Lehman Bankruptcy Examiner Cites Company's "Balance Sheet Manipulation"
According to the March 11, 2010 bankruptcy examiner’s report, the collapse of Lehman Brothers was a result of the deteriorating economic climate, exacerbated by Lehman’s executives, whose conduct ranged from "serious but non-culpable errors of business judgment to actionable balance sheet manipulation."
The Report was prepared pursuant to a January 2009 bankruptcy court order directing the trustee to appoint an examiner to investigate the events leading up to Lehman’s collapse. The examiner appointed was Anton Valukas of the Jenner & Block law firm.
The full report is nine volumes long, consisting of 2,200 pages, and can be found here. The executive summary (which alone is 239 pages long) can be found here. According to news reports, Valukas spent $38 million conducting his examination. He and his team interviewed more than 100 people and scrutinized more than 10 million documents, plus 20 million pages of e-mails from Lehman.
The examiner’s report states that as conditions worsened during 2008 and in order to "buy itself time," Lehman "painted a misleading picture of its financial condition." For example, the report states, that while reporting a significant loss at the end of the second quarter 2008, Lehman "sought to cushion the bad news by trumpeting that it had significantly reduced its net leverage ratio," while failing to disclose that it had been using an "accounting device" – known as Repo 105 – that had "no substance" and whose sole purpose was to allow Lehman to "manage its balance sheet."
The report states that Lehman neither disclosed its use of nor "the significance of the use of the magnitude of its use of" Repo 105, to the Government, to rating agencies, to investors or even to its own Board. Its auditors were aware of but did not question the transaction. The Repo 105 balance sheet manipulation is summarized on the WSJ.com Deal Journal blog, here.
The examiner concluded that the business decisions that brought Lehman to a crisis "may have been in error but were largely within the business judgment rule." However, the "decision not to disclose the effects of these judgments does give rise to colorable claims against the senior officers who oversaw and certified misleading financial statements," including CEO Richard Fuld and the company’s CFOs, Christopher O’Meara, Erin Callan and Ian Lowitt.
The examiner also found that there is a "colorable claim that the "sole function" of the Repo 105 transactions was "balance sheet manipulation" that "created a misleading picture of Lehman’s true financial health."
The examiner also concluded that there are "colorable claims" against the company’s auditor, Ernst & Young, on the grounds that it "did not meet professional standards" for its "failure to question and challenge improper or inadequate as disclosures."
The examiner’s report explains that the report uses the phrase a "colorable claim" to mean one for which "there is sufficient credible evidence to support a finding by a trier of fact," without presuming the finder of fact’s ultimate conclusion.
The examiner also reviewed the actions of Lehman’s lenders, JP Morgan and Citigroup. The report concludes that "The demands for collateral by Lehman’s lenders had direct impact on Lehman’s liquidity pool," adding that "Lehman’s available liquidity is central to the question of why Lehman failed." Citigroup, which handled currency trades for Lehman, received a new guarantee from Lehman when Lehman was already insolvent and didn’t give enough value in return, the report said. The report concludes that "a colorable claim exists to avoid the Amended Guaranty as constructively fraudulent."
The examiner also reviewed the acquisition of Lehman’s North American brokerage, concluding that "a limited amount of assets" belonging to Lehman were "improperly transferred to Barclays."
The examiner recites at the outset of the report that under the relevant bankruptcy code provisions one purpose of a bankruptcy examination is to determine the existence of "a cause of action for the estate." Given the bankruptcy examiner’s conclusion that there are colorable claims against Fuld and the other former Lehman’s officials, as well as against its outside auditor, it seems reasonable to anticipate that the next step with be the bankruptcy trustee’s initiation of claims against these individuals and the auditor.
By way of comparison, after the New Century Financial bankruptcy examiner issued a report issued a report critical of company officials and the company’s auditor (about which refer here), the bankruptcy trustee filed a lawsuit (refer here) seeking to hold New Century’s auditors liable. In addition, the claimants in the New Century securities class action lawsuit relied heavily on the Examiner's findings in their amended complaint, which later suvived a motion to dismiss. I noted at the time of the dimissal that the bankruptcy examiner's findings may have strongly influenced the court in its dismissal motion ruling.
