripartyrepobookaccordingly.
6339See email from Thomas Fontana, Citigroup, to Christopher Foskett, Citigroup, et al. (June 12, 2008)
[CITILBHIEXAM00074930](AfterspeakingwiththeCFOandTreasurer,wemadearequestfor$5Bin
a cash deposit.); see also email from Christopher Foskett, Citigroup, to John Havens, Citigroup, et al.
(June 12, 2008) [CITILBHIEXAM 00074930] (I have been on the phone this morning with Ian Lowitt,
newCFOofLehmanandPaoloTonucci,globalTreasurer.Inordertokeepourclearingcapabilitiesat
levelstheyrequiretoefficientlyoperate,IhaveaskedthemtoputupacashdepositaswedidwithBear
Stearns last summer to offset any intraday or end of day shortages that may occur. While
disappointed, they have directed their team to put it in place.); cf. email from Daniel J. Fleming,
Lehman,toIanLowitt,Lehman(June12,2008)[LBEXAM008609008610](Citibankisaskingfora$3bn
cash deposit tonight to cover intraday exposures.). Ultimately, Lehman provided and Citigroup
accepted a deposit in the amount of $2 billion. See email from Thomas Fontana, Citigroup, to Richard
Blaszkowski,Citigroup,etal.(June12,2008)[CITILBHIEXAM00051023](AlotofstressontheLehman
nameinthemarkettoday.Wetookina$2Bdepositandresizedtheclearinglines.);emailfromDaniel
J.Fleming,Lehman,toIanLowitt,Lehman,etal.(June12,2008)[LBEXAM008608](Willbedepositing
$2bnwithCititonight.Nolienorrightofoffset,astraightovernightfedfundsdeposit.).
1682
address JPMorgans intraday exposure.6340 In fact, at the time of LBHIs bankruptcy,
Lehman had provided more than $16 billion in the aggregate to its clearing banks to
securetheirintradayexposurealiquidityoutflowthatLehmanfailedtoaccountfor
inanyamountinitsliquiditystresstests.6341
Lehman also failed to take into account the temporary liquidity cost of
operational friction, which Lehman knew would be present in a stress event.
Operational friction includes the temporary impact on liquidity arising from the
difference in timing between Lehmans delivery of payment of the account balance to
clientsandthetimeittookLehmantosellandprocesspaymentfortheseassets.6342
Azerad acknowledged that Lehman was aware that operational friction would
getworseinastressevent.6343Intheordinarycourseofitsbusiness,Lehmanemployed
twosourcesoffundingtoaddressthetemporaryliquidityimpactofoperationalfriction
commercialpaperandthebrokerdealersoperationalcashcushion.6344Whilethese
6340EmailfromCraigJones,LehmantoJohnFeraca,Lehman(June19,2008)[LBEXAM001775].Jones
informed Feraca: Today we moved several unencumbered assets (Sasco, Spruce, Pine, Fenway) to
LCPIs DTC box at Chase to generate an additional $5.4 billion of NFE. This will help us absorb the
increaseinintradaymarginingthatChasewantsustoimplement.
6341Paolo Tonucci & Robert Azerad, Liquidity Of Lehman Brothers (Oct. 7, 2008), at p.
9[LBHI_SEC07940_844701].
6342Lehman, Presentation to S&P, Liquidity Management At Lehman Brothers (May 15, 2008), at p. 17
[LBEXDOCID008669](definingoperationalfrictionaschangeinlockups,transferofpositionsacross
depots,changeinsecuredfunding,etc.).
Brothers [Draft] (June 5, 2008), at p. 24 [LBEXDOCID 1300305] (Lehman assumed that it could [u]se
termcommercialpapertomitigateshorttermliquidityoutflowssuchasunforeseenoperationalfriction
(fails));seealsoLehman,PresentationtotheFederalReserveUpdateonCapital,Leverage,andLiquidity
1683
sourceswereavailableoutsideofastressevent,Lehmansownstresstestsassumedthat
neitherofthesewouldbeavailableduringastressevent.
As noted above, the tests assumed that Lehman would not be able to issue
commercialpaperduringthestressevent.6345Lehmansbrokerdealerswerestructured
tonotrequireliquidityinfusionsfromLBHIinordertooperateintheordinarycourse
of their business, and their prime broker business, in particular, was designed to be
selfsufficient.6346 However, in a stress event, Lehman projected that the largest
liquidity stress would be felt at the broker dealers, which because they could not roll
maturing repos, would experience significant cash outflows.6347 For example, in the
April21scenario,Lehmanprojectedthatitsmainbrokerdealers,LBIandLBIE,would
lose$33.1billionofrepocapacityonthefirstdayofaliquiditystresseventandatotal
of$57.3billionafterfourweeks.6348InaninternalversionofthestresstestdoneonJune
12,2008,LehmanprojectedthatLBIandLBIEwouldlose$21.8billionofrepocapacity
(May28,2008),atpp.7,16[LBHI_SEC07940_062581](statingthatLehman[i]ncreasedourCPprogram
tomitigateriskofoperationalfrictioninaveryvolatileenvironmentfollowingBearStearns).
6345See, e.g., Lehman, Presentation to the Federal Reserve & SEC Updated Stressed Liquidity Scenario
(July2,2008),atp.3[LBEXDOCID1300104](Inabilitytorollunsecureddebt);seealsoJointRequestof
SEC and FRBNY: Liquidity Scenarios for CSEs (May 20, 2008), at p. 2 [LBHI_SEC07940_50519596]
(identifyingcommercialpaperasanareaofpotentialimpactinastressevent).
6346Lehman, Presentation to S&P, Liquidity Management At Lehman Brothers (May 15, 2008), at p. 17
[LBEXDOCID008669].
6347Lehman, Liquidity Stress Scenario Analysis (Apr. 21, 2008), at p. 5 [LBEXDOCID 008608]; see also
ApocalypseNowliquiditystressscenarioasofJune12,2008[LBEXDOCID022363];cf.PaoloTonucci
& Robert Azerad, Change In Liquidity Week Of September 8, 2008 (Sept. 24, 2008), at p. 4
[LBHI_SEC07940_740011] (During the week of September 8, LBI and LBIE, Lehmans U.S. and
European broker dealers, respectively, experienced a loss of liquidity, which required Holdings to
provideliquiditysupport,resultinginanincreaseoftheirpayablestoHoldings.).
6348Lehman,LiquidityStressScenarioAnalysis(Apr.21,2008),atp.5[LBEXDOCID008608].
1684
on thefirst day ofa liquidityevent,and$33.9billionover fourweeks.6349AsLehman
acknowledgedinitsApril21stresstest,LBIandLBIEwouldhavetoborrowcashfrom
the Holding companies to compensate for the lost repo funding.6350 Thus, it was
unreasonable for Lehman to assume that brokerdealers, which it projected would
require substantial infusions of liquidity during the stress event, would have the
necessaryliquiditytomitigatetheimpactofoperationalfriction.
Despite the absence of these funding sources, and the foreseeable logistical
challenges ofcoveringtheconcurrentwithdrawalofassetsbyLehmansprimebroker
customers in a stress event, Lehmans stress test projections made no allowance for
operational friction. Azerad acknowledged that Lehman believed there would be a
liquidity impact due to operational friction, but because it was difficult for them to
model or estimate precisely, they did not take it into account at all in their
projections.6351DuringtheweekpriortoLBHIsbankruptcyfiling,Lehmanexperienced
a$4billionliquidityoutflowarisingfromthetemporaryimpactoftheunwindingof
theprimebrokerbusiness.6352OnSeptember24,2008,TonucciandAzeradprepareda
postmortem analysis after the bankruptcy petition showing that after it released its
6349ApocalypseNowliquiditystressscenarioasofJune12,2008[LBEXDOCID022363].
6350Lehman,LiquidityStressScenarioAnalysis(Apr.21,2008),atp.5[LBEXDOCID008608].
6351ExaminersInterviewofRobertAzerad,Sept.23,2009(secondinterview),atpp.910.
6352PaoloTonucci&RobertAzerad,ChangeInLiquidityWeekOfSeptember8,2008(Sept.24,2008),atp.
4[LBHI_SEC07940_740011].ApostmortempreparedbyAzeradandTonuccishowedtherewasatotal
$9 billion loss attributable to operational friction, including the $4 billion prime broker unwind, a $3
billionliquidityoutflowdueto[p]endingpaymentsbetweenLBIandLBIE,a$1billion[i]ncreasein
marginrequirements,anda$1billioneffectofreporebalancing.Id.
1685
third quarter2008earningson September9,2008,itsprimebrokercustomers started
pullingtheirlongandshortbalancesfromLBIEtootherprimebrokers,thatthespeed
of their withdrawal coupled with their request for sameday transfers . . . resulted in
operational frictions as Lehmans operations group was struggling processing these
requests, and that the resulting operational friction worsened our liquidity position
atacriticalpointforLehman.6353
Therefore, because there is sufficient evidence to support a determination that
Lehman could have reasonably foreseen the substantial effect that operational friction
arisingfromthewithdrawalofcustomeraccountswouldhaveonitsliquidity,evenif
on a temporary basis, it was unreasonable for Lehman not to take the impact of
operationalfrictionintoaccountinitsliquiditystresseventplanning.Lehmanknewor
should have known that the factors that it assumed would mitigate an increase in
operational friction would not have that effect in a stress event. In view of the
foregoing, there is sufficient evidence to support a determination that the stress tests
employedtwoassumptionswhich,giventheinformationavailabletoLehmanwhenthe
tests were developed, were not reasonably constructed and that LBHI and the LBHI
Affiliates identified below were operating with unreasonably small capital during the
period beginning early in the third quarter of 2008 and ending the date of each
respectivebankruptcyfiling.
6353See
Paolo Tonucci & Robert Azerad, Liquidity Of Lehman Brothers (Oct. 7, 2008), at p. 13
[LBHI_SEC07940_844701].
1686
(iii) OtherCapitalAdequacyMetrics
There are other metrics bearing upon capital adequacy such as Lehmans cash
capitalsurplus, which was ata record $15.0billionas ofSeptember2,2008andnear
record levels as of September 10, 2008,6354 its Equity Adequacy Framework, which
showedthatithadsufficientequitytoavoidbankruptcyprovideditcouldliquidateall
its assets in an orderly winddown,6355 and its CSE Capital Ratio, which had
substantially improved by the end of the second quarter of 2008.6356 Although these
metrics provide some evidence that Lehman could have reasonably believed it was
engaged in business with adequate capital, these metrics do not preclude a
determination that Lehman was not adequately capitalized against the specific,
foreseeableandlikelyliquidityriskarisingfromitsrelianceonshorttermrepofunding
tosupportlessliquidandilliquidinventory,andtheothercontingentcoststhatmight
ariseinaliquiditystressevent.
a. CashCapitalSurplus
Lehmantrackedandreportedametricofcapitaladequacycalleditscashcapital
surplus,whichitdefinedasitsmeasureoflongtermfundingsourcesoverlongterm
6354Lehman,2008Q3LiquidityMetrics,Version1(Sept.2,2008),atp.8[LBEXDOCID1300336];Lehman,
FundingLehmanBrothers(Sept.10,2008),atp.10[LBHI_SEC07940_739985].
6355Lehman,EquityAdequacyFramework(May19,2008),atp.1[LBEXDOCID1302799].
6356CompareLBHI10Q(July10,2008),atp.103(showingaTier1CSECapitalratioof10.7percentanda
TotalRiskBasedCapitalRatioof16.1percent),withLehman,PresentationtotheExecutiveCommittee,
The Firms Equity Adequacy [Draft] (Oct. 2007), at p. 15 [LBEXDOCID 2489685] (showing a Tier 1
CapitalRatioof7.0percentandaTotalCapitalRatioof10.5percent).
1687
funding requirements.6357 In theory, if a companys longterm capital needs are
covered by sources of longterm capital (including debt and equity), its risk of a
liquidity mismatch is manageable because its longterm needs mature with its long
termcapitalsources.6358
The existence of Lehmans cash capital surplus does not preclude a
determinationthatLehmanwasengagedinbusinesswithunreasonablysmallcapital
becauseitwasbasedonassumptionsaboutthenormalfunctioningoftherepomarket
to support less liquid inventory even under adverse market conditions.6359 Lehmans
Cash Capital Model explicitly assumed that there would only be an impairment of
securedfunding,notacompletelossforcertainassetclasses,andthatsuchimpairment
wouldbeaddressedbytheliquiditypool.6360
b. EquityAdequacyFramework
Another measure of capital adequacy was Lehmans Equity Adequacy
Framework. The Equity Adequacy Framework was an attempt to measure the
estimatedamountofcapitalrequiredtoallowtheFirmtoreorganizeandrestructure
6357LBHI10Q(July10,2008),atp.82.

