Anton R. Valkus, Examiners Report - in Re Lehman Brothers Inc., Et Al., (2010-03-10) - Volume 1

UNITEDSTATESBANKRUPTCYCOURT
SOUTHERNDISTRICTOFNEWYORK
x
:
Inre
:
:
LEHMANBROTHERSHOLDINGSINC.,
:
etal.,
:
Debtors.
:
x
Chapter11CaseNo.
0813555(JMP)
(JointlyAdministered)
REPORTOF
ANTONR.VALUKAS,EXAMINER
March11,2010
Jenner&BlockLLP
353N.ClarkStreet
Chicago,IL606543456
3122229350
919ThirdAvenue
37thFloor
NewYork,NY100223908
2128911600
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

b. TheEvidenceDoesNotSupporttheExistenceofa
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
2. ThereIsEvidenceToSupportAFindingThat
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
VOLUME7
LegalIssues
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
Tab17
Repo105
Tab18
SummaryofLehmanCollateralatJPMorgan
Tab19
LehmansDealingswithBankofAmerica
Tab20
KnowledgeofSeniorLehmanExecutivesRegardingThe
InclusionofClearingBankCollateralintheLiquidityPool
Tab21
LBHISolvencyAnalysis
Tab22
PreferencesAgainstLBHIandOtherLehmanEntities
VOLUME9
Tab23
AnalysisofAPB,JournalEntry,CashDisbursement,and
JPMorganCollateral
Tab24
ForeignExchangeTransactions
Tab25
IntercompanyTransactionsOccurringWithinThirtyDaysBefore
Bankruptcy
Tab26
CUSIPswithBlankLegalEntityIdentifiers
Tab27
CUSIPsNotAssociatedwithanLBHIAffiliate
Tab28
CUSIPsAssociatedSolelywithanLBHIAffiliate
Tab29
CUSIPsAssociatedwithBothLBIandLBHIAffiliates
Tab30
CUSIPsAssociatedwithSubordinatedEntities
Tab31
CUSIPsAssociatedwithLBHIAffiliatesNotDeliveredtoLBIina
FinancingTrade
Tab32
September19,2008GFSDataset
Tab33
SummaryBalanceSheetsofLBHIAffiliates
Tab34
TangibleAssetBalanceSheetVariations
ii

x
:
Inre
:
:
:
etal.,
:
Debtors.
:
x
Chapter11CaseNo.
0813555(JMP)
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
OnJanuary 29,2008,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.

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.

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).

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.

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).

Lehman publicly asserted throughout 2008 that it had a liquidity pool sufficient to
weatheranyforeseeableeconomicdownturn.31
ButLehmandidnot publiclydisclosethatbyJune 2008 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
abilitytocontinueitsusualclearingbusinesswiththosebankshaditdonesowasfar
fromclear.35ByAugust,substantialamountsofcomfortdepositshadbecomeactual
31Final
Transcript 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
OnSeptember10,2008,Lehmanannouncedthatit was projecting a$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.SecretaryPaulsons predictionturned outto be
rightitwasnotenough.
BythecloseoftradingonSeptember12,2008,Lehmansstockpricehaddeclined
to$3.65pershare,a94%dropfromthe$62.19January2,2008price.42
70.00
$62.19
60.00
50.00
Lehman Stock Price
40.00
$31.75
30.00
$27.50
$20.96
20.00
10.00
$7.79
$7.25
9-Sep-08
10-Sep-08
$3.65
0.00
2-Jan-08
17-Mar-08
10-Jun-08
1-Jul-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 topicsassignedby theCourt tothe
ExaminerandcontainstheExaminersanalysisandconclusions.
53See
Markus 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,to file astatementof. . .anyfactascertained pertaining to
fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the
managementoftheaffairsofthedebtor,ortoacauseofactionavailabletotheestate.56
Becausethetenbulletedtopicssetoutatpages34oftheExaminerOrderoverlap,the
Examiner has grouped theminto three substantiveareas:(A)Why Did LehmanFail?
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/orfinancialparticipants including butnotlimited to, JPMorganChase, 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
SeeLehmanBrothersHoldingsInc.,MinutesofMeetingoftheBoardofDirectors(Mar.31,2008)
57
(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
Usage
Net
Leverage
Q42007 $38.6B71
Q12008 $49.1B74
Q22008 $50.4B77
16.172
15.475
12.178
Net
Leverage
Without
Repo105
17.873
17.376
13.979
Difference
1.7
1.9
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].
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).
83Examiners
21