General Growth Properties Settles Credit Crisis-Related Securities Suit: According to a February 23, 2010 filing in the Northern District of Illinois, the parties to the credit crisis-related securities suit arising out of the collapse of General Growth Properties has been settled for $15.5 million, subject to court approval. The parties’ stipulation of settlement can be found here.
The General Growth Properties suit was one of the cases first filed in late 2008 as the subprime meltdown morphed into a full blown credit crisis, as I discussed in a post at the time, here.
The lead complaint, which can be found here, was filed in January 2009. The plaintiffs alleged that General Growth’s survival depended on its ability to refinance in November 2008 approximately $1.5 billion of its $27 billion of outstanding debt. Ultimately the company was unable to refinance its debt and it filed for bankruptcy in April 2009. The plaintiffs essentially alleged that the eleven individual defendants misrepresented the company’s ability to refinance its debt.
The complaint also alleged that the company’s senior executives had improperly loaned money to certain executives so that the executives did not have to sell their company shares in a margin call. The companies also allege that the company’s officials improperly sought to have the company’s shares included in the SEC’s short selling ban, so that the officials could sell their share at inflated prices.
In a September 29, 2009 opinion (here), Northern District of Illinois Milton Shadur granted in part and denied in part the defendants’ motion to dismiss. According to the settlement stipulation, in January 2010, the parties submitted the case to mediation, from which the settlement ultimately resulted.
The General Growth suit is one of only a handful of cases filed in the wake of the subprime meltdown and the ensuing credit crisis that has reached the settlement stage, and one of only a smaller handful of cases that have been settled following a dismissal motion ruling. We undoubtedly will see more settlements ahead as more cases work their way through the system.
I have in any event added the General Growth Properties settlement to my list of subprime and credit crisis-related case resolutions, which can be accessed here. My recent status update on the subprime and credit crisis related securities litigation can be found here.
Special thanks to Adam Savett of the Securities Litigation Watch blog for providing me with a copy of the stipulation of settlement.
Hello Polly: Many readers undoubtedly saw the article in yesterday’s Wall Street Journal (here) reporting that the Bank of America has apologized after its local contractor entered the home of a mortgage borrower, while she was away, and cutoff her utilities, padlocked the door and "confiscated her pet parrot, Luke." The homeowner, separated from her parrot for a week, filed a lawsuit against the bank for emotional distress.
This momentous story was deemed by the Journal’s editors to be worthy of a front page photograph of the homeowner, now fortunately reunited with her beloved parrot.
We mention this because, as was pointed out to us by a loyal reader, the Journal’s front page above- the- fold color photograph was headlined with the phrase "Hello, I Wish to Register a Complaint." We suspect that the Journal’s editors ran the picture on the front page for the sole reason that it gave them an excuse to use that headline.
If the topic is parrots, the only possible reference is to the immortal Monty Python dead parrot sketch, which believe it or not has its own Wikipedia page, here. The skit begins with John Cleese entering a pet shop and stating (as reflected in this script of the sketch) "Hello, I wish to register a complaint." Cleese’s problem in the sketch is not that his parrot has been confiscated; rather, his problem is that the parrot he had just purchased is dead. Deceased. It is no more. It has ceased to exist. It has joined the choir celestial. This is an ex-parrot
We are delighted to have this pretext to be able to embed a video of the sketch below. Because we think everyone should know a dead parrot when they see one.
It has now been over three years since the first subprime-related securities class action lawsuit was filed in February 2007, yet many of the cases filed in the ensuing litigation wave are still only in their earliest stages. While the vast majority of these cases are still unfolding, there have been some important recent developments, suggesting that the evolving litigation wave has passed some significant milestones. With that possibility in mind, it seems appropriate to check in for a status report on the subprime and credit crisis-related litigation wave.