Brothers[Draft](June5,2008),atp.7[LBEXDOCID1300305](notingthatunderitsprincipleofmatch
funding,itsassetsandliabilitieswouldhaveselffundingandselfliquidatingcharacteristics.).
6359Lehman calculated the size of the long inventory haircut as the average difference between the
market value of the collateral pledged and secured financing proceeds received for a specific asset
categoryinanormalmarketenvironment.Lehman,GFSTraining:CashCapitalModule(Jan.2006),at
pp. 4, 15 [LBEXDOCID 1682556]. Lehmans cash capital model did not assume that Lehmans repo
counterpartieswouldsimplystopfundingcertainassetclassesentirely.
6360SinceCashCapitalisraisedtofundonlythenormalmarkethaircut...,Lehmanfundscontingent
haircutwideningrequirementwithshorttermfunds(currentportionofLTDorSTD).Id.at27.
1688
without resorting to bankruptcy in case of a severe and prolonged crisis.6361 An
importantassumptionbehindthisorderlyliquidationscenariowasthatLehmanrelied
uponthesufficiencyofitsliquiditypooltoensure[]wehavesufficienttime(oneyear)
toarrangefordispositionofassetsorrestructuringofliabilities.6362
Although the orderly liquidation scenario envisioned by the Equity Adequacy
Framework is some evidence that Lehman was adequately capitalized, the Equity
Adequacy Framework analysis did not properly account for the market reaction in a
stressedliquidityevent,givenLehmansbusinessmodelandtheimportanceofmarket
confidence to its daytoday operation and survival.6363 Lehman could not expect to
conduct an orderly and complete liquidation of its inventory and assets without a
market reaction, especially given the swiftness of the near collapse of Bear Stearns.6364
6361Lehman,EquityAdequacyFramework(May19,2008),atp.2[LBEXDOCID1302799].
6362Id.at3.
6363Matthew Albrecht, S&P, Investment Services Industry Survey (May 29, 2008), at p. 1 (noting that
investmentbanksrelyontheirreputationsinallaspectsoftheirbusiness,fromfacilitatingtradingand
financial advisory work, to finding new investments, to borrowing capital, and that the most
troublesomecrisisthatthesefirmscanface...isacrisisofconfidenceinthefirm.).
6364Although following the Bear Stearns event, the Federal Reserve created new facilities designed to
supporttheliquidityofnoncommercialbanksnamely,thePrimaryDealerCreditFacility(PDCF)and
the Term Securities Lending Facility (TSLF) through which financial institutions holding less liquid
collateralcouldobtaintemporaryloansortemporaryexchangesformoreliquidformsofcollateral,such
asgovernmentandagencysecurities,Lehmanadmittedthatuseofsuchfacilitieswasseenascarryinga
stigma that would undermine market confidence. Examiners Interview of Robert Azerad, Sept. 23,
2009(secondinterview),atp.11(notingthatuseofthePDCFwindowcarriedastigma.);seealsoU.S.
DepartmentoftheTreasury,OfficeofThriftSupervision,ExaminerinChargeRonaldS.Marcus,Report
ofExaminationofLehmanBrothersHoldingsInc.(May19,2008),atp.2(describingthePDCFasalast
resortlineofcredit.);emailfromDonaldKohn,FRBNY,toBenS.Bernanke,FederalReserve(June11,
2008) [FRB to LEH Examiner 000069] (noting that if Lehman accessed the PDCF window, such usage
might be the kiss of death in any case.). Further evidence shows that in its final week prior to its
bankruptcy filing, Lehman did not utilize the PDCF window to stave off bankruptcy. The SEC and
FederalReserve,intheirjointrequesttoCSEstoperformliquiditystresstestsfollowingtheBearStearns
1689
Thus, the mere fact of a reported equity adequacy surplus does not, without more,
precludeadeterminationofunreasonablysmallcapital.
c. CSECapitalRatio
In December 2005, Lehman submitted itself to supervision under the SEC as a
CSE. This supervision subjected Lehman to certain minimum capital requirements,
including the reporting of a capital adequacy measurement consistent with the
standards adopted by the Basel Committee on Banking Supervision.6365 By 2008,
LehmanwasrequiredtomeasureanddiscloseitsTotalRiskBasedCapitalRatio,which
wasessentiallyameasureofLehmansequitycapitalandsubordinateddebtdividedby
itsriskweightedassets,althoughitalsomeasureditsTier1CapitalRatio,whichwasa
similar metric that used a narrower definition of equity capital.6366 Lehman was also
requiredtonotifytheSECifitsTotalRiskBasedCapitalRatiofellbelow10percent.6367
event, asked CSEs to model their stress test projections without reliance upon the PDCF or TSLF. See
Joint Request of SEC and FRBNY: Liquidity Scenarios for CSEs (May 20, 2008), at p. 1
[LBHI_SEC07940_505195].
6365LBHI10Q(July10,2008),atp.102.
6366Id.atp.101.
6367Id.TotalRiskBasedCapitalwasthesumbothTier1andTier2capital.Tier1Capitalwascomposed
ofLehmanscommonstockholdersequity,less(i)Lehmansidentifiableintangibleassetsandgoodwill;
(ii) deferred tax assets dependent upon future taxable income; (iii) cumulative gains or losses, net of
taxes, that arise from application of fair value accounting on Lehmans financial debt liabilities, and
which are attributable to Lehmans credit spread, and (iv) other deductions, including Lehmans
investments in insurance subsidiaries, but plus (x) unrestricted securities issued by Lehman, including
perpetual, noncumulative preferred securities and (y) restricted securities used by Lehman. Tier 2
CapitalincludesallcomponentsofTier1Capitalplusseniorandsubordinatednotes,generallyincluding
qualifyingseniorandunsecurednotesthatareunsecuredandhavematuritiesgreaterthanfiveyears.Id.
at101102.
1690
There was substantial correlation between Lehmans Equity Adequacy, CSE Capital
AdequacyandNetLeverageRatiometrics.6368
However,likeitsimprovednetleverageratiosasofthesecondquarterof2008,
Lehmans CSE Capital Ratio metrics do not preclude a finding that Lehman was
engagedinbusinesswithunreasonablysmallcapital.GiventhenatureofLehmans
enterprise,Lehmansabilitytooperatewasprimarilyafunctionofitsliquidityrisk,not
necessarily the value of its assets as compared to its liabilities.6369 Metrics of capital
adequacy such as the CSE Capital Ratio, the net leverage ratio, the Equity Adequacy
Framework and the Cash Capital Surplus were essentially snapshots of Lehmans
capitalstructureatagivenpointintime.However,itisdifficulttomeasureliquidity
riskwithsuchmetrics.6370AsPaulShotton,oneofLehmansmostseniorriskmanagers,
recognizedintheaftermathoftheBearStearnsevent,[e]quitysufficiencymetricsneed
6368Lehman,EquityAdequacyFramework(May19,2008),atp.8[LBEXDOCID1302799](recognizinga
close alignment between [the] EAF and CSE metrics); Lehman, Presentation to the Executive
Committee,TheFirmsEquityAdequacy[Draft](Oct.2007),atp.12[LBEXDOCID2489685](notingthat
thenetleverageratioandCSECapitalratiowerecomplementarycapitaladequacymetrics).
6369Email from Paul Shotton, Lehman, to Chris OMeara, Lehman (Apr. 15, 2008)
[LBHI_SEC07940_768467](Liquidityismoreimportantthancapital;mostentitieswhichgobankruptdo
sobecausetheyrunoutoffinancing,notbecausethevalueoftheirassetsfallsbelowthevalueoftheir
liabilities.).
6370SeePeterNeu&LeonardMaltz,LiquidityRiskManagement3(JohnWiley&Sons2007)(Retrospective
and concurrent measuresof liquidity have little value. Prospective viewsare critical.). See also Ethan
Penner, Can the Financial Markets Make a Comeback? Wall Street Journal, Aug. 27, 2007, p. A11
(attributing maxim, liquidity is an illusion always there when you dont need it, and rarely there
when you do, to former Drexel Burnham Lambert CEO Michael Milken). A similar statement was
voicedbyLehmansPaulShottoninhisApril15,2008emailtoChrisOMeara:Liquidityistheultimate
uselessconceptplentifullyavailablewhenitsnotneeded,neverpresentwhenitis.Seeemailfrom
Paul Shotton, Lehman, to Chris OMeara, Lehman (Apr. 15, 2008) [LBHI_SEC07940_768467]. Both
commentsillustratetheprinciplethatliquiditycannotbemeasuredwithastaticmetric.
1691
tobebasedonanticipatedliquidityavailabilityduringstressedmarketperiods,noton
normalmarket experience.6371 Therefore, these static capital adequacy metricsdo not
preclude a determination that Lehman was engaged in business with unreasonably
small capital to the extent they are not based upon projections of liquidity under
stressedmarketconditions.
(g) LBHIAffiliateUnreasonablySmallCapitalAnalysis
IntheprecedingSectionoftheReport,theExaminerconcludesthat,pursuantto
adebtorbydebtoranalysis,thereissufficientevidencetosupportadeterminationthat
certainLBHIAffiliateswereeithersolventorinsolvent,butthattherewasinsufficient
evidence to determine the solvency of others.6372 However, the financial condition of
unreasonably small capital is distinct from insolvency, such that an entity might be
solventandyetstillhaveunreasonablysmallcapital.6373Thus,aseparatedebtorby
6371Email from Paul Shotton, Lehman, to Chris OMeara, Lehman (Apr. 15, 2008)
[LBHI_SEC07940_768467](Liquidityismoreimportantthancapital;mostentitieswhichgobankruptdo
sobecausetheyrunoutoffinancing,notbecausethevalueoftheirassetsfallsbelowthevalueoftheir
liabilities.).
6372SeeSectionIII.B.3.cofthisReportforadiscussionofLBHIAffiliatesolvency.
6373Boyerv.CrownStockDistrib.,Inc.,587F.3d787,794(7thCir.2009)(Thedifferencebetweeninsolvency
andunreasonablysmallassetsintheLBOcontextisthedifferencebetweenbeingbankruptontheday
the LBO is consummated and having at that moment such meager assets that bankruptcy is a
consequence both likely and foreseeable.); see also Moody, 971 F.2d at 1070 (Because an inability to
generate enough cash flow to sustain operations must precede an inability to pay obligations as they
comedue,unreasonablysmallcapitalwouldseemtoencompassfinancialdifficultiesshortofequitable
insolvency.);Brandtv.Hicks,Muse&Co.,Inc.(InreHealthcoIntl),208B.R.288,302(Bankr.D.Mass.1997)
(describing the unreasonably small capital standard as connot[ing] a condition of financial debility
short of insolvency (in either the bankruptcy or equity sense), but which makes insolvency reasonably
foreseeable); MFS/Sun Life Trust, 910 F. Supp. at 944 (The test is aimed at transferees that leave the
transferor technically solvent but doomed to fail.); In re Vadnais Lumber Supply, Inc., 100 B.R. 127, 137
(Bankr.D.Mass.1989)(notingthatunreasonablysmallcapital[]...encompassesdifficultieswhichare
shortofinsolvencyinanysensebutarelikelytoleadtoinsolvencyatsometimeinthefuture).
1692
debtor analysis is warranted to determine which, if any, of the LBHI Affiliates was
engagedinbusinesswithunreasonablysmallcapital.
AdeterminationthatLBHIwasoperatingwithunreasonablysmallcapitalhas
implications upon whether any of LBHIs Affiliates were also operating with
unreasonably small capital. Courts have held that where a parent company is left
withunreasonablysmallcapitaltooperateitsbusiness,itssubsidiarieswouldalsobe
left in that same financial condition to the extent they were not independently
funded.6374Thisisespeciallytrueincaseswherethereisacentralizedcashmanagement
systembetweenparentcompanyandaffiliatesonaconsolidatedenterprisebasis,6375or
where there is direct or indirect funding support from a parent to its subsidiaries or
affiliates.6376
The Examiners analysis of whether the LBHI Affiliates may have had
unreasonably small capital focused on those entities that had significant operations
dependent on funding and/or capital support from LBHI since the LBHI Affiliates
capitaladequacyisdirectlylinkedtothatofLBHI.6377TheExaminerfindsthattheeight
6374In re TOUSA, Inc., B.R. , Bankr. No. 0810928, 2009 WL 3519403, at 14 (Bankr. S.D. Fla. Oct. 30,
2009).SeealsoIngallsv.SMTCCorp.(InreSMTCMfg.ofTex.),Bankr.No.0416354CAG,Adv.No.06
1283,2009WL2940161,at*5658(Bankr.W.D.Tex.Sept.11,2009).
6375InreTOUSA,Inc.,2009WL3519403,at*31.
6376SeeTeleglobeUSA,Inc.v.BCEInc.(InreTeleglobeCommcnsCorp.),392B.R.561,602603(Bankr.D.Del.
2008) (holding that the test for subsidiary solvency should not exclude the funding support actually
given by the immediate corporate parent until the point when it would no longer be reasonable to
expectsuchsupport).
6377 See Section III.B.3.c of this Report, which provides the Examiners DebtorbyDebtor analysis of the
solvencyoftheLBHIAffiliates.
1693
LBHI Affiliates that relied on LBHI for funding and/or credit support were CES
Aviation,CESAviationV,CESAviationIX,LCPI,LBSF,LBCS,LOTCandLBCC.The
Examiner therefore concludes that there is sufficient evidence to support a colorable
basisforfindingthattheseentitieshadunreasonablysmallcapitalbeginningearlyin
the third quarter of 2008 and at all times through each applicable petition date. The
Examiner also observes that there exists evidence that would support a contrary
finding.Asconflictingevidenceexists,afinderoffactwillneedtoconsidercarefullyall
available evidence in determining whether LBHI and the LBHI Affiliates had
unreasonably small capital. The Examiner expresses no opinion as to what
determinationafinderoffactwouldmakeinconsideringthiselement.
e) InsiderPreferencesAgainstLBHI(ThirdBullet)
(1) Summary
This Section of the Report discusses insider preferences against LBHI. The
Examiner identified LBSF, LBCS and LCPI as those LBHI Affiliates for which a
determinationcouldbemadeofinsolvencyorborderlinesolvencybeginningonJune1,
2008.TheExaminertailoredthepreferenceanalysistocolorableclaimsthattheseLBHI
AffiliatesmighthaveagainstLBHI.Generally,theExamineridentifiedcashtransfersto
LBHI not in connection with safeharbored activity as preferential if the cash was
transferredfororonaccountofanantecedentdebt.TheExaminersfindingsareas
follows:
1694
There is evidence to support a finding for each element of a preference claim
underSection547(b)oftheBankruptcyCodeinanactionbyLBSFagainstLBHI.There
is also evidence to support a finding for each element of the new value and ordinary
coursedefensesthatLBHIcouldassert.Anyconclusionwouldbedeterminedbyatrier
offact.
There is evidence to support a finding for each element of a preference claim
underSection547(b)oftheBankruptcyCodeinanactionbyLBCSagainstLBHI.There
is also evidence to support a finding for each element of the new value and ordinary
coursedefensesthatLBHIcouldassert.Anyconclusionwouldbedeterminedbyatrier
offact.
TheExaminerhasbeenunabletodeterminewhetherthereisevidencetosupport
afindingforeachelementofapreferenceclaimunderSection547(b)oftheBankruptcy
CodeinanactionbyLCPIagainstLBHIbecausetheExaminer,asdiscussedbelow,has
beenunabletotracethematerialmovementofmoneybetweenLCPIandLBHIthatwas
notinconnectionwithasafeharboredevent.
The Examiner has not analyzed whether CES Aviation LLC, CES Aviation V
LLC,andCESAviationIXLLChavecolorablepreferenceclaimsagainstLBHIbecause
theseentitiesclaimswouldberelativelyinsignificantcomparedtothepotentialclaims
ofotherLBHIAffiliates;theExaminerdeterminesthatitwouldbeanimprudentuseof
estateresourcestofurtherinvestigateanypotentialclaims.
1695
Because the Examiner determined that the remaining LBHI Affiliates were not
insolvent orontheborderlineof solvencyon May31, 2008,theExaminer,forreasons
statedbelow,didnotinvestigatewhethertherewasevidencetosupporteachelement
ofapreferenceclaimunderSection547(b)oftheBankruptcyCodeinanactionagainst
LBHI.
(2) LegalSummary
This Section addresses whether any LBHI Affiliate has colorable claims against
LBHI for potential insider preferences arising under the Bankruptcy Code or state
law.6378TheLBHIAffiliateisthedebtorseekingtoavoidapreferencepayment;LBHIis
theinsiderorcreditorreceivingthatpayment.6379Asuccessfulpreferenceclaimunder
6378Some courts have found that state preference law is an adjunct to, and supplemental of, those
powers specifically provided for in the Bankruptcy Code which enable the trustee to avoid certain
transfers.Perkinsv.PetroSupplyCo.(InreRexploreDrilling,Inc.),971F.2d1219,1222(6thCir.1992);see
alsoProvidentHosp.TrainingAssnv.GMACMortgageCorp.(InreProvidentHosp.&TrainingAssn),79B.R.
374,379(Bankr.N.D.Ill.1987)(recognizingavailabilityofstatepreferencelawasameansofattackinga
transferundersection544(b));AssociatedGrocersofNeb.Coop.,Inc.v.AmHomeProd.Corp.(InreAssociated
GrocersofNeb.Coop.,Inc.),62B.R439,445(D.Neb.1986).ButseeSherwoodPartners,Inc.v.Lycos,Inc.,394
F.3d1198(9thCir.2005)(findingthatstatepreferencelawwaspreemptedbysection547).
The Examiner reviewed preference law in New York and Delaware. The Examiner concluded
that New York does not have a preference statute available to the trustee. Cf. Sharp Intl Corp. v. State
Street Bank and Trust Co. (In re Sharp Intl Corp.), 403 F.3d 43, 5455 (2d Cir. 2005) (explaining that
preferentialpaymentstononinsidersarenotfraudulentconveyancesandarenotavoidableunderNew
York law). Delaware does have a preference statute, see DEL. CODE 10 7387 (1995), but it is unclear
whether the Delaware statute could be used by the trustee in these cases because it has been applied
narrowlybyDelawarecourts.SeeDodgev.WilmingtonTrustCo.,1995WL106380,at*24(Del.Ch.1995)
(noting that Delawares preference statute had not been cited by a Delaware court since 1917 and