Inthesectionsthatfollow,thisreportwilldescribeindetailthefactsandanalysis
thatsupporttheExaminersconclusions.Thatdetailwillincludethebasesnotonlyfor
thecolorableclaims that the Examinerhas found, butalsoforthose theExaminer 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
specifically assignedaspartofthe Examiner Orderand becausethesubject
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 but notlimited 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 created bythe Examinerremain aresourcefortheestateandthe
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 Examinersfinancialadvisors ultimatelyrequested accessto 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. There areobvious prosand consto theuse of sworn,
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
inevitablytakes moretime,createsadditionalexpenseandmakes somewitnesses less
35

willingtogivefullcooperation;moreover,thecreationoftranscribedstatementsmight
have impacted pending Government investigations. Balancing these factors, the
Examinerdecidedtouseinformalinterviewswhereverpossibleandthatturnedoutto
be possiblein allcases.Toassure accuracy,allinterviewswere conducted by atleast
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 noticeof the topicsheintendedto coverand advancecopiesofthe
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 were and areextremelybusy with
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
:
Inre
:
:
:
etal.,
:
Debtors.
:
x
Chapter11CaseNo.
0813555(JMP)
REPORTOF
EXAMINERANTONR.VALUKAS
Section III.A.1: Risk

TABLEOFCONTENTS
III. ExaminersConclusions......................................................................................................43
A. WhyDidLehmanFail?AreThereColorableCausesofActionThat
AriseFromItsFinancialConditionandFailure?.....................................................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
(ii)
InternalOppositiontoGrowthofCommercialReal
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
(i)
CountercyclicalGrowthStrategywithRespectto
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
(ii)
ApplicationofCaremarkandCitigrouptoLehmans
Directors ............................................................................... 193
42

III.
EXAMINERSCONCLUSIONS
FromItsFinancialConditionandFailure?
1.
BusinessandRiskManagement
a) ExecutiveSummary
In2006, Lehmanadopted amoreaggressivebusinessstrategybyexpanding 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.
TheExaminerconcludes thatthe conductofLehmansofficers,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
to evaluatetherisksofpotential investmentsand balance themagainst theirpotential
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 the firmcouldassumewithoutjeopardizing its abilityto achieve a 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
Boardthattheriskappetitelimit was a 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)
ReportedNetAssets156
Q406 Q107 Q207 Q307 Q407 Q108 Q208

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 explainthebusinessandriskdecisions that led Lehman 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
remainon thebalancesheet,exacerbatingtheriskof alossofconfidenceinthefirms
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.
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.
231Examiners
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
ExaminersInterviewofJohnD.Macomber,Sept.25,2009,atp.11.
239
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.
252Lehman,
Update on Lehman Brothers Subprime Mortgage Origination Business Presentation to

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
259
Examiners 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 tightened its subprime lending operations. 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
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
281
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].
296Lehman, Update on Lehman Brothers Subprime Mortgage Origination Business Presentation to
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.
298Lehman, Update on Lehman Brothers Subprime Mortgage Origination Business Presentation to
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 theBoard had used the term
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
reference to Mortgage Maker orAltB in theirpresentationbecausetheybelieved 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 ofcontingentcommitmentsremainedonLehmans books.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
businesssriskappetitelimitbysignificant amountsin2007and2008.336BylateApril
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 tradingbusinessesfocus isonrevenues,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.
Id.
371
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,
Goodmantold Antoncicthat Hughsonfelttrappedin thatRoger [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
(ii) InternalOppositiontoGrowthofCommercialReal
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.
381ExaminersInterviewofPaulA.Hughson,Oct.28,2009,atp.3.
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
405Lehman,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].
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
commitmentwouldhaveonthefirmsriskappetitelevels,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, not including 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 crisiswould 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.TheyconvincedMcGeeandBerkenfeldtokilleverything
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.
497
Email 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.506Thecommitteeprojected negative month 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 hewas not awareofthe information containedin the presentation, and if 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.
536ExaminersInterviewofChristopherM.OMeara,Aug.14,2009,atp.11.
140

