Case 1:08-cv-05598-LAK Document 159 Filed 12/03/10 Page 1 of 75
UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
IN RE LEHMAN BROTHERS ERISA Civil Action No.: 08 Civ. 5598 (LAK) LITIGATION
SECOND CONSOLIDATED AMENDED COMPLAINT FOR VIOLATIONS OF THE EMPLOYEE RETIREMENT INCOME SECURITY ACT
CONFIDENTIAL INFORMATION SUBJECT TO PROTECTIVE ORDER
FILED UNDER SEAL
Dated: New York, New York September 22, 2010 Case 1:08-cv-05598-LAK Document 159 Filed 12/03/10 Page 2 of 75
Plaintiffs Alex E. Rinehart, Monique Miller Fang, Jo Anne Buzzo, Maria DeSousa, and
Linda Demizio (collectively, the “Plaintiffs”) allege the following based upon personal information as to themselves and the investigation of Plaintiffs’ counsel, which includes, among other things, a review of U.S. Securities and Exchange Commission (“SEC”) filings by Lehman
Brothers Holdings Inc. (“Lehman” or the “Company”), including the Company’s proxy statements (Forms DEF-14A), annual reports (Forms 10-K), quarterly reports (Forms 10-Q), current reports (Forms 8-K), and the annual reports (Forms 11-K) filed on behalf of the Lehman
Brothers Savings Plan (the “Plan”); a review of the Forms 5500 filed by the Plan with the U.S.
Department of Labor (“DOL”) and U.S. Department of the Treasury; a review of published accounts surrounding Lehman’s bankruptcy; a review of documents governing the operations of the Lehman Brothers Savings Plan (the “Plan”); and a review of the March 11, 2010 report and documents collected by the Bankruptcy Court-appointed examiner, Anton R. Valukas (“the
Examiner”), submitted in Lehman’s bankruptcy proceedings, In re Lehman Brothers Holdings
Inc., 08-13555 (JMP) (Bankr. S.D.N.Y.).
I. NATURE OF THE ACTION
1. This action is brought on behalf of the Plan and all Plan participants to recover losses to the Plan for which Defendants are personally liable pursuant to Sections 409 and
502(a)(2) of the Employee Retirement Income Security Act (“ERISA”), 29 U.S.C. §§ 1109 and
1132(a)(2). In addition, under ERISA § 502(a)(3), 29 U.S.C. § l132(a)(3), Plaintiffs seek other equitable relief from Defendants, including, without limitation, injunctive relief and, as available under applicable law, constructive trust, restitution, equitable tracing, and other monetary relief.
2. The Plan is a 401(k) retirement plan sponsored by the Company to provide Plan participants an easy and convenient way to save toward their retirement (LEHMAN-
ERISA0000345).
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3. Plaintiffs’ claims arise from the failure of Defendants, who were or are fiduciaries of the Plan, to act solely in the interest of the Plan and its participants and beneficiaries and to exercise the required skill, care, prudence, and diligence in administering the Plan and its assets during the period from March 16, 2008, to June 10, 2009 (the “Class Period”).
4. Throughout the Class Period, Defendants allowed the Plan to acquire and hold
Lehman common stock (“Lehman Stock” or “Company Stock”) through the Lehman Brothers
Common Stock Fund (“Company Stock Fund”), which invested primarily in Lehman Stock, even as the Company headed for bankruptcy and even though they knew or should have known that Company Stock was an imprudent means of saving for retirement because, among other things: (i) the run on the bank that caused the virtual collapse of Bear Stearns put the Defendants on notice that Lehman very well might be the next in line to fail; (ii) the Company was the most highly leveraged of the large remaining investment clearing firms after Bear Stearns’ collapse, indeed, as of April 2008, it was leveraged 30.7 to 1, i.e., it borrowed $30.70 dollars for each dollar of equity; (iii) the Company was exposed to significant risk that it would not be able to fund its ongoing operations if there was a deterioration in the credit, subprime, or other financial markets or if its counterparties withdrew funds or demanded additional collateral from it; (iv) the
Company used undisclosed repurchase and resale (“repo”) transactions, known as “Repo 105” and “Repo 108” transactions (together, “Repo 105”), to artificially and temporarily reduce
Lehman’s net leverage ratio, an important measure of the Company’s inherent risk; (v) the
Company was exposed to catastrophic losses from trading in subprime mortgage backed derivatives, the nature and extent of which the Company failed to disclose fully; (vi) the
Company was exposed to catastrophic losses from collateralized debt obligations (“CDOs”), and had failed to timely write down its positions in these securities, the nature and extent of which
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the Company failed to disclose fully; (vii) the Company was exposed to catastrophic losses from mortgage backed security originations, and had failed to timely write down its positions in these securities, the nature and extent of which the Company failed to disclose fully; (viii) the
Company had materially overvalued its positions in commercial and subprime mortgages, and in securities tied to these mortgages; (ix) the Company had inadequate reserves for its mortgage and credit related exposure; (x) the Company was exposed to catastrophic losses from its investments in commercial real estate, and had failed to timely write down its positions in these securities, the nature and extent of which the Company failed to disclose fully; and (xi) the Company lacked adequate internal and financial controls.
5. Accordingly, Plaintiffs allege in Count I that certain Defendants, each having certain responsibilities regarding the management and investment of Plan assets, breached their fiduciary duties to the Plan and Plan participants by failing to prudently and loyally manage the
Plan’s investment in Company Stock by, among other things: (i) continuing to offer Company
Stock as a retirement saving option; (ii) continuing to acquire and hold shares of Company Stock in the Plan when it was imprudent to do so; (iii) failing to provide complete and accurate information to Plan participants regarding the Company’s financial condition and the prudence of investing in Company Stock; and (iv) maintaining the Plan’s pre-existing investment in
Company Stock when Company Stock was no longer a prudent investment for the Plan.
6. Defendants’ actions and inactions conflicted with the express purpose of ERISA retirement plans, which is to provide funds for participants’ retirement. See ERISA § 2, 29
U.S.C. § 1001 (“Congressional Findings And Declaration Of Policy”).
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7. In Count II, Plaintiffs allege that certain Defendants failed to avoid or ameliorate inherent conflicts of interests which crippled their ability to function as independent,
“single-minded” fiduciaries with only the Plan’s and its participants’ best interests in mind.
8. In Count III, Plaintiffs allege that the Director Defendants, and in particular the
Compensation Committee Defendants (defined below), breached their fiduciary duties by failing to adequately monitor other persons to whom management/administration of Plan assets was delegated, despite the fact that such defendants knew or should have known that such other fiduciaries were imprudently allowing the Plan to continue offering Company Stock as an investment option and investing Plan assets in Company Stock when it was no longer prudent to do so.
9. As alleged below, Defendants responsible for selecting and monitoring the Plan’s retirement savings options imprudently permitted the Plan to offer, acquire, and hold Company
Stock during the Class Period despite the Company’s serious mismanagement, improper business practices, and dire financial circumstances. Defendants’ breaches have caused the Plan and its participants to suffer millions of dollars in losses of retirement savings.
10. ERISA §§ 409(a) and 502(a)(2), 29 U.S.C. §§ 1109 and 1132(a)(2), authorize participants, such as Plaintiffs, to sue in a representative capacity for losses suffered by the Plan as a result of breaches of fiduciary duty. Pursuant to that authority, Plaintiffs bring this action on behalf of the Plan and as a class action under Fed. R. Civ. P. 23 on behalf of all participants in the Plan whose Plan accounts were invested in the Company Stock Fund during the Class Period.
II. JURISDICTION AND VENUE
11. The Court has subject-matter jurisdiction over this action pursuant to ERISA §
502(e)(1), 29 U.S.C. § 1132(e)(1), and 28 U.S.C. § 1331.
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12. ERISA provides for nationwide service of process. ERISA § 502(e)(2), 29 U.S.C.
§ 1132(e)(2). All Defendants are either residents of the United States or subject to service in the
United States. Therefore, the Court has personal jurisdiction over them. The Court also has personal jurisdiction over Defendants pursuant Fed. R. Civ. P. 4(k)(1)(A) because Defendants are all subject to the jurisdiction of a court of general jurisdiction in the State of New York.
13. Venue is proper in this District pursuant to ERISA § 502(e)(2), 29 U.S.C. §
1132(e)(2), because the Plan is administered in this District, some or all of the fiduciary breaches for which relief is sought occurred in this District, and Lehman had its principal place of business in this District.
III. PARTIES
A. Plaintiffs
14. Plaintiff Alex E. Rinehart is a participant in the Plan, within the meaning of
ERISA § 3(7), 29 U.S.C. § 1102(7), and held Company Stock in his individual Plan account during the Class Period.
15. Plaintiff Monique Miller Fang is a participant in the Plan, within the meaning of
ERISA § 3(7), 29 U.S.C. § 1102(7), and held Company Stock in her individual Plan account during the Class Period.
16. Plaintiff Jo Anne Buzzo is a participant in the Plan, within the meaning of ERISA
§ 3(7), 29 U.S.C. § 1102(7), and held Company Stock in her individual Plan account during the
Class Period.
17. Plaintiff Maria DeSousa is a participant in the Plan, within the meaning of ERISA
§ 3(7), 29 U.S.C. § 1102(7), and held Company Stock in her individual Plan account during the
Class Period.
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18. Plaintiff Linda Demizio is a participant in the Plan, within the meaning of ERISA
§ 3(7), 29 U.S.C. § 1102(7), and held Company Stock in her individual Plan account during the
Class Period.
B. The Company
19. The Company, through predecessor entities, was founded in 1850. For more than a century, Lehman and its predecessor entities served the financial needs of corporations, governments and municipalities, institutional clients, and high-net-worth individuals worldwide.
The Company provided a full array of services in equity and fixed income sales, trading and research, investment banking, asset management, private investment management and private equity. The Company’s worldwide headquarters in New York and regional headquarters in
London and Tokyo were complemented by a network of offices in North America, Europe, the
Middle East, Latin America and the Asia Pacific region. Through its subsidiaries, the Company was a global market-maker in all major equity and fixed income products.
20. On September 15, 2008, Lehman filed a voluntary petition for relief under
Chapter 11 of Title 11 of the United States Code in the United States Bankruptcy Court for the
Southern District of New York captioned In re Lehman Brothers Holdings Inc., et. al., Case
Number 08-13555 (JMP).
21. On September 17, 2008, NYSE Regulation, Inc. (“NYSE Regulation”) announced the immediate suspension of trading of Company Stock on the New York Stock Exchange
(“NYSE”). Lehman Stock now trades over the counter for approximately six cents a share.
22. Claims are not asserted against Lehman in this action because of the automatic stay of proceedings against it under Section 362(a) of the Bankruptcy Code, 11 U.S.C. § 362(a).
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C. Defendants
23. All Defendants named below are fiduciaries of the Plan within the meaning of
ERISA, and all Defendants breached their fiduciary duties in various ways, as is alleged herein.
(i) Director Defendants
24. Defendant Richard S. Fuld, Jr. (“Fuld”) served as Chairman of the Board of
Directors (the “Board”) and Chief Executive Officer (“CEO”) of Lehman during the Class
Period. According to the Company’s proxy statement filed with the SEC on or about March 5,
2008 (the “March 5 Proxy Statement”), Defendant Fuld also served as chairman of the Executive
Committee of the Board. Defendant Fuld was a fiduciary of the Plan, within the meaning of
ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that he exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the
Plan’s assets.
25. Defendant Michael L. Ainslie (“Ainslie”) served as a director of Lehman during the Class Period. According to the March 5 Proxy Statement, Defendant Ainslie was a member of the Audit Committee. Defendant Ainslie was a fiduciary of the Plan, within the meaning of
ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that he exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the
Plan’s assets.
26. Defendant John F. Akers (“Akers”) served as a director of Lehman during the
Class Period. According to the Company’s March 5 Proxy Statement, Defendant Akers was
Chairman of the Compensation and Benefits Committee (the “Compensation Committee”), and a member of the Finance and Risk Committee. Defendant Akers was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that he exercised
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discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
27. Defendant Roger S. Berlind (“Berlind”) served as a director of Lehman during the Class Period. According to the Company’s March 5 Proxy Statement, Defendant Berlind was a member of the Audit Committee and the Finance and Risk Committee. Defendant Berlind was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that he exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
28. Defendant Thomas H. Cruikshank (“Cruikshank”) served as a director of
Lehman during the Class Period. According to the Company’s March 5 Proxy Statement,
Defendant Cruikshank was a member of the Nominating and Corporate Governance Committee.
Defendant Cruikshank was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29
U.S.C. § 1002(21)(A), in that he exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
29. Defendant Marsha Johnson Evans (“Evans”) served as a director of Lehman.
Defendant Evans was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29
U.S.C. § 1002(21)(A), in that she exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
According to the March 5 Proxy Statement, Defendant Evans was a member of the
Compensation Committee and the Finance and Risk Committee, and served as the Chairman of the Nominating and Corporate Governance Committee.
30. Defendant Sir Christopher Gent (“Gent”) served as a director of Lehman during the Class Period. Defendant Gent was a fiduciary of the Plan, within the meaning of ERISA §
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3(21)(A), 29 U.S.C. § 1002(21)(A), in that he exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets. According to the March 5 Proxy Statement, Defendant Gent was a member of the
Compensation Committee and the Audit Committee.
31. Defendant Jerry A. Grundhofer (“Grundhofer”) served as a director of Lehman during the Class Period. Defendant Grundhofer was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that he exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the
Plan’s assets.
32. Defendant Roland A. Hernandez (“Hernandez”) served as a director of Lehman during the Class Period. According to the Company’s March 5 Proxy Statement, Defendant
Hernandez was a member of the Finance and Risk Committee. Defendant Hernandez was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that he exercised discretionary authority with respect to the management and administration of the
Plan and management or disposition of the Plan’s assets.
33. Defendant Henry Kaufman (“Kaufman”) served as a director of Lehman during the Class Period. According to the Company’s March 5 Proxy Statement, Defendant Kaufman was the Chairman of the Finance and Risk Committee. Defendant Kaufman was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that he exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
34. Defendant John D. Macomber (“Macomber”) served as a director of Lehman during the Class Period. Defendant Macomber was a fiduciary of the Plan, within the meaning
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of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that he exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the
Plan’s assets. According to the March 5 Proxy Statement, Defendant Macomber was a member of the Compensation Committee, Executive Committee and the Nominating and Corporate
Governance Committee.
35. Defendants Fuld, Ainslie, Akers, Berlind, Cruikshank, Evans, Gent, Grundhofer,
Hernandez, Kaufman, and Macomber are collectively referred to herein as the “Director
Defendants.”
36. The Director Defendants were and are fiduciaries of the Plan within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that they: (i) were named fiduciaries of the
Plan; and (ii) exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
37. According to Article X, Section 10.1 of the Plan Document at LEHMAN-
ERISA0000082, the Board was responsible for appointing the members of the Benefit
Committee:
The complete authority and discretion to control and manage the operation and administration of the Plan shall be placed in the Employee Benefit Plans Committee of the Company. The Committee shall consist of at least three members appointed from time to time by the Board of Directors or its delegate(s) to serve at the pleasure thereof. Any member of the Committee may resign by delivering his written resignation to the Company.
38. The Board was ultimately responsible for monitoring and administering the Plan.
Because of their positions as directors of the Company, the Director Defendants had access to material, non-public information concerning Lehman, including the Company’s true financial condition and outlook, which they had an obligation to share with the other Plan fiduciaries so
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they could properly evaluate the prudence of Lehman Stock as a Plan investment option. The
Board had a responsibility to carry out its duties in such a manner as to best serve the interests of the Plan’s participants.
39. Indeed, Defendant Fuld chaired, and Defendant Macomber was a member of, the
Company’s Executive Committee, which was responsible for assessing Lehman’s risk exposure and related disclosures. Lehman’s Executive Committee reviewed “risk exposures, position concentrations and risk-taking activities on a weekly basis, or more frequently as needed.” See
Form 10-Q for the second quarter of 2008, filed with the SEC on or about July 10, 2008.
Additionally, the Executive Committee “allocate[d] the usage of capital to each of [the
Company’s] businesses and establishes trading and credit limits for counterparties.” Id. In a conference just prior to the Class Period, Ms. Callan, Lehman’s Chief Financial Officer for the first half of the Class Period, explained that the Executive Committee consisted of thirteen people, including herself and Fuld, who met twice a week for two hours at a time and “devote[d] a significant amount of that time to risk.” Lehman Brothers Holdings Inc. at Credit Suisse
Group Financial Services Forum, February 6, 2008. Ms. Callan stated that the Executive
Committee addressed “any risk that passes a certain threshold, any risk that we think is a hot topic” and “anything else during the course of the week that’s important.” Id. Further, Ms.
Callan stated that the Executive Committee was “intimately familiar with the risk that we take in all the different areas of our business. And [Defendant Fuld] in particular . . . keeps very straight lines into the businesses on this topic.” Id.
40. The other committees of the Board also had specialized knowledge about
Lehman’s financial condition. According to the March 5 Proxy Statement, the Finance and Risk
Committee, which consisted of Defendant Kaufman, who chaired the Committee, and
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Defendants Akers, Berlind, Evans and Hernandez, “reviews and advises the Board of Directors on the financial policies and practices of the Company, including risk management. The Finance
[and Risk] Committee also periodically reviews, among other things, budget, capital and funding plans and recommends a dividend policy and Common Stock repurchase plan to the Board of
Directors.”
41. According to the March 5 Proxy Statement, the Nominating and Corporate
Governance Committee, which consisted of Defendant Evans, who chaired the Committee, and
Defendants Cruikshank and Macomber, “is responsible for overseeing the Company’s corporate governance and recommending to the Board of Directors corporate governance principles applicable to the Company. The Nominating [and Corporate Governance] Committee also considers and makes recommendations to the Company’s Board of Directors with respect to the size and composition of the Board of Directors and its Committees and with respect to potential candidates for membership on the Board of Directors.”
42. According to the March 5 Proxy Statement, the Audit Committee, which consisted of Defendant Cruikshank, who chaired the Committee, and Defendants Ainslie,
Berlind and Gent:
assists the Board of Directors in fulfilling its oversight of the quality and integrity of the Company’s financial statements and the Company’s compliance with legal and regulatory requirements. The Audit Committee is responsible for retaining (subject to stockholder ratification) and, as necessary, terminating, the independent registered public accounting firm. The Audit Committee annually reviews the qualifications, performance and independence of the independent registered public accounting firm and the audit plan, fees and audit results, and pre-approves audit and non-audit services to be performed by the independent registered public accounting firm and related fees. The Audit Committee also oversees the performance of the Company’s corporate audit and compliance functions.
43. Further, as described below, the Board was a named fiduciary of the Plan under
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the Plan Document and was expressly authorized and empowered to appoint and remove the
Benefit Committee members. See Plan Document, Article X, Section 10.1 at LEHMAN-
ERISA0000082; see also Lehman Brothers Savings Plan Summary Plan Description, dated
January 1, 2008 (the “SPD”) at LEHMAN-ERISA0000364 (“The Plan is administered by the
Employee Benefit Plans Committee (called the ‘Committee’ in this booklet) which is appointed by the Compensation and Benefits Committee of the Board of Directors of Lehman Brothers
Holdings Inc.”).
(ii) The Compensation Committee Defendants
44. Defendant Compensation and Benefits Committee. The Board delegated Plan administration to the Compensation and Benefits Committee of the Board (the “Compensation
Committee”). See Lehman Brothers Holdings Inc. Compensation and Benefits Committee of the
Board of Directors Charter (the “Charter”) at p. 1 (“The purpose of the Compensation and
Benefits Committee (the ‘Compensation Committee’) shall be to: . . . [d]ischarge the responsibilities of the Board of Directors with respect to the Corporation’s compensation and benefits programs and compensation of the Corporation’s executives”); see also SPD at
LEHMAN-ERISA0000364.
45. The Compensation Committee and its members were and are fiduciaries of the
Plan within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that they: (i) were named fiduciaries of the Plan; and (ii) exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
See Plan Document, Article X, Section 10.1 at LEHMAN-ERISA0000082; see also SPD at
LEHMAN-ERISA0000364 (“The Plan is administered by the Employee Benefit Plans
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Committee (called the ‘Committee’ in this booklet) which is appointed by the Compensation and
Benefits Committee of the Board of Directors of Lehman Brothers Holdings Inc.”).
46. According to the March 5 Proxy Statement, the members of the Compensation
Committee were as follows: (i) Defendant Akers served as Chair of the Compensation
Committee; and (ii) Defendants Evans, Gent, and Macomber were members of the
Compensation Committee.
47. The Company, acting through the Employee Benefit Plans Committee (the
“Benefit Committee”) (with respect to amendments) and the Compensation Committee (with respect to either amendment or termination), reserves the right to amend, modify, suspend, or terminate the Plan at any time. See SPD at 20 (LEHMAN-ERISA0000363).
48. Because of their positions as directors of the Company, the Compensation
Committee Defendants had access to material, non-public information concerning Lehman, including the Company’s true financial condition and outlook, which they had an obligation to share with the other Plan fiduciaries so they could properly evaluate the prudence of Lehman
Stock as a Plan investment option.
(iii) Benefit Committee Defendants
49. Defendant Lehman Brothers Holdings Inc. Employee Benefit Plans Committee.
The Plan is and was administered by the Benefit Committee, which is and was appointed by the
Compensation Committee. See SPD at 21 (LEHMAN-ERISA0000364). The Benefit
Committee has and had “complete authority and discretion to control and manage the operation and administration of the Plan.” See Plan Document, Article X, Section 10.1 (LEHMAN-
ERISA0000082); see also SPD at 2 (LEHMAN-ERISA00000345).
50. The Benefit Committee was designated the “Plan Administrator” and a “Named
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Fiduciary” under the Plan Document. See Plan Document, Article X, Section 10.9 (LEHMAN-
ERISA0000085) (“For purposes of the Act, the ‘Named Fiduciary’ for operation and administration of the Plan and the ‘Plan Administrator’ shall be the Committee, and the
Committee is hereby designated as agent for service of legal process”).
51. The members of the Benefit Committee were appointed by, and served at the pleasure of, the Board or the Compensation Committee as its delegate.
52. Throughout the Class Period, the Benefit Committee consisted of at least three members. See Plan Document, Article X, Section 10.1 (LEHMAN-ERISA0000082).
53. The Benefit Committee had full discretion and authority to make all decisions in connection with the administration of the Plan, including, but not limited to, decisions concerning eligibility to participate in the Plan and concerning benefits to which any participant or beneficiary is entitled, as well as with regard to Plan interpretation and determination of any fact under the Plan. See SPD at 21 (LEHMAN-ERISA0000364).
54. The Benefit Committee had all powers and discretion necessary or helpful for the carrying out its responsibilities, including the discretion and exclusive right to determine any question arising in connection with the interpretation, application, or administration of the Plan.
See Plan Document, Article X, Section 10.2 (LEHMAN-ERISA0000075).
55. Among other powers, the Benefit Committee had the power and discretion to:
(a) determine all questions arising out of or in connection with the provisions of the Plan or its administration, including, without limitation, the power and discretion to resolve ambiguities, to determine relevant facts, to rectify errors, and to supply omissions;
(b) make rules and regulations for the administration of the Plan which are not inconsistent with the terms and provisions of the Plan;
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(c) construe all terms, provisions, conditions and limitations of the Plan;
(d) determine all questions relating to the eligibility of persons to receive benefits hereunder, all other matters upon which the benefits or other rights of a Member or other person shall be based hereunder;
(e) determine all questions relating to the administration of the Plan (1) when disputes arise between an Employer and a member or his Beneficiary, spouse or legal representatives, and (2) in order to promote the uniform administration of the Plan for the benefit of all parties concerned;
(f) direct the Trustee as to the method by which and persons to whom benefits will be paid;
(g) establish procedures for determining whether a domestic relations order is a qualified domestic relations order (“QDRO”) as described in Section 7.12 and for complying with any such QDRO;
(h) determine the method of making corrections necessary or advisable as a result of operating defects in order to preserve qualification of the Plan under Section 401(a) of the Code pursuant to procedures of the Internal Revenue Service applicable in such cases (such as those set forth in Revenue Procedure 2006-27 and similar guidance);
(i) compromise or settle claims against the Plan and direct the Trustee to pay amounts required in any such settlements or compromise;
(j) appoint an Administrator and delegate to such Administrator those tasks of recordkeeping, Plan valuation, communication with Members, and other such ministerial and administrative tasks as the Committee deems appropriate; and
(k) exercise, in its capacity as named fiduciary under the Plan, all discretion that the Trust Agreement or any other contract with the Administrator provides shall or may be exercised by the Company.
See Plan Document, Article X, Section 10.2 (LEHMAN-ERISA0000075-76).