refusing to broaden its reach beyond assignments in trust). The Examiners focus in identifying
potentiallypreferentialtransfers,therefore,isontransferssubjecttoavoidanceunderSection547ofthe
BankruptcyCode.
6379See11U.S.C.101(2)(A),(31)(B)(iii),(31)(E).
1696
Section547oftheBankruptcyCoderequires6380thedebtor6381toprove:atransferofan
interest of the debtor in property (1) to or for the benefit of a creditor; (2) for or on
account of an antecedent debt owed by the debtor before such transfer was made; (3)
madewhilethedebtorwasinsolvent;(4)made(A)onorwithin90daysbeforethedate
offilingofthepetition;or(B)betweenninetydaysandoneyearbeforethedateofthe
filingofthepetition,ifsuchcreditoratthetimeofsuchtransferwasaninsider;and(5)
that enables such creditor to receive more than such creditor would receive if (A) the
casewereacaseunderChapter7ofthistitle;(B)thetransferhadnotbeenmade;and
(C) such creditor received payment of such debt to the extent provided by the
provisions of this title.6382 LBHI is an insider of LBHI Affiliates. Consequently, the
applicablereachbackperiodforinsiderpreferencesisoneyear.
The Bankruptcy Code presumes insolvency on and during the 90 days
immediatelyprecedingthedateofthefilingofthepetition.6383Thecreditorcanrebut
thepresumptionofinsolvencybyintroducingevidencethattendstosuggestthatthe
debtorwassolventatthetimethetransferwasmade.6384
6380For a more detailed discussion of the law of preferences, see Appendix 1, Legal Issues, at Section
IV.A.D.
6381Section 1107 of the Bankruptcy Code gives the debtor in possession all the rights of a trustee with
exceptionsnotrelevanthere.
638211U.S.C.547(b).
638311U.S.C.547(f).SeeSectionIII.B.3.cofthisReport,whichdiscusseseachDebtorssolvency.
63845CollieronBankruptcy,547.12(15thed.2005).
1697
The Examiner Order refers to colorable claims against LBHI and does not
mention any potential defenses that LBHI could assert. The Examiner recognizes,
however,thatinthecontextofpreferenceclaimsunderSection547(b)oftheBankruptcy
Code,itisimportanttoconsiderpotentialdefensesthatcouldberaisedbyadefendant
underSection547(c).Thedebtorhastheburdenofprovingtheelementsofapreference
claim,andthecreditorhastheburdenofprovinganydefensetosuchaclaim.6385There
are many potential defenses that defendantcreditors may assert,6386 but the Examiner
has limited the discussion of potential defenses to those that appear to be colorable
basedonareviewoftheDebtorsbooksandrecords.
Inadditiontothedefensesdiscussedabove,thesafeharborsoftheBankruptcy
Codeprotectqualifyingtransfersfrombeingavoidedaspreferential.6387
(3) SourcesofPotentialPreferentialActivity
Upon initial investigation, most of the activity at Lehman was in respect of
transfersthatwereprotected,orexemptfromavoidance,bytheBankruptcyCodessafe
harborprovisions.Therefore,evenifsuchtransferssatisfiedthecriteriaforpreferential
transfers pursuant to Section 547 of the Bankruptcy Code, they could not be avoided
pursuant to Section 546. In light of this determination, the Examiner focused the
investigationonactivitynotinconnectionwithtransfersprotectedbythesafeharbors.
638511U.S.C.547(g).
6386See11U.S.C.547(c).
6387For a more detailed discussion of the Bankruptcy Codes safe harbor provisions, see Appendix 1,
LegalIssues,atSectionIV.E.
1698
TheExamineridentifiedthemovementofcashbetweenLBHIanditsAffiliatesfororon
account of an antecedent debt that was not in connection with securities contracts,
commodities contracts, forward contracts, repo agreements, or swap agreements.6388
The Examiner identified three sources of cash transfers that are potentially not in
connectionwithsafeharboredactivity:(1)fundingactivity6389inGCCM,whichwas
the manual movement of cash between bank accounts owned by affiliates and bank
accounts owned by LBHI; (2) quasifunding activity, which was automatic funding
like activity occurring in GCCM when LBHI acted as central banker by receiving or
extendingvalueonbehalfofitsaffiliates;and(3)trustreceiptactivity,whichwasthe
movementofmoneyrecordedthroughLehmansMTStradingsystem.Eachsourceof
activitywillbediscussedinturn.
First, GCCM funding activity refers to the manual movement of cash between
bank accounts owned by affiliates and bank accounts owned by LBHI.6390 Although
6388See Section III.B.2.c of this Report, which addresses the operation of Lehmans cash management
system.
6389Fundingactivity,asreferredtointhisSectionoftheReport,issimilartowhatisoftenreferredtoas
cash sweeps, but it is nondirectional. As discussed in Section III.B.2.b of this Report, the Examiner
defines cash sweeps to mean the transfer of cash that occurred between September 15, 2008 and the
datethattheapplicableLBHIAffiliatecommenceditsChapter11casefrom(i)anLBHIAffiliatetoLBHI
or(ii)athirdpartytoLBHIforthebenefitofanLBHIAffiliate(itdoesnotincludethesettlementofpre
existingobligations).
6390TheExaminersinvestigationofpotentialpreferencesrelatedtofundingactivityassumesthatmoney
transferredfromanLBHIAffiliatetoLBHIremovedthemoneyfromtheaffiliatesestate.TheExaminer,
forthepurposesofthispreferenceanalysis,assumesthattheaffiliatewouldnothaveasection541/542
claimagainstLBHI.SeeAmduraNatlDistrib.Co.v.AmduraCorp.(InreAmduraCorp.),75F.3d1447(10th
Cir.1996)(concludingthatmoneyheldbyparentdebtorinacashmanagementsystemwasnotproperty
ofsubsidiarydebtorundersection541oftheBankruptcyCode);SouthmarkCorp.v.Grosz(InreSouthmark
Corp.), 49 F.3d 1111 (5th Cir. 1995) (concluding that money held by parent debtor pursuant to a cash
1699
GCCM referred to such activity as funding activity, which this Section of the Report
adopts,theExaminerbifurcatesfundingactivityintothefollowingtwocategories:up
funding,whichreferstotransfersofmoneyfromaffiliatestoLBHI(commonlyreferred
toascashsweeps),anddownfunding,whichreferstotransfersfromLBHItoaffiliates.
The purpose of upfunding was to concentrate Lehmans cash at LBHI. Lehmans
TreasuryGroupsoughttofundeachaffiliatesaccountto$0.00bytheendoftheday.6391
Although Lehman invested the concentrated money overnight, the Examiner has
observedno evidence suggestingthatupfunding activitywas in connectionwithany
safeharbored event.6392 The Examiner expresses no opinion in this Section of the
Report, however, on whether downfunding is protected by the safe harbors, as the
ExaminerOrderdoesnottasktheExaminertoinvestigateclaimsthatLBHImayhave
againstaffiliatesforpotentialinsiderpreferences.6393
management system was property of parentdebtors estate for purposes of preference analysis when
parentdebtormadepaymentonbehalfofsubsidiarydebtor);EnronCorp.v.PortofHoustonAuth.(Inre
EnronCorp.),2006WL2385194,at*67(Bankr.S.D.N.Y.June2,2006);cf.R2Inv.v.WorldAccess,Inc.(Inre
World Access, Inc.), 301 B.R. 217, 26371 (Bankr. N.D. Ill. 2003) (discussing at length ownership of
concentration account); Cassirer ex rel. Estate of Schick v. Herskowitz (In re Schick), 234 B.R. 337 (Bankr.
S.D.N.Y.1999);seegenerallyDerekFeagans,ConcentrationAccountsandBankruptcy:WhereOWheredidthe
BankruptcyEstateGo?,67U.MO.KAN.CITYL.Rev.145(1998).
6391ExaminersInterviewofDanielJ.Fleming,Dec.17,2009,atp.2.Flemingnotedmanyexceptionsto
thegeneralpolicyoffundingaccountstozero.Forexample,ifLBIhadextramoneyattheendoftheday
itwastrappedbecauseLBIcouldnotlendtoLBHIonanunsecuredbasislikeotherLehmanentities.
6392Id. The Examiner has observed no evidence suggesting that upfunding is in connection with a
ProtectedContract.ForamoredetaileddiscussionoftheBankruptcyCodessafeharborprovisions,see
Appendix1,LegalIssues,atSectionIV.E.
6393See 11 U.S.C. 741(7)(A)(v) (extension of credit to settle a securities transaction is a securities
contract). No reported cases have been found interpreting Section 741(7)(A)(v). The Examiner
addressed downfunding in the context of LBHIs new value defense, however, because newvalue
calculationsdonotexcludesafeharboredactivity.See11U.S.C.547(c)(4).
1700
Second,quasifundingactivityreferstoautomaticfundinglikeactivityoccurring
inGCCMwhenLBHIactedascentralbankerbyreceivingorextendingvalueonbehalf
ofaffiliates.Inotherwords,whenLBHIactedascentralbanker,GCCMcreatedmany
automaticquasifundingtransactionsthatwerecoupledwithactivitythatispotentially
protectedbythesafeharbors.Quasifundingactivitytakesmanyforms,butitfollows
the basic premise that Lehman attempted to reduce the movement of cash between
bankaccountsthateventuallyupfundedtoLBHI.6394Quasifundingactivityiscoupled
with an event that, absent GCCM, would have required the movement of cash in a
different way.6395 The Examiner and his financial advisors have been unable to
catalogue all types of quasifunding activity,6396 but several examples are described in
thefollowingparagraphs.
6394SeeSectionIII.B.2ofthisReport,whichdiscussestheconceptoffundingtreesinGCCM.
6395GCCMreferredtothisactivityasintercompanyactivity.ExaminersInterviewofDanielJ.Fleming,
Dec.17,2009,atpp.34.
6396The Examiner has not categorically determined whether quasifunding is in connection with safe
harboredactivitybecausetherearesomanypermutationsofactivitygeneratedbyGCCM.Whetherthe
safeharborsapplytoquasifundingactivitywilldependonhowexpansivelythephraseinconnection
withfoundineachofthesafeharborprovisionsofSections546(e),(f),(g),and(j)isinterpreted.One
court has stated that a natural reading of in connection with suggests a broader meaning similar to
relatedto.Interbulk,Ltd.v.LouisDreyfusCorp.(InreInterbulkLtd.),240B.R.195,202(Bankr.S.D.N.Y.
1999).Anothercourt,ininterpretingthisphrase,heldthatprejudgmentattachmentsthatapartytopre
petition swap agreements obtained in state court actions brought to recover for the debtors alleged
breach of the swap agreements were transfers made in connection with swap agreements, and were
thereforeprotectedbySection546(g)becausetheactionstakenbythepartystemmedfromthefailureof
theswapagreements.CasadeCambioMajaparaS.A.deC.V.v.WachoviaBank,N.A.(InreCasadeCambio
Majapara S.A. de C.V.), 390 B.R. 595 (Bankr. N.D. Ill. 2008). Although no court has addressed any
limitationontheinconnectionwithlanguage,itcannotbeboundless.Inanyevent,theExaminernotes
the tension between the safeharbors expansive in connection with language and the general
propositionthatcourtslooktosubstanceoverforminthecontextofpreferenceidentification.E.g.,Dean
v.Davis,242U.S.438,443(1917)(Merecircuityofarrangementwillnotsaveatransferwhicheffectsa
preferencefrombeinginvalidassuch.);NatlBankofNewportv.NatlHerkimerCountyBank,225U.S.178,
1701
When Lehman implemented GCCM, it sought to limit the number of bank
accounts that it needed to maintain. But Lehman determined that it was less
cumbersometoconvertexistingaffiliatebankaccountsintonocreditaccountsthanit
was to close them and provide new payment instructions to thirdparties.6397 When
moneywasdepositedintonocreditbankaccounts,itwasautomaticallyforwardedto
and deposited into an LBHI bank account. In substance, therefore, deposits into no
creditaccountsrepresentedtwodistincttransactions:acounterpartyremitsapayment
to the affiliate (transaction number one, which is potentially a safeharbored activity),
and Lehman upfunds the money to LBHI at the end of the day (transaction number
two, which is an upfunding activity).6398 Indeed, Lehman employees noted that it
would be a distinction without a difference to consider quasifunding activity to be
184(1912)(Itisnotthemereformormethodofthetransactionthatthe[bankruptcy]actcondemns,but
theappropriationbytheinsolventdebtorofaportionofhispropertytothepaymentofacreditorsclaim,
sothattherebytheestateisdepletedandthecreditorobtainsanadvantageoverothercreditors.);Pacific
N. Oil, Inc.v. Erickson (Inre Seaway Express Corp.),940F.2d 669 (Table), 1991WL 136238, at *2 (9th Cir.
1991)(Indeterminingwhetheratransferhasbeenapreference,abankruptcycourtmustlookthrough
formtosubstance,andtreatthetransactionaccordingtoitsrealnature.(citationsomitted));Katzv.First
Natl Bank of Glen Head, 568 F.2d 964, 97071 (2d Cir. 1977) (looking beyond form to substance in
preferenceaction);cf.Orrv.KinderhillCorp.,991F.2d31,35(2dCir.1993)(notingincontextoffraudulent
transfer under New York law that [i]n equity, substance will not give way to form, and technical
considerationswillnotpreventsubstantialjusticefrombeingdone(citationomitted)).
6397TheExaminerunderstandsthattheseaccountsmayalsobereferredtoassubaccounts.
6398Quasifunding activity could work in the opposite direction that is, LBHI could pay an obligation
owedbyanaffiliate.Inotherwords,thisfunctionedinthesamewayashavingLBHIforwardthemoney
onanunsecuredbasistotheLBHIAffiliate(transactionnumberone),andthenhavingtheLBHIAffiliate
remitthepaymenttothecounterparty(transactionnumbertwo).
1702
anythingotherthanfundingactivity,6399andtheresultingaccountingentrieswouldbe
thesame.Infact,beforeLehmanimplementedGCCM,activityoccurredthisway.6400
Therearemany other examplesof quasifunding activityoutsidethecontextof
nocredit accounts. For example, it was common practice for an affiliate to direct
counterpartiestoremitsettlementpaymentstoLBHIbecauseitwaseasierforLBHIto
keepthecashandadjusttheaffiliatesintercompanyobligationtoLBHIthanitwasto
directcounterpartiestopaytheaffiliateandupfundlater.Or,forexample,ifthepayor
andpayeeof atransaction werebothLehmanaffiliates,and theirbankaccountswere
onthesamefundingtree(thatis,theirrespectivebankaccountswouldultimatelyup
fundtoLBHIattheendoftheday),cashwouldnotmoveinrespectofthattransaction
andeachaffiliatesintercompanyobligationtoLBHIwouldbeadjustedaccordingly.
TheExaminerbifurcatesquasifundingactivityintothefollowingtwocategories:
quasiupfunding, which refers to GCCM activity that caused an affiliates antecedent
debttoLBHItoshrinkbecauseLBHIkeptmoneyorvaluethatwasowedtoanaffiliate,
and quasidownfunding, which refers to GCCM activity that caused an affiliates
antecedentdebttoLBHItogrowbecauseitrepresentsanextensionofcreditgivenby
LBHI.
6399ExaminersInterviewofDanielJ.Fleming,Dec.17,2009,atp.4.SeeSectionIII.B.2.c.3ofthisReport,
whichdiscussesthedistinctionsbetweeninhousevirtualbankaccountsandrealworldbankaccounts.
1703
Third,theExaminersfinancialadvisorsreviewedMTS,Lehmansageoldfixed
income trading platform, for potential preferential activity that occurred outside of
GCCM. Although Lehmans goal was to move all of Lehmans cash management
functionstoGCCM,6401LBHIcontinuedtofunditsaffiliatesindifferentwaysthrougha
multitudeofextraordinarilycomplexsourcesystemsandtradingplatformsatthetime
ofitsbankruptcy.6402LehmancreatedsecuritiesknownastrustreceiptsinMTSthat
fundedcertainaffiliatebank accountstiedto thatsystem.6403TheExaminers financial
advisorsreviewedMTS,whereappropriate,toidentifypotentialpreferentialactivity.
Theidentificationofcashtransfersnotinconnectionwithsafeharboredactivity
wasverydifficultoutsideofGCCM,andDanielJ.Fleming,LehmansformerHeadof
Global Cash and Collateral Management, could not identify all potential sources of
fundingactivity,norcouldheidentifyallthesystemsusedtotransfermoneybetween
Lehmans3000plusbankaccounts.6404Notwithstandingthescopeanddiligenceofthe
investigation,theExaminerrecognizesthatthedataavailablearelikelyincompleteand
6402SeeSectionIII.B.2.cofthisReport,whichdiscussesLehmanscashmanagementsystem.GCCMwas
fullyintegratedinEuropeandpartiallyintegratedintheUnitedStates.ItwasnotintegratedinAsia.
6403ExaminersInterviewofDanielJ.Fleming,Dec.17,2009,atp.6;ExaminersInterviewofAdaShek,
Nov. 24, 2009,at p.8. The Examiner hasfound noevidence that funding throughtrust receipts was
improper.TheuseoftrustreceiptsisdiscussedingreaterdetaillaterintheReport.TheLECforLCPI,
which was a primary LBHI Affiliate that utilized trust receipts, would manually allocate the funding
associated with trust receipts to the general ledger intercompany funding account between LCPI and
LBHIattheendofeachmonth.ExaminersInterviewofAdaShek,Nov.24,2009,atpp.89.Moreover,
the trade detail in the MTS system labels these transactions as unsecured intercompany funding.
Appendix22,Duff&Phelps,PreferencesAgainstLBHIandOtherLehmanEntities(Feb.1,2010).
1704
thatmoneymovedthroughLehmaninwaysnotidentifiedinthisSectionoftheReport.
Accordingly,itispossiblethatpotentialpreferentialactivitymayhaveoccurredoutside
whatiscapturedbyfundingandquasifundingactivityinGCCM,andtrustreceiptsin
MTS.
(4) DeterminationsandAssumptionsonSection547(b)Elements
TheExaminerdeterminedthatitwasprudenttofocusthepreferenceanalysison
LBHI Affiliates that were either insolvent or on the borderline of insolvency, because
proofofinsolvencyatthetimeanypreferentialtransferismadeisarequiredelementof
a preference claim. Only six LBHI Affiliates were insolvent or on the borderline of
insolvency for significant portions of the twelve months before their respective filing
dates,whichisillustratedbythefollowingchart:6405
Balance Sheet Solvency for Borderline and Insolvent Debtor Entities