In a ruling that may have potential significance for the many claims that have been filed against the rating agencies in the subprime litigation wave, on February 17, 2010, Southern District of New York Judge
In one of the largest subprime-related securities lawsuit settlements so far, Moneygram Corporation has agreed to settle its subprime-related securities class action and accompanying derivative suit for $80 million, according to the company’s February 25, 2010 press release (
In an interesting and potentially significant February 22, 2010 opinion (
Just when it seemed as if the dismissal motion rulings in the subprime-related securities suits
In an interesting February 11, 2010 decision (
In a 90-page January 27, 2010 opinion (
In a January 14, 2010 order (
Since the outset of the subprime securities class action litigation wave I have tried to keep track both of the lawsuits as they are filed (refer
Beazer Homes has announced in its December 22, 2009 filing on Form 8-K (
In a provocative statement suggesting the unlikelihood of "damage awards" against subprime lenders’ directors and officers, XL Capital Ltd. CEO
In a series of recent rulings in coverage litigation arising out of the 2007 collapse of
Bankruptcy cases filed in the U.S. federal courts continued to surge in the twelve months ended September 30, 2009, according to statistics released on November 25, 2009 by the
The onslaught of bank closures continues. The FDIC’s closure of
As a result of a November 2, 2009 ruling (
On October 19, 2009, in a securities case from an earlier era involved allegedly misleading statements regarding asset-backed securities, Southern District of New York Judge
The worst of the global financial crisis may be past, and we may even be well on the road to economic recovery, but there still may be considerable pain yet to come, particularly in connection with commercial mortgages. Increased vacancies, declining property values and shortages of refinancing capital could mean increasing numbers of commercial mortgage defaults ahead.
In the latest of the subprime and credit crisis cases to be dismissed, on September 30, 2009, District of Massachusetts Judge
In several prior posts (most recently
In my recent subprime and credit crisis lawsuit status update (
It is now over two and a half years since the first subprime-related securities class action lawsuit was filed in February 2007, yet many of the cases filed as part of the ensuing litigation wave are still only in their earliest stages. But there have been some important developments recently – for example,
Among the causes many cite for the subprime meltdown is the willingness of the rating agencies to assign investment grade rating to securities backed by subprime mortgages. For that reason, in many of the lawsuits filed as part of the subprime litigation wave,
In the first appellate court decision related to the subprime and credit crisis litigation wave, the United States Court of Appeals for the Eighth Circuit on September 1, 2009 affirmed the dismissal of the NovaStar Financial subprime related securities class action lawsuit. A copy of the Eighth Circuit’s opinion can be found
Finacial Downturn, Not Fraud, Caused Plaintiffs’ Losses: In a ruling that is interesting for what it says about the relevance of the overall economic downturn to the wave of subprime lawsuits, on August 20, 2009, Eastern District of Pennsylvania Judge R. Barclay Surrick, Jr. granted the motion to dismiss the securities fraud lawsuit that Luminent Mortgage Corporate had filed against Merrill Lynch and related entities. A copy of the August 20 opinion in the case, which was filed solely on behalf of the named plaintiffs and not as a class action, can be found
It seems that Southern District of New York Judge
Two recent dismissal motion rulings in cases arising out of the subprime and credit crisis litigation wave involve two companies from outside the original core of the subprime lending sector – student lender First Marblehead and residential home builder Levitt Corporation. When these cases were filed early in 2008, I cited each of them as examples of how the subprime litigation wave was expanding to encompass a broader range of companies.
Earlier this year, when the auction rate securities lawsuit against UBS was dismissed (refer
In a July 1, 2009 opinion (
In its most significant enforcement action yet related to the subprime meltdown, on June 4, 2009, the SEC filed a civil securities fraud complaint (
Most of the cases filed in the subprime and credit crisis-related litigation wave are still in their earliest stages, but as the early returns have trickled in, one recurring question as been how the cases are faring. More than once (refer
The resulting graph, shown on the left (a more legible image is linked on Shnier’s blog) shows that beginning in November 2007 and for the following twelve months “the running count started out in the negative numbers,” which is “favorable to defendants.” But the trendline crossed into positive numbers – more favorable to plaintiffs – and has stayed there ever since December 2008. Schnier’s conclusion? The “trendline is moving upward in favor of dismissals being denied.”
In prior posts (most recently
In a pair of separate rulings late last week, district court judges took on the plaintiffs’ allegations in a couple of high profile lawsuits arising out of the subprime meltdown. The courts’ rulings make it clear that the plaintiffs’ allegations in these cases will be highly scrutinized, but that (in one of the two cases) the judicial hurdles are not entirely insurmountable.
Though the subprime and credit crisis-related securities litigation wave is now well into its third year, relatively few of the cases have yet settled or otherwise finally been resolved. However, the parties to one of the securities lawsuits filed in the earliest stages of the litigation wave have announced that they have settled the case, in a development that potentially may have significance for the many other pending cases.