easilyseehowmuchbelow(orabove) theusage wascompared to the limit.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 inability to securitize orsyndicate risksthat 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
Q4 2007
Q3 2007
4.5
Q1 2008
PeriodbetweenRAexcessand Boardnotification
4.0
3.5
$inBillions
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Feb28,07
May31,07
May29,2007
Archstone
agreement.
Aug31,07
Aug13,2007
Archstoneis
addedintoRA.RA
waslater
retroactively
updatedtoreflect
thecommitment
sinceJune1,2007.
RAexcesses
beginsoon
thereafter.
Nov30,07
Sep11, 2007
Boardof
Directorsistold
thatRA"remains
withinthe
establishedrisk
limits."
FirmwideUsage
Feb29,08
Oct15,2007
Boardisfirst
toldabout RA
excess.
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 was partly 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
Examinersfinancialadvisorscalculate thatif the same assumptions usedfor 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.
611ExaminersInterviewofRichardS.Fuld,Jr.,Dec.9,2009,atp.10.
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
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
630
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
means towardsdevelopingitsinvestmentbankingbusiness. 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.Theirdecisionto usetheir practical business experience rather thanrely
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

(i) CountercyclicalGrowthStrategywithRespectto
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 applicableto Lehmansreal estatebusiness, Lehmans officers
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 grew spectacularly 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)
OldFrameworkSTL
NewFramework
DealName
Original
fordealswithSTL
STLfordealswith
Commitment
over$250MM3
STLover$400MM3
Date2
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
651
326
USFoodService
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
440
220
IBMInternationalGroupBV
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
378
189
FormulaOneGroup
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
276
138
TheKlocknerPentaplastGroup
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
neverthelessapproachedthe newlimit by May2007. Lehmanenteredinto 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;theydidnot put
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
TheExamineralsodoesnot finda 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

failedto undertake their responsibilities would theybreach theirduty of
loyalty.678
(b) LehmansDirectorsDidNotViolateTheirDutyofLoyalty
A directors duty of loyalty [e]ssentially...mandates that the best interest of
the corporationanditsshareholders take precedenceoveranyinterest possessedbya
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 the Caremarkstandard for assessing director oversightliability.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, the Court found theallegations legally insufficient toshowthat
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
(ii) ApplicationofCaremarkandCitigrouptoLehmans
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.BecauseLehman managementshandlingof riskdidnotviolatethe
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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UNITEDSTATESBANKRUPTCYCOURT

II. ProceduralBackgroundandNatureoftheExamination ..............................................28

Over the weekend of September 1214, an intensive series of meetings was

42Morningstar DocumentResearch Co.,LBHI Historic StockPrices (Jan.1, 2008 throughSept. 15,2008)

Valuation The Examiner has explored this subject because it is central to

Lehmans Interaction With Government Agencies As part of the

Section III.A.1: Risk

(iii) DecisionNotToEnforceSingleTransactionLimit .......... 73

(iii) Archstone ............................................................................. 108

RiskAppetiteDisclosures .................................................. 139

(iii) ConcentratedInvestmentsinLeveragedLoans ............. 175

(vi) StressTesting ....................................................................... 181

In2006, Lehmanadopted amoreaggressivebusinessstrategybyexpanding its

Update on Lehman Brothers Subprime Mortgage Origination Business Presentation to

Lehmans management decided to exceed risk limits with respect to

Lehmans management decided to treat primary firmwide risk limit the

Although these decisions by Lehmans management ultimately proved to be

Q406 Q107 Q207 Q307 Q407 Q108 Q208

The dramatic growth in Lehmans principal investments and in its balance

Update on Lehman Brothers Subprime Mortgage Origination Business Presentation to

June 2007, $1.1 billion Lehman financing to Thomas Properties Group to

July 2007, $1.5 billion Lehman financing to ProLogis to acquire the

October 2007, $1.5 billion Lehman financing to Blackstone for its

The enormous growth of Lehmans commercial real estate balance sheet

Directors, Re: Project Easy Living(May 22,2007) [LBEXDOCID1350952],attached to emailfromJulia

p. 2 [LBEXDOCID 200792], attached to email from Paolo R. Tonucci, Lehman, to Christopher M.

p. 2 [LBEXDOCID 200792], attached to email from Paolo R. Tonucci, Lehman, to Christopher M.

433Lehman, Business and Financial Review Q2 2008 (Aug. 5, 2008), at p. 14 [LBHI_SEC07940_659768];

2007), at p. 6 [LBHI_SEC07940_026226]; Lehman, Estimated Third Quarter Financial Information

Interview of Roger Berlind, May 8, 2009, at p. 4; Examiners Interview of John D.

Minutes of the Board of Directors (Nov. 8, 2007), at p. 6 [LBHI_SEC07940_026650]; Lehman, Board of

R. Tonucci, Lehman, 2008 Financial Plan Presentation (Jan. 29, 2008), at p. 1

The Examiner investigated three potential claims in connection with Lehmans

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