Fiscal Years 2007 and 2008
CES Aviation CES Aviation V CES Aviation IX LBCS LBSF LCPI

Solvency Solvency Solvency Solvency Solvency Solvency
Determination Determination Determination Determination Determination Determination
September-07 Borderline Insolvent Insolvent Borderline Borderline Borderline
October-07 Borderline Insolvent Insolvent Borderline Borderline Borderline
November-07 Borderline Insolvent Insolvent Borderline Borderline Borderline
December-07 Borderline Insolvent Insolvent Borderline Borderline Borderline
January-08 Borderline Insolvent Insolvent Borderline Borderline Borderline
February-08 Borderline Insolvent Insolvent Borderline Borderline Insolvent
March-08 Borderline Insolvent Insolvent Borderline Borderline Borderline
April-08 Borderline Insolvent Insolvent Borderline Borderline Insolvent
May-08 Borderline Insolvent Insolvent Borderline Borderline Insolvent
June-08 Borderline Insolvent Insolvent Borderline Borderline Insolvent
July-08 Insolvent Insolvent Insolvent Borderline Borderline Insolvent
August-08 Insolvent Insolvent Insolvent Borderline Borderline Borderline

6405See Section III.B.3.c of this Report, which discusses each LBHI Affiliates solvency during the pre
petitionperiod.
1705
GiventhecomplexityofLehmansnumeroussourcesystemsandthesubstantial
costofanalyzingthem,theExaminerhasdeterminedthatitwouldbeprudenttolimit
the analysis to the period between June 1, 2008 and each debtors respective filing
date,6406whichisreferredtoastheDefinedPreferencePeriod.Moreover,becausethe
assetsoftheaviationentitieswererelativelyinsignificantwhencomparedtotheother
LBHI Affiliates, the Examiner focused the analysis on LBSF, LBCS, and LCPI. As the
ExamineralsofocusedhisanalysisontheDefinedPreferencePeriod,thisReportdoes
not address colorable preference claims that LBSF, LBCS, and LCPI may have against
LBHIinrespectofpreDefinedPreferencePeriodtransfers.
In light of theExaminers conclusionthat there isinsufficientevidenceto rebut
thepresumptionofinsolvencypursuanttoSection547(g)oftheBankruptcyCodewith
respect to LOTC and LBCC after September 12, 2008, the Examiner considered
conducting a preference analysis with respect to those LBHI Affiliates. The Examiner
notes, as the Defined Preference Period for LBSF, LBCS, and LCPI began on June 1,
2008,therewasasufficientuniverseofpotentiallypreferentialtransferstowarrantthe
expenditure of resources to analyze such transfers. Conversely, the applicable period
for LOTC and LBCC would only begin after September 12, 2008; thus the universe of
6406As discussed in greater detail in Appendix 22, Duff & Phelps, Preferences Against LBHI and Other
LehmanEntities(Feb.1,2010),p.4,therewasnofundingactivityrecordedinGCCMduringOctober
2008.TherewassomeactivityinGCCMrelatingtoquasifundinginOctober2008thatdidnotexceed
$10 million for LBSF and LBCS combined. Id. at pp. 13, 16. The Examiners financial advisors
disregardedactivityinOctober2008forthepurposesofthispreferenceanalysis.
1706
potentialpreferentialtransfersforLOTCandLBCCwouldbemuchsmallerandwould
consistofatypelikelytobeshieldedbythesafeharborprovisionsoftheBankruptcy
Code. At the same time, the cost of conducting such a review for LOTC and LBCC
wouldbematerialbecauseofthecomplexityofLehmansfinancialreportingsystems,
the dislocation caused by LBHIs bankruptcy filing on September 15, 2008, and the
resulting disruption in Lehmans financial reporting systems. Consequently, the
Examiner determined that it would not be a prudent use of resources to conduct a
preferenceanalysisforLOTCandLBCC.
The Examiner made the following determinations with respect to certain
elementsofaSection547(b)claim(thesedeterminationsapplytoallpreferenceclaims
that could be asserted by LBSF, LBCS, and LCPI, as discussed herein). First, the
Examinerconcludes,inthecontextoffunding,thatthetransferringLBHIAffiliatehada
colorable interest . . . in [the] property transferred. This was evidenced by the
accounting records6407 (including virtual account titles in the cash management
system6408),andthelackofanyevidencesuggestingthatthetransferringentitydidnot
haveaninterestinthepropertytransferred.
Second, LBSF, LBCS, and LCPI had significant antecedent debt obligations to
LBHI.Thisisevidencedbyintercompanycreditbalanceswith,orobligationsto,LBHI
6407E.g.,InreSchick,234B.R.at34243(discussingwhetherfundsindebtorsbankaccountwereownedby
debtorforpurposesofsection541oftheBankruptcyCode).
6408SeeSectionIII.B.2.cofthisReport,whichdiscussesinhousevirtualaccountsinGCCM.
1707
onthebooksandrecordsofLBSF,LBCS,andLCPI.Similarly,thebooksandrecordsof
LBHI reflect debit balances with, or receivables from, LBSF, LBCS, and LCPI. The
Examiner has observed no evidence suggesting these intercompany payables to LBHI
representedanythingotherthandebtobligations.6409
Third, the Examiner concludes that upfunding and quasiupfunding
transactionsrepresentedpaymentsfororonaccountoftheantecedentdebtbecause
theliabilityonthebooksandrecordsofLBSF,LBCS,andLCPIwasreducedwhenthe
transfers were made. Similarly, the receivable on the books and records ofLBHI was
reducedwhenthetransfersweremade.6410Forthesamereason,theExaminerconcludes
thatthepaymentsmadebyLBSF,LBCS,andLCPIbenefitedLBHI.6411
Furthermore,theExaminerassumedforthepurposesofthisanalysisthatLBHI
received more from any preferential activity than it would have received under a
hypothetical Chapter 7 liquidation. Before making this assumption, however, the
Examinerfirstconsideredwhetheralloranypartofthedebtthatwassatisfiedwould
havebeenonaccountofasecuredobligationbyvirtueofSection553spreservationof
6409See,e.g.,CelotexCorp.v.HillsboroughHoldingsCorp.(InreHillsboroughHoldingsCorp.),176B.R.223,248
50(M.D.Fla.1994)(findingthat,underthecircumstancesofthecase,theintercompanyaccountpayables
were debt obligations and not equity investments); cf. Amdura Corp. v. Ryder Truck Rental, Inc. (In re
AmduraCorp.),151B.R.557,55960(Bankr.D.Colo.1993).
6410LCPI,LBSF,andLBCS(aswellastheotherLBHIAffiliates)hadmultipleintercompanyaccountswith
LBHI. However, unsecured funding was always recorded in the same intercompany account on the
books and records (the account numbers all began with 12620). Ernst and Young Walkthrough
Template(Nov.30,2009),atp.6[EYSECLBHICORPGAMX07033384].
6411See generally Bank of Am. Natl Trust & Sav. Assoc. v. 203 N. LaSalle St. Pship, 526 U.S. 434 (1999)
(discussingonaccountoflanguageinadifferentcontextundertheBankruptcyCode).
1708
setoff rights. Braniff Airways, Inc. v. Exxon Co., U.S.A.6412 addressed the concept of
permissible preference[s]byvirtueofSection506(a)oftheBankruptcy Code,which
affords secured status to claims of setoff under Section 553(a).6413 The Examiner
concludesthatLBHIdoesnothaveanargumentthatsuchpreferentialtransferswould
be on account of a secured claim by virtue of any setoff right under the rationale of
BraniffAirways.6414
6412814F.2d1030(5thCir.1987).
6413Id.at1034.
6414LBHIsbooksandrecordsreflectmultipleintercompanyaccountswithitsaffiliates.Similarly,many
of the affiliates books and records reflect multiple intercompany accounts with LBHI. In many cases,
however,thebooksandrecordsofanaffiliatereflectbothpayablesandreceivableswithLBHIandthe
books and records of LBHI reflect both payables and receivables with any particular affiliate. The
apparent mutuality of obligations raises the question of whether an LBHI Affiliate could prove the
hypotheticalliquidationanalysisunderSection547(b)(5)oftheBankruptcyCodegiventhesecuredstatus
ofmutualdebtsunderSections553and506.Inotherwords,ifLBHIwasindebtedtoanaffiliateformore
thantheaffiliatewasindebtedtoLBHI,theaffiliatemaynotsatisfyitsSection547(b)(5)burdenbecause
LBHIsrightofsetoffunderSection553wouldhaveencompassedanypreferencepaymentamounthad
thepreferencenotbeenmade.SeeBraniffAirways,814F.2dat1035;cf.BrooksFarmsv.U.S.DeptofAgric.
(InreBrooksFarms),70B.R.368,37273(Bankr.E.D.Wis.1987);InreRevereCopperandBrass,Inc.,32B.R.
577, 583 n.3 (Bankr. S.D.N.Y. 1983). The Examiner reviewed the intercompany account balances on
LBHIsbooksandrecordsagainsttheintercompanyaccountbalancesonLBSF,LBCS,andLCPIsbooks
andrecordsforAugustandSeptember2008.TheExamineralsoreviewedSchedulesBandFfromLBHI,
LBSF, LBCS, and LCPIs Amended Schedules and Statements, which address inter alia intercompany
receivables and unsecured intercompany payables, respectively. The schedules for LBCS, LBSF, and
LCPIcanbefoundatdocketnumbers3061,3066,and3067,respectively,andtheAmendedSchedulesfor
LBCS,LBSF,andLCPIcanbefoundatdocketnumbers3939,3921,and3927,respectively.Asillustrated
inAppendix22,Duff&Phelps,PreferencesAgainstLBHIandOtherLehmanEntities(Feb.1,2010)atex.
1, LBSF, LBCS, and LCPI all owed LBHI significantly more than LBHI owed LBSF, LBCS, or LCPI,
respectively,attheendofSeptember2008.Assuch,theExaminerhasobservednoevidencesuggesting
that LBHI owed LBSF, LBCS, and LCPI more than it was owed on September 15, 2008. Therefore, the
ExaminerhasconcludedthatLBSF,LBCS,andLCPIwillnotbeprecludedfromprovingahypothetical
liquidationanalysisasrequiredbySection547(b)(5)oftheBankruptcyCodeundertherationaleofBraniff
Airways.
1709
(5) ScopeofDefensesUnderSection547(c)
TheExamineranalyzedthenewvalueandordinarycoursedefensesunder
Sections 547(c)(4) and 547(c)(2) of the Bankruptcy Code, respectively, for funding and
quasifundingactivity,whereappropriate.6415
New Value Defense. The new value defense provides that a creditor may
deduct from any liability it owes a debtor as a result of a preferential transfer any
amountofnewvaluethatitgavethedebtorafterthepreferentialtransferoccurred.6416
For example, if a debtor pays a creditor $100 on day one in respect of an antecedent
debt and all other criteria for a preference are satisfied, and on day two, the creditor
extendsnewcreditworth$90thatisnotsubsequentlyrepaidbythedebtor,only$10of
the$100paymentisapreference.6417
6415TheExaminerdoesnotaddresswhetherLBHImayassertmultipledefensesunderSection547(c)of
theBankruptcyCode.SeeG.H.LeidenheimerBakingCo.v.Sharp(InreSGSMAcquisitionCo.,LLC),439F.3d
233,242n.7(5thCir.2006).
6416Section547(c)(4)providesthat[t]hetrusteemaynotavoidunderthissectionatransfer...(4)toor
forthebenefitofacreditor,totheextentthat,aftersuchtransfer,suchcreditorgavenewvaluetoorfor
the benefit of the debtor (A) not secured by an otherwise unavoidable security interest; and (B) on
account of which new value the debtor did not make an otherwise unavoidable transfer to or for the
benefitofsuchcreditor.
6417If there were multiple extensions of new value, the Examiner applied the wellestablished rule that
extensionscanbeappliedtoanyprecedingpreferentialtransferandnotjusttheimmediatelypreceding
preferentialtransfer.SeeWilliamsv.AgamaSys.,Inc.(InreMicroInnovationsCorp.),185F.3d329,33637
(5thCir.1999)(discussingthemajorityandminorityrulesfornewvalue,andadoptingmajorityrule,
which permits the crediting of new value against any prior preference and not only the immediately
precedingone);seealsoInreSGSMAcquisitionCo.,LLC,439F.3dat24143;Katzv.StarkTrust(InreVan
Dyck/ColumbiaPrinting),289B.R.304,315(D.Conn.2003);5CollieronBankruptcy547.04[4][d](15thed.
2008);cf.InreAdelphiaBus.Solutions,Inc.,341B.R.415,426(Bankr.S.D.N.Y.2003)(recognizingnewvalue
defenseinthecontextofacashmanagementsystem).
1710
Howquasifundingwillbecharacterizedinrelationtothesafeharbors,however,
appears to be an issue of first impression that is, whether such funding is safe
harbored, not safeharbored, or somewhere inbetween.6418 Therefore, the Examiners
financialadvisorsconstructedthreemodelstocalculateLBHIspreferenceexposurenet
of new value.6419 First, the Examiners financial advisors calculated LBHIs preference
exposure solely by considering upfunding activity as preferential and downfunding
activity as new value. Second, the Examiners financial advisors calculated LBHIs
preference exposure by considering only upfunding activity as preferential, but gave
LBHI new value credit for both downfunding and quasidownfunding activity. The
followingchartillustratesthiscalculation:
AntecedentDebt Antecedent
debt
$0 PreferenceExposure
NewValue obligation
(upfunding)
(Downfunding+
SafeHarboredActivity
quasidown
$10 (Quasiupfunding
funding)
excludedasnon
preferential)
$20
Time
Third, the Examiners financial advisors calculated LBHIs preference exposure
by considering upfunding and quasiupfunding as preferential, but gave LBHI new
6418EachdaythereweremanyquasifundingtransactionsbetweenLBHIandLBSF,LBCSandLCPI.For
thepurposesofthisanalysis,however,theExaminergroupedthemalltogether,eventhougheachoneis
potentiallyunique.
6419These are referred to as models one, two, and three in Appendix 22, Duff & Phelps, Preferences
AgainstLBHIandOtherLehmanEntities(Feb.1,2010).
1711
value credit for both downfunding and quasidownfunding activity. The following
illustratesthiscalculation:
Antecedent
AntecedentDebt
debt
$0 Preference
NewValue obligation
Exposure(Up
funding+ (Downfunding+
$10 quasiup quasidown
funding)
funding)
$20
Time
Ordinary Course Defense. The ordinary course defense permits creditors to
argue that debts were incurred in the ordinary course and payments on account of
thosedebtsweremadeintheordinarycourseofbusinessbetweentheparties.6420The
6420Section547(c)(2)providesthat[t]hetrusteemaynotavoidunderthissectionatransfer...(2)to
theextentthatsuchtransferwasinpaymentofadebtincurredbythedebtorintheordinarycourseof
business or financial affairs of the debtor and the transferee, and such transfer was (A) made in the
ordinarycourseofbusinessorfinancialaffairsofthedebtorandthetransferee;or(B)madeaccordingto
ordinarybusinessterms.11U.S.C.547(c)(2).TheExamineraddressedsubsection547(c)(2)(A)andnot
subsection (B), which discusses whether the payments were made according to ordinary business
terms.
The purpose of section 547(c)(2) is to leave undisturbed normal financial relations, because it
doesnotdetractfromthegeneralpolicyofthepreferencesectiontodiscourageunusualactionbyeither
the debtor or his creditors during the debtors slide into bankruptcy. Savage & Assocs., P.C. ex rel.
Teligent,Inc.v.Mandl(InreTeligent,Inc.),380B.R.324,340(Bankr.S.D.N.Y.2008)(quotingH.R.Rep.No.
95595,at373(1977)).Indeterminingwhetherthedebtwasincurredintheordinarycourseofbusiness,
the court will look to other transactions between the parties. Jacobs v. Matrix Cap. Bank (In re
AppOnline.com,Inc.),315B.R.259,283(Bankr.E.D.N.Y.2004).Indeterminingwhetheratransferismade
in the ordinary course of business, a court may consider (i) the prior course of dealing between the
parties, (ii) the amount of the payment, (iii) the timing of the payment, (iv) the circumstances of the
payment, (v) the presence of unusual debt collection practices, and (vi) changes in the means of
payment.InreTeligent,380B.R.at340.[T]hecornerstoneofthiselementofapreferencedefenseisthat
thecreditorneeds[to]demonstratesomeconsistencywithotherbusinesstransactionsbetweenthedebtor
andthecreditor.InreSchick,234B.R.at348(quotingWJM,Inc.v.Mass.DeptofPub.Welfare,840F.2d
996,1011(1stCir.1988))(alterationinoriginal).Thecreditormustestablishabaselineofdealingsto
1712
Examiner has not located any authority that discusses ordinary course defenses in
preference actions asserted by debtoraffiliates against their debtorparents in the
contextofcomplexcashmanagementsystems,whichistheprimarysourceofpotential
preferential activity here.6421 Nonetheless, repeated transfers made to a debtors
corporate parent on account of an antecedent debt that resulted from continual
extensionsofcreditforoperatingpurposeshavebeenupheldasunavoidableordinary
coursetransfersinothercases.6422
(6) FindingsforLBSF
The following chart illustrates LBHIs preference exposure to LBSF during the
DefinedPreferencePeriod:
enablethecourttocomparethepaymentpracticesduringthepreferenceperiodwiththepriorcourseof
dealing.Id.
6421Cf.InreAdelphiaBus.Solutions,Inc.,341B.R.at426(recognizingordinarycoursedefenseinthecontext
ofacashmanagementsystem);InreHillsboroughHoldingsCorp.,176B.R.at24750(recognizingordinary
coursedefenseincontextofpiercingthecorporateveilwhenparentsweptcashfromsubsidiaries).
6422E.g., Waldschmidt v. Ranier (In re Fulghum Constr. Corp.), 872 F.2d 739 (6th Cir. 1989) (upholding
ordinary course defense when debtor made repeated payments to parentpartnership to reduce
antecedentdebtobligationthatwascreatedbymorethan100extensionsofcreditforvariouspurposes
includingoperatingexpenses);CCIConstr.Inc.v.AllfirstBank(InreCCIConstr.Co.),371B.R.83(Bankr.
M.D.Pa.2007)(discussingordinarycoursedefenseincontextofrevolvingunsecuredcashmanagement
facilitywithbanklender);Redmondv.EllisCountyAbstract&TitleCo.(InreLibertyLivestockCo.),198B.R.
365 (Bankr. D. Kan. 1996) (discussing ordinary course and new value defenses on running account
balancebetweenrelatedcompanies).
1713