56. Further, the Benefit Committee was a named fiduciary with respect to control or management of the assets of the Plan, and had the following authority:
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(a) to appoint an investment manager or managers (within the meaning of Section 3(38) of the Act) to manage (including the power to acquire and dispose of any assets of the Plan), and
(b) to direct the Trustee with respect to the management of assets of the Plan not subject to the authority of such an investment manager (including, without limitation, the selection of such mutual funds or other investment options as it may deem appropriate to carry out the investment objectives of each of the respective Investment Funds established by the Committee as provided in Section 9.2).
See Plan Document, Article X, Section 10.12 (LEHMAN-ERISA0000085-86).
57. In addition to the foregoing, under the Plan Document, the Benefit Committee
also had exclusive fiduciary responsibility for determining whether Plan provisions requiring the
establishment and maintenance of the Company Stock Fund should continue to be given effect in
accordance with their terms as required by ERISA § 401(a)(1)(D), 29 U.S.C. § 1101(a)(1)(D), or
whether such provisions were inconsistent with ERISA to any extent, including in particular the
fiduciary duty rules of ERISA §§ 404(a)(1) and (a)(2), 29 U.S.C. §§ 1104(a)(1) and (2). See id.
58. Article IX, Section 9.2(a) of the Plan Document similarly provided plan
fiduciaries the right to eliminate or curtail investments in Lehman Stock:
(a) The Trust Fund shall consist of the Lehman Stock Fund and, until January 31, 2007, the American Express Stock Fund, each as described more fully in Section 1.32, and such other Investment Funds as the Committee shall establish from time to time. The Committee shall have the right (i) to establish and disestablish such other Investment Funds from time to time to implement and carry out investment objectives and policies established by the Committee, and (ii) to eliminate or curtail investments in Lehman Stock (or, prior to January 31, 2007), American Express Stock) if and to the extent that the Committee determines that such action is required in order to comply with the fiduciary duty rules of section 404(a)(1) of ERISA, as modified by section 404(a)(2) of ERISA.
See Plan Document, Article IX, Section 9.2(a) (LEHMAN-ERISA0000079) (Emphasis added).
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59. As a named fiduciary, the Benefit Committee had full and exclusive responsibility for monitoring, with the requisite prudence, diligence, skill and care required thereby, the suitability of acquiring and holding Company Stock within the meaning of the fiduciary duty rules of section ERISA §§ 404(a)(1) and (a)(2). See Trust, RecordKeeping and Administrative
Services Agreement between Lehman Brothers Holdings Inc. and Fidelity Management Trust
Company – Lehman Brothers Savings Plan Trust (the “Trust Agreement”), Section 5(e)(ii)(A)
(LEHMAN-ERISA00000203).
60. As a named fiduciary, the Benefit Committee also was responsible for filing all reports required under Federal or state securities laws with respect to the Trust’s ownership of
Company Stock, including, without limitation, any reports required under section 13 or 16 of the
Securities Exchange Act of 1934 (“Exchange Act”). See Trust Agreement, Section 5(e)(v)
(LEHMAN-ERISA00000205).
61. As a named fiduciary, the Benefit Committee was responsible for notifying the
Trustee in writing of any requirement to stop purchases or sales of Company Stock pending the filing of any report required by law or otherwise. See id.
62. Defendant Wendy M. Uvino (“Uvino”) served as the Chair of the Benefit
Committee during the Class Period. Defendant Uvino was a Senior Vice President and Global
Head of Lehman’s employee benefits functions during the Class Period. In her role, Defendant
Uvino managed all aspects of the benefits programs and oversaw the Human Resources data management functions. Defendant Uvino signed the Plan’s 2007 Form 11-K (filed on June 26,
2008) as the Chairperson of the Benefit Committee. Defendant Uvino also signed the Form 5500 for year ended 2006. Defendant Uvino was a fiduciary of the Plan, within the meaning of
ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that she was a named fiduciary and exercised
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discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
63. Defendant Amitabh Arora (“Arora”) served as a member of the Benefit
Committee during the Class Period. Defendant Arora was Lehman Brothers’ Global Head of
Rates Strategy at Lehman during the Class Period. Prior to his employment at Lehman in this capacity, he was the Chief of Mortgage Research at Morgan Stanley. Before that, he spent seven years at Lehman in mortgage modeling. By virtue of his position at Lehman, as well as his background and expertise in the mortgage industry, Defendant Arora knew or should have known of Lehman’s exposure to catastrophic losses from inter alia, trading and holding for its own account in subprime mortgage backed derivatives and mortgage backed securities, and that
Lehman had had materially overvalued its positions in commercial and subprime mortgages, and in securities tied to these mortgages. Defendant Arora either did share, or should have shared, the benefits of his knowledge and expertise with the other members of the Benefit Committee.
Defendant Arora was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29
U.S.C. § 1002(21)(A), in that he was a named fiduciary and exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
64. Defendant Mary Pat Archer (“Archer”) served as a member of the Benefit
Committee during the Class Period. Defendant Archer was a Managing Director at Lehman during the Class Period. Defendant Archer worked as the lead on real estate transactions for
Lehman. In that capacity, she was fully familiar with Lehman’s exposure to the vagaries of the mortgage markets and that the failure of Bear Stearns had started with its exposure to the mortgage backed securities market. In late 2001 or early 2002, she transitioned into a more
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administrative role, as the Head of Human Resources for Lehman’s fixed income businesses, including mortgages, government bonds, corporate bonds and others, in which position she knew or should have know of Lehman’s exposure to catastrophic losses from inter alia, trading and holding for its own account in subprime mortgage backed derivatives and mortgage backed securities, and that Lehman had had materially overvalued its positions in commercial and subprime mortgages, and in securities tied to these mortgages. Defendant Archer either did share, or should have shared, the benefits of her knowledge and expertise with the other members of the Benefit Committee. Defendant Archer was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that she was a named fiduciary and exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
65. Defendant Michael Branca (“Branca”) served as a member of the Benefit
Committee during the Class Period. Defendant Branca was a Research Analyst during the Class
Period. As a research analyst, Defendant Branca knew about Lehman’s growing exposure to the financial crisis long before the Company became insolvent. Defendant Branca either did share, or should have shared, the benefits of his knowledge and expertise with the other members of the
Benefit Committee. Defendant Branca was a fiduciary of the Plan, within the meaning of
ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that he was a named fiduciary and exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
66. Defendant Evelyne Estey (“Estey”) served as a member of the Benefit Committee during the Class Period. Defendant Estey was a Managing Director and Chief Administrative
Officer prior to the Class Period. Defendant Estey’s husband, Arthur S. Estey, was also a
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Managing Director at Lehman. Defendant Estey’s senior executive position makes it more probable than not that she knew about Lehman’s growing exposure to the financial crisis long before the Company became insolvent. Defendant Estey either did share, or should have shared, the benefits of her knowledge and expertise with the other members of the Benefit Committee.
Defendant Estey was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29
U.S.C. § 1002(21)(A), in that she was a named fiduciary and exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
67. Defendant Adam Feinstein (“Feinstein”) served as a member of the Benefit
Committee during the Class Period. Defendant Feinstein was Managing Director, Equity
Research at Lehman during the Class Period. By virtue of his expertise in equity research,
Defendant Feinstein had the necessary skills and expertise to evaluate Lehman’s financial condition and knew after the run on the bank at Bear Stearns that Lehman, which was highly leveraged, was extremely susceptible to a “run on the bank,” and was likely to be the next firm to collapse. Defendant Feinstein either did share, or should have shared, the benefits of his knowledge and expertise with the other members of the Benefit Committee. Defendant Feinstein was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that he was a named fiduciary and exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
68. Defendant David Romhilt (“Romhilt”) served as a member of the Benefit
Committee during the Class Period. Defendant Romhilt was the Chief Investment Officer of
Lehman Brothers Trust Company, N.A., charged with, inter alia, working with trust personnel to assist clients in implementing portfolio strategies and in diversifying their portfolios to avoid
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undue risk during the Class Period. Defendant Romhilt’s work as Chief Investment Officer gave him both the expertise and timely information about Lehman’s high risk portfolio and leveraged balance. Defendant Romhilt either did share, or should have shared, the benefits of his knowledge and expertise with the other members of the Benefit Committee. Defendant Romhilt was a fiduciary of the Plan, within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), in that he was a named fiduciary and exercised discretionary authority with respect to the management and administration of the Plan and management or disposition of the Plan’s assets.
69. Defendants Uvino, Arora, Archer, Branca, Estey, Feinstein, and Romhilt are collectively referred to herein as the “Benefit Committee Defendants.”
70. As alleged herein, by virtue of their senior executive and management positions, the Benefit Committee Defendants had, or had access to, knowledge about Lehman’s financial and operating condition and prospects during the Class Period.
(iv) Additional “John Doe” Defendants
71. Without limitation, unknown “John Doe” Defendants 1-10 include other individuals, including members of the Benefit and Compensation committees, directors of
Lehman, as well as other Company officers and employees who are or were fiduciaries of the
Plan, within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A), during the Class
Period. The identities of the John Doe Defendants are currently unknown to Plaintiffs; once their identities are ascertained, Plaintiffs will seek leave to join them to the instant action under their true names.
IV. THE PLAN
72. The Plan is an employee pension benefit plan, as defined by ERISA § 3(2)(A), 29
U.S.C. § 1002(2)(A). Specifically, the Plan is a defined contribution plan within the meaning of
ERISA § 3(34), 29 U.S.C. § 1002(34). The Plan is a legal entity that can sue and be sued.
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ERISA § 502(d)(1), 29 U.S.C. § 1132(d)(1). However, the Plan is not a party in an action for breach of fiduciary duty such as this. Rather, pursuant to ERISA § 409, 29 U.S.C. § 1109, and the law interpreting it, the relief requested in this action is for the benefit of the Plan and its participants and beneficiaries.
73. The assets of an employee benefit plan, such as the Plan here, must be “held in trust by one or more trustees.” ERISA § 403(a), 29 U.S.C. § 1103(a). During the Class Period, the assets of the Plan were held in trust by the Plan Trustee, Fidelity Management Trust
Company. See SPD at 22 (LEHMAN-ERISA0000365); 2007 Form 11-K at 6; Trust Agreement at 6 (LEHMAN-ERISA0000197).
74. The Plan, formerly known as the Lehman Brothers Holdings Inc. Tax Deferred
Savings Plan, was adopted effective January 1, 1984, as the Shearson Lehman Brothers Holdings
Inc. Tax Deferred Savings Plan.
75. As stated in the Summary Plan Document, the purpose of the Plan was and is to help participants plan for retirement. See SPD at 2 (LEHMAN-ERISA00000345) (“The Lehman
Brothers Savings Plan (‘Plan’) is a 401(k) plan that provides you with an easy and convenient way to save toward your retirement”).
76. Employees were eligible to participate in the Plan immediately upon their hire date, if the employee is paid on an hourly, salaried, or commission basis, except if (i) the employee is employed outside of the United States, unless the employee is paid through a U.S. based payroll in U.S. dollars, (ii) the employee is employed in a special purpose program (such as student intern), (iii) the employee does not have a valid Social Security Number, or (iv) the employee is a leased employee, or the employee performs services for an Employer under an arrangement in which the employee is treated as a consultant, an independent contractor or an
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employee of another entity. See SPD at 3 (LEHMAN-ERISA0000346); see also Plan
Document, Article II, Section 2.1 (LEHMAN-ERISA0000025).
77. Plan participants have multiple accounts under the Plan, each containing a specific type of contribution;
• Before-Tax Account and Catch-up Contributions Account (“Before-Tax Accounts”); • Roth 401(k) Account and Roth Catch-up Contributions Account (“Roth Accounts”); • Employer Contributions Account Rollover Account • After-Tax; and • Rollover Account.
See SPD at 3 (LEHMAN-ERISA0000346).
78. The Plan invested in Company Stock through the Company Stock Fund.
Investment in the Company Stock Fund consists exclusively of (i) shares of Company Stock and
(ii) such cash or short-term fixed income investments. See Trust Agreement, Section 5(e)
(LEHMAN-ERISA0000201); Plan Document, Section 8.3(a) (LEHMAN-ERISA000076).
79. Throughout the Class Period, Plan participants were permitted to contribute a whole percentage of their pay, up to 50 percent (50%), for investment in the Plan. See Plan
Document Section 3.1(a) (LEHMAN-ERISA0000027); see also SPD January 1, 2008 at 3 (“You can contribute between 1% and 50% (in 1% increments) of your Pay to the Plan as Before-Tax or as Roth Contributions. You must select the percentage of your Pay you wish to contribute in each payroll period, whether the contributions will be Before-Tax Contributions or Roth
Contributions, and specify the investment fund(s) in which you want your contributions invested”).
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80. Throughout the Class Period, Plan participants were permitted to allocate 20 percent (20%) of their Plan contributions to the Company Stock Fund in the Plan. Pursuant to the Plan Document, Article VII, Section 6.1(c):
Company Stock Fund Limitations. A Participant shall not be entitled to direct investment in the Company Stock Fund of (i) more than fifty percent (50%) of his or her Section 401 (k) Contributions prior to such pay date as of which the Committee determines that the procedures necessary to implement the reduced limit set forth in clause (ii) hereof are in place (the “New Limit Effective Date”), or (ii) more than twenty percent (20%) of the total of his or her Section 401(k) Contributions as of any pay date on or after the New Limit Effective Date (or after January 1, 2008, in the case of a Participant’s initial election for the investment of Section 401(k) Contributions). In the event that a Participant’s investment election for the allocation of Section 401(k) Contributions exceeded the 20% limit in clause (ii) prior to the New Limit Effective Date and the Participant fails to make a new investment election compliant with such 20% limit by the deadline established by the Committee, the excess of his or her Section 401(k) Contributions for pay dates on and after the New Limit Effective Date shall be invested in such other Investment Fund as the Committee shall direct, until such time as the Participant shall make a new election or new elections compliant with such 20% limit. The limitations of this Section 6.l(c) shall also apply to initial elections for the investment of Rollover Contributions (and the date of such contribution shall be treated as a pay date in applying the New Limit Effective Date).
81. Throughout the Class Period, the Plan Document expressly authorized the Benefit
Committee to limit, curtail, or eliminate altogether Plan participants’ allocation of their Plan contributions to the Company Stock Fund to permit the Benefit Committee members to comply with their fiduciary duties under ERISA §§ 404(a)(1) and (a)(2), 29 U.S.C. §§ 1004(a)(1) and
(a)(2). See supra ¶¶ 57-58.
82. Pursuant to Section 6.3(a) of the Plan Document, the Company made matching contributions:
Basic and Matching Contributions. Effective for Plan Years ending on or after December 31, 2007, Basic and Matching
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Contributions for Plan Years ending after the Spinoff Date and prior to December 31, 2007 shall be invested in the Company Stock Fund, subject to the Member’s right thereafter to elect transfers out of the Company Stock Fund in accordance with Section 6.2(a). Basic and Matching Contributions for Plan Years ending December 31, 2007 and thereafter shall be invested in accordance with the Participant’s current election on file for the investment of Section 401(k) Contributions or, if no such election shall be on file, in the Investment Fund or Funds designated from time to time by the Committee.
See Plan Document, Section 6.3(a) (LEHMAN-ERISA0000054).
83. The Company Stock Fund is one of the investment options available for Plan participants. In its 2007 Form 11-K, filed on June 26, 2008, Lehman reported that the Plan had approximately $228,691,000 invested in the Company Stock Fund as of December 31, 2007, when Company Stock was trading at $65.44 per share. At that time, there were 13,743,452.374 shares of Lehman stock in the Company Stock Fund, representing 10.63% of the assets of the entire Plan and the third largest investment fund. See 2007 Form 11-K, LEHMAN-
ERISA0000563. The Plan explicitly authorized the Benefit Committee to limit or curtail any investment option, including the Company Stock Fund or divest assets invested in any investment option as prudence dictates.
84. As proof that the Benefit Committee had the power to do so, it decided on June
10, 2009, nine months after Lehman filed for bankruptcy, that Lehman Brothers Stock Fund should be liquidated -- long after the stock had become worthless. See, e.g., Minutes of the
Benefit Committee, dated June 10, 2009 at LEHMAN-ERISA0000997 (“The Lehman Brothers
Stock Fund should be liquidated. Since it has been determined that the Lehman Brothers
Holdings Inc. common stock is deemed to be worthless, the Committee determined that the Fund should be liquidated after adequate notice to participants”).
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85. During the Class Period, the Committee failed to consider whether Company
Stock was a prudent retirement investment for Plan participants, and therefore took no action to eliminate or curtail Company Stock as a Plan investment option before the stock became worthless.
86. Plan participants are 100% vested in their own contributions and Company matching contributions upon completion of three (3) years of vesting service. See Plan
Document, Article VII, Section 7.1.1 (LEHMAN-ERISA0000057) (“[a] Member shall have a fully vested and non-forfeitable interest in the portion of his Employer Contributions Account attributable to Basic and Matching Contributions for Plan Years beginning on and after January
1, 2005 upon completion of three Years of Vesting Service, or death while employed by an
Employer or Affiliate”).
87. The following documents, previously filed by the Company with the SEC pursuant to the Exchange Act, are incorporated by reference into the operative SPD, dated
January 1, 2008:
The Company’s Annual Report on Form 10-K for the fiscal year ended November 30, 2006, filed with the Commission on February 13, 2007 pursuant to Section 13 or 15(d) of the Exchange Act, the Company’s Quarterly Report on Form 10-Q for the quarterly period ended August 31, 2006, filed with the Commission on October 10, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Quarterly Report on Form 10-Q for the quarterly period ended May 31, 2006, filed with the Commission on July 10, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Quarterly Report on Form 10-Q for the quarterly period ended February 28, 2006, filed with the Commission on April 10, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on February 2, 2007 pursuant to Section 13 or 15(d) of the Exchange Act, the Company’s Current Report on Form 8-K, filed with the Commission on February 9, 2007 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the
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Commission on February 2, 2007 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on January 31, 2007 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on January 19, 2007 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on December 29, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on December 28, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on December 27, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on December 21 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on December 14, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on December 12, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on December 7, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on December 4, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on December 1, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on November 22, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on November 13, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on October 30, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on October 27, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on October 25, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on October 24, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on October 2, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on September 15, 2006
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pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on September 13, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on August 30, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on August 16, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on August 3, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on July 26, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on July 21, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on July 3, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on January 30, 2004 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on June 29, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on June 12, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on May 31, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on May 30, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on May 24, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on May 3, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on April 25, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on April 4, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on March 31, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on March 31, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on March 28, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on March 24, 2006 pursuant to Section
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13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on March 16, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on March 15, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on March 10, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on March 10, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on March 3, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on February 28, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on February 21, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on February 10, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on January 26, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on January 23, 2006 pursuant to Section 13 or 15(d) of the Exchange Act; the Company’s Current Report on Form 8-K, filed with the Commission on January 17, 2006 pursuant to Section 13 or 15(d) of the Exchange Act.
See SPD at 22-23 (LEHMAN-ERISA0000365-367).
88. Certain other documents, filed by the Company with the SEC pursuant to the
Exchange Act after publication of the SPD, also were incorporated by reference into the SPD:
In addition, each other document filed by the Company or by the Plan pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of this booklet and prior to the termination of the Company’s offering of Plan interests and common stock in connection with the Plan shall be automatically incorporated by reference into this booklet and constitute part of the aforementioned prospectus from the date of filing of such document. In the event of any inconsistency between any information in this booklet and any document incorporated by reference, the latest information shall prevail and shall be deemed to replace any prior inconsistent information.
Id.
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V. DEFENDANTS’ FIDUCIARY STATUS
A. The Nature of Fiduciary Status
89. Named Fiduciaries. ERISA requires every plan to have one or more “named fiduciaries.” ERISA § 402(a)(1), 29 U.S.C. § 1102(a)(1). The person named as the
“administrator” in the plan instrument is automatically a named fiduciary, and in the absence of such a designation, the sponsor is the administrator. ERISA § 3(16)(A), 29 U.S.C. §
1002(16)(A).
90. De Facto Fiduciaries. ERISA treats as fiduciaries not only persons explicitly named as fiduciaries under § 402(a)(1), but also any other persons who in fact perform fiduciary functions. See ERISA § 3(21)(A)(i), 29 U.S.C. § 1002(21)(A)(i). Thus, a person is a fiduciary to the extent “(i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, (ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or (iii) he has any discretionary authority or discretionary responsibility in the administration of such plan.” Id.
91. Each Defendant was a fiduciary with respect to the Plan and owed fiduciary duties to the Plan and the participants in the manner and to the extent set forth in the Plan’s documents, under ERISA, and through their conduct.
92. As fiduciaries, Defendants were required by ERISA § 404(a)(1), 29 U.S.C.
§ 1104(a)(1), to manage and administer the Plan and the Plan’s investments solely in the interest of the Plan participants and beneficiaries and with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.
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93. Plaintiffs do not allege that each defendant was a fiduciary with respect to all aspects of the Plan’s management and administration. Rather, as set forth below, Defendants were fiduciaries to the extent of the fiduciary discretion and authority assigned to or exercised by each of them, and the claims against each Defendant are based on such specific discretion and authority.
94. Instead of delegating all fiduciary responsibility for the Plan to external service providers, Lehman chose to assign the appointment and removal of fiduciaries to itself and the other Defendants named herein. These persons and entities in turn selected Lehman employees, officers and agents to perform most fiduciary functions.
95. ERISA permits fiduciary functions to be delegated to insiders without an automatic violation of the rules against prohibited transactions. ERISA § 408(c)(3), 29 U.S.C.
§ 1108(c)(3). However, insider fiduciaries, like external fiduciaries, must act solely in the interest of participants and beneficiaries, not in the interest of the Plan sponsor.
B. Director Defendants’ Fiduciary Status
96. Lehman, as a corporate entity, cannot act on its own without any human counterpart. In this regard, during the Class Period, Lehman relied directly on the Director
Defendants to carry out their fiduciary responsibilities under the Plan and ERISA.
97. The Director Defendants were responsible for appointing, and hence monitoring, and removing, the members of the following committees: (i) the Benefit Committee, see
LEHMAN-ERISA0000082 (“The Committee shall consist of at least three members appointed from time to time by the Board of Directors or its delegate(s) to serve at the pleasure thereof”);
SPD at 20 (LEHMAN-ERISA0000364) (“The Plan is administered by the Employee Benefit
Plans Committee (called the ‘Committee’ in this booklet) which is appointed by the
Compensation and Benefits Committee of the Board of Directors of Lehman Brothers Holdings
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Inc.”); and (ii) the Compensation Committee, see Charter at 1-2 (“Members of the Compensation
Committee shall be appointed by the Board of Directors, and each member shall serve until a successor is duly elected and qualified or until earlier resignation or removal. The members of the Compensation Committee may be removed, with or without cause, by a majority vote of the
Board of Directors”). Thus, according to DOL regulations, the Director Defendants exercised a fiduciary function under ERISA. 29 C.F.R. § 2509.75-8 (D-4).
98. The Director Defendants’ duty to monitor included the responsibility to appoint, evaluate, and monitor other fiduciaries, including, without limitation, the members of the
Compensation Committee and the Benefit Committee.
99. As monitoring fiduciaries, the Director Defendants, had the control and authority, and indeed had the duty to:
(a) ensure that the monitored fiduciaries possess the needed credentials and experience, or use qualified advisors and service providers to fulfill their duties. They must be knowledgeable about the operations of the Plan, the goals of the Plan, and the behavior of the
Plan’s participants;
(b) ensure that the monitored fiduciaries are provided with adequate financial resources to do their job;
(c) ensure that the monitored fiduciaries have adequate information to do their job of overseeing the Plan’s investments;
(d) ensure that the monitored fiduciaries have ready access to outside, impartial advisors when needed;
(e) ensure that the monitored fiduciaries maintain adequate records of the information on which they base their decisions and analysis with respect to the Plan’s investment
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options; and
(f) ensure that the monitored fiduciaries report regularly to the Director
Defendants. The Director Defendants must then review, understand, and approve the conduct of the hands-on fiduciaries.
100. The Director Defendants were obligated to review and oversee the Compensation
Committee Defendants and the Benefit Committee Defendants, to ensure that these monitored fiduciaries were performing their fiduciary obligations, including those with respect to the investment of the Plan’s assets, and were obligated to take prompt and effective action to protect the Plan and its participants when they were not. In addition, the Director Defendants were obligated to provide the monitored fiduciaries with complete and accurate information in their possession that they knew or reasonably should have known that the monitored fiduciaries must have in order to prudently manage a plan and a plan’s assets.
101. Additionally, the Board had the following discretion:
The Board of Directors or any other person or persons entitled to act as the representative of the Company exercising the rights of the Company as settlor and plan sponsor. The persons acting as the Committee or, to the extent determined by such persons, any member or members of the Committee designated by such persons, shall be the Company Representative, except to the extent the Board of Directors determines otherwise or designates other person(s) (by name or position) to be Company Representative for any or all of such purposes.
