In a detailed 106-page opinion dated July 27, 2011 (here), Southern District of New York Judge Lewis Kaplan granted in part and denied in part the defendants’ motions to dismiss in the consolidated Lehman Brothers Securities Litigation. Though Judge Kaplan knocked out certain of the plaintiffs’ allegations, what Judge Kaplan called the “core” of plaintiffs’ allegations remain, particularly with respect the company’s quarter-end Repo 105 transactions.


As detailed here, the plaintiffs allege that the defendants made false and misleading statements about Lehman Brothers prior to the company’s September 2008 collapse. The defendants include certain former officers and directors of the company; the company’s auditor; and the company’s offering underwriter. The plaintiffs amended their consolidated complaint following the March 2010 release of the report of the Lehman Brothers bankruptcy examiner (about which refer here), which, described the company’s alleged “balance sheet manipulation,” among other things by using a quarter end accounting device know as “Repo 105.” The defendants moved to dismiss.


In his July 27 opinion, Judge Kaplan granted the defendants motion to dismiss s to certain of the plaintiffs’ allegations, finding that the plaintiffs had not adequately alleged misleading falsity, for example, with respect to statements about the company’s use of risk mitigants and with respect to certain aspects of the company’s liquidity.


However, Judge Kaplan found that the allegations were sufficient with respect to a number of the plaintiffs’ other allegations, particularly with respect to the company’s use of the Repo 105 transactions; its statements about its net leverage; its statements about its use of stress testing; its statements about risk management; its statements about value at risk; and its statements about concentrations of credit risk.


With respect to the Repo 105 transactions, Judge Kaplan said that “repetitive, temporary, and undisclosed reduction of net leverage at the end of each quarter is sufficient to make out a claim.”


With respect to the statements that the plaintiffs had sufficiently alleged to be false and misleading, Judge Kaplan found that the plaintiffs had also sufficiently alleged scienter. In finding that the plaintiffs had adequately alleged scienter against the officer defendants in connection with the statements concerning the Repo 105 transactions, Judge Kaplan said:


The suggestions that defendants believed that the Repo 105 transactions were permissible in and of themselves and that the financial reporting for them, in and of itself, complied with GAAP does not address the core of plaintiffs’ claims  – that they were used to reduce temporarily and artificially Lehman’s net leverage and paint a misleading picture of the company’s financial position at the end of each quarter. The allegations of that these transactions were used at the end of each reporting period, in amounts that increased as the economic crisis intensified, to affect a financial metric that allegedly was material to investors, credit rating agencies, and analysts supports a strong inference that the Insider Defendants knew or were reckless in not knowing that use of the Repo 105 transactions and the manner in which they were accounted for painted a misleading picture of the company’s finances.


Although Judge Kaplan also knocked out many of the allegations against E&Y, the company auditor, Judge Kaplan also found that the amended complaint “adequately alleges that D&Y misrepresented in the 2Q08 that it was ‘not aware of any material modification that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.’”


Judge Kaplan’s conclusions as to the sufficiency of the Exchange Act allegations against the individual defendants also extended to the sufficiency of the Securities Act allegations against the Underwriter Defendant.


As a result of Judge Kaplan’s rulings, one of the highest profile securities suits filed in the wake of the credit crisis will now go forward. Unsurprisingly, the allegations concerning the Repo 105 transaction had a significant impact on Judge Kaplan’s consideration of the plaintiffs’ claims. While any resolution of this case would be challenging, the difficulty for all concerned is that due to the multiplicity and complexity of the various legal matters arising out of the company’s collapse, the amount of D&O insurance remaining is rapidly declining. Even if the defendants feel strongly that they are wrongly accused, they will have to think hard about whether it is better to try to work a deal while insurance funds remain, or to fight on in the hope of ultimate vindication – preferably before the insurance funds are gone.


Nate Raymond’s July 27, 2011 Am Law Litigation Daily article discussing the decision can be found here.


I have in any event added the Lehman brothers ruling to my running tally of the subprime meltdown and credit crisis related dismissal motion rulings, which can be accessed here.


Special thanks to a loyal reader for providing me with a copy of Judge Kaplan’s ruling.


Second Circuit Affirms Dismissal in CBRE Realty Subprime-Related Securities Suit: In another ruling in a subprime-related securities class action lawsuit, on July 26, 2011, the Second Circuit affirmed the district court’s dismissal of the subprime-related securities suit that had been filed against CBRE Realty Finance. The Second Circuit’s opinion can be found here.


As discussed here, the plaintiffs had alleged that in connection with company’s September 2006 IPO, the company’s offering documents had not adequately disclosed the risk of default in connection with two Maryland condominium conversion projects known as Triton. In July 2009, the District of Connecticut dismissed the plaintiffs’ claims because the loans were fully collateralized at the time of the IPO. The plaintiffs appealed.


In its July 26 opinion, a three-judge panel of the Second Circuit affirmed the district court, but on different grounds. The Second Circuit held that “the alleged misstatements were not material because the value of the transactions composed an immaterial portion of the issuer’s total assets.”


I have also added the Second Circuit’s opinion in the CBRE case to my table of credit crisis lawsuit dismissal motion rulings.