Preferential Preference PreferenceExposureNetofNewValue

Activity Exposurewithout duringtheDefinedPreferencePeriod
NewValueduring Downfunding Downfunding
theDefined NewValueOnly andQuasidown
PreferencePeriod fundingNew
Value
UpfundingOnly $19.4billion $3.8billion $636million
Upfundingand $29.4billion n/a $718million
Quasiupfunding
In addition, there is evidence supporting LBHIs ordinary course defense. In short,
there is evidence to support each element of a preference claim, but there is also
evidencetosupporteachelementofthenewvalueandordinarycoursedefenses.6423
DiscussionofPreferentialTransfers.OnJune1,2008,LBSFhadanantecedent
debt owed to LBHI of approximately $7.5 billion.6424 The intercompany accounts
between LBSF and LBHI experienced significant activity after that day. The
intercompany account activity resulted from funding and quasifunding activity that
6423SeeAppendix22,Duff&Phelps,PreferencesAgainstLBHIandOtherLehmanEntities(Feb.1,2010)
for a detailed and lengthy discussion of the models developed, methodologies used, and assumptions
madeinreachingthesecalculations.
6424AsillustratedinAppendix22,Duff&Phelps,PreferencesAgainstLBHIandOtherLehmanEntities
(Feb. 1, 2010) at ex. 2, LBHI and LBSF had multiple intercompany accounts. Not every intercompany
accountwasusedforfundingactivitiesthatis,someaccountsrepresentedrepoorderivativeliabilities
or receivables, and they were generally in connection with safeharbored activity. The $7.5 billion
obligation noted above was derived from the sum of the intercompany obligations based on the two
accounts in the general ledger that were used for funding and quasifunding activities in GCCM. One
account was between LBHINew York and LBSF, and the other account was between LBHI (UK) and
LBSF.IftheotherintercompanyaccountsbetweenLBSFandLBHIwereincluded,theobligationwould
belarger.Inclusionoftheotheraccountswasunnecessaryforthepreferenceanalysis,however,because
thetotaldollaramountofeverypotentialpreferentialtransferwaslessthantheoutstandingliabilityfrom
thesumofthesetwofundingaccountsonthedayeachtransferwasmade.
1714
was observed in GCCM.6425 The Examiner has observed nothing suggesting that up
fundingwasrelatedtotrades,repos,orsimilaractivity,andtheExaminerunderstands
that it was performed on an unsecured basis for the purpose of concentrating cash at
LBHI.DuringtheDefinedPreferencePeriod,therewas$19.4billionand$10.1billionin
upfunding and quasiupfunding activity, respectively.6426 Together, this amounts to
$29.4billioninpotentiallypreferentialactivity.
NewValueDefense.LBHIsnewvaluedefensecapturesthemajorityofLBSFs
preference claim. The Examiners financial advisors calculated LBHIs new value
defense in three ways as noted above. First, the Examiners financial advisors
calculated LBHIs preference exposure solely by considering upfunding activity as
preferentialanddownfundingactivityasnewvalue.LBHIsexposuretoLBSFduring
the Defined Preference Period under this calculation is $3.8 billion.6427 Second, the
ExaminersfinancialadvisorscalculatedLBHIspreferenceexposurebyconsideringup
fundingactivityaspreferential,butgaveLBHInewvaluecreditforbothdownfunding
and quasidownfunding activity. LBHIs exposure to LBSF during the Defined
6425Daniel J. Fleming noted that funding activity for LBSF occurred in an LBI bank account in which
LBSF was clearing its derivative payment activity from RISC, another Lehman trading platform (it is
unclearwhetherLBHIorLBHI(UK)providedthefundsforthisaccount).Thisfundingactivitywould
notbecapturedinthefundingcolumnbecauseLBSFdidnotowntheaccountintoandfromwhichthe
moneywastransferred.Nonetheless,Flemingnotedthatthisactivitywaslikelycapturedinthequasi
funding activity column. As for LBSF generally, Fleming noted that funding activity may have
occurredinotherregions,buthecouldnotidentifyhowitmayhavebeencapturedbyLehmanssystems.
ExaminersInterviewofDanielJ.Fleming,Dec.17,2009,atp.8.
6426Appendix22,Duff&Phelps,PreferencesAgainstLBHIandOtherLehmanEntities(Feb.1,2010).
6427Id.
1715
Preference Period under this calculation is $636 million.6428 Third, the Examiners
financial advisors calculated LBHIs preference exposure by considering upfunding
andquasiupfundingaspreferential,butgaveLBHInewvaluecreditforbothdown
funding and quasidownfunding activity. LBHIs exposure to LBSF during the
DefinedPreferencePeriodunderthiscalculationis$718million.6429
Ordinary Course Defense. There is evidence for LBHI to assert an ordinary
coursedefenseevenifthenewvaluedefensedoesnotprecluderecovery.
Based on LBHI and LBSFs books and records, the debts incurred by LBSF
appear to be in the ordinary course of business between LBHI and LBSF. There is
consistent funding activity between LBHI and LBSF during the two years prior to
LBSFsbankruptcy.Duringtheyearpriortobankruptcy,thenumberofdownfunding
transactionsrangedfromthirtytwotosixtythreepermonth,andduringthetwoyears
prior to bankruptcy, the number of downfunding transactions ranged from seven to
sixtythreepermonth.6430SuchdownfundingactivityisconsistentwithLBHIsroleas
centralbankerwithintheLehmanenterprise.Similarly,thereisconsistentquasidown
6428Id.
6429Id. LBHIs preference exposure to LBSF under the second and third calculations resulted from up
fundingthatoccurredattheendofthedayonSeptember12,2008.Althoughsuchapotentialpreference
may not be covered under the new value defense, this fact pattern is similar to that described in In re
FulghumConstr.Corp.872F.2d739,whichaddressedthisissueundertheordinarycoursedefense.
6430Appendix22,Duff&Phelps,PreferencesAgainstLBHIandOtherLehmanEntities(Feb.1,2010)at
exs.1821.Thelownumberoffundingtransactions(eitherupordownfunding)priortoMay2007is
consistentwiththeExaminersunderstandingthatGCCMwasintheimplementationphases.
1716
funding activity.6431 The Examiner has observed no evidence suggesting that down
funding or quasidownfunding was not in the ordinary course of business between
LBHIandLBSF.
Similarly,theExaminerhasreviewedthenonexhaustivefactorscourtsusewhen
determining whether payments made on account of an antecedent debt are in the
ordinarycourseofbusinessbetweenthedebtorandthetransferee.6432Uponreviewof
those factors, there is evidence to support LBHIs defense. As a threshold matter,
formerLehmanemployeesstatedthatitwasLehmansgoaltoupfundeachaffiliates
bankaccountto$0.00attheendofeachday,6433whichisnotinconsistentwiththebooks
andrecords.TheExaminerandhisfinancialadvisorsreviewedfundingactivitydating
backtoJune2006;fundingactivity(bothupanddownfunding)regularlyoccurredin
significantamountsineverymonthbeforeLBSFsbankruptcy.6434TheExaminerhasnot
identified anything inthe DefinedPreferencePeriodthat deviated from this historical
practice. Finally, the Examiner has observed no evidence that LBSFs potentially
preferentialtransfersweremadeinanticipationofbankruptcy,orthattheyweredone
because of unusual debt practices by LBHI. In short, there is evidence to support a
ex.1.
6432TheExaminerhasnotreviewedthealternativegroundsforreliefunderSection547(c)(2)(B),namely
whetherthepurportedpreferencepaymentsweremadeaccordingtoordinarybusinessterms.
6433ExaminersInterviewofDanielJ.Fleming,Dec.17,2009,atp.2.Thenotableexceptiontothispractice
waswithLBI.
exs.1820.
1717
findingthatsuchactivitywasrecurring,customary,anddesignedtofacilitateLBSFs
business.6435TheExaminerhasthereforedeterminedthatthereisevidenceforLBHIto
assertadefenseunderSection547(c)(2)oftheBankruptcyCode.Anyconclusionwould
bedeterminedbyatrieroffact.
(7) FindingsforLBCS
The following chart illustrates LBHIs preference exposure to LBCS during the
DefinedPreferencePeriod:
Preferential Preference PreferenceExposureNetofNewValue