See Plan Document § 1.15 – Company Representative (LEHMAN-ERISA0000012).
102. Further, each of the Director Defendants exercised his or her discretionary authority with respect to the Plan by determining or participating in decisions about the substantive content of Lehman’s SEC filings, which were incorporated by reference into the
SPD. Such filings were intended to communicate to Plan participants information necessary for them to manage their retirement benefits under the Plan.
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103. Consequently, in light of the foregoing duties, responsibilities and actions, the
Director Defendants were named fiduciaries of the Plan pursuant to ERISA § 402(a)(1), 29
U.S.C. § 1102(a)(1), or de facto fiduciaries within the meaning of ERISA § 3(21), 29 U.S.C. §
1002(21), during the Class Period in that they exercised discretionary authority or discretionary control respecting management of the Plan, exercised authority or control respecting management or disposition of the Plan’s assets, and had discretionary authority or discretionary responsibility in the administration of the Plan.
C. Compensation Committee Defendants’ Fiduciary Status
104. The Compensation Committee and its members had the following powers and duties:
• Oversee evaluation of the Corporation’s management; • Discharge the responsibilities of the Board of Directors with respect to the Corporation’s compensation and benefits programs and compensation of the Corporation’s executives; and • Produce an annual Compensation Committee report for inclusion in the Corporation’s annual proxy statement, in accordance with applicable rules and regulations of the New York Stock Exchange, Inc. (“NYSE”), Securities and Exchange Commission (“SEC”) and other regulatory bodies.
See Charter at 1 (Emphasis added).
105. Additionally, the Compensation Committee had the discretion to appoint the
members of the Benefit Committee. See SPD at 21 (LEHMAN-ERISA0000364).
106. The Compensation Committee Defendants’ duty to monitor included the responsibility to appoint, evaluate, and monitor other fiduciaries, including, without limitation, the members of the Benefit Committee.
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107. As monitoring fiduciaries, the Compensation Committee Defendants had the control and authority, and indeed the duty, to:
(a) ensure that the monitored fiduciaries possess the needed credentials and experience, or use qualified advisors and service providers to fulfill their duties. They must be knowledgeable about the operations of the Plan, the goals of the Plan, and the behavior of the
Plan’s participants;
(b) ensure that the monitored fiduciaries are provided with adequate financial resources to do their job;
(c) ensure that the monitored fiduciaries have adequate information to do their job of overseeing the Plan’s investments;
(d) ensure that the monitored fiduciaries have ready access to outside, impartial advisors when needed;
(e) ensure that the monitored fiduciaries maintain adequate records of the information on which they base their decisions and analysis with respect to the Plan’s investment options; and
(f) ensure that the monitored fiduciaries report regularly to the Compensation
Committee Defendants. The Compensation Committee Defendants must then review, understand, and approve the conduct of the hands-on fiduciaries.
108. The Compensation Committee Defendants were obligated to review and oversee the Benefit Committee Defendants, to ensure that these monitored fiduciaries were performing their fiduciary obligations, including those with respect to the investment of the Plan’s assets, and were obligated to take prompt and effective action to protect the Plan and its participants when they were not. In addition, the Compensation Committee Defendants were obligated to
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provide the monitored fiduciaries with complete and accurate information in their possession that they knew or reasonably should have known that the monitored fiduciaries must have in order to prudently manage the Plan and the Plan’s assets.
109. The Compensation Committee also had the discretion to amend, modify, suspend, or terminate the Plan at any time. See SPD at 20 (LEHMAN-ERISA0000363).
110. Consequently, in light of the foregoing duties, responsibilities, and actions, the
Compensation Committee Defendants were named fiduciaries of the Plan pursuant to ERISA §
402(a)(1), 29 U.S.C. § 1102(a)(1), or de facto fiduciaries within the meaning of ERISA § 3(21),
29 U.S.C. § 1002(21), during the Class Period in that they exercised discretionary authority or discretionary control respecting management of the Plan, exercised authority or control respecting management or disposition of the Plan’s assets, and had discretionary authority or discretionary responsibility for the administration of the Plan.
D. The Benefit Committee Defendants’ Fiduciary Status
111. The Benefit Committee has the following powers and duties:
The Committee shall be the “Named Fiduciary” with respect to control or management of the assets of the Plan, and shall have authority (a) to appoint an investment manager or managers (within the meaning of Section 3(38) of the Act) to manage (including the power to acquire and dispose of) any assets of the Plan), and (b) to direct the Trustee with respect to the management of assets of the Plan not subject to the authority of such an investment manager (including, without limitation, the selection of such mutual funds or other investment options as it may deem appropriate to carry out the investment objectives of each of the respective Investment Funds established by the Committee as provided in Section 9.2). Without limiting the generality of the foregoing, the Committee as such Named Fiduciary shall have exclusive responsibility for determining whether the Plan provisions requiring the establishment and maintenance of the Company Stock Fund (and the American Express Stock Fund until January 31, 2007) may continue to be given effect in accordance with their terms as required by Section 401(a)(1)(D) of the Act, or whether such provisions are to any extent inconsistent with
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applicable requirements of the Act, including in particular the fiduciary duty rules of Section 404(a)(1) of the Act as modified by Section 404(a)(2) of the Act; and no other fiduciary of the Plan shall have responsibility therefor.
See Plan Document Section 10.12 – Named Fiduciary with Respect to Asset Management
(LEHMAN-ERISA0000085-86).
112. The Benefit Committee (and its members) also had the power and discretion to amend the Plan at any time. See SPD at 20 (LEHMAN-ERISA0000363), as well as the other responsibilities delineated at length supra, ¶¶ 49-61.
113. Consequently, the Benefit Committee Defendants were named fiduciaries of the
Plan pursuant to ERISA § 402(a)(1), 29 U.S.C. § 1102(a)(1), or de facto fiduciaries within the meaning of ERISA § 3(21), 29 U.S.C. § 1002(21), during the Class Period in that they exercised discretionary authority or discretionary control respecting management of the Plan, exercised authority or control respecting management or disposition of the Plan’s assets, and had discretionary authority or discretionary responsibility in the administration of the Plan.
VI. FACTUAL BACKGROUND TO BREACHES OF FIDUCIARY DUTY
A. Background Of The Subprime Industry
114. Subprime lending is the practice of making mortgage loans to persons who are generally unable to access credit from traditional financial institutions. This is because the borrowers do not satisfy income, credit, documentation, or other underwriting standards mandated by traditional mortgage lenders and loan buyers, which typically lend only to more credit-worthy borrowers.
115. Because subprime borrowers are seen as “higher risk,” their loans carry interest rates that are at least two percentage points higher than those offered to borrowers with better
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credit. So, for example, while a credit-worthy borrower could obtain a mortgage at 5% interest, the same mortgage would cost a subprime customer 7% interest or more.
116. Instead of holding mortgage loans themselves, lenders generally sold subprime mortgages bundled with other mortgages into pools of securities. These mortgage-backed securities were offered for sale to institutional and individual investors.
117. In The Impact Of Securitization On The Emergency Economic Stabilization Act
Of 2008 (October 2, 2008), Talcott J. Franklin explained the process by which mortgage-backed securities are created:
The process by which mortgage-backed securities are created begins when a Borrower obtains a loan from a Lender. The Lender sells that loan to a Purchaser. The Purchaser generally holds the loan for a period of weeks or months, and then sells the loan to a Depositor, who immediately deposits that loan (and many other loans) into the Trust. The Trust is administered by a Servicer (who is the face of the Trust with the Borrowers) and a Trustee (who is the face of the Trust with the investors, typically called Certificateholders). Once the loans are sold into the Trust, Borrowers begin making their payments to the Servicer, who sends those payments to the Trustee. The Trustee then distributes those payments to the Certificateholders based on a pre-established priority of payment.
118. The following simplified graphic generally depicts how mortgage loans are originated, purchased and sold, in order to create mortgage backed securities:1
1 Printed with permission from the interactive supplement to Talcott J. Franklin & Thomas F. Nealon III, Mortgage and Asset Backed Securities Litigation Handbook (Thomson West).
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119. Often, the cash flow from these mortgage backed securities supported a second investment, called a collateralized debt obligation (“CDO”). Id. A CDO is an investment-grade derivative security backed by a pool of bonds, loans, or other assets, such as mortgages. Rights to the CDO’s cash flow is typically divided into a number of tranches rated by credit risks, with the lower tranches offering higher premiums to compensate for the higher risk assumed, and vice versa.
120. In essence, issuers like Lehman and others created instruments that appeared to be investment grade out of what was essentially subprime paper. Ultimately, the purchasers of even these supposedly safe, triple-A-rated CDO tranches found their investments tainted by the poisonous subprime loans, which began to default at alarming rates during the Class Period.
121. Such a system works best if the underlying asset backed securities held by the
CDO are uncorrelated – that is, if they are unlikely to go bad all at once. CDOs holding only
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subprime investments (e.g., notes, bonds, or other instruments dependent upon mortgages for their value) were highly correlated because they held only subprime securities and were therefore vulnerable to a rise in defaults on subprime mortgage loans. However, because of the high yields on subprime mortgages, they were very attractive for investment banks creating CDOs. See
FDIC Outlook, A New Plateau for the U.S. Securitization Market, available at http://www.fdic.gov/bank/analytical/regional/ro20063q/na/2006_fall01.html.
122. One type of CDO is a “cash” CDO. A cash CDO represents real credit-sensitive assets (e.g., bonds or loans) which are sold. This can be done for a number of reasons, including to remove assets from the originator’s balance sheet, to receive cash by monetizing assets, or to transfer risk.
123. Another type of CDO is a “synthetic” CDO. Synthetic CDOs are inherently riskier than cash CDOs, as they do not represent real cash assets like bonds or loans. Instead, synthetic CDOs add credit exposure to a portfolio of fixed income assets, without owning those assets, through the use of credit derivatives such as credit default swaps. Mark P. Zimmett, A
Primer on the ABCs of CDO Litigation, 239 N.Y.L.J. 62 (2008).
124. In essence, synthetic CDOs are simply wagers on the performance of other assets, like subprime mortgages.
125. In the event of default of a cash CDO, there are assets that can be sold to offset any loss. By contrast, for a synthetic CDO using credit default swaps, credit protection is offered by the seller of the swap, who receives periodic cash payments, called premiums, in exchange for agreeing to assume the risk of loss on a specific asset in the event that asset experiences a default or other credit event. In the event of a synthetic CDO default, the swap is exercised and the loss is borne by the credit protection seller.
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126. In short, credit default swaps are a form of unregulated insurance. Unlike traditional insurance, however, credit default swaps carry a significant risk factor. In a typical insurance policy, the seller is required to have capital reserves to be able to pay in case the insurance is called upon or triggered. However, in the case of credit default swaps, there is no similar requirement that adequate capital reserves be put to the side. Credit default swaps are privately negotiated contracts that are “traded over the counter,” meaning they are not regulated by a public exchange, and they are an investment vehicle in their own right, unrelated to the synthetic CDOs.
127. Moreover, while credit default swaps give speculators a means of earning large profits from changes in a company’s credit quality, sellers of credit default swaps (like Lehman) effectively have an unfunded exposure to the risk of default on the underlying debt instruments.
This is a market that represents the “weapons of financial mass destruction” label which Warren
Buffett gave to the derivatives.
128. When a company participates in the credit derivatives market, it increases its exposure to credit and liquidity risk. Credit risk refers to the risk of loss arising from the default by a borrower, counterparty, or other obligor when it is unable or unwilling to meet its obligations. Liquidity and funding risk refers to the risk that the company will be unable to finance its operations due to a loss of access to the capital markets or difficulty in liquidating its assets.
129. Furthermore, because they were little more than “side bets,” the value of many credit derivatives now far exceeds the value of the underlying instruments they protect.
130. On October 18, 2008, Christopher Cox, Chairman of the SEC, estimated that there were $55 trillion in credit default swaps outstanding, which is “more than the gross domestic
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product of all nations on earth combined.” The International Swaps and Derivatives Association, a trade group, recently estimated that there are approximately $62 trillion worth of credit default swaps outstanding, with approximately one-third of the credit default swaps contracts lacking collateral (i.e., that issuers of the swaps had not set aside assets in case the CDOs default).
131. By comparison, according to data from the New York State Insurance
Department, where most credit default swaps are sold, there is only approximately $6 trillion in outstanding corporate debt and $7.5 trillion in mortgage-backed debt in the United States.
132. The subprime market has grown rapidly in recent years. According to the Federal
Reserve Bulletin, Higher-Priced Home Lending and the 2005 HMDA Data, Summer 2006, in
1994, fewer than 5% of mortgage originations in the United States were subprime. However, by
2005, subprime mortgages accounted for approximately 26% of all mortgage loans.
133. Subprime mortgages totaled approximately $600 billion in 2007, and accounted for approximately one-fifth of the total U.S. home loan market. Approximately $1.3 trillion in subprime mortgages are currently outstanding.
134. After the dot-com technology bubble burst in 2001, the housing market in the
United States began a rapid and sustained increase in perceived value. With dramatically decreased interest rates and widely available credit, even those who could not afford a down- payment or had checkered credit histories were afforded access to credit to purchase homes.
Loan incentives and a long-term trend of rising housing prices encouraged borrowers to grant adjustable-rate mortgages (“ARMs”) with lower payment streams in the early years, based on the expectation that refinancing would be available later when the increased payments were triggered, secured by ever increasing home values. Speculation fueled rapidly increasing prices, as numerous Americans sought to purchase homes only to “flip” or quickly sell them for a profit.
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135. The rapid growth of the subprime lending industry has been attributed to a number of factors that occurred in 2004 and 2005. These factors include rising home prices, declining affordability, historically low interest rates, intense lender competition, innovations in the structure and marketing of mortgages, and an abundance of capital from lenders and mortgage securities investors.
136. The mortgage market was further fueled by significant mortgage-backed securities liquidity, with investors increasingly seeking higher yields through higher-risk securitizations that provided lenders with access to capital markets to fund mortgage operations while simultaneously transferring credit risk away from the lenders to securitization investors.
The share of U.S. mortgage debt held outside the government-sponsored enterprises by private mortgage-backed securitizations doubled between 2003 and 2005, helping to fuel the growth of subprime and non-traditional mortgages.
137. From 2001 to mid-2004, prime borrowers with a preference for fixed-rate mortgages refinanced in record numbers as long-term interest rates fell to the lowest rates in a generation. As interest rates began to rise in 2004 and the pool of potential prime borrowers looking to refinance shrank, lenders struggled to maintain or grow market share in a declining origination environment, and did so by extending loans to subprime borrowers with troubled credit histories.
138. Lenders accommodated these borrowers by diversifying mortgage offerings as they competed to attract borrowers and meet prospective homebuyers’ financing needs. Because of the affordability aspect alleged above, borrowers increasingly sought mortgage loans with payment option and interest-only structures in 2004 and 2005. Such non-traditional mortgages
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were designed to minimize initial mortgage payments by eliminating or relaxing the requirement to repay principal during the early years of the loan.
139. Lenders also turned to Alternative-documentation loans, or “Alt-A” loans, which are flexible instruments primarily credit-score driven, since the candidates for these loans tend to lack proof of income from traditional employment, and, in exchange, pay a higher rate of interest than fully documented loans. Alt-A loans are made to people with purportedly better than subprime credit.
140. Payment option and interest-only loans appear to have made up as much as 40 to
50 percent of all subprime and Alt-A loans securitized by private issuers of mortgage-backed securities during 2004 and 2005, up from 10 percent in 2003.
141. The majority of subprime originations over the past several years were “2/28 and
3/27” hybrid loan structures. These hybrid loans provide an initial fixed-rate period of two or three years, after which the loan converts to an ARM and the interest rate adjusts to the designated loan index rate for the remaining 28 or 27 years of the loan. These 2/28 and 3/27 loans accounted for almost three-quarters of subprime securitized mortgages in 2004 and 2005.
142. In late 2004 and early 2005, there was a growing sense of concern regarding the subprime industry, and in particular over eased lending standards. To address those concerns, the Federal Reserve and other banking agencies issued guidance on subprime lending. The
Interagency Guidance on Nontraditional Mortgage Product Risks highlighted sound underwriting procedures, portfolio risk management, and consumer protection practices that were recommended to prudently originate and manage non-traditional mortgage loans. A major recommendation was that a lender’s analysis of repayment capacity should include an evaluation of the borrower’s ability to repay debt by final maturity at the fully indexed interest rate, assuming
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a fully amortizing repayment schedule, rather than just under the initial interest rate. The guidance also reminded institutions to communicate clearly the risks and features of these products to consumers in a timely manner, before consumers applied for a loan.
143. In late 2005, however, house prices began to level off and then began to decline.
The vast bulk of mortgages that had originated earlier in the decade with adjustable rates began to reset, causing families to experience rapid and significant increases in monthly payments just as home prices were leveling off or declining.
144. Increasing foreclosure rates in 2006 and 2007 led to faster decreases in home prices by mid-2007 and thereafter. Defaults and foreclosure activity increased dramatically as
ARM interest rates reset higher. Subprime borrowers with ARMs experienced a large increase in delinquency and foreclosure rates, while prime borrowers experienced almost no increase in delinquencies and foreclosures. Borrowers were not able to avoid sharp payment increases as they could in earlier years. Even borrowers with enough equity to refinance their adjustable rate mortgages faced difficulty finding a loan with affordable payments, as interest rates edged higher than in earlier years.
145. Moreover, an unusually large number of subprime loans defaulted shortly after origination. In many of these “early payment defaults,” borrowers stopped making payments before they faced payment shocks, suggesting that in 2006 some lenders had lowered their underwriting standards in response to reduced borrower demand for credit.
146. In 2006, approximately 80,000 subprime borrowers who took out mortgages that were packaged into securities fell into delinquency. In 2006 and early 2007, dozens of lenders participating in the subprime mortgage business ceased operating as defaults and delinquencies on recent loans skyrocketed. This includes, among others:
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(a) Merit Financial Inc., of Kirkland, Washington, filed for bankruptcy and closed its doors, firing all but 80 of its 410 employees; Merit’s marketplace had declined about
40% and sales were not bringing in enough revenue to support overhead. “‘Bottom fell out’ at
Merit Financial,” Seattle Post-Intelligencer (May 5, 2006).
(b) On December 28, 2006, Ownit Mortgage Solutions, the 11th largest
United States issuer of subprime mortgages, filed for bankruptcy. Earlier in the month, Ownit abruptly shut its doors and told its 800 workers not to return.
(c) On February 5, 2007, Mortgage Lenders Network USA Inc., a company that catered to borrowers with weak credit, filed for bankruptcy. 880 of its 1,600 employees had been laid off earlier in the year.
(d) On February 12, 2007, ResMae Mortgage, a subprime lender, filed for bankruptcy. According to Bloomberg, in its Chapter 11 filing, ResMae stated that “[t]he subprime mortgage market has recently been crippled and a number of companies stopped originating loans and United States housing sales have slowed and defaults by borrowers have risen.” Also in its filing, ResMae stated that it could not cope with the “enormous” surge in loan defaults.
(e) On February 20, 2007, NovaStar Financial, a company specializing in originating, investing, and servicing non-conforming residential mortgages, reported a substantial loss. Floyd Norris of The New York Times noted: “The class of 2006 may live on as a very bad memory in subprime land.”
(f) On March 1, 2007, Fremont General announced it was delaying fourth- quarter results in an annual filing with the SEC, sparking concern about its subprime mortgage business. The next day, Fremont General announced it was going to stop making subprime loans
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and put its subprime business up for sale.
(g) On March 8, 2007, New Century Financial, the second largest subprime lender in 2006, stopped making loans.
(h) On March 20, 2007, People’s Choice Home Loan, Inc., a mortgage lender for people with credit problems, filed for bankruptcy.
(i) On April 2, 2007, New Century Financial filed for bankruptcy.
(j) On April 6, 2007, American Home Mortgage Investment Corporation, the tenth largest retail mortgage lender in the United States, wrote down the value of risky mortgages rated one step above subprime.
(k) On August 6, 2007, American Home Mortgage, one of the United States’ largest home lenders, filed for bankruptcy. According to the Associated Press on August 7,
2007, “A weak housing market and a spike in payment defaults scared investors from mortgage debt including bonds and other securities backed by home loans.”
(l) On August 13, 2007, Aegis Mortgage Corp, one of the United States’ top
30 mortgage lenders, filed for bankruptcy. The company also fired 782 out of 1,302 employees.
(m) On September 21, 2007, HSBC Holdings announced its plans to close its
U.S. subprime unit, Decision One Mortgage, and to record an impairment charge of about $880 million. HSBC stated that it no longer believed the mortgage business was sustainable.
Approximately 750 U.S. employees were expected to be affected by the decision. See The Joint
Economic Committees’ Subprime Mortgage Market Crisis Timeline, July 10, 2008.
147. During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure activity, up 79% from 2006. In a speech at Georgetown University School of Law
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on October 16, 2007, Treasury Secretary Henry M. Paulson, Jr., called the bursting housing bubble “the most significant risk to our economy.”
148. Even back in 2006, “[a]mong those who tried to sound the alarm was Michael
Gelband, who had been Lehman’s head of fixed-income trading for two years. In late 2006, in a discussion with Fuld about his bonus, Gelband remarked that the good times were about to hit a rough patch, for which the firm was not well positioned. ‘We’re going to have to change a lot of things,’ he warned. Fuld, looking unhappy, said little in reply.” See Too Big to Fail, Andrew
Ross Sorkin, at p. 123.
B. Lehman’s Involvement In The Subprime Industry
149. Over the past decade, Lehman became a major participant in the mortgage market and in underwriting securities backed by subprime mortgages. The Company was heavily invested in CDOs and purchased several mortgage originators to fuel its securitization of mortgage-backed CDOs.
150. Despite the staggering risks associated with investments in derivative instruments such as CDOs and credit default swaps, Lehman sought short-term profits at the expense of the
Company’s long-term viability, all in the face of a growing market consensus that the subprime market was highly risky and would subject those involved to significant losses when the “music stopped.”
151. Lehman established itself as a leader in the market for subprime mortgage backed securities back to the mid-1990s, when the sector was still tiny. “How Wall Street Stoked The
Mortgage Meltdown,” The Wall Street Journal (June 28, 2007).
152. In 1999, Lehman started operating its own subprime lending unit, called Finance
America, in a joint venture with subprime lender Amresco Inc., which was as a minority partner.
Id. In 2001, Lehman bought out Amresco and another minority investor in 2004. Id.
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153. Lehman also took an ownership stake in California-based BNC Mortgage in 2000 after helping management take the company private. Id.
154. In 2004, Lehman purchased management’s remaining stake in BNC Mortgage
LLC, which was lending more than $1 billion per month by the first quarter of 2006. Id.;
Yalman Onaran, “Lehman Brothers Fault-Finding Points to the Last Man Fuld as Shares
Languish,” Bloomberg News (July 22, 2008) (“Lehman Fault-Finding”).
155. In 2005 and 2006, “Lehman topped other Wall Street firms . . . packaging more than $50 billion in subprime-mortgage-backed securities” “How Wall Street Stoked The
Mortgage Meltdown,” The Wall Street Journal (June 28, 2007).
156. By 2006, Lehman was the nation’s top underwriter for subprime mortgage-backed securities, with approximately 11 percent of the market. Lehman also bought mortgage lender
Aurora Loan Services, LLC, which provides Alt-A Loans, which, as described above, are loans that are not considered subprime, but are nonetheless made without full documentation of the borrower’s assets. Aurora originated more than $3 billion per month in loans in the first half of
2007. Lehman Fault-Finding, Bloomberg News, July 22, 2008.
157. In June 2007, Lehman said it would merge BNC with its Aurora Loan Services unit. “How Wall Street Stoked The Mortgage Meltdown,” The Wall Street Journal (June 28,
2007).
158. Lehman’s appetite for accumulating subprime debt continued throughout the market collapse of 2007 and 2008, during which it continued to aggressively underwrite mortgage-backed securities, accumulating an $85 billion portfolio. Id.
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159. In addition, Lehman was one of the ten largest participants in the credit default swaps market, and issued billions of dollars of these contracts in the past several years. See
“Derivatives Pose New Wrinkle in Lehman Case,” The New York Sun (Sept. 25, 2008).
160. Moreover, Lehman’s exposure was not limited just to CDOs, credit default swaps, and other subprime mortgage-backed securities. The crisis impacting the subprime market was not limited to the residential sector, but its shock waves affected the commercial real estate market as well, to which, as alleged below, the Company also had considerable exposure.