The collapse of the market for auction rate securities (ARS) has generated a flood of litigation, mostly brought by angry ARS investors against the broker dealers who sold them the securities or against the mutual funds that allegedly failed to disclose that their assets were invested in these kinds of securities. More recently (refer for example
In a development that may foreshadow further "gatekeeper" claims as part of the current credit crisis litigation wave, on April 1, 2009, the trustee for the New Century Financial Corp. liquidation initiated lawsuits in California and New York against KPMG and its international parent, seeking to recover $1 billion in damages for negligence and for aiding and abetting breaches of fiduciary duty.
A federal judge has ruled that securities class action plaintiffs who availed themselves of UBS’s auction rate securities regulatory settlement cannot separately maintain claims for damages against UBS. But while this ruling would seem to represent at least the beginning of the end for many similarly placed plaintiffs, we may still be a long way from the end of the auction rate securities litigation, despite the regulatory settlements.
On March 9, 2009, in a short but strongly worded opinion, Judge
General Motors’ March 4, 2009 filing on Form 10-K (
Even though I was not even away a full week for the recent PLUS D&O Symposium, there was a flood of noteworthy developments while I was gone. Here is a roundup of last week’s news and notes.
In the lists of those supposedly responsible for the current financial mess, the rating agencies are among those usually featured prominently. Numerous investors have in fact sued the rating agencies claiming the ratings misled them into making their investment (about which refer, for example,
By now it is not news that the current credit crisis and related litigation wave have both spread far beyond the residential real estate sector in which they both first began. But the details surrounding the extension remain interesting and may even contain hints about what may lie ahead, as suggested by a recent lawsuit.
As the difficulties and challenges from the global economic crisis continue to mount, one recurring question has been – how could things possibly have gone so wrong?
Even after Merrill Lynch’s recent $550 million settlement of the subprime-related securities and ERISA lawsuits pending against the company (about which refer
In a subprime-related lawsuit that highlights the advantages ERISA claimants may have over litigants seeking relief under the securities laws, a federal court has refused to dismiss the complaint filed under ERISA on behalf of benefits plan participants of NovaStar Financial.
In a February 12, 2009
The credit-crisis securities litigation wave, which began with the filing of the first subprime mortgage-related lawsuits in early February 2007, is about to enter its third year. Though the wave has evolved during the intervening period, it shows no sign of slowing down. The more interesting question going forward will be whether the litigation, which up until now has largely been concentrated in the financial sector, will spread to encompass companies in the wider economy.
The growing problems surrounding
As detailed in a recent post (
Among the many lawsuits that have flooded in as part of the subprime and credit crisis litigation wave has been a profusion of lawsuits against the mortgage-backed securities issuers and their securities offering underwriters. These lawsuits, typically filed under the ’33 Act and alleging misrepresentations in the offering documents, claim that investors who purchased securities in the offering have been harmed due to the deterioration in the performance of the underlying mortgages.
In recent days, all eyes have been on two of the world’s largest banks. Commentators have questioned, for example, whether Citigroup should be nationalized (refer
As has been well-publicized, within a matter of weeks of closing its acquisition of Merrill Lynch, Bank of America announced previously undisclosed 4Q08 operating losses at Merrill of $21.5 billion that required BofA to obtain an emergency $20 billion cash injection from the U.S. Treasury, as well as an additional $118 billion asset backstop. BofA’s stock market valuation has dropped more $100 billion since the day before the merger was announced through the company’s January 16 earnings release.
They aren’t the first subprime lawsuit settlements, but the two massive settlements Merrill Lynch announced this past Friday are unquestionably the largest subprime subprime securities lawsuit settlements so far, and they certainly suggest the enormous stakes that may be involved in the mass of subprime and credit crisis-related litigation cases that remain pending.
First, with respect to the credit crisis litigation, on January 12, 2009, plaintiffs’ lawyers issued a press release (
According to their release (
In recent posts discussing year-end trends, my observations included predictions that credit crisis related lawsuits would continue in 2009 and that increased levels of bank failures could lead to further "dead bank" litigation. As it turns out, 2009’s first-filed securities class action lawsuit appears to reflect both of these projected trends.
2008 was a remarkably eventful year, from the dramatic events that rocked the financial markets to the Presidential election that resulted in a change in national leadership. Virtually all of the significant events during 2008 also had an impact on the world of D&O insurance, one way or another. In all likelihood, significant developments will continue to emerge during 2009, with further implications for the D&O marketplace.