Activity Exposurewithout duringtheDefinedPreferencePeriod
NewValueduring Downfunding Downfunding
theDefined NewValueOnly andQuasidown
PreferencePeriod fundingNew
Value
UpfundingOnly $3.3billion $643million $15million
Upfundingand $4.3billion n/a $633million
Quasiupfunding
In addition, there is evidence supporting LBHIs ordinary course defense. In short,
there is evidence to support each element of a preference claim, but there is also
evidencetosupporteachelementofthenewvalueandordinarycoursedefenses.6436
DiscussionofPreferentialTransfers.OnJune1,2008,LBCShadanantecedent
debt owed to LBHI of approximately $2.2 billion.6437 The intercompany accounts
6435InreFulghumConstr.Corp.,872F.2dat745.
6436SeeAppendix22,Duff&Phelps,PreferencesAgainstLBHIandOtherLehmanEntities(Feb.1,2010)
for a detailed and lengthy discussion of the models developed, methodologies used, and assumptions
madeinreachingthesecalculations.
1718
between LBCS and LBHI experienced significant activity after that day. The
intercompany account activity resulted from funding and quasifunding activity that
was observed in GCCM. The Examiner has observed nothing to suggest that up
funding was related to trades, repos, or similar activity, and evidence suggests that it
was performed on an unsecured basis for the purpose of concentrating cash at LBHI.
During the Defined Preference Period, there was $3.3 billion and $1.0 billion in up
fundingandquasiupfundingactivity,respectively.6438Together,therewas$4.3billion
inpotentiallypreferentialactivity.
New Value Defense. LBHIs new value defense captures the majority of the
amount of LBCSs preference claim. The Examiners financial advisors calculated
LBHIsnewvaluedefenseinthreewaysasnotedabove.First,theExaminersfinancial
advisors calculated LBHIs preference exposure solely by considering upfunding
activity as preferential and downfunding activity as new value. LBHIs liability to
(Feb. 1, 2010) at ex. 1, LBCS and LBHI had multiple intercompany accounts. Not every intercompany
or receivables, and they were generally in connection with safeharbored activity. The $2.2 billion
obligation noted above was derived from the sum of the intercompany obligations based on the two
accountsinthegeneralledgerthatwereusedforfundingandquasifundingactivitiesinGCCM.Ifthe
other intercompany accounts between LBCS and LBHI were included, the obligation would be larger.
Inclusionoftheotheraccountswasunnecessaryforthepreferenceanalysis,however,becausethetotal
dollaramountofeverypotentialpreferentialtransferwaslessthantheoutstandingliabilityfromthesum
ofthesetwofundingaccountsonthedayeachtransferwasmade.
6438Appendix22,Duff&Phelps,PreferencesAgainstLBHIandOtherLehmanEntities(Feb.1,2010),at
ex.6.
1719
LBCS during the Defined Preference Period under this calculation is $642 million.6439
Second, the Examiners financial advisors calculated LBHIs preference exposure by
considering upfunding activity as preferential, but gave LBHI new value credit for
bothdownfundingandquasidownfundingactivity.LBHIsexposuretoLBCSduring
the Defined Preference Period under this calculation is $15 million.6440 Third, the
ExaminersfinancialadvisorscalculatedLBHIspreferenceexposurebyconsideringup
fundingandquasiupfundingaspreferential,butgaveLBHInewvaluecreditforboth
downfundingandquasidownfundingactivity.LBHIsexposuretoLBCSduringthe
DefinedPreferencePeriodunderthiscalculationis$633million.6441
Ordinary Course Defense. There is evidence for LBHI to assert an ordinary
coursedefenseintheeventthatthenewvaluedefensedoesnotprecluderecovery.
Based on LBHI and LBCSs books and records, the debts incurred by LBCS
appear to be in the ordinary course of business between LBHI and LBCS. There is
consistentfundingactivitybetweenLBHIandLBCSduringthesixteenmonthspriorto
LBCSs bankruptcy. During the sixteen months prior to bankruptcy, the number of
downfundingtransactionsrangedfromninetothirtysevenpermonth.6442Thisdown
funding activity is consistent with LBHIs role as central banker within the Lehman
6439Id.
6440Id.
6441Id.
6442Id.atexhs.911.Thelownumberoffundingtransactions(eitherupordownfunding)priortoMay
2007isconsistentwiththeExaminersunderstandingthatGCCMwasintheimplementationphases.
1720
enterprise. Similarly, there is consistent quasidownfunding, although such activity
was less frequent before February 2008.6443 The Examiner has observed no evidence
suggestingthatdownfundingorquasidownfundingwasnotintheordinarycourseof
businessbetweenLBHIandLBCS.
Similarly,theExaminerhasreviewedthenonexhaustivefactorscourtsusewhen
determining whether payments made on account of an antecedent debt are in the
ordinarycourseofbusinessbetweenthedebtorandthetransferee.6444Uponareviewof
those factors, there is evidence to support LBHIs ordinary course defense. As a
threshold matter, former Lehman employees stated that it was Lehmans goal to up
fund each affiliates bank account to $0.00 at the end of each day,6445 which is not
inconsistent with the books and records. The Examiner reviewed funding activity
dating back to April 2007; funding activity (both up and downfunding) regularly
occurred in every month before LBCSs bankruptcy. The Examiner has not identified
anything in the Defined Preference Period that deviated from this historical practice.
TheExaminerdoesnote,however,thatquasiupfundingexceedsquasidownfunding
ex. 12. The low number of quasifunding transactions (either up or downquasifunding) prior to
February 2008 is consistent with the Examiners understanding that GCCM was in the implementation
phases.
6444TheExaminerhasnotreviewedthealternativegroundsforreliefunderSection547(c)(2)(B),whichis
whetherthepurportedpreferencepaymentsweremadeaccordingtoordinarybusinessterms.
6445ExaminersInterviewofDanielJ.Fleming,Dec.17,2009,atp.2.Thenotableexceptiontothispractice
waswithLBI.
1721
forthefirsttimeinAugust2008,whichdeviatesfromthepriormonths.6446Finally,the
ExaminerhasobservednoevidencethatLBCSspotentiallypreferentialtransferswere
made in anticipation of bankruptcy, or that they were done because of unusual debt
practicesbyLBHI.Inshort,thereisevidencetosupportafindingthatsuchactivitywas
recurring, customary, and designed to facilitate LBCSs business.6447 The Examiner
thus determines that there is evidence for LBHI to assert a defense under Section
547(c)(2) of the Bankruptcy Code. Any conclusion would be determined by a trier of
fact.
(8) FindingsforLCPI
TheExaminerhasbeenunabletodeterminewhetherthereisevidencetosupport
afindingforeachelementofapreferenceclaimunderSection547(b)oftheBankruptcy
CodeinanactionbyLCPIagainstLBHIbecausetheExaminersfinancialadvisorshave
beenunabletotracethematerialmovementofmoneybetweenLCPIandLBHIthatwas
notinconnectionwithasafeharboredevent.
Discussion of Preferential Activity. On June 1, 2008, LCPI had an antecedent
debt of at least $35.2 billion to LBHI,6448 and there was significant activity in the
ex.22.
6447InreFulghumConstr.Corp.,872F.2dat745.
(Feb. 1, 2010) ex. 3, LCPI and LBHI had multiple intercompany accounts. Not every intercompany
orreceivables.The$35.2billionobligationnotedabovewasderivedfromthesumoftheintercompany
obligationsbasedonthetwoaccountsinthegeneralledgerthatwereusedforfundingandquasifunding
1722
intercompany accounts between LCPI and LBHI after that day. Similar to LBSF and
LBCS, the Examiner attempted to identify funding and quasifunding activity as the
primary source of potential preferential activity. However, identifying and analyzing
potentialpreferentialactivityforLCPIprovedconsiderablymorecomplicatedthanfor
LBSFandLBCS.Consequently,theExaminerhasbeenunabletoidentifyandanalyze
allpotentialsourcesofpreferentialactivity.
As a threshold matter, LCPIs main operating account was not tied to GCCM,
andtherefore,therewasnofundingactivityinGCCMduringtheDefinedPreference
Period. There was, however, significant quasifunding activity flowing through
GCCM,whichprimarilycamefromasourcesystemcalledLoanIQ.6449TheExaminer
concludes not to include quasifunding activity in the preference analysis for LCPI,
however, because payments flowing from Loan IQ through GCCM consisted of
principal and interest payments, among other things, on loans in which LCPI had a
nominal interest. Moreover, other quasifunding activity was de minimis when
comparedtotheothersourcesofpotentialpreferentialactivitytheExamineridentified.
Unlike LBSF and LBCS, the Examiner looked beyond GCCM and focused on two
specific sources of potential preferential activity: transfers made on account of trust
activities.ExaminersInterviewofAdaShek,Nov.24,2009,atpp.89.OneaccountwasbetweenLBHI
NewYorkandLCPI,andtheotheraccountwasbetweenLBHI(UK)andLCPI.Iftheotherintercompany
accountsbetweenLCPIandLBHIwereincluded,theobligationwouldbelarger.
6449LoanIQisafullyintegratedglobal,multicurrencysystemfortheprocessingandadministrationof
the commercial bank loan product. Lehman, GTS: Operations Technology Loan IQ Homepage on
LehmanLive,atp.1[LBEXLL3356457].
1723
receiptsintheMTStradingsystem,andpaymentsmadetoLBHIresultingfromcapital
infusionsmadeintoLCPIbyLBI.
Trust Receipts. As noted in Section III.B.2.c of this Report, prior to 2002,
Lehmans infrastructure for cash management was decentralized and fragmented.6450
There were numerous systems used to transfer and manage cash,6451 and this
fragmentationwasadrivingfactorbehindthecreationofGCCM.AtthetimeofLBHIs
bankruptcy, however, GCCM was only partially integrated, and the implementation
process was rolledout by source system or trading platform. MTS, one of Lehmans
primarytradingplatformsusedprimarilyfordomesticfixedincomesecurities,wasnot
integratedintoGCCM.MTSwasanantiquatedtradingplatform6452anditsfunctionality
waslimitedtobuys,sells,repos,reverserepos,borrowings,andpledgings.6453MTSdid
nothavepaymentfunctionality,andunlikesomeofLehmansothertradingplatforms
thatsettledtransactionsthroughGCCM,settlementsfromMTSflowedthroughFPS,an
entirelyseparatepaymentandsettlementsystem.
BecauseMTSwasoutdated,Lehmanusedtrustreceipts,whichweredummy
securitiescreatedinMTS,tofundcertainbankaccountsthatweretiedtoMTS.6454Trust
6451Id.
6452MTSwasusedbyLehmanbeforeitmergedwithShearsonin1984.Id.at6.
6453Id.
6454Id.atp.7.
1724
receiptswereusedtoovercomeMTSslimitedfunctionalityasatradingsystem,6455and
theExaminerhasdiscoverednoevidencesuggestingthattheirusewasforanimproper
purpose. Trust receipts had different security names or IDs, which were used for
different funding and recordation purposes, and some examples include Trust 01,
Trust 15, or Trust 24.6456 During the Defined Preference Period, LCPI primarily
usedTrust86andTrust89.
Historically,LCPIsmainoperatingaccountwasresidentinMTS,althoughLCPI
opened accountson othersystemsovertime.6457Therefore,theExaminerunderstands
that to move cash between LBHI and LCPI, a funding transaction needed to be
executed in MTS.BecauseMTShadlimitedfunctionality,however, Lehman used the
repoandreverserepofunctions.TheExaminerhasdiscoverednoevidencesuggesting
that anyone at Lehman considered trust receipts to be repos or reverse repos, and all
evidence points to the contrary. The Examiner understands that settlements from the
MTS system into LCPIs bank account occurred through the FPS settlement system.6458
ThisprocessisroughlyequivalenttothefundingfunctionsthatexistedinGCCM.
TheExaminersfinancialadvisorsidentifiedallTrust86andTrust89activityin
MTS during the Defined Preference Period and have performed an analysis on such
6455Id.atp.6.
6456Lehmanusedmorethanahundreddifferenttrustreceiptsandeventuallystartedrecyclingthem.Id.
atp.6n.2.
6457Id.atp.7.
6458ThetransactionwasalsobookedinTreasuryWorkstation,asoftwareplatformutilizedbyLehmans
TreasuryGroup.
1725
activity, which is discussed in considerable detail in the attached appendix.6459 The
Examiners financial advisors reviewed data in GCCM (for LBHI cash receipt
information, even though MTS and GCCM were not tied together), GSSR (Lehmans
bankaccountreconciliationsoftwarethatshowedbankaccounttransactions),Treasury
Workstation (a suite of applications utilized by Lehman Treasury Group for various
fundingfunctions),andMTS(Lehmansfixedincometradingsystem).TheExaminers
financial advisors attempted to trace the movement of money and to identify the
purposeassociatedwithtrustreceiptsusedbyLCPI.Tocompletethistask,accessto
certain FPS data, which contained settlement and payment data for MTS, as well as
certain presettlement data, is required because this information is understood to
containnettinginformationbeforetransferinstructionswerecreatedbetweenLCPIand
LBHIbankaccounts.BarclayswouldnotgranttheExaminersfinancialadvisorsaccess
toFPSbecausetheExaminerunderstandsthatBarclayscouldnotadequatelysegregate
Lehmanlegacydata.6460TheExaminersfinancialadvisorshavefurtheradvisedthata
review of the presettlement data could potentially require a lengthy and costly
investigation.Accordingly,theExaminercannotmakeadeterminationaboutwhether
LCPIhasacolorablepreferenceclaimagainstLBHIonaccountoftrustreceipts.
pp.1822.
6460Appendix6,Duff&Phelps,DataSystemsAccess(Feb.1,2010),atp.33.
1726
LCPI Capital Infusions. As noted above, LCPI received multiple capital
infusions from LBI, its parent, over the course of the several months prior to its
bankruptcyfiling.6461Generally,whenacompanyreceivesacapitalinfusionitrecords
anasset(inmanyinstancescash)andpaidincapitalonitsbooksandrecords.When
LBIinfusedcapitalintoLCPI,however,LCPIneverreceivedanassetonitsbooksand
records because the individuals instructing the transfer indicated that LCPI did not
have a bank account to receive LBIs infusion.6462 Instead, LBI transferred the cash in
respect of the capital infusion to LBHI, which received the cash on LCPIs behalf.6463
BecauseLCPIhadasignificantintercompanyobligationtoLBHI,thetransferfromLBI
toLBHIwasrecordedassatisfyingpartofthatobligationintheamountofthecapital
infusion.6464Thefollowingillustratestheflowofcashandjournalentries:
6461SeeSectionIII.B.3.c.3.a,whichdiscussescapitalinfusions.
6462EmailfromJeffreySu,Lehman,toArthurMiller,Lehman,etal.,(May30,2008),atp.1[LBEXDOCID
276482]; email from Hui Wang, Lehman, to Helen Chu, et al., Lehman (Aug., 28, 2008), at p. 1
[LBHI_SEC07940_552712].Itwasconfirmedonmultipleoccasions,however,thatLCPIdidhaveitsown
bankaccounts.ExaminersInterviewofDanielF.Fleming,Dec.17,2009,atp.8.LCPIsschedulesthat
were filed with the U.S. Bankruptcy Court also confirm that LCPI had bank accounts. See Amended
SchedulesofAssetsandLiabilitiesforLehmanCommercialPaperInc.,InreLehmanBros.Holdings,Inc.,
No.0813555(Bankr.S.D.N.Y.June15,2009).
6463Daniel J. Fleming noted that if LCPI had received the cash it would have eventually upfunded to
LBHI anyway. In other words, he noted that it did not matter if LCPI or LBHI received the money
becauseLBHIwouldeventuallyreceivethemoneyattheendoftheday.ExaminersInterviewofDaniel
J.Fleming,Dec.17,2009,atp.8.
6464See Email from Hui Wang, Lehman, to Helen Chu Lehman, et al., (Aug. 28, 2008), at pp. 12
[LBHI_SEC07940_552712].
1727
LBHI RelevantJournalEntries:

Potential LBHIreceiveswire LBIincreasesinvestment
Indirect on behalf of LCPI assetinLCPIandreduces
Preference
cash;LBHIincreasescash
LBI andreducesreceivable
fromLCPI.
LCPIreducesitsdebt
obligationtoLBHIand
creditspaidincapital
LCPI (fromLBIsinfusion).
There were two capital infusions during the Defined Preference Period: one in
July2008for$275millionandoneinAugust2008for$900million.6465TheExaminerhas
located internal emails relating to the $900 million infusion.6466 The $900 million
transfercouldrepresentanindirectpreferenceevenifLCPIneverhadtheinfusedcash
in its bank account because the transfer reduced LCPIs antecedent debt owed to
LBHI.6467
Although the Examiner Order did not direct the Examiner to analyze potential
defensestoclaims,itisimportanttonotethatmoneyflowedbetweenLCPIandLBHI
(and between LBI and LBHI) in significant amounts on an almost daily basis through
6465Asnotedabove,theseamountsweredeterminedbynotingthechangeinAdditionalPaidInCapital
asreportedinLehmansHyperionfinancialsystem.
6466TheExaminerlocateddocumentationfortheMay2008capitalinfusionbutitwasoutsidetheDefined
PreferencePeriod.SeeEmailfromJeffreySu,Lehman,toArthurMiller,Lehman,etal.,(May30,2008),at
6467E.g.,Warscov.PreferredTechnicalGroup,258F.3d557,564(7thCir.2001)(Astheexplicitlanguageof
theBankruptcyCodemakesclear,however,thetransferneednotbemadedirectlybythedebtor;indirect
transfers made by third parities to a creditor on behalf of the debtor may also be avoidable under the
Code. (citing Dean v. Davis, 242 U.S. 438, 443 (1917) (Mere circuity of arrangement will not save a
transferwhicheffectsapreferencefrombeinginvalidassuch.)).
1728
trust receipts and potentially other means. For example, $900 million was a common
dollar amount for transfers between affiliates, and the Examiners financial advisors
identifiedatleastthree$900millionpaymentsfromLBItoLBHIonAugust28,2008.6468
The Examiners financial advisors also identified two transfers from LCPI to LBHI on
August29,2008(one wasfor$900 million andonewasfor$104million).6469 Assuch,
the $900 million potential indirect preference is likely one in a very large series of
transfersbetweenLCPIandLBHI(andbetweenLBIandLBHI).Thismakesanalysesof
newvalueandordinarycoursedefensesveryrelevantforpurposesofdeterminingthe
benefit of a claim to recover these transfers. Because the costs of performing this
accounting would be substantial, the Examiner did not trace the movement of cash
associated with trust receipts (nor has it been confirmed whether the $900 million
potentialpreferenceismutuallyexclusiveoftransfersoccurringthroughtheuseoftrust
receipts)orperformtheotheraccountingnecessarytoconcludeanewvalueorordinary
courseanalysisunderSections547(c)(2)or(4)withrespecttothesetransfers.6470
6468SeeAppendix22,Duff&Phelps,PreferencesAgainstLBHIandOtherLehmanEntities(Feb.1,2010),
atex.25.
6469Id. The $900 million transfer from LCPI to LBHI was between different bank accounts than those
identifiedontheemailsinstructingthewiretransfers.
6470AsdiscussedinSectionIII.B.3.c.3ofthisReport,theExaminerconcludedthattheAugust2008capital
infusion was sufficient to render LCPI solvent. Indeed, members of Lehmans LEC group would meet
regularlytopredicttheamountofcapitalthatLCPIandotherentitiesneeded.ExaminersInterviewof
AdaShek,Nov.24,2009,atp.7.TheMayandJuly2008infusionswereinsufficienttoestablishsolvency,
but in August 2008 infusion was sufficient. The Examiner concluded, however, that the August 2008
capitalinfusionwassufficienttorenderLCPIborderlinesolvent,suchthatitsratioofequitytoassets
was0.4%.TheExaminerhasnot,however,obtainedsufficientandreliablepostAugust2008information
tomakeadeterminationastoLCPIssolvencyafterAugust31,2008.Thus,theExaminerrecognizesthat
1729
f) PreferencesAgainstNonLBHILehmanAffiliates(FourthBullet)
As with the previous Section discussing insider preferences against LBHI, the
ExamineridentifiedLBSF,LBCSandLCPIasthoseLBHIAffiliatesthatwereinsolvent
or on the borderline of insolvency beginning on June 1, 2008. There is a significantly
larger population of potential intercompany relationships from which potential
preferences could be identified, however. Although LBSF, LBCS and LCPI did not
maintain extensive intercompany accounts with each affiliate, the list of potential
intercompanyrelationshipsisextensive.
The approach for identifying nonLBHI preferences was similar to that with
LBHI,asdiscussedabove,butLBHIAffiliatesgenerallydidnotprovidefundingtoeach
other.6471 This created problems in identifying potential preferences that were not in
connection with safeharbored activity. To be sure, the Examiners financial advisors
reviewed GCCM and confirmed that no funding activity for LBSF, LBCS, and LCPI
was located in that system. Fleming did note, however, that LCPI may have funded
some of its subsidiaries through MTS, and there was significant trust receipt activity
all postAugust 2008 transfers may be subject to an extensive solvency determination by a trier of fact.
See, e.g., Matson v. Strickland (In re Strickland), 230 B.R. 276, 283 (Bankr. E.D. Va. 1999) (noting that
[e]videnceofinsolvencyonthedateoftheallegedpreferenceisthecriticalissueandproofofinsolvency
on any other date is insufficient). Because the Examiner has observed that Lehman may have over
markedsomeofitsassets,theExaminerincludedpostinfusiontransferswithinthepreferenceanalysis
and makes no distinction between transfers made while LCPI was insolvent or while it was
borderlinesolvent.
6471Examiners Interview of Daniel J. Fleming, Dec. 17, 2009, at p. 2. Funding activities, as described
under the section addressing insider preferences against LBHI, were the primary source of interest for
insiderpreferencesbecausemostactivityatLehmanwasinrespectofsafeharboredactivity.SeeSection
III.B.3.eofthisReport,whichdiscussestherationaleforidentifyingfundingactivities.
1730
involving LCPI with both LBHI and other affiliates.6472 The Examiners financial
advisors identified every counterparty for trust receipts involving LCPI and other
Lehman entities during the Defined Preference Period, which can be found in the
attachedappendix.6473
The Examiners financial advisors attempted to trace the movement of cash
associated with trust receipts between LCPI and LBHI. The Examiners financial
advisors primarily reviewed GCCM, GSSR, Treasury Workstation, and MTS. The
ExaminerdidnothaveaccesstocertainFPSdata,whichwouldpurportedlycontainthe
settlementandpaymentdataforMTS.Asexplainedabove,theExaminerreceiveddata
regardingLehmanspresettlementfunctionverylateintheinvestigationandhasnot
reviewedsuchdataforthesepurposes.
g) AvoidanceAnalysisofLBHIandLBHIAffiliatesAgainst
FinancialParticipantsandPreChapter11Lenders(Fourthand
EighthBullets)
(1) Summary
ThisSectionoftheReportaddresses:(1)thefourthbulletoftheExaminerOrder,
regarding whether any LBHI Affiliate has colorable claims against LBHI or any other
entitiesforpotentiallyvoidabletransfersorincurrencesofdebt;and(2)theeighthbullet
oftheExaminerOrder,whichcoversthetransactionsandtransfers,includingbutnot
6472SeeSectionIII.B.3.e.8ofthisReport,whichdiscussestrustreceiptactivityandhowitwastheresultof
asoftwarelimitationinMTS.
6473Appendix22,Duff&Phelps,PreferencesAgainstLBHIandOtherLehmanEntities(Feb.1,2010),at
ex.26.
1731
limitedtothepledgingorgrantingofcollateralsecurityinterestamongthedebtorand
the preChapter 11 lenders and/or financial participants including but not limited to,
JPMorgan Chase, Citigroup, Inc., Bank of America, the Federal Reserve Bank of New
Yorkandothers.6474TheExaminerhasconsultedwiththepartiesininterest,reviewed
issues identified by those parties, conducted his own independent review and
examinationandexercisedhisdiscretionastowhichissuestoincludeinthisanalysis.
First,withrespecttothefourthbullet,theExaminerhasnotidentifiedanyLBHI
AffiliatethathasacolorableclaimagainstLBHIunderSections548or544andstatelaw
for potentiallyvoidabletransfers orincurrencesofdebt. Because ofthe magnitudeof
the data and the costs involved in reviewing every transfer that occurred during the
applicablelookbackperiods,theExaminerandhisfinancialadvisorsdevelopedasetof
criteriadesignedtopullsuspecttransfersfromtheinformationcontainedinLehmans
APB trading database (APB). The APB contains over five terabytes of data. The
Examiners financial advisors applied their methodology to determine whether any
tradesorotheractivitycouldpotentiallybeavoidableasagainstanidentifiedgroupof
counterparties.Uponreviewofthatanalysis,theExaminerdidnotfindanycolorable
claims belonging to an LBHI Affiliate or LBHI. The Examiner did, however, identify
trades involving thirtyseven securities that belonged to LBI that warranted further
investigation and has provided that information to the SIPA Trustee. The Examiner
6474AcompletediscussionofLehmansdealingswithpreChapter11lendersand/orfinancialparticipants
andpotentialcolorablestatelawclaimsagainstthemisdiscussedinSectionIII.A.5ofthisReport.
1732
concluded that further analysis of data in the APB would not be costeffective. The
Examiner also sought to test his review of the Debtors transfers by examining cash
disbursementsidentifiedontheDebtorsStatementofFinancialAffairs(SOFA).The
ExaminerwasnotabletocompletehisanalysisbecausetheDebtorshavebeenunable
toprovidethebackupdataforthesetransfersinthetimeframenecessarytoallowthe
ExaminertoreachconclusionsaboutthetransfersidentifiedontheSOFA.
Second, with respect to the eighth bullet, the Examiner reviewed various
guaranties entered into by LBHI shortly before its bankruptcy filing and transfers of
collateral in connection with those guaranties and concludes that there are colorable
claimsagainstJPMorganandCititoavoidtheguarantiesthattheyreceivedfromLBHI
and certain related transfers under Sections 547(b), 548 and 544 and state law. The
Examinerbelievesthatsuchclaimsaresubjecttosubstantialdefensesincluding,butnot
limited to, that the transfers of collateral to JPMorgan or Citi are protected from
avoidance based upon the safeharbor provisions of the Bankruptcy Code. The
Examinerfindsinsufficientevidencetosupporttheexistenceofcolorableclaimsagainst
FRBNY, BNYM, HSBC and the CME Group (CME). The Examiner elected not to
examine the BofA transactions for purposes of determining whether colorable claims
exist with respect to these transactions due to the fact that these transactions are the
subject of ongoing litigation. The Examiner was unable to reach a conclusion with
respect to a $200 million collateral transfer to Standard Bank because of the lack of
1733
information showing whether a Lehman Chapter 11 Debtor was the source of this
collateraltransfer.6475
(2) APBAnalysis
Lehman kept systematic records of trades in its APB database, which
consolidatedtraderecordsfrommultipleLehmantradingsystems.TheAPBdatabase
is extensive and it contains over five terabytes of data.6476 When the Examiners
financial advisors obtained access to the database, the scope of information that the
database contained was unclear. The Examiners objective was to identify patterns of
tradingbehavior,tradesofinterestorotheractivityafterAugust1,2008thatwarranted
further investigation, such as trades with indicia of actual fraud under Section
548(a)(1)(A)orotherpotentiallyavoidableactivity.TheExaminersfinancialadvisors
methodology is described in detail in Appendix 23, Duff & Phelps, Analysis of APB,
JournalEntry,CashDisbursementandJPMorganCollateral(Feb.1,2010).
TheExaminerfirstidentifiedapopulationoftradingcounterpartiesconsistingof
largebanksandclearinghouses,potentiallyrelatedparties,andcounterpartiestrading
6475TheExaminernotesthatclaimsanalyzedhereinarisingunderSections547(b),548and544andstate
law are dependent upon an analysis of Lehmans financial condition as of the time of these transfers.
Because the Examiner was directed only to determine if these claims were colorable, the Examiners
financialadvisorshavelimitedtheiranalysistoadeterminationastowhetherevidenceexiststosupport
afindingoftherequisitefinancialcondition.
6476 Appendix 23, Duff & Phelps, Analysis of APB, Journal Entry, Cash Disbursement and JPMorgan
Collateral(Feb.1,2010).
1734
in illiquid assets.6477 The Examiners financial advisors then applied two selection
methodologies. First, the Examiners financial advisors excluded all nonprincipal
trades, Level 1 and most Level 2 assets, and trades involving exchangelisted assets.
Thisyielded30,000tradesforfurtherreview.Second,theExaminersfinancialadvisors
identified trades involving either (1) assetbacked securities, (2) noninvestment grade
debt securities, or (3) Lehmans own debt or equity securities as being the most
appropriatetoreview.Further,theExaminersfinancialadvisorsscrutinizedindividual
transactions exceeding $50 million regardless of these criteria and generally included
suchtradesforsubsequenttesting.Thisyielded5,100tradesforfurtherreview.
Afterthispopulationoftradeswasidentified,theExaminersfinancialadvisors
classified the trades by counterparty; this analysis is discussed at length in Appendix
23, Duff&Phelps, AnalysisofAPB, JournalEntry,CashDisbursementand JPMorgan
Collateral (Feb. 1, 2010). From these approximately 5,100 trades, the Examiners
financialadvisorsthenidentifiedthosetradeswhereapricediscrepancyofover30%to
thethencurrentmarketvalueexistedtoLehmansdetriment.Thisyieldedthirtyseven
tradesofinterestthatrequiredfurtherinvestigation.
Thefirststepininvestigatingthesethirtyseventradeswastoidentifytheprior
ownerofthesecuritiestodeterminewhichLehmanentityreceivedapotentiallyunfair
6477ThefourteenselectedcounterpartieswereBankofAmerica,Barclays,Citi,HSBC,JPMorgan,BNYM,
FRBNY, Standard Bank, R3 Capital Management, One William Street, Fortress Investment Group,
Blackrock, BlueMountain Capital and Stark Investments. Narrowing the field of APB by date only,
beginningAugust1,2008,yieldedoveronemilliontrades.
1735
price(theAPBdatabasedidnotpermitthisquerytobeconductedinthefirstinstance).
The Examiners financial advisors discovered, however, that no LBHI Chapter 11
Affiliate owned any of the thirtyseven securities identified under this methodology
betweenAugust1andSeptember19,2008.Inmanycases,however,LBI(aChapter7
Affiliate) was the owner. Because this matter is outside of the scope of the Examiner
Order, the Examiner contacted the SIPA Trustee and provided him with the
information that the Examiner discovered so that he may investigate these trades
further. Because this methodology did not yield any LBHI Affiliate transactions
warranting further review (i.e., there was never an interest of the Debtor in the
property), the Examiner ceased the analysis under the APB Approach as it did not
appear that further analysis would be costeffective or result in the identification of
colorableclaims.6478
6478TheExaminersfinancialadvisorsalsoattemptedtoanalyzesignificantmanualjournalentries(witha
grossbalanceofgreaterthan$500million)thatwereenteredintothegeneralledgerbetweenSeptember
1,2007andSeptember12,2008.Therewere138manualjournalentriesthatsatisfiedthiscriteriaandit
was determined that they potentially could represent one or more of the following activities: (1) third
partyassettransfers;(2)forgivenessofdebt;(3)equitytransfers;or(4)anyunusualorindistinguishable
activity.CompletionofthisanalysiswasdependentuponassistancefromBarclaysandtheDebtorswith
specific knowledge regarding the purpose of the entries. The Examiner attempted to gain such
supporting documentation for the 138 selected entries and to schedule interviews with the controllers
responsible for preparation of these entries. Based on communications with the Debtors and the
conclusion that the Examiners financial advisors would be too reliant on third parties to complete this
analysis, the Examiner ceased this methodology prior to completion. For a complete discussion of the
analysis conducted by the Examiners financial advisors, see Appendix 23, Duff & Phelps, Analysis of
APB,JournalEntry,CashDisbursementandJPMorganCollateral(Feb.1,2010).
1736
(3) CashDisbursementAnalysis
In addition to the APB analysis, the Examiner and his financial advisors
reviewed the Debtors SOFA schedules. In order to identify payments most likely to
represent avoidable transactions, the following selection criteria were applied to
identifyactivityofinterest.First,theExaminersfinancialadvisorsidentifiedpayments
made to counterparties that satisfy one or more of the following criteria: (1) the
counterpartyisamajorbank/clearinghouse,(2)thecounterpartyconductsasignificant
volume of trades, and (3) the counterparty is involved in transactions with illiquid
assets. There were thirteen such counterparties. Second, the Examiners financial
advisors identified payments to creditors that were opaquely described (for example,
ATTN FUNDS MANAGEMENT) or that received $1 billion or more in total
paymentsduringtheperiodreflectedintheSOFASchedules3b.Third,theExaminers
financialadvisorsidentifiedsixadditionalpaymentsbecausethetermcollateralwas
includedinthecreditorsname.
The foregoing selection criteria yielded 416 payments representing
disbursements of approximately $160 billion. The Debtors provided assistance to the
ExaminersfinancialadvisorsinidentifyingtheLehmancashsettlementsystemusedto
transact each payment. Pursuant to an analysis of the cash settlement systems,
however, the Examiners financial advisors determined that 192 of the 416 payments
were likely related to transactions subject to the safeharbor provisions of the
1737
BankruptcyCodebecausethereisevidencethatthesepaymentspertaintoeitherrepo
transactions(51)orderivativespayments(141).TheExaminersfinancialadvisorswere
unable to resolve the remaining selected payments (224) because the Debtors post
petitionmanagerswereunabletoprovidetheExaminerwiththenecessarydatapriorto
thefilingofthisReport.Forthecompletediscussionoftheanalysisconductedbythe
Examiners financial advisors, see Appendix 23, Duff & Phelps, Analysis of APB,
JournalEntry,CashDisbursementandJPMorganCollateral(Feb.1,2010).
(4) PledgedCollateralAccountsAnalysis
In the period prior to the bankruptcy, certain counterparties that provided
clearingservicesorothercredittoLehmanrequestedincreasesinpledgedcollateralasa
prerequisite for continuing to extend credit.Suchpledgesofcollateraloften involved
cashdisbursements,whicharesubjecttotheCashDisbursementAnalysis.However,in
circumstanceswhereassetswereseizedfromaccountssubjecttolien,nocashortrade
record exists. With access to a firms pledged collateral accounts, it is possible to
identifyseizedassetsandtracetheassetsbacktotheoriginallegalentitythatprovided
theassetsusedforcollateral.TheExaminerwasprovidedwithlimitedaccesstocertain
LehmanpledgedaccountsatJPMorgan.Forasummaryoffindingsrelatingtotracing
certainsecuritiesbelievedtobeheldinpledgedaccountsatJPMorganatSeptember12,
2008, see Appendix 23, Duff & Phelps, Analysis of APB, Journal Entry, Cash
1738
DisbursementandJPMorganCollateral(Feb.1,2010).Thispledgedcollateralaccount
analysisalsodidnotyieldanycolorableavoidanceclaims.6479
(5) AvoidanceAnalysisforCertainPreChapter11Lendersand
FinancialParticipants
(a) JPMorganAvoidanceAnalysis
(i) Background
JPMorgan acted as LBIs (LBHIs U.S. brokerdealer subsidiary) principal
clearing bank for securities trading and triparty repo agreements. In that role,
JPMorgan assisted LBIs clearance and settlement of securities and LBIs funding
throughtripartyrepos.
Beginninginearly2008,JPMorganbegantheprocessofrevampingitsapproach
to dealing with its credit risk to Lehman. To protect itself, JPMorgan requested
additionalcollateral,soughtamendmentstoitsagreementswithLehmantostrengthen
its rights in the event of a Lehman default and made changes to its procedures for
dealingwithLehman.TheExaminersanalysisofclaimsarisingundertheBankruptcy
Codetoavoidthetransfersofthisadditionalcollateralortheincurrenceofobligations
focusedontwosetsofagreementsthatJPMorganandLBHIenteredintoonAugust29,
The pledged collateral account analysis provides further detail with respect to LBHIs pledge of
6479
Spruce,Freedom,Pine,Kingfisher,andVerano,allassetbackedsecurities,toJPMorgan.SeeAppendix
23,Duff&Phelps,AnalysisofAPB,JournalEntry,CashDisbursementandJPMorganCollateral(Feb.1,
2010);seealsoAppendix18,LehmanCollateralatJPM.LCPIappearstohavesoldthesesecuritiestoLBHI
viaprincipaltrades.SeeAppendix23,Duff&Phelps,AnalysisofAPB,JournalEntry,CashDisbursement
and JPMorgan Collateral (Feb. 1, 2010) (containing trade information for many of these securities). As
such,thetransfersofthesesecuritiesfromLCPItoLBHIwouldbeprotectedfromavoidancebythesafe
harborprovisionsoftheBankruptcyCodeasatransferinconnectionwithasecuritiescontract.
1739
2008andSeptember10,2008.Thefactsuponwhichthisanalysisisbasedaresetforth
ingreaterdetailinSectionIII.A.5.b,butaresummarizedhereintotheextentnecessary
toassistthereaderinunderstandingtheExaminersconclusions.
InAugust2008,JPMorganrequestedthatLehmanenterintonewagreementsin
part because JPMorgan wanted a guaranty from LBHI. In addition, JPMorgan
requestedthenewagreementsgivenconcernbyJPMorganandLehmancounterparties
that additional Lehman subsidiaries that were not party to the Clearance Agreement
were conducting operations through JPMorgans clearing system.6480 The parties
ultimately executed three documents on August 29, 2008 (though dated August 26,
2008):6481 (1) an amendmenttoaclearanceagreement(the AugustAmendment tothe
ClearanceAgreement);6482(2)aguaranty(theAugustGuaranty);6483and(3)asecurity
agreement (the August Security Agreement, collectively, the August
Agreements).6484
In late August and September 2008, Lehmans deteriorating financial condition
became increasingly apparent.6485 Reports began to surface that The Korea
6480 Examiners Interview of Daniel J. Fleming, Apr. 22, 2009, at p. 5; Examiners Interview of Paul W.
Hespel,Apr.23,2009,atp.3.
6481SeeemailfromPaulW.Hespel,GoodwinProcter,toNikkiG.Appel,JPMorgan,etal.(Aug.29,2008)
[JPM20040004629].
6482SeeAmendmenttoClearanceAgreement(Aug.26,2008)[JPM20040005856].
6483Guaranty(Aug.26,2008)[JPM20040005879].
6484SecurityAgreement(Aug.26,2008)[JPM20040005867].
6485 See e.g., Andrew Ross Sorkin, Struggling Lehman Plans to Lay Off 1,500, N.Y. Times, Aug. 28, 2008
(Lehmanshareslost73%oftheirvaluebetweenJanuary2008andtheendofAugust2008);seealsoemail
from Ricardo S. Chiavenato, JPMorgan, to David A. Weisbrod, JPMorgan (Aug. 22, 2008) [JPM2004
1740
DevelopmentBank(KDB)had abandoned(orwas likelytoabandon)its acquisition
talkswith Lehman,6486andLehmansstockpricehaddroppedsignificantly.6487Shortly
before9:00p.m.onSeptember9,JPMorgansentdraftguarantyandsecurityagreements
toAndrewYeung,inhousecounselatLehman.6488AdraftamendmenttotheClearance
Agreement arrived later that night.6489 The parties ultimately executed three key
documentsonSeptember10,2008:(1)anAmendmenttotheClearanceAgreement(the
September Amendment to the Clearance Agreement);6490 (2) an amended Guaranty
(the September Guaranty);6491 and (3) an amended Security Agreement (the
SeptemberSecurityAgreement,andcollectively,theSeptemberAgreements).6492
The Examiner concludes that there are colorable claims to avoid the September
and August Guaranties as constructive fraudulent obligations under Sections 548 and
0061226] (Lehman may face serious problems next week if it is not acquired . . . and its losses are
large.).
6486 Francesco Guerrera, et al., Equities Suffer as Lehman Shares Fall 45%, Fin. Times, Sept. 9, 2008
(LehmanssharesfellafteranewswirereportcitedanunnamedKoreangovernmentofficialassaying
thatKoreaDevelopmentBank,astaterunlender,haddecidednottoinvestinLehman.);SusanneCraig,
et al., Korean Remarks Hit Lehman, Wall St. J., Sept. 9, 2008 (A KDB official said the comments [by the
ChairmanofSouthKoreasFinancialServicesCommission]wouldlikelybestrongenoughtodeterthe
bankfrompursuingaLehmandeal....).
6487 Examiners Interview of Richard S. Fuld, Jr., May 6, 2009, at p. 11; Examiners Interview of Donna
Dellosso,Feb.27,2009,atp.4;SusanneCraig,etal.,LehmanFacesMountingPressures,WallSt.J.,Sept.10,
2008,atA1;SusanneCraig,etal.,KoreanRemarksHitLehman,WallSt.J.,Sept.9,2008.
6488 Email fromJeffreyAronson, JPMorgan, to Andrew Yeung,Lehman, et al.(Sept. 9,2008) [JPM2004
0005594];ExaminersInterviewofAndrewYeung,Mar.13,2009,atp.4.
6489 Email fromJeffreyAronson, JPMorgan, to Andrew Yeung,Lehman, et al.(Sept. 9,2008) [JPM2004
0005039].AdraftAuroraGuarantyanddraftControlAgreementweresentwiththedraftAmendmentto
theClearanceAgreementaswell.Seeid.
6490AmendmenttoClearanceAgreement(Sept.9,2008)[JPM20040005861].
6491Guaranty(Sept.9,2008)[JPM20040005813].
6492SecurityAgreement(Sept.9,2008)[JPM20040005873].
1741
544 and New York state law.6493 In addition, the Examiner concludes that there are
colorable claims to avoid as much as $6.9 billion of the $8.6 billion in collateral that
LBHItransferredtoJPMorgantosecuretheSeptemberGuarantyunderSections547(b),
548and 544and statelaw,but thatthe claims toavoidthecollateral transfersmay be
defeatedbythedefensesunderSections546(e),(f),(g)and(j).6494
TransfersinConnectionwiththeSeptember
Agreements
The September Amendment to the Clearance Agreement expanded JPMorgans
lienontheLehmanpartiesaccountsandsecuredtheirexistingorfutureindebtedness,
obligationsandliabilitiesofanykindtoJPMorgan,whetherarisingundertheClearance
Agreementornot.6495TheSeptemberGuarantyexpandedLBHIsliabilitytoJPMorgan
making it the guarantor of all obligations and liabilities of all direct or indirect
subsidiaries of LBHI to JPMorgan and its affiliates of whatever nature, irrespective of
6493 Although Section 548 of the Code authorizes the avoidance of the incurrence of an obligation as
constructivelyfraudulentiflessthanreasonablyequivalentvalueisexchangedandthedebtoriseither
(a)insolvent,or(b)undercapitalizedor(c)unabletopayitsdebtsassuchdebtsareexpectedtomature,
theNewYorkUniformFraudulentConveyanceActonlyallowsfortheavoidanceoftheincurrenceofan
obligation if the debtor is insolvent or has a subjective intent not to pay such debts as such debts are
expected to come due. Compare 11 U.S.C. 548(a), with McKinneys Debtor and Creditor Law 274
(2010);seealsoInreM.Fabrikant&Sons,Inc.,394B.R.721,734n.13(Bankr.S.D.N.Y.2008)(Byitsterms,
section 274 (unreasonably small capital) applies to conveyances but not obligations ....). For a more
detaileddiscussionoftheelementsofafraudulenttransferorapreferenceclaim,seeAppendix1,Legal
Issues,atSectionsIV.A,IV.D.
6494 For a complete discussion of potential colorable state law claims against JPMorgan, see Section
III.A.5.b.
6495AmendmenttoClearanceAgreement(Sept.9,2008),atp.1[JPM20040005861].
1742
whethertheyaccruedpursuanttotheClearanceAgreement.6496TheSeptemberSecurity
Agreement expanded the definition of accounts in which JPMorgan held a security
interesttoincludeallLehmanaccountsatJPMorganoritsaffiliates.6497
ConstructiveFraudulentObligation
LBHIIncurredanObligationWithinthe
ApplicableLookBackPeriodsWhenit
ExecutedtheSeptemberGuaranty
The Examiner has concluded that there is evidence to support a finding that
LBHIincurredanobligationwithintheapplicablelookbackperiodssetforthinSection
548 or New York state law when it entered into the September Guaranty. Rubin v.
Manufacturers Hanover Trust Co.6498 is the seminal decision addressing whether the
incurrenceofobligationsunderaguarantymaybeavoidedasaconstructivefraudulent
obligation.Rubinheldthattheexecutionofaguarantyitselfisnottheincurrenceofan
obligation but that the obligation is incurred when the loan is made to the primary
obligor,therebycreatingacontingentliabilityfortheguarantor.6499Here,theSeptember
GuarantyrequiredLBHItoguaranteeallobligationsandliabilitiesoftheBorrowersto
the Bank of whatever nature, whether now existing or hereafter incurred.6500 As of
6498Rubinv.ManufacturersHanoverTrustCo.,661F.2d979(2dCir.1981).
6499Id.at99091.
1743
September9,2008,theLehmanentities(whichincludedLBIandallofLBHIsdirector
indirect subsidiaries) owed obligations to JPMorgan. Thus, upon execution of the
September Guaranty on September 10, 2008, LBHI had a contingent liability to repay
JPMorgan if one of the Lehman entities could not repay JPMorgan. Thus, LBHI
incurred an obligation to JPMorgan within the twoyear look back period of Section
548(a)andthesixyearlookbackperiodunderNewYorklaw.6501
LBHIReceivedLessThanReasonably
EquivalentValueorDidNotReceiveFair
ConsiderationinExchangeforGranting
JPMorgantheSeptemberGuaranty
The Examiner has concluded that there is evidence to support a finding that
LBHIdidnotreceivereasonablyequivalentvalueorfairconsiderationinexchangefor
incurring the additional obligations imposed upon it by the September Guaranty.
Reasonablyequivalentvalueorfairconsiderationmeansmorethanjustthegoodand
valuableconsiderationneededtosupportasimplecontract.6502Instead,consideration
is fair or reasonably equivalent if, in exchange for incurring the obligation, the
debtorreceivespropertyofareasonablyequivalentvalueorisrelievedofanantecedent
obligation.6503 The focus of this analysis is upon LBHI and whether LBHI and its
6501McKinneysCivilPracticeLawandRules213(2010);IslandHolding,LLCv.OBrien,775N.Y.S.2d72,
74(Sup.Ct.2004).
6502Rubin,661F.2dat991.
6503Id.;seealsoLiebowitzv.ParkwayBank&TrustCo.(InreImageWorldwide,Ltd.),139F.3d574,580(7thCir.
1998).Section548definesvaluetomeanproperty,orsatisfactionorsecuringofapresentorantecedent
debtofthedebtor11U.S.C.548(d).
1744
creditors received something of value when, on the eve of its Chapter 11 filing, LBHI
took