161. As the nation’s top underwriter for subprime mortgage-backed securities, a leader in the market for subprime mortgage backed-securities, and one of the ten largest participants in the credit default market, Lehman’s exposure to the risk of catastrophic loss from a decline in those markets was greater than most (if not all) other investment banks.
162. Despite the fact that the Benefit Committee Defendants and the Director
Defendants knew or should have known about the Company’s deteriorating mortgage portfolio and serious financial problems, the Benefit Committee Defendants and the Director Defendants permitted Plan participants to invest in the Company Stock Fund, and the Company Stock Fund to acquire and hold Company Stock, throughout the Class Period. The Benefit Committee
Defendants and the Director Defendants knew or should have known that Company Stock was not a prudent retirement savings option in light of the following materially adverse facts which seriously impacted the overall health of the Company: (i) the run on the bank that caused the virtual collapse of Bear Stearns put the Defendants on notice that Lehman very well might be the next in line to fail; (ii) the Company was the most highly leveraged of the large remaining investment clearing firms after Bear Stearns; (iii) the Company used Repo 105 to artificially and temporarily reduce Lehman’s net leverage ratio; (iv) the extent of the Company’s exposure to
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losses incurred from trading in subprime mortgage backed derivatives; (v) the extent of the
Company’s exposure to losses incurred from mortgage-backed securities, including its failure to timely write-down its positions in these securities; (vi) the nature and extent of its exposure to losses incurred from mortgage-backed security originations, including its failure to timely write- down its positions in these securities; (vii) that the Company had materially overvalued its positions in commercial and subprime mortgages, and in securities tied to these mortgages; (viii) that the Company had inadequate reserves for its mortgage and credit related exposure; (ix) the extent of the Company’s exposure to losses incurred from its commercial-real-estate holdings, including its failure to timely write-down its positions in these holdings that the Company had grossly overvalued; (x) that the Company’s financial statements were not prepared in accordance with the generally accepted accounting principles (“GAAP”); and (x) that the Company lacked adequate internal and financial controls.
163. Specifically, by no later than the collapse of Bear Stearns, Defendants knew or should have known that the Plan’s heavy investment in Company Stock was imprudent since
Lehman, which was highly leveraged, was encountering enormous and very serious problems as a result of its significant investments in commercial real estate, CDOs, credit default swaps, and other similar vehicles, as well as internal control and risk management failures. As a consequence of those Company-specific problems, which were not adequately or completely disclosed to the market or the participants in the Plan, investment in the Company Stock Fund was exceedingly risky and the Company’s Stock was artificially inflated.
C. Lehman’s Use Of Materially Inaccurate Repo 105 Transactions
164. Both prior to and during the Class Period, Lehman described the importance of net leverage to its business. As explained in Lehman’s Form 10-Q for the quarter ended
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February 29, 2008, filed on April 8, 2008 (“First Quarter 2008 Form 10-Q”): “[t]he relationship of assets to equity is one measure of a company’s capital adequacy. Generally, this leverage ratio is computed by dividing assets by stockholders’ equity. The Company believes that a more meaningful, comparative ratio for companies in the securities industry is net leverage, which is the result of net assets divided by tangible equity capital.”
165. In calculating the numerator for its net leverage ratio, Lehman defined “net assets” in its First Quarter 2008 Form 10-Q as total assets less: (i) cash and securities segregated and on deposit for regulatory and other purposes; (ii) collateralized lending agreements; and (iii) identifiable intangible assets and goodwill. For the denominator, Lehman included stockholders’ equity and junior subordinated notes in “tangible equity capital,” but excluded identifiable intangible assets and goodwill. Lehman’s publicly reported net leverage ratio, therefore, supposedly compared the Company’s riskiest assets to its available stockholders equity to absorb losses sustained by such assets.
166. Lehman, along with the majority of investment banking firms on Wall Street, routinely entered into sale and repurchase agreements to satisfy short-term cash needs, borrowing cash from counterparties at fixed interest rates and putting up collateral, typically in the form of financial instruments, to secure financing (referred to herein as “Ordinary Repo” transactions). Upon maturity of the Ordinary Repo transactions, Lehman would repay the cash to the counterparty, plus interest, and reclaim its collateral, ending the arrangement.
167. Indeed, the Examiner explained that “Lehman funded itself through the short-term repo markets and had to borrow tens or hundreds of billions in those markets each day from counterparties to be able to open for business.”
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168. Lehman accounted for Ordinary Repos as financings – i.e., debt – recording both an asset (the cash proceeds of the Ordinary Repo loan) and a liability (an obligation to repay the
Ordinary Repo loan). Significantly, the collateral that securitized the Ordinary Repo remained on Lehman’s balance sheet, and the incoming cash and corresponding liability had the effect of increasing Lehman’s net leverage ratio as the numerator (net assets) increased, while the denominator (tangible equity capital) remained the same.
169. Unbeknownst to Plan participants, however, Lehman entered into tens of billions of dollars worth of undisclosed Repo 105 transactions, which resembled Ordinary Repo transactions in all material respects except that Lehman recorded the transaction on its books as though the asset collateralizing the loan had actually been sold and removed from its balance sheet. Lehman then used the cash received from the Repo 105 loans to pay down other existing liabilities, which had the effect of reducing Lehman’s net leverage ratio by reducing the numerator in the net leverage ratio (net assets) through the “sale” of the collateralizing asset and the use of cash to pay down other short-term debt while having no corresponding impact on the denominator in the net leverage ratio (tangible equity ratio). As a result, the Repo 105 accounting reduced Lehman’s reported net leverage ratio at the end of each reporting period during the Class Period without reducing Lehman’s actual risk.
170. Significantly, the reduction in the net leverage ratio was only temporary, and wholly illusory. Pursuant to the terms of these Repo 105 transactions, just days after the
Company’s quarter ended, Lehman would repay the Repo 105 counterparty, and the collateralized assets would return to Lehman’s balance sheet, thereby immediately and materially increasing the net leverage ratio by highly material amounts shortly after the quarter had closed.
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171. In his prepared testimony before Congress, the Examiner explained that: Lehman did not disclose that it had only temporarily reduced its net leverage ratio through Repo 105 transactions, “[c]onsequently, Lehman’s statement that the net leverage ratio was a ‘more meaningful’ measurement of leverage was rendered misleading because that ratio – as reported by Lehman – was not an accurate indicator of Lehman’s actual leverage, and in fact, understated
Lehman’s leverage significantly.”
172. In addition, Lehman’s public statements regarding its liquidity (the immediate ability to access funds to pay down short-term obligations) was rendered materially inaccurate because its financial statements and related footnote disclosures failed to disclose Lehman’s immediate obligation to repay tens of billions of dollars in Repo 105 transactions just days after the end of each fiscal quarter. Thus, Lehman’s reported that short-term or current liabilities were similarly understated by a material amount. As a result, Lehman did not have nearly as much in available liquidity or in its liquidity pool as it represented. Lehman failed to disclose this material information to Plan participants.
173. Significantly, a Repo 105 transaction was a more expensive form of short-term financing than an Ordinary Repo. Lehman had the ability to conduct an Ordinary Repo transaction using the same securities and with substantially the same counterparties, at a lower cost, but instead engaged in Repo 105 transactions that had the effect of temporarily “removing” tens of billions of dollars of assets off Lehman’s balance sheet at the end of each quarter.
174. At bottom, Lehman’s Repo 105 transactions lacked economic substance, and
Lehman’s reported de-leveraging failed to reflect its true financial condition. As the Examiner reported: “Lehman’s Global Financial Controller [Martin Kelly] confirmed that ‘the only
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purpose or motive for [Repo 105] transactions was reduction in the balance sheet’ and that ‘there was no substance to the transaction.’” Id. (emphasis in original).
175. Prior to and during the Class Period, the quarterly cycle of temporarily
“removing” as much as $50 billion of assets off its balance sheet (as reflected the Table below) for only days at quarter-end created the false impression that Lehman had reduced its balance sheet exposure and net leverage, and fostered the appearance of increased liquidity, and thereby made Lehman’s financial health appear significantly more sound than it actually was.
Undisclosed Repo 105/108 Usage (in billions) 2Q07 3Q07 4Q07 1Q08 2Q08 Repo 105 $23.1 $29.1 $29.7 $42.2 $44.5 Repo 108 $8.6 $6.9 $8.9 $6.9 $5.8 Total $31.9 $36.4 $38.6 $49.1 $50.3
176. As the Examiner explained, “Lehman defined materiality, for purposes of reopening a closed balance sheet, as “any item individually, or in the aggregate, that moves net leverage by 0.1 or more (typically $1.8 billion).” Lehman’s use of Repo 105 moved net leverage not by tenths but by whole points.” (footnote omitted). Prior to and during the Class Period,
Repo 105 transactions decreased Lehman’s net leverage between 15 and 19 times its own materiality threshold of 0. 1, as set forth in the table below.
Repo 105 and 108 Transactions and Reported Net Leverage Reported Net Actual Net Difference As Multiple of Reporting Repo 105 Leverage Leverage Lehman’s 0.1 Materiality Period (billions) Ratio Ratio Threshold 2Q07 $31.9 15.4x 16.9x 15 times 3Q07 $36.4 16.1x 17.8x 17 times 4Q07 $38.6 16.1x 17.8x 17 times 1 Q08 $49.1 15.4x 17.3x 19 times 2Q08 $50.4 12.1x 13.9x 18 times
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177. In addition, prior to and during the Class Period, the Repo 105 transactions also caused Lehman’s short term and total liabilities to be materially understated, as reflected in the table below:
Repo 105 Transactions and Total and Short Term Liabilities (in billions) 2Q07 3Q07 2007 1Q08 2Q08 Year End Total Reported Liabilities $584.73 $637.48 $668.57 $761.20 $613.16 Reported Short Term $483.91 $517.15 $545.42 $632.92 $484.97
Repo 105’s $31.90 $36.40 $38.60 $49.10 $50.40 % of Repo 105’s to Total Liabilities 5.45% 5.71% 5.77% 6.45% 8.22% % of Repo 105’s to Short-Term Liabilities 6.59% 7.04% 7.08% 7.76% 10.39%
178. The failure to disclose the tens of billions of dollars in Repo 105 transactions consistently rendered statements in Lehman’s quarterly filings during the Class Period materially inaccurate, including but not limited to the following:
(a) Each Class Period Form 10-Q, incorporated by reference into the SPD, represented that securities sold under agreements to repurchase, are “treated as collateralized agreements and financings for financial reporting purposes.” This statement was materially inaccurate because it failed to disclose that, through Lehman’s Repo 105 program, tens of billions of dollars in securities sold each quarter pursuant to agreements to repurchase were not treated as “financings for financial reporting purposes” but were treated as sales by Lehman;
(b) Each Class Period Form 10-Q, incorporated by reference into the SPD, represented purported to describe all of Lehman’s material off-balance sheet arrangements. In fact, each filing expressly included a discussion and table purportedly summarizing all “Off-
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Balance Sheet Arrangements” in the MD&A section. Such descriptions were materially inaccurate because, among other things, they failed to list or discuss the material fact that
Lehman had agreed to tens of billions of dollars in off-balance sheet commitments that were not included in these descriptions;
(c) Each Class Period Form 10-Q, incorporated by reference into the SPD, contained a statement that the “Consolidated Financial Statements are prepared in conformity with U.S. generally accepted accounting principles,” and included certifications from Fuld stating that “this report does not contain any untrue statements of a material fact or omit to state a material fact” and that “the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flow of the registrant.” These statements were materially inaccurate for, among other reasons described herein, failing to disclose the Repo 105 transactions, which falsely reduced net leverage and understated liabilities and violated GAAP.
179. In addition to the materially inaccurate statements referenced immediately above, additional materially inaccurate statements regarding Repo 105 in Lehman’s quarterly filings during the Class Period specifically include:
(a) The First Quarter 2008 Form 10-Q reported that Lehman’s net leverage ratio was 15.4, which was materially inaccurate because it failed to take into account $49.102 billion in Repo 105 assets that were temporarily removed from Lehman’s financial statements.
Had the Repo 105 transactions been included, Lehman’s net leverage ratio would have been
17.3, representing an increase 19 times greater than Lehman’s own materiality threshold of a change in net leverage of 0.1.
(b) In addition, the First Quarter 2008 Form 10-Q reported $197.128 billion in
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securities sold under agreements to repurchase. This statement was materially inaccurate because it excluded over $49 billion in Repo 105 assets that Lehman had temporarily removed from its balance sheet, which Lehman had agreed to repurchase days after the end of the quarter.
(c) The Second Quarter 2008 Form 10-Q reported that Lehman had reduced its net leverage ratio to approximately 12. This statement was materially inaccurate because the
Second Quarter 2008 Form 10-Q failed to take into account $50.383 billion in Repo 105 assets that were temporarily removed from Lehman’s financial statements.
(d) The Second Quarter 2008 Form 10-Q also stated that the Company had finished the quarter with record levels of liquidity, by growing its liquidity pool to approximately
$45 billion. This statement was materially inaccurate as it fails to describe the impact that Repo
105 has on the calculation of Lehman’s liquidity.
180. Defendant Fuld and the other Defendants knew or should have known that
Lehman’s Repo 105 transactions lacked substance as genuine sales. Whereas Ordinary Repo transactions provide financing but do not impact the balance sheet, Lehman’s Repo 105 transactions did. Elevating form over substance, Lehman engaged in tens of billions of Repo
105 transactions at the end of its quarters for the purpose of improving the appearance of its balance sheet and net leverage ratio.
181. In particular, Defendant Fuld had direct knowledge of Repo 105 transactions. For example, the night before a March 28, 2008 Executive Committee meeting requested by Herbert
McDade (Lehman’s newly appointed “balance sheet czar”) to discuss Lehman’s Repo 105 program and to request Joseph Gregory’s (Lehman’s president and Chief Operating Officer) freezing of the Repo 105 usage, Defendant Fuld received an agenda of topics including “Repo
105/108” and “Delever v Derisk” and a presentation that referenced Lehman’s $49.1 billion
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quarter-end Repo 105 usage for the first quarter 2008.
182. As the Examiner explained, Mr. McDade had specific discussions with Defendant
Fuld about Lehman’s Repo 105 usage in June 2008. During that discussion, Mr. McDade walked Defendant Fuld through Lehman’s Balance Sheet and Key Disclosures document, and discussed with Defendant Fuld Lehman’s quarter-end Repo 105 usage – $38.6 billion at year-end
2007; $49.1 billion at 1Q08; and $50.3 billion at 2Q08. Based upon their conversation, Mr.
McDade understood that Defendant Fuld “was familiar with the term Repo 105,” “knew, at a basic level, that Repo 105 was used in the Firm’s bond business” and “understood that [reduction of Repo 105 usage] would put pressure on traders.”
183. Defendant Fuld also met regularly, at least twice a week, with Mr. Gregory and members of the Executive Committee to discuss the state of the Company. As the Examiner concluded, based on these facts, as well as the fact that Defendant Fuld was admittedly focused on balance sheet and net leverage reduction in 2008, throughout the Class Period Defendant Fuld knew about Repo 105 transactions prior to signing Lehman’s Forms 10-Q and that Repo 105 was used to understate Lehman’s net leverage ratio and inherent risk. Also as the Examiner concluded, Defendant Fuld’s failure to disclose the misleading use of Repo 105 to understate
Lehman’s net leverage ratio and inherent risk subjected Defendant Fuld to “colorable claims.”
184. Also as reported by the Examiner, the inaccurate use of Repo 105 to understate
Lehman’s net leverage ratio and inherent risk was widely known by the Company’s senior managers: “many former top executives were regularly apprised of the scope of the firm’s Repo usage. For example, a report entitled ‘Balance Sheet and Disclosure Scorecard,’ which was circulated to various members of senior Lehman management on a daily basis from April 2008 through September 2008, tracked, among other things, the daily benefit that Repo 105
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transactions provided to Lehman’s balance sheet.”
185. The Examiner interviewed many members of Lehman’s senior management who were aware of Repo 105, and who agreed that the undisclosed Repo 105 transactions were sham transactions with no legitimate business purpose or economic substance. These members of senior management include: (a) Martin Kelly, Lehman’s Global Financial Controller; (b) Joseph
Gentile, an executive in Lehman’s Fixed Income Division who reported to Gerard Reilly,
Lehman’s Global Product Controller; (c) Edward Grieb, Lehman’s former Global Financial
Controller who reported directly to O’Meara; (d) Matthew Lee, a former Lehman Senior Vice
President, Finance Division, in charge of Global Balance Sheet and Legal Entity Accounting through at least June 20082; (e) Kaushik Amin, former Head of Liquid Markets; (f) Jerry
Rizzieri, a member of Lehman’s Fixed Income Division; (g) Mitchell King, former Head of
Lehman’s United States Agencies trading desk; (h) Herbert McDade, Lehman’s Head of Equities from 2005-08 and COO from June to September 2008; (i) Michael McGarvey, a former Senior
Vice President in Lehman’s Fixed Income Division; (j) Paolo Tonucci, Lehman’s former
Treasurer; (k) Marie Stewart, Lehman’s Global Head of Accounting Policy; and (l) John Feraca, who ran the Secured Funding Desk in Lehman’s Prime Services Group.
186. Plaintiffs believe that, after a reasonable opportunity for further investigation and discovery, the evidence will show that, throughout the Class Period, the Director Defendants, the
Compensation Committee Defendants, and the Benefit Committee Defendants knew or reasonably should have known that Repo 105 was used to understate Lehman’s net leverage ratio
2 In fact, on June 12, 2008, Mr. Lee was interviewed by Mr. William Schlich and Ms. Hillary Hansen of Ernst & Young (“E&Y”). According to Ms. Hansen’s notes of the interview, Mr. Lee warned E&Y about the Company’s Repo 105 practice including the enormous volume of Repo 105 activity that Lehman engaged in at quarter-end. These notes recounted Mr. Lee’s allegation that Lehman moved $50 billion of inventory off its balance sheet at quarter-end through Repo 105 transactions and that these assets returned to the balance sheet about a week later.
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and inherent risk.
187. Thus, Defendants breached their fiduciary duties to Plan participants by failing to disclose the truth to them and allowing them to continue saving for retirement with risky
Company Stock in their Plan accounts
D. GAAP Violations Relating To Repo 105
188. As alleged in more detail below, the failure to disclose Lehman’s use and accounting treatment of Repo 105 transactions in its financial statements and related footnotes incorporated by reference into the SPD violated numerous GAAP provisions. This material omission caused Lehman’s financial reports to present an unrealistic and unreliable picture of the
Company’s business realities to Plan participants by misrepresenting its net leverage and liquidity, in violation of, inter alia, Accounting Release 173 (“[I]t is important that the overall impression created by the financial statements be consistent with the business realities of the company’s financial position and operations”) and FASCON 1 (specifically ¶¶32, 34 & 42) and
FASCON 2 (specifically ¶¶15, 33, Figure 1, ¶¶58, 79-80, 91-97, 160).
189. Lehman represented in its public filings that all transactions containing short-term repurchase commitments were recorded as “secured financing transactions,” which effectively had no net impact on Lehman’s balance sheet. In truth, however, Lehman accounted for its Repo
105 transactions as “sales” under FAS 140, which had a profound impact on Lehman’s balance sheet. By categorizing its Repo 105 transactions as “sales,” the transferred securities were removed from the balance sheet, replaced by cash, and a liability was never recorded. Lehman then used this cash to pay down existing, short-term liabilities, effectively reducing its balance sheet.
190. To qualify as a sale under FAS 140, the company transferring the entity must divest itself of the assets and relinquish all control over the assets. The retention of any portion
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of control over the assets precludes treatment of a transfer of financial assets as a “sale.” Only when the transferor has divested itself of the assets from a control perspective, such that the asset is effectively “isolated from the transferor – put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership,” and “the transferor does not maintain effective control over the transferred assets through” for example “an agreement that both entitles and obligates the transferor to repurchase or redeem them before their maturity” can the transaction be deemed a “sale.”
191. Repurchase agreements like Lehman’s Repo 105 transactions are not ordinarily treated or accounted for as sales. Guidance in FAS 140 itself states that categorizing a repurchase agreement as a sale is unusual. Indeed, unlike Lehman, other investment banks did not record similar repurchase transactions as “sales.”
192. Lehman’s Repo 105 transactions were not “sales” for a number of reasons, not least of which was that they lacked the necessary business purpose and economic substance to be recorded as legitimate sales under GAAP. Unlike a true sale, there was no legitimate business purpose to the transactions. Indeed, as explained above, the Repo 105 transactions were a more expensive form of short-term financing for Lehman than an Ordinary Repo transaction.
193. Moreover, unlike an actual sale, Lehman’s repurchase agreements required
Lehman to repurchase the collateral after a fixed period of time; they did not merely grant
Lehman the right to do so. While characterizing the short-term financing as a “sale” on its financials, Lehman in fact was obligated to repurchase these assets within days after the close of the reporting period.
194. Furthermore, FAS 140 specifically notes that the determination of whether a transfer of assets qualifies as a sale might depend upon a legal determination of whether such
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arrangement represents a “true sale at law.” Lehman, however, was unable to obtain a true sale opinion from any United States law firm. Lehman did not disclose its inability to obtain such an opinion or its decision to nevertheless treat its Repo 105 transactions as sales. That Lehman attempted to satisfy the requirements of FAS 140 through an opinion from Linklaters, a law firm, in the United Kingdom within the context of English Law (and then channel Repo 105 transactions through a Lehman subsidiary in the United Kingdom) cannot justify the accounting treatment. Because no U.S. firm would provide the opinion under U.S. law, there was no basis in FAS 140 for recording the transactions as sales, nor was there legitimate business or economic substance behind channeling the Repo 105 transactions through the United Kingdom.
195. Lehman’s accounting for its Repo 105 transactions also failed fundamental tenets of financial reporting under GAAP. GAAP requires that the overall impression created by financial statements be consistent with the business realities of the company’s financial position and operations, such that the financial statements are useful and comprehensible to users in making rational business and investment decisions. See, e.g., FASCON 1, ¶¶9, 16, 33-34;
FASCON 5, ¶5. FASCON 1 states that “Financial reporting should include explanations and interpretations to help users understand financial information.” ¶54. Under GAAP, “nothing material is left out of the information that may be necessary to [ensure] that [the report] validly represents the underlying events and conditions.” FASCON 2, ¶¶79-80. FASCON 5 explains that footnotes are an integral part of financial statements and are read in conjunction with the notes to the financial statements. Here, Lehman’s accounting treatment for its Repo 105 transactions, and the total absence of any disclosures about Repo 105 in footnotes, the MD&A section of the SEC filings, or elsewhere created a false impression of Lehman’s business condition, violating GAAP. An analyst or a Plan participant reading Lehman’s SEC filings from
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cover to cover, with unlimited time, would not have learned about the Repo 105 program or
Lehman’s true net leverage. To the contrary, Lehman affirmatively told readers that its repurchase agreements were treated as financial arrangements, not sales, under FAS 140.
196. In addition, GAAP requires that financial statements place substance over form.
FASCON 2, for example, states in relevant part:
. . . The quality of reliability and, in particular, of representational faithfulness leaves no room for accounting representations that subordinate substance to form . . . (FASCON 2, ¶59)
197. Additionally, AU § 411 states, in relevant part:
Generally accepted accounting principles recognize the importance of reporting transactions and events in accordance with their substance. (AU § 411.06)
E. Lehman’s Financial Condition Prior To The Class Period
198. A document entitled “Lehman Brothers 401(k) Savings Plan Review and
Diagnostic Project Proposal and Timeline” dated November 17, 2006, states that an outside investment consultant, Mercer Investment Consulting (Mercer”), made a proposal to the Benefit
Committee that they consider instituting limitations on the Lehman Company Stock Fund and better communicate the risk of investing in the Lehman Company Stock Fund to Plan participants. LEHMAN-ERISA0001023-26. There is no showing that the Benefit Committee ever followed Mercer’s recommendations during the Class Period when the Benefit Committee had a chance to protect the retirement savings of the Plan participants. Mercer was ultimately retained by Defendant Uvino on March 8, 2007 to conduct a structure review and diagnostic to the Plan, including the above referred analysis of Company Stock limitations and communications of risk. See LEHMAN-ERISA0000442-46. A formal engagement letter with
Mercer for ongoing monitoring of the Lehman Defined Benefit and Defined Contribution Plans was signed by Defendant Uvino that same day. LEHMAN-ERISA0000447-51. Nevertheless,
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during the Class Period Defendants continued to fail to set sufficient limits with respect to ownership of Company Stock in the Plan, and failed to appropriately communicate the risks of
Company Stock ownership to Plan participants.