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UNITEDSTATESBANKRUPTCYCOURT

(ii) ChrisOMeara ..............................................................................1002

OnJanuary29,2008, Lehman BrothersHoldingsInc. (LBHI1) reportedrecord

Lehmans financial plight, and the consequences to Lehmans creditors and

shareholders, was exacerbated by Lehman executives, whose conduct ranged from

serious but nonculpable errors of business judgment to actionable balance sheet

manipulation;bytheinvestmentbankbusiness model, which rewardedexcessive risk

required the confidence of counterparties to sustain. Lehman maintained

approximately $700 billion of assets, and corresponding liabilities, on capital of

In 2006, Lehman made the deliberate decision to embark upon an aggressive

growth strategy, to take on significantly greater risk, and to substantially increase

leverage on its capital.12 In 2007, as the subprime residential mortgage business

profit from a countercyclical strategy.13 As it did so, Lehman significantly and

Contemporaneous Lehman emails describe the function called repo 105

ButLehmandidnot publiclydisclosethat byJune2008 significantcomponents

Months earlier, on June 9, 2008, Lehman preannounced its second quarter

OnSeptember 10, 2008, Lehmanannouncedthat itwasprojectinga$3.9billion

troubledassetsinto a separateentity.SecretaryPaulsonsprediction turned outto be

Over the weekend of September 1214, an intensive series of meetings was

conducted by and among Treasury Secretary Paulson, FRBNY President Timothy F.

42Morningstar DocumentResearch Co.,LBHI Historic StockPrices (Jan.1, 2008 throughSept. 15,2008)

worst day in 7 years with Dow down 504 points . . . ), available at

PartIIIdetailsthefactsandanalysison the topics assignedby theCourt tothe

BankruptcyCode,thatis,tofileastatementof. . .anyfactascertained pertaining to

fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the

Examiner has grouped theminto threesubstantiveareas:(A)WhyDid Lehman Fail?

obligations. Lehman was unable to maintain confidence because a series of business

The Examiner Order does not contain a definition of what constitutes a

factual investigation, the Examiner believes it is more appropriate to use a higher

accumulated.67 Against this backdrop, Lehman turned to Repo 105 transactions to

Date Repo105 Reported Net Difference

management alleging accounting improprieties;82 in the course of investigating the

thecolorable claimsthattheExaminer has found,butalso for thosetheExaminer has

2. Valuation The Examiner has explored this subject because it is central to

6. Lehmans Interaction With Government Agencies As part of the

[Bullet 1] Whether LBCC [Lehman Brothers Commercial Corporation] or any other

The Examiner has identified approximately $60 million of administrative

was to investigateand,further, mandatesthat the Examiner shall perform theduties

ordered.]101 Under 11 U.S.C. 1106(a)(3), the Examiner is to investigate the acts,

investigation conducted . . . including any fact ascertained pertaining to fraud,

dishonesty, incompetence, misconduct, mismanagement, or irregularity in the

The available universe of Lehman email and other electronically stored

In most cases, documents were produced to the Examiner under stipulated

document databases createdbytheExaminerremainaresourcefor theestateandthe

Answering the questions posed by the Examiner Order necessarily required an

The second challenge was moredaunting. Atthe timeofitsbankruptcyfiling,

financial advisors to identify and acquire an indepth understanding of the most

The Examinersfinancialadvisorsultimately requestedaccess to 96 ofthe most

of Lehmans systems were arcane, outdated or nonstandard. Becoming proficient

and error experimentation in others. In numerous instances, the Examiners

large bankruptcy proceedings, including WorldCom, SemCrude and Refco, and

possible interviews be conducted informally, without requiring that the witness be

sworn andwithout transcripts. Thereare obviousprosandcons totheuseofsworn,

inevitably takes moretime,createsadditionalexpenseandmakessomewitnesses less

have impacted pending Government investigations. Balancing these factors, the

be possible inall cases.Toassureaccuracy,allinterviews wereconducted byat least

In the vast majority of cases, the interviewees were represented by counsel.

provided advance notice of the topicsheintendedtocover andadvancecopiesof the

Examiner if he or she believed it was appropriate to correct or supplement the

AlthoughtheDebtorsprofessionals and personnel wereandare extremely busywith

the daytoday requirements of Lehmans liquidation, they remained responsive to

Throughout the course of the investigation, the Examiner conducted regular,

Section III.A.1: Risk

(b) TheExplosioninLehmansLeveragedLoanBusiness ............. 95