199. Despite this November 2006 warning from Mercer, on December 4, 2006, the
Benefit Committee nonetheless decided to switch the Plan’s default investment option to the
Company Stock Fund. See LEHMAN-ERISA0000914-915. Henceforth, if a Plan participant did not direct where his or her retirement funds should go, by default they were invested in the
Lehman Company Stock Fund. The meeting minutes provided:
Following a detailed discussion, with questions, the Committee authorized the proposal. The Committee agreed to continue to monitor the performance of existing investment options consistent with past and current practice contemporaneous with the project, and noted that, except as where circumstances would demand or dictate otherwise, prospective decisions about the replacement or retention of specific investment options should, in addition to other relevant factors, take into consideration the progress and aims of this plan review and project.
There being no further business, the meeting was adjourned.
200. While the Benefit Committee determined that the Company Stock Fund would be the default investment option during this meeting, there was no discussion of its prudence.
201. On December 15, 2006, the International Herald Tribune reported that “[r]evenue from fixed-income trading rose more than 25 percent at both Lehman and Bear Stearns, faster than in the third quarter. The banks, based in New York, cited rising sales of so-called credit products, which include credit-default swaps, the world’s fastest-growing derivative market.”
International Herald Tribune, “Record Profits at Bear Stearns and Lehman Brothers” (Dec. 15,
2006) (Emphasis added).
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202. By December 2006, Lehman was already making what proved to be futile efforts to reduce its exposure to subprime debt. Specifically, in late 2006, on information and belief,
Lehman quietly allowed certain traders to “short” – or hedge against – impending mortgage losses. As Bloomberg News reported on July 22, 2008, “By the end of 2006, Lehman started hedging against its mortgage exposure. Some traders were allowed to bet against the prices of home loans by shorting indexes tied to mortgage securities.” These efforts were of course too little too late for Lehman as other investment banks had already began limiting their risk exposure and reducing their leverage.
203. At the same time, Lehman was increasing its risk. In order to engage in riskier transactions, Lehman raised its risk appetite limit four times between December 2006 and
December 2007, from $2.3 to $3.3 billion, then to $3.5 billion, then to $4.0 billion, and then regularly exceeded even these increased limits by hundreds of millions of dollars.
204. Lehman also had “concentration limits,” which were designed to ensure that the
Company did not take too much risk in a single, undiversified business or area. However,
Lehman routinely and consistently disregarded the concentration limits with respect to its leveraged loan and commercial real estate business, including by failing to enforce the
Company’s “single transaction limits,” which were meant to ensure that its investments were properly limited and diversified by business line and by counterparty. The single transaction limit was composed of two limits: (i) a limit applicable to the notional amount of the expected leveraged loan (i.e., the total value of a leveraged position’s assets); and (ii) a limit applicable to the amount that Lehman was at risk of losing on the leveraged loan. The Examiner explained that, in late 2006, Lehman decided “to disregard the single transaction limit” even though it had stated that the freedom to waive the single transaction limit “would be exercised only in ‘rare
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circumstances’” (footnote omitted). By July 2007, Lehman had committed to approximately 30 deals that exceeded its $250 million loss threshold, and five deals that violated the notional limit of $3.6 billion. Lehman also committed approximately $10 billion more than the single transaction limit allowed with respect to 24 of its largest high yield deals. Moreover, the
Company did not impose a limit on its leveraged loan bridge equity commitments, in which
Lehman took on riskier equity pieces of real estate investments and which could directly affect its balance sheet and liquidity position if not sold. Lehman ultimately exceeded its risk limits by margins of 70% for commercial real estate and by 100% for its leveraged loans.
205. As of December 31, 2006, the Company Stock Fund had a balance of
$233,380,458 which was equal to 12% of the entire Plan. At that time, it was the second largest investment fund by asset size in the Plan (LEHMAN-ERISA0001376-1377), demonstrating that employees are pre-disposed to invest in company stock inside 401(k) plans, a fact that was, or should have been, well-known, to Defendant fiduciaries.
206. In a January 2007 Board meeting, the Director Defendants were informed of
Lehman’s growth strategy and of its decision to take on more risk. As per the Examiner, “[a]ll of the directors . . . agreed with Lehman’s growth strategy at the time it was undertaken.”
207. On February 13, 2007, the Company filed its annual report for fiscal year 2006 on
Form 10-K with the SEC (“2006 Form 10-K”). The 2006 Form 10-K also discussed, among other things, the Company’s commercial real estate investments, stating in relevant part:
Real Estate. In addition to our origination and securitization of commercial mortgages, we also invest in commercial real estate in the form of debt, joint venture equity investments and direct ownership interests. We have interests in properties throughout the world.
* * *
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Principal transactions revenue improved 25% in 2006 from 2005, driven by broad based strength across fixed income and equity products. In Fixed Income Capital Markets, the notable increases in 2006 were in credit products, commercial mortgages and real estate. The 2006 increase in net revenues from Equities Capital Markets reflects higher client trading volumes, increases in financing and derivative activities, and higher revenues from proprietary trading strategies. Principal transactions in 2006 also benefited from increased revenues associated with certain structured products meeting the required market observability standard for revenue recognition. Principal transactions revenue improved 37% in 2005 from 2004, driven by improvements across both fixed income and equity products. In Fixed Income Capital Markets, businesses with higher revenues over the prior year included commercial mortgages and real estate, residential mortgages and interest rate products. Equities Capital Markets in 2005 benefited from higher trading volumes and improved equity valuations, as well as increases in financing and derivative activities from the prior year.
(Emphasis added).
208. Despite that upbeat description of the Company’s results for 2006, Defendants knew or should have known that its risk from subprime lending was not limited to residential housing, but included commercial real estate as well, an area in which the Company also faced considerable exposure.
209. At this time, Defendants, particularly the Benefit Committee Defendants, knew that Company Stock was foundering. According to a performance comparison prepared by
Mercer for the first third of 2007, the year-to-date return on Company Stock was -6.6%, while the benchmarks it was compared to, the S&P 500 and S&P Financials, had year-to-date returns of 5.1% and .5% respectively. LEHMAN-ERISA0001087-89.
210. In May of 2007, however, senior Lehman executives were becoming more vocal regarding mounting concerns with Lehman’s mortgage portfolio. For example, Michael
Gelband, a senior Lehman executive in charge of fixed income, cautioned the Company against taking more risk in the subprime field. In response, the Company fired him. As Bloomberg
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News reported on July 22, 2008, “At least two executive who urged caution were pushed aside . .
. Michael Gelband, 49, who ran fixed income . . .was pushed out altogether in May 2007 after he balked at taking more risk.” Lehman Fault-Finding, Bloomberg News (July 22, 2008).
211. While Defendant Fuld publicly stated that Lehman was “better positioned than ever,” the Company was terminating senior executives who expressed concern about its risky subprime portfolio.
212. On May 17, 2007, the Benefit Committee met and discussed whether to continue to invest Plan retirement funds in the Invesco Stable Value Fund. At the same time, however, there were no discussions by the Benefit Committee members during this meeting about the
Company Stock Fund or whether it was a prudent retirement savings option. See LEHMAN-
ERISA0000916.
213. A Performance Comparison prepared by Mercer Investment Consulting for May
2007 listed a balance of only $263,767,620 in Company Stock in the Plan. LEHMAN-
ERISA0001601. Its May 2007 and year to date returns were -2.3% and -8.7% respectively. In contrast, Lehman’s benchmarks were: (1) S&P 500: 3.5% and 8.8% respectively, and (2) S&P
Financials: 2.3% and -2.8% respectively. Id.
214. Yet again, despite acknowledging “continued weakness in the U.S. residential mortgage business,” the Company did not disclose the seriousness of the Company’s exposure related to its subprime holdings to the public or the Plan participants.
215. On July 10, 2007, Lehman’s subprime portfolio began to unravel. Specifically, on that date, the Company reported in its Form 10-Q for the quarter ended May 31, 2007
(“Second Quarter 2007 Form 10-Q”) that it had “unrealized” losses of $459 million in the quarter from mortgages and mortgage-backed assets in its inventory.
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216. On that same day, Bloomberg News published an article entitled “Lehman
Brothers Leads Brokerage Stocks Lower After S&P Subprime Warning,” which stated in relevant part:
Lehman Brothers Holdings Inc. led declines in shares of U.S. securities firms after Standard & Poor’s said it may cut ratings on $12 billion of bonds backed by subprime mortgages, a move that could shave trading profits.
* * *
Some insurers and pension funds are required to sell bonds when they’re downgraded, potentially depressing prices of $800 billion in subprime mortgage bonds and $1 trillion of collateralized debt obligations, which repackage mortgage bonds into new securities. Lehman and other Wall Street firms have seen their revenue from fixed-income trading and sales drop in the second quarter, mostly due to weakness in mortgages.
“Downgrades further hurt the mortgage bond business of the securities firms,” said David Hendler, an analyst at CreditSights Inc. “Although they’ve fallen a lot already and the rating agencies usually are behind the curve, their downgrades bring down prices more.”
S&P said today that it’s preparing to lower the ratings on 2.1 percent of the $565.3 billion of subprime bonds issued in late 2005 through 2006 because of a worse-than-anticipated U.S. housing slump. The company said it’s also reviewing the “global universe” of collateralized debt obligations, or CDOs, that contain subprime mortgages, which are loans to the least creditworthy borrowers.
217. On that news, Company Stock fell $3.76 per share, or over 5 percent, to close on
July 10, 2007, at $71.10 per share on unusually heavy trading volume. Although the news had a negative effect on the price of Company Stock, the price remained inflated as Lehman failed to disclose, among other things, the full nature and extent of its exposure to the mortgage crisis and the credit market downturn.
218. In response to the news, rather than clearly and unambiguously informing the
Plan participants fully of the nature and extent of Lehman’s exposure to risky subprime
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investments, Defendants did the exact opposite. On July 18, 2007, Bloomberg News published an article entitled “Lehman Brothers Says Subprime Speculation ‘Unfounded,’” which stated in relevant part:
Lehman Brothers Holdings Inc., the largest underwriter of US. mortgage bonds, denied speculation that it may face greater potential losses from subprime mortgages than previously disclosed.
Speculation about a planned announcement from Lehman Brothers related to its subprime holdings spurred investors to demand higher premiums to insure against the risk of owning Wall Street firms’ bonds and helped prompt gains in Treasuries, according to traders including Thomas Tucci, head of U.S government bond trading at RBC Capital Markets in New York.
“The rumors related to subprime exposure are unfounded,” Lehman spokeswoman Kerrie Cohen said today.
(Emphasis added.)
219. On July 10, 2007, after two credit rating agencies, Standard & Poor’s and
Moody’s Investors Service, downgraded bonds backed by subprime mortgages, prompting investors to sell the securities, a third credit rating agency, Fitch’s Investors Service followed suit, and downgraded as well on August 1, 2007.
220. Also on July 10, 2007, Bloomberg reported that, according to Christopher Wallen, an analyst from Institutional Risk Analytics, “when ratings agency puts a whole class [i.e., bonds backed by subprime mortgages] on watch, it will force all the credit officers to get off their butts and reevaluate everything. This could be one of the triggers we’ve been waiting for.” Id.
221. On July 26, 2007, Bloomberg reported that the risk of owning Lehman’s bonds
“soared” and the Company Stock price plunged “as concerns escalated that investment banks will be hurt by losses from subprime mortgages and corporate debt.” As reported by Bloomberg
News, as the risk mounted, the cost of five-year credit default swaps on $10 million face amount
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of the Company’s bonds jumped by as much as $24,000, to $104,000 a year. These facts were known throughout Lehman and were certainly known by the Benefit Committee Defendants.
222. The annual cost of credit default swaps protecting against losses on $10 million of the Company’s debt for five years surged to $219,000 at the end of May 2008, and to $800,000 a year by September 11, 2008. “The Two Faces of Lehman’s Fall,” THE WALL STREET JOURNAL
(Oct. 6, 2008). Such increases in the cost of credit-default swaps signaled a significant deterioration in investor confidence.
223. On the July 26, 2007 news, the price of Company Stock fell an additional $3.16 per share, or 4.7 percent, to close on July 26, 2007 at $64.50 per share, again on unusually heavy trading volume.
224. On July 31, 2007, Bloomberg News published an article entitled “Bear, Lehman
Brothers, Merrill, Goldman Traded as Junk, Derivatives Show,” which stated in relevant part:
On Wall Street, Bear Stearns Cos., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Goldman Sachs Group Inc., are as good as junk.
Bonds of U.S. investment banks lost about $1.5 billion of their face value this month as the risk of owning the securities increased the most since at least October 2004, according to Merrill indexes. Prices of credit-default swaps based on the debt imply that their credit ratings are below investment grade, data compiled by Moody’s Investors Service show.
The highest level of defaults in 10 years on subprime mortgages and a $33 billion pileup of unsold bonds and loans for funding acquisitions are driving investors away from debt of the New York-based securities firms. Concerns about credit quality may get worse because banks promised to provide $300 billion in debt for leveraged buyouts announced this year.
* * *
Prices of credit-default swaps for Goldman, the biggest investment bank by market value, Merrill, the third largest, and Lehman Brothers, the No. 1 mortgage bond underwriter, also equate to a
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Ba1 rating, data from Moody’s credit strategy group show. Bonds of New York-based Goldman and Merrill are rated Aa3, seven levels higher than swaps suggest. Lehman Brothers is rated A1, the same as Bear Stearns.
(Emphasis added).
225. On this news, the Company’s shares fell an additional $2.80 per share, or over 4.3 percent, to close on July 31, 2007 at $62.00 per share, again on heavy trading volume.
226. In a performance comparison prepared by Mercer (LEHMAN-ERISA0001099-
104) Defendants, particularly the Benefit Committee Defendants, were advised that the Lehman
Stock Fund’s financial performance, year-to-date through and including July 2007, was negative
22.9%, though its compared benchmark, the S&P 500, was up 3.6% and its other benchmark, the
S&P Financials, was only down 9.1%.
227. As the risk of failure continued to grow, Lehman and the other investment banks obfuscated the extent of their total risk. As reported in The Wall Street Journal on August 2,
2007:
The mystery of “where are the losses?” has confounded hedge funds searching for opportunities to bet against banks whose day of reckoning has yet to come.
“We’ve been looking for financials that show losses from these securities on their books, and they’ve been very difficult to find,” says Keith Long, president of Otter Creek Management, a hedge fund in Palm Beach, Fla., with $150 million in assets. “It’s very opaque.”
Investors have long complained about the lack of transparency when it comes to huge financial firms, whose balance sheets are so big that they can easily mask multimillion-dollar gains or losses. Analysts and investors currently cite several potential factors that could help hide subprime wounds.
228. On information and belief, Lehman was engaged in such efforts to conceal the extent of its subprime exposure. For example, Bloomberg News later reported that, “Lehman’s
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hedges helped offset losses in the second half of 2007 and the first quarter of 2008. While the firm wrote down the value of mortgage-related assets by more than $10 billion, the net reduction to profit was only $3.3 billion.” Lehman Fault-Finding, Bloomberg News (July 22, 2008)
(Emphasis added). In short, Lehman used a gain from one area to offset the totality of a loss in another, all the while continuing to assure the Plan’s participants that Company Stock was prudent for retirement savings.
229. On August 7, 2007, the Benefit Committee met and decided to eliminate three investment funds as retirement savings options. It eliminated the Fidelity Equity – Income Fund; the Neuberger Berman Focus Fund and the Neuberger Berman Fasciano Fund. It also considered the prudence of the Calamos Growth Fund, the Templeton Developing Markets Fund and the Lehman Brothers High Income Bond Fund. The Benefit Committee “agreed to continue to monitor the performance of these investment options, and also explore potential candidates whom Mercer believes the Committee might judge to be viable or comparable alternatives for these strategies for future consideration.” Importantly, there were no discussions during this meeting about the Company Stock Fund or whether it was a prudent retirement savings option.
See LEHMAN-ERISA0000917-918.
230. On August 10, 2007, Business Week published an article entitled “Subprime Woes
Wallop Wall Street Firms,” which stated in relevant part:
As more news about the looming credit crunch slapped major stock indexes lower on Thursday, the U.S.’s big investment banks got hit even harder. . . . Lehman Brothers (LEH) dropped more than 7%. Market anxiety had already caused financial stocks to drop more than 5% in the last month.
* * *
One problem for big investment banks and hedge funds is they reveal very little to the public or investors about their internal
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holdings. “We don’t know how many hidden skeletons there are in anybody’s closet,” Larkin says.
231. During a conference call to discuss Lehman’s third quarter results on September
18, 2007, Christopher O’Meara, Lehman’s Chief Financial Officer, Controller, and Executive
Vice President until December 2007, sought to quell concerns by referring to Lehman’s “strong” risk management and liquidity position as a “competitive advantage” separating Lehman from other troubled Wall Street firms. Mr. O’Meara claimed that Lehman’s liquidity position was
“stronger than ever”:
We attribute this performance to several factors: Our strong risk management culture with regards to the setting of risk limits and the management of market and counterparty credit risks; and our strong liquidity framework . . .
To reiterate, our liquidity position is stronger than ever, we consider our liquidity framework to be a competitive advantage which positions us to support our clients and take advantage of market opportunities even in a stress environment.
* * *
Before we move on to outlook, I wanted to make a few comments about fair value and marking to market. As I know it has been the subject of much discussion in the marketplace. First of all, we carry all of our financial instruments, inventory and lending commitments at fair value. We have a robust process in place in which employees, independent of the businesses, review the marks for accuracy or reasonableness using all the information available in the marketplace including third-party pricing sources where applicable.
* * *
So overall, despite the fact that some amount of judgment has to be used in determining fair values in a distressed environment, we feel very good about our process of marking-to-market and the marks themselves. Historically, our prudent approach to valuing positions has proven out in past distressed environments.
(Emphasis added).
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232. Nevertheless, given Lehman’s considerable exposure to subprime market risk,
Defendants knew or should have known that the Company lacked sufficient liquidity to weather the subprime crisis.
233. In fact, despite Mr. O’Meara’s assurances about Lehman’s “fair value” and
“marking-to-market” processes, a key factor in Lehman’s bankruptcy was its failure to appropriately “mark-to-market” its commercial real estate portfolio, which was considered to be over-valued by approximately $10 billion.
234. During this same time period, unbeknownst to Plan participants, senior Lehman executives were cautioning against continued hedging against the Company’s mortgage positions. Specifically, Madelyn Antoncic, the former head of risk at Lehman, “[w]as moved to a government relations job in September 2007” after warning Company officials “[t]hat hedging mortgage positions had curtailed Lehman’s profit.” Lehman Fault-Finding, Bloomberg News,
July 22, 2008. In short, as alleged above, Lehman squeezed out or reassigned critics of the
Company’s tactics related to its subprime investments.
235. Meanwhile, Plan fiduciaries were specifically warned of the advent of the subprime crisis by Mercer in their Third Quarter 2007 Defined Contribution Performance
Evaluation. See LEHMAN-ERISA0001210-97. In the Performance Evaluation, Mercer provides an “Economic Update” regarding “Subprime Mortgages and the Credit Crunch.”
LEHMAN-ERISA0001212. It also describes “The Sub Prime Contagion” in a chart which depicts “The Makings of the Credit Crunch and Its Effects:
78 Case 1:08-cv-05598-LAK Document 159-1 Filed 12/03/10 Page 4 of 40
See LEHMAN-ERISA0001213. This chart explains about, inter alia, Alt-A or No Doc Loans,
CDOs, and the fallout therefrom. Defendant Uvino and the other Benefit Committee Defendants therefore knew or should have known about the risks that could impact Company Stock in light of the subprime crisis.
236. In the Third Quarter 2007 Defined Contribution Performance Evaluation, Mercer also lists Lehman Stock as one of the 25 largest negative contributors to the S&P 500 Index.
LEHMAN-ERISA0001216 (noting that it underperformed the S&P Financials Index by 12.6%).
LEHMAN-ERISA0001225. At this point, Company Stock represented 10.2% of the Plan.
LEHMAN-ERISA0001236. Nevertheless, despite these warnings, Defendant Uvino and the
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other Defendants, particularly the Benefit Committee Defendants, took no action to protect Plan participants with Lehman Stock in their Plan accounts from this “Sub Prime Contagion.”
237. Another document (LEHMAN-ERISA0001004) contains a chart entitled
“Participants Invested in Company Stock” as of September 30, 2007.
As the chart depicts, overall 68% of Plan participants were invested in Company Stock, an average of 28% of assets were invested in Company Stock, and 3% of participants were invested
100% in Company Stock. Nevertheless, despite these statistics, Defendants again failed to take any actions to protect Plan participants with Company Stock in their Plan portfolio.
238. On October 4, 2007, Moody’s reported that subprime mortgage bonds originated in the first half of 2007 included loans that were going delinquent at the fastest recorded rate.
The Moody’s report predicted that accelerating delinquencies from 2007 bonds were likely to surpass the number of delinquencies in 2006, which hit a peak not seen since 2000. See Joint
Economic Committees’ Subprime Mortgage Market Crisis Timeline, dated July 10, 2008.
239. On October 10, 2007, the Company filed with the SEC its quarterly report on
Form 10-Q for the third quarter of 2007 (“Third Quarter 2007 Form 10-Q”). The Third Quarter
2007 Form 10-Q reaffirmed the financial results previously released on September 18, 2007.
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240. The Third Quarter 2007 Form 10-Q also discussed, among other things, weaker results in the Company’s commercial real estate business:
Net revenues and volumes in our securitized products business were down compared to the benchmark 2006 three and nine month periods due to continued corrections in the mortgage industry, primarily in the U.S., and sluggish domestic housing markets. Although there was active trading related to certain securitized products, there was also significant credit spread widening across securitizations’ capital structures, including highly rated classes of securities, during the three month period. As a result, negative valuation adjustments, after consideration of hedges, associated with these asset-backed securities were recorded. Our volumes for residential origination and securitization declined during the 2007 three months. Results in our commercial real estate business were also weaker due to widening in credit spreads and lower asset sale activity during the period.
(Emphasis added).
241. On October 11, 2007, the Benefit Committee met and again discussed the performance of the Invesco Stable Value Fund. Once again, however, there were no discussions during this meeting about the Company Stock Fund or whether it was a prudent retirement savings option. See LEHMAN-ERISA0000973.
242. On October 18, 2007, Standard & Poor’s cut the credit ratings on $23.35 billion of securities backed by pools of home loans that were offered to borrowers during the first half of the year. The downgrades affected even AAA-rated securities, the highest of the 10 investment-grade ratings as well as the rating of government debt. See Joint Economic
Committees’ Subprime Mortgage Market Crisis Timeline, dated July 10, 2008.
243. On November 19, 2007, the Benefit Committee met and in response to new
Department of Labor regulations (not because of any considerations of prudence), changed the default investment option from the Company Stock Fund to the Fidelity Freedom Fund that corresponded with the participant’s target retirement date. Once again, there were no discussions
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during this meeting about the Company Stock Fund and whether it was prudent to continue offering it as a retirement savings option. See LEHMAN-ERISA0000974-975.
244. On December 13, 2007, the Company issued a press release entitled “Lehman
Brothers Reports Record Net Revenues, Net Income and Earnings Per Share for Fiscal 2007;
Reports Net Income of $886 Million and Net Revenues of $4.4 Billion for the Fourth Quarter of
Fiscal 2007,” which stated in relevant part:
Lehman Brothers Holdings Inc. (NYSE: LEH) today reported net income of $886 million, or $1.54 per common share (diluted), for the fourth quarter ended November 30, 2007, representing decreases of 12% and 10%, respectively, from net income of $1.0 billion, or $1.72 per common share (diluted), reported for the fourth quarter of fiscal 2006. For the third quarter of fiscal 2007, net income was $887 million; or $1.54 per common share (diluted).
* * *
Net revenues (total revenues less interest expense) for the fourth quarter of fiscal 2007 were $4.4 billion, a decrease of 3% from $4.5 billion reported in the fourth quarter of fiscal 2006 and an increase of 2% from $4.3 billion reported in the third quarter of fiscal 2007. Capital Markets net revenues decreased 10% to $2.7 billion in the fourth quarter of fiscal 2007 from $3.0 billion in the fourth quarter of fiscal 2006. Fixed Income Capital Markets reported net revenues of $860 million, a decrease of 60% from $2.1 billion in the fourth quarter of fiscal 2006, due to the very challenging markets experienced during the period; although strong results from client activity were reported in the Foreign Exchange and Commodities businesses. Fixed Income Capital Markets recorded negative valuation adjustments on trading assets, principally in the Firm’s Securitized Products and Real Estate businesses. These valuation adjustments were offset, in part, by valuation gains on economic hedges and liabilities, as well as realized gains from the sale of certain leveraged loan positions, resulting in a net revenue reduction in Fixed Income Capital Markets of approximately $830 million.
(Emphasis added).
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245. Rather than explain the dire implications of the “negative valuation adjustments”, in the December 13, 2007 press release, Defendant Fuld said, among other things:
Despite what continues to be a difficult operating environment, the Firm’s results for the quarter highlight our ability to perform across market cycles and deliver value to our shareholders. Our global franchise and brand have never been stronger, and our record results for the year reflect the continued diversified growth of our businesses. As always, our people remain committed to managing risk and providing the best solutions to our clients.
(Emphasis added).
246. Despite the growing concern over credit risk then pervading the markets, and despite the concerns expressed internally by senior Lehman executives, Defendants failed to disclose the risk to Plan participants. For example, in the Company’s December 13, 2007,
Fourth Quarter Earnings call, Erin Callan, Lehman’s Chief Financial Officer, said that Lehman had put the risk behind it:
In general, as we have indicated, we have come through the current downturn very well positioned on a competitive basis. We believe we can capitalize on this opportunity for 2008.
(Emphasis added).
247. Thus, in the wake of an uproar of concerns regarding the collapse of the subprime markets, Lehman continued to assure the market and Plan participants of the continued viability of Company Stock and of the fact that the Company would remain virtually unscathed by the subprime crisis, despite the Plan’s material investment in Company Stock.
248. Despite these assurances, Defendants were aware of the risk associated with
Lehman’s subprime and mortgage investment portfolio and failed to disclose the full nature and extent of the risk of catastrophic loss from the Plan participants (and, for that matter, from the public market).
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249. Indeed, another performance comparison prepared by Mercer for 2007, demonstrates that Company Stock was down 18.2% although the S&P, Lehman’s benchmark was up 5.5%. The S&P Financials, Lehman’s other benchmark, was down 19.2%. LEHMAN-
ERISA0001366.
250. Unsurprisingly, the Company Stock Fund was down in total value for the year ended December 31, 2007. Despite having receipts of $88.53 million that year, it had approximately $47.88 million in withdrawals and lost approximately $45.33 million due to losses in Lehman Stock, leaving the Plan down by approximately $5 million. LEHMAN-
ERISA0000583. In light of the Defendants’ failures to properly disclose the true state of
Lehman’s financial affairs, there was approximately $42.82 million contributed to the Company
Stock Fund by Plan participants during the 2007 calendar year.
251. As early as January 2008, in a presentation to Lehman’s Board, from Eric Felder, one of Defendant Fuld’s top executives, the Director Defendants were warned that “liquidity can disappear quite fast.” LB 010443, et seq. (produced in connection with the House Committee on
Oversight and Government Reform, Congressional hearing held on October 6, 2008 (“Lehman
Congressional Hearing”)). As recognized by Rep. Henry A. Waxman, Chairman of the House
Committee on Oversight and Government Reform, during the Lehman Congressional Hearing,
Lehman ignored the mounting liquidity concerns in 2007, and instead depleted its capital reserves by over $10 billion through year-end bonuses, stock buybacks, and dividend payments.
Preliminary Hearing Transcript, p. 7.
252. On January 10, 2008, the Benefit Committee met and considered the advisability of continuing to offer the Lehman Brothers High Income Bond Fund and the Fidelity Capital and
Income Fund as investment alternatives. The Committee decided to retain the Lehman Brothers
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High Income Bond Fund and eliminate the Fidelity Capital and Income Fund. Once again, there were no discussions during this meeting about the Company Stock Fund or whether it was a prudent retirement savings option. See LEHMAN-ERISA0000976-977.
253. On January 17, 2008, the Company issued a press release announcing that it would substantially reduce its resources and capacity in the U.S. residential mortgage origination space.
254. On January 29, 2008, Lehman filed its annual report for fiscal year 2007 on Form
10-K with the SEC (“2007 Form 10-K”), which reaffirmed the financial results previously announced on December 13, 2007.
255. The 2007 Form 10-K also admitted that the deteriorating housing market would likely also stress other components of the capital markets, such as commercial real estate:
In the U.S., economic growth showed signs of strength at the beginning of our fiscal year, driven by higher net exports and consumption levels, among other indicators, but the pace of growth slowed in the latter half. Over the twelve-month period, the U.S. housing market weakened, business confidence declined, and, in the last six months of the year, consumer confidence dropped. The labor market followed the same trajectory, showing signs of deterioration in the second half of the period as unemployment levels increased modestly and payroll data showed some signs of weakness. Responding to concerns over liquidity in the financial markets and inflationary pressures, the U.S. Federal Reserve reduced rates three times during the calendar year and made an additional inter-meeting rate cut in January 2008, and most observers anticipate additional reductions will occur in the early part of our 2008 fiscal year. Long-term bond yields declined, with the 10-year Treasury note yield ending our fiscal year down 52 basis points at 3.94%. The S&P 500 Index, Dow Jones Industrial Average and NASDAQ composites were up 5.7%, 9.4%, and 9.4%, respectively, from November 2006 levels. The current high levels of U.S. home inventories suggest that an extended period of construction declines and housing price cuts will combine with tighter credit conditions and increasing oil prices to slow down consumer spending. We believe those conditions will continue to strain the capital markets, particularly the securitized products and
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residential housing components. We also believe that those conditions will stress other components of the capital markets, such as commercial real estate. We believe these impediments will decrease the U.S. growth rate in 2008.
256. On February 26, 2008, the Benefit Committee met and selected the Times Square
Mid-Cap Growth Fund as a new investment option. An update was provided on the Invesco
Stable Value Fund and in particular, the Benefit Committee was presented with an overview as to the Invesco Stable Value Fund’s sector and credit exposure, subprime mortgage exposure and market-to-book ratio. Nevertheless, there were no similar discussions during this meeting about
Lehman’s or the Company Stock Fund’s credit exposure, subprime mortgage exposure or market-to-book ratios or whether the Company Stock Fund was a prudent retirement savings option. See LEHMAN-ERISA0000978-979.
F. Defendants Ignored Lehman’s Deteriorating Financial Condition And Prospects, Which Differed Substantially From Public Statements Throughout The Class Period, And The Systemic Risk Of A Financial Collapse
257. Despite what they knew or should have known about Lehman’s risky business practices, Defendants allowed the Plan and its participants to acquire and hold Company Stock through the Company Stock Fund for retirement savings while the Company fostered a materially inaccurate picture of itself in the public.
258. On March 14, 2008, the last trading day before the start of the Class Period,
Lehman’s Stock price closed at $39.26.
259. On Wednesday, March 12, 2008, Bear Stearns’ President Alan Schwartz reaffirmed Bear Stearns’ financial position and liquidity, stating that Bear Stearns had more than
$17 billion in excess cash on its balance sheet. Mr. Schwartz also affirmed Bear Stearns’ book value of $80 per share. On Friday March 14, 2008, Bear Stearns stock price closed at $30 per share, giving it a market value of more than $3.5 billion.
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260. Yet, two days later, on Sunday, March 16, 2008, Bear Stearns announced a deal where it was to be sold to JP Morgan Chase & Company (“JP Morgan”) for a mere $2 per share, or about $236 million, a mere fraction of the company’s market value on Friday March 14, 2008.
261. By the collapse of Bear Stearns on March 16, 2008, Lehman was the most highly- leveraged of the nation’s largest financial institutions, and owned or was exposed to an enormous amount of sub-prime and counterparty risk. Thus, Lehman had become the most vulnerable investment bank to the systemic risk of a financial melt-down. That risk materialized only six months later when Lehman filed for bankruptcy.
262. By no later than March 16, 2008, it was or should have been apparent to
Defendants that the Company was likely next in line for serious risk of financial failure in light of its serious debt risks stemming from the Company’s mortgage portfolio. Throughout the
Class Period, Defendant Fuld’s frantic efforts to sell Lehman or locate a strategic partner were an abject failure. Nevertheless, Defendants failed to provide participants with the necessary disclosures, causing Company Stock to be overinflated. Moreover, the Director Defendants and
Compensation Committee Defendants failed to provide the Benefit Committee Defendants with material information concerning Lehman’s true financial condition so that they could properly evaluate the prudence of continuing to include Lehman Stock as a Plan investment option.
263. As Lehman moved closer to bankruptcy, Defendants continued to offer Company
Stock as a retirement saving option in the Plan through the Company Stock Fund, failed to reduce the number of shares of Company Stock held by the Plan or prevent Plan participants from allocating even more shares of the Company Stock Fund to their accounts, and failed to disclose the full nature and extent of the risk of catastrophic loss from the Plan participants, all in breach of their fiduciary duties.
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264. After Bear Stearns’ demise, Lehman became the next target on Wall Street. As the Examiner found, “with the implosion and near collapse of Bear Stearns in March 2008, it became clear that Lehman’s growth strategy had been flawed, so much so that its very survival was in jeopardy. The markets were shaken by Bear’s demise, and Lehman was widely considered to be the next bank that might fail.” (footnotes omitted). As the Examiner reported, the view that Lehman was the next bank that might fail was shared by SEC Chairman
Christopher Cox, Federal Reserve Bank of New York President Timothy F. Geithner, Treasury
Secretary Henry M. Paulson, Jr., and Federal Reserve Chairman Ben S. Bernanke.
265. As a result of this widespread perception, on March 17, 2008, Lehman’s Stock price continued its precipitous decline. Defendant Fuld and his top brass formulated a plan to create a media blitz to assure the market that Lehman had sufficient liquidity. However, as was later shown to be the case, Defendants knew or should have known Lehman’s liquidity was insufficient to weather the storm.
266. Also, on March 17, 2008, Defendant Fuld spoke with John Mack, chief executive officer of Morgan Stanley, concerning developments at Lehman in light of, inter alia, the collapse of Bear Stearns. In response to Mack’s phone call, Defendant Fuld informed him that two banks, Deutsche Bank and HSBC, reputedly would not trade with Lehman.
267. After Bear Stearns’ collapse, Treasury Secretary Paulson began pushing
Defendant Fuld to find a buyer for Lehman. On The Brink: Inside the Race to Stop the Collapse of the Global Financial System, Henry M. Paulson, Jr. p. 173. Then President of the Federal
Reserve Bank of New York Timothy Geithner, and Secretary Paulson repeatedly informed
Defendant Fuld that “the government had no legal authority to invest capital in an investment bank.” Id.
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268. Indeed, throughout most of the Class Period, Defendant Fuld, on behalf of
Lehman, was frantically searching either for such a buyer or a large investor to rescue the
Company from the credit crisis, though this was not revealed to the Plan participants.
269. On March 18, 2008, the Company issued a press release announcing its financial results for the first quarter of 2008. The Company reported a profit of $489 million and disclosed that it held $6.5 billion in “other asset-backed securities” – which it did not identify as
CDOs – and that it had taken a write-down of just $200 million to reflect the decreased value of those securities. These announcements reassured Plan participants and the investing public, which had become concerned about the impact of the roiling credit market on Lehman, particularly in the wake of the collapse of Bear Stearns just days earlier.
270. The press release stated, in pertinent part, as follows:
NEW YORK– March 18, 2008 – Lehman Brothers Holdings Inc. (ticker symbol: LEH) today reported net income of $489 million, or $0.81 per common share (diluted), for the first quarter ended February 29, 2008, representing decreases of 57% and 59%, respectively, from net income of $1.15 billion, or $1.96 per common share (diluted), reported for the first quarter of fiscal 2007. Fourth quarter fiscal 2007 net income was $886 million, or $1.54 per common share (diluted).
First Quarter Business Highlights
• Experienced record client activity across our Capital Markets businesses, which was offset, in part, by the effect of the continued dislocations in the credit markets that significantly impacted the Firm’s results
• Maintained strong liquidity position, with the Holding Company having a liquidity pool of $34 billion and unencumbered assets of $64 billion, with an additional $99 billion at our regulated entities, at quarter end
• Reported record net revenues in the Investment Management segment
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• Ranked #2 in announced global M&A transactions for the first two months of calendar 2008, according to Thomson Financial.
* * *
Net Revenues
Net revenues (total revenues less interest expense) for the first quarter of fiscal 2008 were $3.5 billion, representing decreases of 31% and 20%, respectively, from $5.0 billion reported in the first quarter of fiscal 2007 and $4.4 billion reported in the fourth quarter of fiscal 2007. Net revenues for the first quarter of fiscal 2008 reflect negative mark to market adjustments of $1.8 billion, net of gains on certain risk mitigation strategies and certain debt liabilities.
Business Segments
Capital Markets reported net revenues of $1.7 billion in the first quarter of fiscal 2008, a decrease of 52% from $3.5 billion in the first quarter of fiscal 2007. Fixed Income Capital Markets reported net revenues of $262 million, a decrease of 88% from $2.2 billion in the first quarter of fiscal 2007, as strong performances in liquid products such as high grade corporate debt, foreign exchange and interest rate products were offset, in part, by continued deterioration in the broader credit markets, in particular residential mortgages, commercial mortgages and acquisition finance. Equities Capital Markets reported net revenues of $1.4 billion, an increase of 6% from $1.3 billion in the first quarter of fiscal 2007, driven by continued growth in prime brokerage and strong activity in execution services.
Investment Banking reported net revenues of $867 million, an increase of 2% from $850 million in the first quarter of fiscal 2007. These revenues were driven by strong merger and acquisition advisory revenues, which increased 34% to $330 million from $247 million in the first quarter of fiscal 2007, and higher equity origination revenues, which increased 23% to $215 million from $175 million in the first quarter of fiscal 2007, partially offset by lower revenues in debt origination as compared to the first quarter of fiscal 2007.
Investment Management reported record net revenues of $968 million, an increase of 39% from $695 million in the first quarter of fiscal 2007. This performance was driven by record revenues in both Asset Management, which increased 49% to $618 million from $416 million in the first quarter of fiscal 2007, and Private
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Investment Management, which increased 25% to $350 million from $279 million in the first quarter of fiscal 2007. The Firm reported assets under management of $277 billion, compared to $282 billion at November 30, 2007.
271. Commenting on the financial results, Defendant Fuld stated:
In what remains a challenging operating environment, our results reflect the value of our continued commitment to building a diversified platform and our focus on managing risk and maintaining a strong capital and liquidity position. This strategy has allowed us to support our clients through these difficult and volatile markets, while continuing to build and strengthen our global franchise for our shareholders.
(Emphasis added).
272. Despite Defendant Fuld’s representations about “managing risk,” as the Examiner explained, and as discussed in greater detail herein, Lehman’s failure to adhere to its risk management policies rendered those policies “meaningless.”
273. Also on March 18, 2008, the Company held a conference call to discuss its financial results. During the conference call, Lehman, through its Chief Financial Officer, Erin
Callan, further reassured the market about the Company’s strength and stability in the mortgage and credit markets:
We saw a quarter where our risk management discipline allowed us to avoid any single outsized loss. And it’s been our operating philosophy for a decade, which many people are very familiar with, that we remain closely focused on our liquidity, our long- term capital position precisely for the purpose of weathering a difficult market environment that we’ve seen surfacing in recent weeks. So we’re set up for that.
* * *
So I think it’s fair to say we continue to do a very, very good job managing the risk on residential mortgages, an area that I think we are credited with a lot of expertise, a great franchise.
* * *
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Let me talk about outlook for a moment, which you’ve probably gotten message so far, but looking forward, despite the positive developments of Fed actions in the past two days and few weeks, we still don’t anticipate the challenging market conditions abating any time soon and we have planned our business accordingly. As we look out to the remainder of the year, we certainly will remain vigilant around risk, capital, and liquidity. As we talked about last quarter, as a firm we remained very cautious overall, but we continue to feel good about our competitive position.
* * *
Now, let me conclude by noting that we don’t expect that this extremely challenging period is going to end in the near term. However, we do believe we have the leadership, the experience, the risk management discipline, the capital strength, and certainly the liquidity to ride out the cycle. In addition, we believe that the current markets will continue to present us with a lot of client and trading opportunities which we look forward to that come from market dislocation. And as we successfully meet these challenges, capture these opportunities, we certainly believe we are positioning ourselves well for the long-term.
(Emphasis added).
274. With regard to the Company’s capital requirements, Lehman’s CFO stated:
We had disciplined liquidity and capital management, which we consider to be a core competency, and maintain robust liquidity to date and we have executed close to two thirds of our full-year capital plan at the end of the first quarter.
* * *
The average tenor of our long-term debt has continued to extend and is seven years at this point. We do believe that long-term debt in general will be harder to obtain throughout 2008, we had that strong point of view since late last year and therefore we will continue to pre-fund as we have done so far this year, our liquidity needs, as we see opportunities in the markets. And consistently with that, we have already completed two-thirds of our capital plan needs for 2008 as we come out of the first quarter.
(Emphasis added).
275. With respect to the Company’s Level 3 Assets (assets that have no reliable market price), Lehman’s CFO stated:
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In terms of level 3 assets, we expect a slight increase for the quarter to 39 billion [dollars]. This represents 5% of total assets. So that’s a rather detailed summary of our exposure. I wanted to give you that color, and wanted to give you some sense of why current dislocations in the market did significantly impact us, as we play in all of these asset classes. So our mark-to-market volatility is significant, we believe a significant portion of this is related to the liquidity.
276. Strikingly, while the First Quarter 2008 Form 10-Q reported a $228 million gain on its Level 3 assets during the first quarter, Lehman’s CFO stated during the Company’s March
18, 2008, conference call that the Company had written down the value of its Level 3 assets by
$875 million.
277. As a result of the Company’s statements through its CFO, the Company’s stock shot up 46.4% to $46.49, on heavy trading volume of 143,046,897, for the biggest one day gain in the stock since it went public in 1994. However, this stock jump was based on the misinformation described by Lehman’s CFO during the conference call. While the market reacted favorably, skeptics worried about accounting problems at Lehman.
278. In a March 19, 2008 article in The Irish Times, Lehman’s CFO was quoted as saying, “I think we feel better about our liquidity than we ever have.” Laura Slattery, “Volatile
Market Claws Back €1.8bn of Earlier Losses,” The Irish Times (Mar. 19, 2008).
279. In a March 19, 2008 article in The Washington Post, Peter Schiff, president and chief global strategist of Euro Pacific Capital was quoted with respect to Lehman’s announcements of the prior day that “I still don't believe any of these numbers because I still don't think there is proper accounting for the liabilities they have on their books . . . . People are going to find out that all these profits they made were phony.”
280. As credit problems continued to mount, Defendants breached their fiduciary duties by continuing to offer Company Stock as a retirement savings option in the Plan, failing to
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reduce the number of shares held by the Plan or prevent Plan participants from allocating even more shares to their accounts, and failing to disclose the full nature and extent of the risk of catastrophic loss from the Plan participants.
281. On March 27, 2008, Secretary Paulson met with his senior staff, recapping the
Bear Stearns situation. When the conversation turned to Lehman, Secretary Paulson informed his colleagues that “[t]hey may be insolvent too.” “He was worried not only about how they were valuing their assets, which struck him as wildly optimistic, but about their failure to raise any capital – not a cent. Secretary Paulson suspected that Fuld had been foolishly resisting doing so because he was hesitant to dilute the firm’s shares, including the more than 2 million shares he personally held.” See Too Big to Fail, Andrew Ross Sorkin, at p. 51. The information was known, or should have been known, at least by the Director Defendants.
282. Knowing that Lehman was in serious need of a capital infusion, on March 28,
2008, Defendant Fuld approached Warren Buffett, CEO of Berkshire Hathaway, to see if he would consider investing in Lehman. However, after examining certain of Lehman’s financial statements, Buffett had too many questions and decided it was imprudent to invest in Lehman.
Buffetts’ conclusion of imprudence was or should have been known to Defendants. If Lehman was an imprudent investment to Buffett, it was certainly imprudent for retirement savings.
283. By March 31, 2008, however, Defendant Fuld managed to raise $4 billion from several investment funds that already held a stake in Lehman. The funds were in the form of convertible preferred stock with a 7.25 percent interest rate and a 32 percent conversion premium.
284. As of March 31, 2008, the Company Stock Fund had lost nearly one hundred million dollars of retirement savings in just three months, and had a balance of only
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$131,766,469, though given the employee pre-disposed bias in favor of investments in company stock, this reduced amount still represented 6.6% of the assets of the entire Plan. At this time the
Company Stock Fund was the fourth largest investment fund by asset size. LEHMAN-
ERISA0001524-1525. It decreased in size by approximately $100 million since the beginning of the year, mostly driven by the -42% return for the first quarter 2008 (it was down approximately
47.7% for the year).
285. This information was presented to the Benefit Committee by way of a Mercer
Performance Comparison for March 2008, which listed March 2008 returns and year to date returns of -26.2% and -42.3% respectively, performances drastically worse than its benchmarks:
(1) S&P 500: -0.4% and -9.4%, respectively, and (2) S&P Financials, -2.7% and -14%, respectively. LEHMAN-ERISA0001514. Once again, the Benefit Committee Defendants failed to take any action to protect Plan participants.
286. On April 8, 2008, Lehman filed with the SEC its quarterly report on Form 10-Q for the first quarter of 2008, which reaffirmed the financial results for the Company previously released on March 18, 2008.
287. The First Quarter 2008 Form 10-Q also discussed the Company’s commercial real estate activities, noting, “Tight credit conditions and high commodity prices are anticipated to place continued strain on the capital markets, particularly the securitized products and commercial real estate components.” (Emphasis added). The First Quarter 2008 Form 10-Q also stated, in relevant part:
In the 2008 three months, credit markets and certain segments of financial asset markets, commercial real estate-related products, for example, declined further from what was observed at the end of the Company’s 2007 fiscal year. As a result of these market events, the Company recorded negative valuation adjustments on certain components of its financial inventory; substantially all of
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which are reflected within the results of operations for the Company’s Fixed Income component of Capital Markets. The negative valuation adjustments resulting from the impact of adverse market conditions were partially mitigated by economic risk management strategies employed as well as valuation changes on certain of the Company’s debt liabilities. The net amount of valuation adjustments in the 2008 three months was an approximate $1.8 billion reduction to the Company’s net revenues.
(Emphasis added).
288. The First Quarter 2008 Form 10-Q also acknowledged that the $6.5 billion of
Lehman’s “other asset-backed securities” consisted entirely of CDOs, and revealed for the first time that 25% of those securities were rated BB+ or lower – a junk rating. The First Quarter
2008 Form 10-Q stated the following regarding the Company’s investments in “other asset- backed securities”:
The Company purchases interests in and enters into derivatives with collateralized debt obligation securitization entities (“CDOs”). The CDOs to which the Company has exposure are primarily structured and underwritten by third parties. The collateralized asset or lending obligations held by the CDOs are generally related to franchise lending, small business finance lending, or consumer lending. Approximately 25% of the positions held at February 29, 2008 and November 30, 2007 were rated BB+ or lower (or equivalent ratings) by recognized credit rating agencies. In determining the fair value interests in CDOs, the Company considers prices observed for similar transactions and data for relevant benchmark instruments, such as swap obligations for similar obligations referenced by the instrument. In both reference periods, the value in the benchmark instruments as well as market developments caused a decline in the fair value of interests in CDOs, not actual defaults on swap obligations.
(Emphasis added).
289. The First Quarter 2008 Form 10-Q reported that the Company held $38.8 billion in Level 3 assets for which there was no reliable market and which were valued based only upon management assumptions. Level 3 assets include CDOs and other derivative securities which
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were particularly difficult to value since the market for them all but evaporated in 2007 as the subprime mortgage market collapsed.
290. On April 11, 2008, at a dinner at the Treasury Building, Secretary Paulson and
Defendant Fuld discussed Lehman’s status. Secretary Paulson told Defendant Fuld that he was concerned about a new International Money Fund report which estimated that mortgage and real estate-related write-downs could total $945 billion in the next two years. Secretary Paulson expressed his concern about the shocking amount of leverage being used by investment banks to raise their returns. At the time, Lehman was leveraged 30.7 to 1, the highest debt burden of any of the nation’s largest investment firms. Secretary Paulson also informed him that Lehman’s recent $4 billion capital raise, as beneficial as it was to the Company, was not going to mark the end of Lehman’s troubles and warned him that the pool of potential buyers for Lehman was not large.
291. Later in April, Robert Steel, undersecretary for domestic finance at the
Department of the Treasury, approached Robert Diamond, Jr., president of Barclays PLC, to ask if Barclays would be interested in acquiring Lehman. The Treasury was clearly concerned about
Lehman’s viability moving forward. Nonetheless, no one at Lehman, including the Plan fiduciaries, took any steps to protect the Plan participants.
292. At a conference on May 21, 2008, David Einhorn, President of Greenlight Capital
LLC, a hedge fund, analyzed the discrepancies between Lehman’s March 18, 2008, announcement of financial results and the Company’s First Quarter 2008 Form 10-Q. During the presentation, Mr. Einhorn discussed the inexplicably small write-down taken on Lehman’s CDO portfolio (only a $200 million write down on $6.5 billion in CDOs when $1.6 billion of these
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instruments were below investment grade) and the more than $1 billion disparity between the reported values of the Company’s Level 3 assets between March 18, 2008, and April 8, 2008.
293. Mr. Einhorn recounted his efforts to obtain an explanation from Lehman, and the constantly changing – and largely implausible – stories that Company management provided in response. According to Mr. Einhorn, when Ms. Callan was asked to clarify how Lehman could justify writing down just 3% of those securities, she responded only that the Company “would expect to recognize further losses” during the second quarter of 2008. Further, as noted in
Andrew Ross Sorkin’s book Too Big to Fail:
He [Einhorn] had suspected that Callan might be in over her head – or the firm was exaggerating its figures – ever since he had the opportunity to speak directly to her and some of her colleagues back in November 2007. He had arranged a call to Lehman to get a better handle on the company’s numbers, and like many firms do as a service to big investors, it made some of its top people available.
But something about the call unnerved him [Einhorn]. He had repeatedly asked how often the firm marked – or revalued – certain illiquid assets, like real estate. As a concept, mark-to-market is simple to understand, but it is a burden to deal with on a daily basis. In the past, most banks had rarely if ever bothered putting a dollar amount on illiquid investments, such as real estate or mortgages that they planned to keep. Most banks valued their illiquid investments simply at the price they paid for them, rather than venture to estimate what they might be worth on any given day. If they later sold them for more than they paid for them, they made a profit; if they sold them for less, they recorded a loss. But in 2007 that straight forward equation changed when a new accounting rule, FAS 157, was enacted. Now if a bank owned an illiquid asset – the property on which its headquarters was located, for example – it had to account for that asset in the same way as it would a stock. If the market went up for those assets in general, it would have to record that new value in its books and ‘write it up,’ as the traders put it. And if it fell? In that case, it was supposed to ‘write it down.’ While it may have been an interesting theoretical exercise – the gains and losses are not actually ‘realized’ until the asset is sold – mark-to-market had a practical impact: A firm that had a huge write-down has less value.
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What Einhorn now wanted to know was whether Lehman reassessed that value every day, every week, or every quarter.
To him it was a crucial question, because as values of virtually all assets continued to fall, he wanted to understand how vigilant the firm was being in reflecting those declines on its balance sheet. O’Meara suggested the firm marked assets daily, but when the controller was brought onto the call, he indicated that the firm marked those assets on only a quarterly basis. Callan had been on the phone for the entire conversation and must have heard the contradictory answers but never stepped in to acknowledge the inconsistency. Einhorn himself didn’t remark on the discrepancy, but he counted it as one more point against the firm.
Id. at 104.
294. Mr. Einhorn’s presentation revealed potential losses that Lehman had yet to acknowledge, and implied that the Company reported a first quarter profit only by overstating the value of its mortgage-backed assets and improperly delayed recognizing the potential losses to a later accounting period.
295. After Mr. Einhorn’s presentation on May 21, 2008, Company Stock closed at
$39.56 per share, on trading volume of 32,443,843, down $2.44 for the day. By June 2, 2008, the price of Company Stock had fallen nearly $6 per share, or almost 15%, to $33.83 per share.
296. On June 1, 2008, several top Lehman executives, including Tom Russo,
Lehman’s chief legal officer, Mark Shafir, the Company’s head of global mergers and acquisitions, and Brad Whitman, the global co-head, financial institutions, mergers and acquisitions, flew to Korea to see if they could obtain an equity infusion of up to $5 billion from
Korea Development Bank (“KDB”) to shore up its financial condition. They returned empty handed on June 5, 2008, unable to even agree on a rudimentary term sheet.
297. While the trip was ultimately unsuccessful, Lehman continued negotiations with
KDB throughout the summer to raise much needed funds. Defendant Fuld personally hired
Joseph Perella of Perella Weinberg Partners to see if he could broker a deal with KDB.
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298. On June 2, 2008, Standard & Poor’s lowered its credit rating for Lehman, citing questions about the Company’s financing of its operations.
299. The Company faced continuing concerns about its liquidity the following day, as
Lehman was forced to deny rumors that it had resorted to borrowing from the Federal Reserve’s
“discount window.” But on June 3, 2008, The Wall Street Journal reported that Lehman intended to raise an estimated additional $3 to $4 billion in capital following other significant fund raising earlier in 2008, including a $4 billion bond offering in January 2008 and the sale of
$1.9 billion of preferred shares in February 2008, which heightened concerns about the
Company’s ability to access the capital it needed.
300. On June 3, 2008, the market price for Company Stock fell nearly $3 per share to
$30.61, or 8%, on heavy volume of 136,822,964, in response to the downgrade and the liquidity concerns.
301. At the same time, Defendant Fuld attempted, unsuccessfully, to raise additional capital to meet Lehman’s liquidity demands from Hank Greenberg, the former chairman of AIG, as well as from General Electric.
302. Despite the Company’s rapidly deteriorating financial condition and prospects,
Defendants continued to breach their fiduciary duties to the Plan and its participants by failing to divest the Plan of any accumulated Company Stock, by permitting Plan participants to add to their Company Stock allocations through the Company Stock Fund, and by failing to disclose material, adverse information to Plan participants.
303. In an email exchange on June 3, 2008, some executives from Neuberger Berman,
Lehman’s money management subsidiary, recommended that Lehman’s top management forgo their bonuses in 2008 to reduce expenses and show that management remained accountable for
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Lehman’s recent performance. (LB 008234-35, produced in connection with the Lehman
Congressional Hearing).
304. George H. Walker, head of Neuberger Berman, responded to that suggestion as follows: “Sorry team. I’m not sure what’s in the water at 605 Third Avenue today . . . . I’m embarrassed and I apologize.” Id.
305. Referring to the executives who suggested that Lehman’s top management forego their 2008 bonuses, Defendant Fuld responded, “Don’t worry – they are only people who think about their own pockets.” Id.
306. The exchange of emails demonstrated that Lehman’s top management was unwilling to accept responsibility for Lehman’s financial woes. Rather, they mocked and ridiculed the suggestion that they defer any portion of their executive compensation.
307. According to a report by the Mortgage Bankers Association (“MBA”) issued on
June 5, 2008, for the first time in history, more than one million homes were reported to be in foreclosure, up from 938,000 homes that were in foreclosure at the end of last 2007. The report included indications that the foreclosure crisis was worsening: 448,000 homes began the foreclosure process during the first quarter of 2008, up from 382,000 that began the process in the last quarter of 2007. According to the report, loans at subprime rates were to blame for 39% of those foreclosures.
308. On June 9, 2008, Benoit D’Angelin, a partner at Centaurus Capital Ltd., a hedge fund, and former co-head of European investment banking at Lehman, sent an e-mail to Hugh
McGee, the global head of investment banking at Lehman, stating that many Lehman bankers had been calling him in the last few days, and the mood had become “truly awful.” (LB 008399, produced in connection with the Lehman Congressional Hearing). The email warned, “all the
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hard work we have put in could unravel very quickly,” and advised that “some senior managers have to be much less arrogant and internally admit that major mistakes have been made. Can’t continue to say ‘we are great, and the market doesn’t understand.’”
309. Mr. McGee forwarded the e-mail to Defendant Fuld that same day, and explained it was representative of many others he had received. Mr. McGee’s intention was to convince
Defendant Fuld that there needed to be a management shake-up. Specifically, he was calling for the ouster of Joseph Gregory, the president and Chief Operating Officer who happened to be a long-time friend of Defendant Fuld, and was quickly losing credibility within Lehman.
310. Nevertheless, Defendants and Lehman’s senior managers made no such admission of mistakes being made to Plan participants.
311. On June 9, 2008, prior to the market opening, Lehman issued a press release announcing its financial results for the second quarter of 2008 one week ahead of schedule.
Lehman reported a net loss of $2.8 billion – nearly ten times the loss analysts had anticipated and the first quarterly loss in the Company’s history – following write-downs of $3.7 billion to the
Company’s mortgage-backed assets. The press release stated in relevant part:
NEW YORK, June 9, 2008 – Lehman Brothers Holdings Inc. (ticker symbol: LEH) announced today that continued challenging market conditions will result in an expected net loss of approximately $2.8 billion, or ($5.14) per common share (diluted) for the second quarter ended May 31, 2008, compared to net income of $489 million, or $0.81 per common share (diluted), for the first quarter of fiscal 2008 and $1.3 billion, or $2.21 per common share (diluted), for the second quarter of fiscal 2007. For the first half of fiscal 2008, the Firm expects to report a net loss of approximately $2.3 billion, or ($4.33) per common share (diluted), compared to net income of $2.4 billion, or $4.17 per common share (diluted), for the first half of fiscal 2007.
The Firm expects to report net revenues (total revenues less interest expense) for the second quarter of fiscal 2008 of negative ($0.7) billion, compared to $3.5 billion for the first quarter of 2008 and $5.5 billion for the second quarter of fiscal 2007. Net
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revenues for the second quarter of fiscal 2008 reflect negative mark to market adjustments and principal trading losses, net of gains on certain debt liabilities. Additionally, the Firm incurred losses on hedges this quarter, as gains from some hedging activity were more than offset by other hedging losses. For the first six months of fiscal 2008, the Firm expects to report net revenues of $2.8 billion, compared to $10.6 billion for the first half of fiscal 2007.
During the fiscal second quarter, the Firm further strengthened its liquidity and capital position (all below amounts estimated as of May 31, 2008):
• Grew the Holding Company liquidity pool to an estimated $45 billion from $34 billion at the end of the prior quarter
• Decreased gross assets by approximately $130 billion and net assets by approximately $60 billion
• Reduced exposure to residential mortgages, commercial mortgages and real estate investments by an estimated 15- 20% in each asset class
• Increased the Firm’s long-term capital through the issuance of $4 billion of convertible preferred stock in April and approximately $5.5 billion of public benchmark long-term debt
* * *
Business Segments
Fixed Income Capital Markets is expected to report net revenues of negative ($3.0) billion, compared to $0.3 billion in the first quarter of 2008 and $1.9 billion in the second quarter of 2007. Excluding mark to market adjustments, related hedges and structured note liability gains, client activity in securitized products, municipals and commodities remained strong, while credit, interest rate and financing were down from last quarter but each up versus the year ago period.
312. Commenting on the financial results, Defendant Fuld stated:
I am very disappointed in this quarter’s results. Notwithstanding the solid underlying performance of our client franchise, we had our first-ever quarterly loss as a public company. However, with our strengthened balance sheet and the improvement in the
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financial markets since March, we are well-positioned to serve our clients and execute our strategy.
313. Also on June 9, 2008, Lehman issued a press release announcing that it would be raising $6 billion in capital through the sale of $4 billion in common stock and $2 billion in preferred stock, dwarfing the June 3, 2008 $3 to $4 billion estimate that The Wall Street Journal had reported Lehman was likely to raise.
314. As reported by The Wall Street Journal on July 10, 2008, “Lehman shares tumbled 8.7% [on June 9, 2008], or $2.81 [per share], to $29.48 . . . stem[ming] from investor frustration over the $6 billion in fresh capital raised by the company. That infusion has increased its cushion against potential losses but is diluting the value of Lehman’s common-stock by about
30%.”
315. After Lehman’s disclosure, Moody’s downgraded its rating of Lehman to
“negative” from “stable,” citing concerns about its exposure to real estate. In addition, the price of Lehman’s shares fell 12%, dropping from $32.29 to close at $28.47 on June 9, 2008.
316. The extent of the Company’s losses and write-downs was staggering. On June 9,
2008, Bloomberg News quoted David Hendler, an analyst at CreditSights Inc., as follows: “It’s kind of sobering for people who have been listening to the company these last six to nine months that they had everything under control.”
317. On June 10, 2008, Defendant Fuld met with his senior management, including
Mr. McGee. During the meeting, Mr. McGee advised Defendant Fuld and the group that
“[m]orale has never been worse . . . . We have to admit publicly we made some mistakes. We continue to spin like we’ve done nothing wrong. We’re better than this.” See Too Big to Fail,
Andrew Ross Sorkin, at p. 127.
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318. By June 11, 2008, it had become clear, at least to Defendant Fuld’s advisors, that management changes were necessary. Defendant Fuld met with the top investment bankers for lunch, including Mr. McGee, Mark Shafir, Jeffrey Weiss, head of the global financial institutions group, and Ros Stephenson and Paul Parker, both Lehman bankers. They informed Defendant
Fuld of all of the problems at Lehman, including the mistakes made by Joseph Gregory, who allowed reckless investments in real estate to decimate the Company. Still, Defendant Fuld refused to do what was best for the Company and fire his friend. Instead, Mr. Gregory took the burden off of him by resigning.
319. On June 12, 2008, the Associated Press published an article entitled “Lehman
Brothers Removes Finance, Operating Chiefs,” which stated in relevant part:
NEW YORK (AP) – Lehman Brothers Holdings Inc. shook up its management Thursday, removing two top executives in a concession that attempts to quell Wall Street anger over recent losses have failed.
The nation’s fourth-largest investment bank said Chief Financial Officer Erin Callan and Chief Operating Officer Joseph Gregory have been removed from their positions, days after the investment bank announced a $3 billion quarterly loss.
Investors were shaken after the company disclosed Monday it needed $6 billion of fresh capital to offset that loss, its first since going public in 1994. “When you have a stumble of this magnitude, change is not a bad thing,” said Lauren Smith, an analyst with Keefe, Bruyette & Woods. “I view the change, on the margin, as a good thing, but this runs a lot deeper than just changing a few high level managers.”
Since March, Callan had been taking on an increasingly more prominent profile as the face of Lehman during the credit crisis. She regularly met with analysts and appeared at investor conferences to talk up the company.
On Monday, Callan again waved the flag – telling analysts on a telephone call that Lehman’s books were in order and that the fresh dose of capital would allow traders to pursue new opportunities.
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But her pep talk failed and shares began to plummet toward a record low.
The lack of confidence in Lehman’s leadership has been hanging over the company for weeks, and it was unclear if the management upheaval will be enough to satisfy critics.
Shares have lost more than 20 percent this week and were down nearly 2 percent at midday.
320. A series of talking points were assembled in an internal document prepared in
June 2008, addressing why the Company had posted record losses during the prior year. In response to questions such as “WHY DID WE ALLOW OURSELVES TO BE SO EXPOSED?” the document gave reasons such as “CONDITIONS CLEARLY NOT SUSTAINABLE”; “SAW
WARNING SIGNS”: “DID NOT MOVE EARLY/FAST ENOUGH”; and “NOT ENOUGH
DISCIPLINE ABOUT CAPITAL ALLOCATION.” (LB 011894, produced in connection with the Lehman Congressional Hearing).
321. When shown the internal document during the October 6, 2008, congressional hearing, Defendant Fuld first claimed ignorance of the document. After Committee members contended it was either his or was reviewed by him, Defendant Fuld admitted: “if you tell me it is mine, I believe you.” Preliminary Hearing Transcript, p. 160.
322. On June 16, 2008, the Company issued a press release entitled “Lehman Brothers
Reports Second Quarter Results – Reports Net Loss of $2.8 Billion, or ($5.14) Per Share,” in which the Company reported a net loss of $2.8 billion for the second quarter ended May 31,
2008, compared to net income of $489 million for the first quarter of fiscal 2008 and $1.3 billion for the second quarter of fiscal 2007. Further, for the six months of fiscal 2008, the Company reported a net loss of approximately $2.3 billion, compared to net income of $2.4 billion, for the first half of fiscal 2007.
323. Unwilling to acknowledge the Company’s steep decline even after reporting
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staggering losses, during a June 16, 2008, earnings call with investors, Defendant Fuld stated,
“Let me discuss our current asset valuation on those remaining positions. I am the one who ultimately signs off and am comfortable with our valuations at the end of the second quarter, because we have always had rigorous internal process. . . . Our capital and liquidity positions have never been stronger.” (Emphasis added).
324. Further, as explained by the Examiner in his Congressional testimony:
In June 2008, one of Lehman’s clearing banks, Citibank, required that Lehman post $2 billion as a “comfort deposit” as a condition for Citi’s continued willingness to clear Lehman’s trades. Lehman was technically free to withdraw the deposit, but it could not do so as a practical matter without shutting down or disrupting the business it ran through Citi. Later in June, Lehman posted $5 billion of collateral to JPMorgan, Lehman’s main clearing bank, in response to an earlier demand by JPMorgan. Lehman continued to count virtually all of these deposits in its reported liquidity pool – nearly $7 billion of a reported $40 billion, 17.5% of the total.
325. In other words, at the very time when Defendants should have been reducing the number of shares of Company Stock in the Plan, prohibiting Plan participants from allocating any more of their retirement contributions to the Company Stock Fund, and informing Plan participants of the nature and extent of Lehman’s exposure to subprime lending, Defendants failed to disclose the truth to them and allowed them to continue saving for retirement with risky
Company Stock in their Plan accounts.
326. Indeed, on June 23, 2008, the Benefit Committee held a regular meeting, which
Defendants Archer, Branca, Estey, Feinstein, Romhilt and Uvino all attended in person, and
Defendant Arora attended by telephone. At this meeting, the Benefits Committee considered the
First Quarter 2008 Performance Evaluation Report of all funds. There was no mention, however, of Lehman’s poor performance in the minutes. At no time during this meeting did the Benefits
Committee Defendants consider the prudence of Company Stock as a retirement savings option
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nor did they consider whether to eliminate or curtail the Company Stock Fund as a retirement savings option. They also never considered whether to disclose the true facts about Lehman’s rapidly deteriorating financial and operating condition. See LEHMAN-ERISA0000980-983.
327. On June 26, 2008, two documents signed by Defendant Uvino and Lehman
Managing Director James Emmert, LEHMAN-ERISA0000907 and LEHMAN-ERISA0000908-
13 concern the audit of the Plan for the years ended as of December 31, 2006 and December 31,
2007 respectively. Each references the filing of the initial complaint in this action earlier in
June, and explicitly notes that members of the Board and the Benefits Committee were being sued for breach of fiduciary duties “by permitting Lehman Stock to remain an investment of the
Plan and by failing to disclose the extent and nature of Lehman’s subprime exposure and the imprudence of continuing to allow Plan participants to save for their retirements with the
Company Stock Fund.” Thus, by no later than June 26, 2008, Defendant Uvino was unquestionably aware of the nature of Plaintiffs’ allegations concerning, inter alia, Lehman’s subprime exposure. The other Defendants sued in June 2008 were no doubt similarly aware.
Nevertheless, Uvino and other Defendants took no action whatsoever to protect Plan participants, despite this clear warning, nearly three months prior to Lehman’s bankruptcy.
328. During the month of June, Lehman’s Stock price plunged. At the beginning of the month, on June 2, 2008, the stock closed at $33.83. But, by June 30th, it had fallen to just
$19.81.
329. As alleged herein, a significant portion of Lehman’s woes pertained to its commercial real estate holdings. However, as the Examiner explained, Lehman entered into “a series of large and risky commercial real estate transactions in the first half of 2007 without stress testing the particular transactions and without conducting regular stress testing on
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Lehman’s aggregate commercial real estate book.” According to the Examiner, stress tests dated
June 30, 2008 demonstrate that a large portion of Lehman’s risk “lay with the businesses that were previously excluded from stress testing.”
330. For example, as the Examiner explained:
One stress test posited maximum potential losses of $9.4 billion, including $7.4 billion in losses on the previously excluded real estate and private equity positions, and only $2 billion on the previously included trading positions. Another stress test showed total losses of $13.4 billion, of which $2.5 billion was attributable to the firm’s included positions, and $10.9 billion was attributable to the excluded positions.
331. Mercer’s Second Quarter 2008, Defined Contribution Performance Evaluation,
LEHMAN-ERISA0001613-1704, painted a grim picture for Plan fiduciaries concerning Lehman
Stock’s performance. It indicates that Lehman again was one of the S&P 500’s twenty-five largest negative contributors, with a -47.16% return. LEHMAN-ERISA0001621. Given that the value of Lehman Stock was dropping like a stone, Company Stock was now the sixth largest investment by asset size in the Plan. LEHMAN-ERISA0001621. The Performance Evaluation also explained that the Company Stock Fund “decreased almost $63 million in value, largely due to $59 million in investment losses.” LEHMAN-ERISA0001629. (Emphasis added). Its quarterly and year to date results were -47.2% and -69.5% respectively. LEHMAN-
ERISA0001647. Once more, Plan fiduciaries chose to take no action to protect Plan participants who were invested in Company Stock in the Plan.
332. The Company’s Form 10-Q, filed on July 10, 2008, for the period ending May 31,
2008 (“Second Quarter 2008 Form 10-Q”), also noted that Lehman had reduced assets,
“inventory positions related to residential mortgages, commercial mortgage and real estate- related investments, and acquisition finance facilities.”
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333. On July 10, 2008, desperate to find a partner for Lehman to raise necessary funds,
Defendant Fuld contacted John Mack, the Chief Executive Officer of Morgan Stanley to see if
Morgan Stanley was interested in investing in, or acquiring, Lehman. They scheduled a meeting at John Mack’s house for July 12, 2008. Nonetheless, this fundraising effort too was unsuccessful.
334. On July 11, 2008, an article entitled “Shares of Lehman Take a Beating as
Anxiety Builds in the Mortgage Market,” appeared in The New York Times, which reported that
Company Stock had fallen 12%, to $17.30 per share (at close on July 10th), when regulators said
“they would not bail out all financial institutions.” The article noted that in 2008, Lehman had lost 70% of its value, while broker-dealer stocks in general were down 33%.
335. Around the same time period, Defendant Fuld was quickly running out of options.
Nevertheless, he made another call to Rodgin Cohen, an attorney at Sullivan & Cromwell, to see if a sale of Lehman to Bank of America was possible. He also began discussions with Herbert
McDade, who was now the president and Chief Operating Officer of the Company, about a plan to shrink Lehman into a hedge fund with a boutique bank attached and trying to take the firm private, outside the glare of public investors.
336. The next day, he met with Gregory Curl, director of corporate planning at Bank of
America, to negotiate the sale of a one-third stake in Lehman in combination with a merger of the Investment Banking Operations under the Lehman name. Curl informed him that Bank of
America’s Chief Executive Officer, Kenneth Lewis, would only be interested in a transaction if there was a clear path to Bank of America taking control of Lehman within a defined period of time. After suggesting a two to three year time period, Curl promised to discuss the proposal with his Chief Executive Officer.
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337. Even after the government announced that it would not bail out other failing financial institutions, significantly increasing the risk that Lehman would collapse under the weight of its subprime mortgage risk, Defendants continued to breach their fiduciary duties by continuing to offer Company Stock as a retirement saving option in the Plan, failing to reduce the number of shares held by the Plan or preventing Plan participants from allocating even more shares to their accounts, and concealing the full nature and extent of the risk of catastrophic loss from the Plan participants.
338. On July 21, 2008, the government stepped in to guide Lehman through its apparent troubles. Secretary Paulson and Timothy Geithner helped schedule a secret meeting between Defendant Fuld and Kenneth Lewis. At the meeting, Defendant Fuld demanded that
Mr. Lewis and Bank of America purchase Lehman for a premium. Two days later, Mr. Lewis informed Defendant Fuld that he did not believe that they could arrange a transaction between their two companies.
339. According to The New York Times, on July 28, 2008, Secretary Paulson made a late-afternoon announcement that four major banks were planning to issue a new type of bond to aid the mortgage market. This announcement, however, did not stem Lehman’s Stock’s slide, which dipped 10.4% by day’s end.
340. On July 29, 2008, Defendant Fuld returned from a trip to Hong Kong, where he met with Min Euoo Song of the KDB to see if they could negotiate a sale of a majority stake in
Lehman to KDB.
341. These negotiations continued in the first week of August when Min Euoo Song flew to New York. He made an offer for KDB to buy Lehman for 1.25 times book value.
Defendant Fuld insisted on a higher offer and essentially broke off the negotiations with KDB
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due to his unrealistic and unsuccessful tactics.
342. Meanwhile, Herbert McDade was formulating a proposal, entitled “The
Gameplan” to split Lehman up into two entities. In essence, his proposal contemplated creating a good bank, which they would keep and a bad bank, which they would spin off in order to rid themselves of the most toxic real estate assets.
343. A Performance Comparison prepared by Mercer for July 2008, ostensibly for the
Benefit Committee Defendants and other Plan fiduciaries, listed a balance of only $60,731,925 in
Company Stock in the Plan, a stunning loss of more than $160 million in just six months.
LEHMAN-ERISA0001610. Its July 2008 and year to date returns were -12.5% and -73.3% respectively. In contrast, Lehman’s benchmarks were: (1) S&P 500: -0.8% and -12.7% respectively, and (2) S&P Financials: 7.1% and -24.7% respectively. Id. Nevertheless,
Defendants failed to consider whether Company Stock was a prudent retirement investment for
Plan participants, and therefore took no action to eliminate or curtail Company Stock as a Plan investment option before the stock became worthless.
344. On August 15, 2008, Secretary Paulson spoke with Defendant Fuld concerning this potential plan to “package commercial real estate into a separate company and spin it off to shareholders.” On The Brink: Inside the Race to Stop the Collapse of the Global Financial
System, Henry M. Paulson, Jr. p. 161. Paulson explained that “Lehman was having trouble attracting any [capital] from the private sector. [Defendant Fuld] asked Tim Geithner and me if the government would invest in Spinco. We each said no – several times. The government had no authority to do so.” Id.
345. In mid-August, the Department of the Treasury was increasingly concerned with the threat of a Lehman bankruptcy. Indeed, Secretary Paulson assigned one of his staff
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members, Steven Shafran, to act as a coordinator between the SEC and the Federal Reserve to create a contingency plan in case Lehman filed for bankruptcy.
346. As the Examiner reported, “Treasury Secretary Henry M. Paulson, Jr., privately told [Defendant] Fuld that if Lehman was forced to report further losses in the third quarter without having a buyer or a definitive survival plan in place, Lehman’s existence would be in jeopardy.”
347. After examining the Company, Shafran found four major risks within Lehman: its repo book, which includes its portfolio of repurchase agreements; its derivative book; its broker dealer; and its illiquid assets, such as real estate and private equity investment.
348. Later that month, Defendant Fuld had a conversation with Kendrick Wilson, advisor to Secretary Paulson, about Lehman’s prospects going forward. Defendant Fuld told him that he was happy with the news of the government takeover of Fannie Mae and Freddie Mac.
He also expressed concern about the lack of deals available to Lehman; a deal with either Bank of America or KDB seemed unattainable at this point. He informed Wilson of Lehman’s intention to pursue a good bank—bad bank strategy, in order to spin off Lehman’s toxic real estate assets. Wilson responded that he was also concerned that Lehman might be forced to accept a deal with a price in the single digits. Defendant Fuld was incredulous and informed him that Lehman would not entertain such an offer.
349. A regularly scheduled meeting of the Benefit Committee was set for August 18,
2009. Upon information and belief, at no time during this meeting did the Benefit Committee
Defendants consider the prudence of Company Stock as a retirement savings option nor did they consider whether to eliminate or curtail the Company Stock Fund as a retirement savings option.
They also never considered whether to disclose the true facts about Lehman’s rapidly
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deteriorating financial and operating condition. See LEHMAN-ERISA0000984 (meeting agenda).
350. The Wall Street Journal reported on August 18, 2008, that some analysts expected a loss of $1.8 billion or more in the company’s fiscal third quarter, which was less than two weeks away. If true, Lehman’s losses since early March would be at least $4.5 billion, or more than the profit Lehman made in fiscal year 2007.
351. On August 19, 2008, The New York Times reported that Lehman was considering selling all or part of its money management division “to private equity firms to raise billions of dollars of capital and ease the pressure cause by losses related to real estate.” The article explained that:
Through the mortgage boom, Lehman was a major player in the selling and packaging of residential and commercial mortgages. That has come back to haunt the firm, whose top management has extolled the virtues of conservative risk management. In the second quarter, Lehman lost $2.8 billion, mostly caused by write- downs from residential real estate investments, and was forced to raise $6 billion. Investors who bought into that deal have been burned as Lehman’s stock has continued to fall.
352. As the New York Times also reported on August 22, 2008, the market price for
Company Stock had “plunged more than 10 percent on 11 days of the last quarter,” and that despite Lehman’s significant exposure on approximately $61 billion in mortgages and asset- backed securities, it was “seeming[ly] reluctant to take drastic steps.”
353. On August 22, 2008, the Company’s Stock closed at just $14.41. As the price for
Company Stock plummeted and as Lehman edged closer to bankruptcy, Defendants continued to breach their fiduciary duties to the Plan and its participants by failing to divest the Plan of any accumulated Company Stock, by permitting Plan participants to add to their Company Stock allocations, and by failing to disclose material adverse information about the Company’s
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growing need for capital to fund continued operations.
354. On August 30, 2008, The Wall Street Journal reported that Lehman was exploring a structure to permit it to offload billions of dollars in real estate loans from its books, by setting up a “so-called good bank/bad bank structure.” The main difficulty, the article explained, was finding financing for such a spinoff or sale of these assets.
355. On or about September 4, 2008, J.P. Morgan, Lehman’s “clearing bank,” i.e., the middleman that stood between Lehman and its clients, demanded $5 billion in additional collateral to protect itself and its clients. October 6, 2008, “The Two Faces of Lehman’s Fall,”
The Wall Street Journal. When this went unresolved, five days later, on September 9, 2008,
Steven Black, co-CEO of J.P. Morgan’s investment bank called Defendant Fuld, demanding an additional $5 billion in collateral. Id. Defendant Fuld agreed to provide $3 billion right away, and did not reach any agreement regarding the prior $5 billion request.
356. A September 5, 2008, a New York Times article, entitled “Lehman May Split Off
Weak Holdings,” further discussed the “good bank/bad bank” solution to the Company’s problems. The article explained that Lehman was “contemplating placing about $30 billion of troublesome commercial mortgages and real estate that it owns into a new publicly traded company – the ‘bad’ bank. The rest of Lehman – the ‘good’ one – would then be able to carry on with the help of a cash infusion from one or more investors.”
357. On that date, Lehman’s stock closed at $16.20. Nevertheless, with the
Company’s options dwindling, Defendants continued to breach their fiduciary duties to the Plan and its participants by failing to divest the Plan of any accumulated Company Stock, by permitting Plan participants to add to their Company Stock allocations, and by failing to disclose material adverse information about the Company’s growing need for capital to fund continued
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operations.
358. On September 9, 2008, top Lehman executives discussed the need to raise between $3 and $5 billion to “shore up capital by early 2009.” “The Two Faces of Lehman’s
Fall,” The Wall Street Journal (October 6, 2008).
359. On September 9, 2008, Defendant Fuld received a call from Kendrick Wilson at the Treasury Department who implored him to reach out to Bank of America to resurrect the merger negotiations.
360. Also on that day, several Lehman executives met with representatives from JP
Morgan and Citigroup to see if they would extend a credit line to Lehman, or otherwise help
Lehman raise capital. The meeting was fruitless; neither bank offered a credit line.
361. That day, Timothy Geithner and Secretary Paulson spoke concerning Lehman.
Geithner informed Paulson that “the markets were very jittery, and that he did not see how
Lehman could survive in its current form. He said he had already spoken with a shaken
[Defendant] Fuld.” On The Brink: Inside the Race to Stop the Collapse of the Global Financial
System, Henry M. Paulson, Jr. p. 175.
362. By the afternoon of September 9, 2008, “the entire industry was beginning to understand the gravity of Lehman’s situation.” Id. at. p. 176.
363. That day, Lehman’s Stock price closed at approximately half its value from the previous day at just $7.79.
364. On September 10, 2008, the Company issued a press release announcing preliminary results for the third quarter ended August 31, 2008. The Company reported a net loss of $3.9 billion and announced “a comprehensive plan of initiatives to reduce dramatically the firm’s commercial real estate and residential mortgage exposure, generate additional capital
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through the sale of a majority stake of the Investment Management Division and reduce the annual dividend, in order to maximize value for clients, shareholders and employees.” The press release stated in pertinent part:
OVERVIEW OF PRELIMINARY THIRD QUARTER RESULTS
Lehman Brothers reported a preliminary net loss of approximately ($3.9) billion, or ($5.92) per common share (diluted), for the third quarter ended August 31, 2008, compared to a net loss of ($2.8) billion, or ($5.14) per common share (diluted), for the second quarter of fiscal 2008 and net income of $887 million, or $1.54 per common share (diluted), for the third quarter of fiscal 2007. The net loss was driven primarily by gross mark-to-market adjustments stemming from write-downs on commercial and residential mortgage and real estate assets.
Net revenues (total revenues less interest expense) for the third quarter of fiscal 2008 are expected to be negative ($2.9) billion, compared to negative ($0.7) billion for the second quarter of fiscal 2008 and $4.3 billion for the third quarter of fiscal 2007. Net revenues for the third quarter of fiscal 2008 reflect negative mark- to-market adjustments and principal trading losses, net of gains on certain risk mitigation strategies and certain debt liabilities.
During the fiscal third quarter, the Firm is expected to incur negative gross mark-to-market adjustments on assets of ($7.8) billion, including gross negative mark-to-market adjustments of ($5.3) billion on residential mortgage-related positions, ($1.7) billion on commercial real estate positions, ($600) million on other asset-backed positions and ($200) million on acquisition finance positions. These mark-to-market adjustments were offset by $800 million of hedging gains during the quarter and $1.4 billion of debt valuation gains. The Firm is also expected to record losses on principal investments of approximately $760 million.
In order to increase operating efficiency, the Firm has eliminated approximately 1,500 positions since the beginning of the third quarter in discretionary corporate areas and businesses that are in secular decline.
365. The September 10, 2008, press release explained that Lehman had “reduced its commercial real estate exposure by 18% in the third quarter from $39.8 billion to $32.6 billion”
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and was eyeing a spin off of the Company’s commercial real estate portfolio into a separate publicly-traded company.
366. In describing the market’s reaction to this announcement, Secretary Paulson wrote
“investors were having none of it. Lehman’s shares fell in pre-market trading, while its CDS jumped to 577 basis points. The market smelled a corpse.” On The Brink: Inside the Race to
Stop the Collapse of the Global Financial System, Henry M. Paulson, Jr., p. 180 (Emphasis added).
367. On September 10, 2008, Lehman publicly announced that its liquidity pool was
$41 billion, even though at least $15 billion had been pledged to various banks, including
JPMorgan and was, in fact, not liquid at all. By doing so, Lehman materially overstated its liquidity pool.
368. On the morning of September 10, 2008, Defendant Fuld and Herbert McDade received reports indicating that more hedge funds were withdrawing their funds from Lehman.
Even GLG Partners of London, whose largest stockholder was Lehman, decreased its business with Lehman.
369. In an investor conference call that day, Defendant Fuld said that Lehman intended to sell a majority stake in its investment management division and would cut its dividend. He told investors the firm was “on the right track to put these last two quarters behind us.”
Defendant Fuld did not mention the discussion among top Lehman executives the night before regarding the Company’s need to raise between $3 and $5 billion.
370. Indeed, when asked during the conference call whether the Company needed to raise another $4 billion, Ian Lowitt, Lehman’s CFO, denied the Company’s need for additional
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capital: “We don’t feel that we need to raise that extra amount.” Earlier in the conference call,
Mr. Lowitt stated, “Our capital position at the moment is strong.”
371. Prior to the conference call, certain Lehman employees were given a preview of the good bank/bad bank proposition that the Company was going to be announcing at that day’s call. Mohammed Grimeh, Lehman’s global head of emerging markets, was horrified that this was the solution that was supposed to save Lehman, and was quoted as saying “[i]f this is all we have, we’re toast!” See Too Big to Fail, Andrew Ross Sorkin, at p. 253.
372. Steven Shafran echoed that sentiment upon listening to the conference call, announcing “[t]his isn’t going to work” to a team of staffers who were listening to the conference call with him at the New York Federal Reserve Building.
373. Hours after the call, Defendant Fuld learned that Moody’s Investors Service planned to cut the Company’s credit rating unless Lehman quickly announced a merger with a strong financial partner. Defendant Fuld called John Mack and arranged a meeting of senior management, without Fuld or Mack, to discuss a Morgan Stanley acquisition of Lehman.
374. Defendant Fuld was unsuccessful on other strategic partner fronts because he refused to allow Goldman Sachs to conduct a due diligence review of Lehman’s books and, despite urging from Secretary Paulson, he refused to press for a sale to Barclays for fear of jeopardizing a potential transaction in the works with Bank of America.
375. The evening of September 10, 2008, senior Morgan Stanley and Lehman employees met at the residence of Walid Chammah, Morgan Stanley’s co-president, but were unable to reach common ground. Chammah also noted that it was unlikely that Morgan
Stanley’s board would be able to act quickly enough to be able to assist Lehman in any case.
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376. On September 10, 2008, Investors Business Daily reported that Company Stock had crashed 45% the previous day, to a near decade low. The article also revealed that Lehman had reportedly ended talks to sell a stake to state-owned Korea Development Bank.
377. In the last hours of trading, on September 10, 2008, Lehman Stock fell to $7.25, a
6.9% drop, while Lehman’s credit default swaps rose, making it considerably more expensive to buy insurance against a Lehman default on its obligations.
378. Also on or about September 10, 2008, Lehman retained Harvey Miller, a famed bankruptcy attorney practicing at Weil, Gotshal & Manges, who, according to the Examiner, began billing time to Lehman bankruptcy preparation. Nevertheless, even as Lehman was preparing for the contingency of a bankruptcy filing, Defendants failed to take any action to protect the interests of Plan participants who were invested in the Company Stock Fund.
379. The next day, on September 11, 2008, analysts’ responses to Lehman’s prior day’s announcements were grim. One Goldman Sachs analyst, William Tanona, wrote that
“[m]anagement did not successfully put to rest the issues that had been pressuring the stock.”
Another analyst, Michael Mayo, removed his buy rating on Lehman that he had kept since April
2007, and stated that “[t]he change in rating agency posture is an unexpected negative that may create a distressed sale situation.”
380. Also on September 11, 2008, John Mack of Morgan Stanley called Defendant
Fuld and informed him that he did not believe that the two companies should continue their negotiations.
381. Defendant Fuld then called Robert Diamond to discuss a merger with Barclays at the urging of Timothy Geithner. After informing Defendant Fuld several times that Barclays
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was not interested, on Defendant Fuld’s final attempt, Diamond said Barclays was willing to talk.
382. That day, Defendant Fuld was asked to resign from the board of the New York
Federal Reserve, to avoid the appearance of impropriety in case the government was required to front any money to find Lehman a strategic partner.
383. Also on September 11, 2008, Jane Buyers Russo, head of J.P. Morgan’s broker- dealer unit, called Lehman’s treasurer, Paolo Tonucci, demanding the $5 billion in collateral that
J.P. Morgan had asked for earlier. “The Two Faces of Lehman’s Fall,” The Wall Street Journal
(October 6, 2008). Jamie Dimon, J.P. Morgan’s chairman and chief executive officer, reiterated this demand of Defendant Fuld in a conference call later that day. In acceding to J.P. Morgan’s demand, Lehman’s computerized trading systems temporarily froze and the Company was nearly left with insufficient capital to support its trading and other operations. Id.
384. That same day, despite Lehman’s precarious cash position, a request was submitted to the Compensation Committee of Lehman’s Board to give three departing executives over $20 million in “special payments.” (LB 004731, et seq., produced in connection with the
Lehman Congressional Hearing).
385. The Company’s Stock price was plagued by even further losses, closing at just
$4.22 on September 11, 2008.
386. On Friday, September 12, 2008, credit rating agencies warned the Company that its debt would be further downgraded if Lehman was unable to raise additional capital. “The
Two Faces of Lehman’s Fall,” The Wall Street Journal (Oct. 6, 2008).
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387. The Examiner reported that “[b]y September 12, two days after it publicly reported a $41 billion liquidity pool, the pool actually contained less than $2 billion of readily monetizable assets.”
388. By then, customers were leaving Lehman in droves, so much so that the Company
“couldn’t properly process the requests.” “The Two Faces of Lehman’s Fall,” The Wall Street
Journal (Oct. 6, 2008). Moreover, the firm’s cash-management system could not handle the overload and, as a result, Lehman’s New York operations were unable to transfer money to its
London accounts, leaving Lehman’s London operations, or its counterparties, short by an estimated $5 billion by Monday September 15, 2008, as estimated by PricewaterhouseCoopers
LLP. Id.
389. Also on September 12, 2008, Secretary Paulson and his team leaked to CNBC economics reporter Steve Liesman that the government would not be bailing out Lehman. At around 9:15, the CNBC ticker reported “Breaking News: Source: There will be no government money in the resolution of LEH situation.” That morning, Lehman stock opened at $3.84, down
9% from the previous day’s close.
390. That day, Mr. Diamond arrived at Lehman, met with Defendant Fuld, and then met with his team of investment bankers conducting their due diligence on Lehman.
391. After close of business Friday, when Lehman’s stock price was just $3.65 per share, Lehman’s busy weekend began. The New York branch of the Federal Reserve arranged emergency meetings which began that night. Representatives of the Federal Reserve asked firms, including Goldman Sachs Group Inc. and Credit Suisse, to value the Company’s commercial-real-estate portfolio and to consider buying it.
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392. At the same time, Lehman worked to try and arrange a sale of the Company to potential buyers Barclays PLC or Bank of America, who were not interested. Additionally, counsel for Lehman continued its preparation for Chapter 11 bankruptcy. The Wall Street
Journal “The Two Faces of Lehman’s Fall,” October 6, 2008.
393. Over the course of those weekend meetings, Lehman was grilled as to why it had not reduced the value of its $32.6 billion commercial-real-estate holdings, as it was obligated to do. As The Wall Street Journal explained, “Securities firms are required to ‘mark to market’ their holdings, meaning to value them on their books at the level at which they could sell them right away.” Executives reviewing Lehman’s commercial real estate portfolio put the
Company’s valuation thereof at approximately 35% greater than it should have been valued. Id.
394. Both Lloyd Blankfein, chief executive of Goldman Sachs, and James Dimon, chief executive of JP Morgan, had informed Secretary Paulson privately that their two companies had reduced most of their exposure to Lehman should it fail. Indeed, Blankfein even announced as much to the group during that Saturday’s meetings, stating “[w]e’ve all seen this coming from miles.” See Too Big to Fail, Andrew Ross Sorkin, at p. 303.
395. Attempts by Defendant Fuld to reach Kenneth Lewis as a last ditch effort to revive merger negotiations with Bank of America were to no avail. After trying to reach him repeatedly, Defendant Fuld called Lewis at home, and Lewis’ wife informed him that Lewis would not take his call and that he should stop calling.
396. Lewis later informed the Examiner that its due diligence regarding a potential transaction with Lehman in September 2008 revealed that Lehman’s commercial real estate marks were too high. In particular, Lewis described a massive “$66 billion hole” in Lehman’s valuation of its assets.
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397. Even as the Company stood on the doorstep of bankruptcy, Defendants continued to breach their fiduciary duties to the Plan and its participants by failing to divest the Plan of any accumulated Company Stock, by permitting Plan participants to add to their Company Stock
Fund allocations, by failing to withdraw the Company Stock Fund as a Plan investment option, and by failing to disclose material adverse information about the Company’s then-impending bankruptcy, unreasonably and inexplicably exposing the Plan’s participants to near-certain catastrophic loss of their retirement savings.
398. By Sunday September 14, 2008, with no bail-out offered by the government and no buyer in sight, having failed to reach a deal with Bank of America, Barclays, Morgan Stanley, or any other buyer, the Company finalized its bankruptcy filing, which was filed shortly after midnight, on September 15, 2008. Id.
399. Lehman filed a voluntary petition to reorganize under Chapter 11 of the Federal
Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York.
Lehman’s bankruptcy filing listed debts of $613 billion and named banks from Tokyo, Hong
Kong, New York, Singapore, Taipei and elsewhere as unsecured creditors of hundreds of millions of dollars. According to The Wall Street Journal, Lehman’s bankruptcy is the largest bankruptcy in U.S. history “by a factor of six.”
400. On September 16, 2008, The New York Times reported that Barclays had reached a tentative agreement to buy Lehman’s core capital markets business for $1.75 billion, which was “far less than Lehman had hoped for.”
401. In describing the Barclays deal, The Wall Street Journal reported on September
17, 2008, that “[t]he price tag, for what was roughly half the entire company, appears to value the business at a tiny fraction of what it would have fetched 18 months ago. The acquisition
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includes Lehman’s headquarters, built in 2001 and currently worth $600 to $900 million, according to real-estate brokers. By comparison, the company’s entire stock-market value in early 2007 was $45 billion.”
402. According to a report by CNN on September 23, 2008, the FBI is investigating
Lehman and other companies as well as their senior executives for potential mortgage fraud.
The FBI is seeking to determine whether anyone at Lehman, including its senior executives, had any responsibility for providing “misinformation,” CNN reported.
403. On September 24, 2008, Datamonitor Wires reported that Barclays had announced that Lehman had begun to reopen for business under the ownership of Barclays
Capital, following the Bankruptcy Court’s approval of Barclays’ agreement to purchase
Lehman’s “fixed income and equity sales, trading and research; prime services; investment banking; principal investing; and private investment management businesses in North America.”
404. On October 7, 2008, The Wall Street Journal reported that at least three United
States Attorneys are investigating whether Lehman misled investors before its bankruptcy filing.
The central issue under investigation is whether Lehman’s public statements concerning the soundness of its financial condition differed from its own “behind the scenes” internal evaluations, such that a case could be brought that Lehman fraudulently misled shareholders and other parties.
405. Separately, prosecutors are investigating whether Lehman: (i) valued its commercial real estate assets at artificially high levels; (ii) improperly transferred $8 billion from its London operations to New York just ahead of its bankruptcy filing; and (iii) misled New
Jersey’s pension fund concerning the Company’s financial health in connection with a $6 billion stock offering in June. As of October 16, 2008, twelve people had been subpoenaed in
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connection with those investigations. Ben James, “Lehman Brothers Targeted in Three Grand
Jury Probes,” available at http://securities.law360.com/articles/73154 .
406. On September 10, 2010, The Wall Street Journal reported that the SEC’s investigation of Lehman is zeroing in on Lehman’s use of Repo 105, and that “the narrowing probe could move the SEC closer to bringing civil charges relating to Lehman’s collapse in
September 2008 . . . .”
G. The Congressional Hearing Into Causes and Effects Of The Lehman Bankruptcy
407. In his opening statement at the October 6, 2008, congressional hearing, Rep.
Waxman charged that Lehman and Defendant Fuld failed to take responsibility for the collapse of Lehman, noting that internal documents “portray a company in which there was no accountability for failure.”
408. The Committee estimated that Defendant Fuld pocketed roughly $480 million in pay since 2000. In his defense, Defendant Fuld suggested that his pay was closer to $350 million in that time, and noted that Lehman’s compensation system ties executive pay to performance.
409. During the congressional hearing, Nell Minow, Editor of the Corporate Library, reviewed the ratings her firm gave to Lehman’s Board:
• March, 2002 – Coverage initiated, initial overall D rating assigned; • June, 2003 – Rating upgraded to overall B; • October, 2003 – Rating downgraded to overall C; • June, 2004 – Rating downgraded to overall D; and • September, 2008 – Rating downgraded to overall F
410. Ms. Minow gave the Committee the following excerpt from one of the Corporate
Library’s analyst notes on the Company:
Although [CEO Richard Fuld’s] 2007 salary of $750,000 is well below the median for companies of similar size, his non-equity
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incentive compensation of $4,250,000 exceeded the 85th percentile. While typical target bonus is two times base salary, Mr. Fuld’s was more than five times his base salary. Additionally, his total annual compensation of $71,924,178 ranks in top 3% for similarly-sized companies. This figure includes $40,278,400 from value realized on the exercise of options and $26,470,870 from value realized on vesting of shares. This raises serious concerns over the alignment of compensation practices with shareholder interests.
411. Defendant Fuld’s compensation over the past five years was as follows:
5-Year Compensation -- Fuld Amount
Base Salary $3,750,000 Annual Bonus $41,150,000 Equity Value Realized $225,068,018 All Other Compensation $391,012 5-year total $269,968,018
412. Commenting on Lehman’s Board, Ms. Minow stated:
Pay that is out of alignment is one of the causes of poor performance but it is also an important symptom – of an ineffective board.
We have looked at bad boards for several years and we often see patterns other than poorly designed pay packages that recur in the boards later proved to be the most dysfunctional. A number of those patterns are present in the Lehman board. They include inadequate expertise and too-long tenure.
While some of the individual director backgrounds at Lehman reflect more experience in banking and financial services than some of the other recent failed firms, overall it did not have the depth of experience it needed. Notes Dennis K. Berman of the Wall Street Journal:
Nine of them are retired. Four of them are over 75 years old. One is a theater producer, another a former Navy admiral. Only two have direct experience in the financial-services industry . . . . Until the 2008 arrival of former US Bancorp chief Jerry Grundhofer, the group was lacking in current financial-knowledge firepower. A number of the members did have past financial-markets expertise, but most of their working lives were tied to a different era: The one
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before massive securitization, credit-default swaps, derivatives trading, and all the risks those products created.
Until recently, one director was actress Dina Merrill, daughter of E.F. Hutton. She retired in 2006 at age 83 after 18 years of service. At the time of her retirement Ms. Merrill was a member of Lehman’s Nominating & Corporate Governance and Compensation & Benefits Committees.
Currently serving on the board is Broadway producer Roger Berlind, 76, the longest tenured member of the Lehman board, his only public company directorship. While we do not recommend over-boarding, it is usually not a good idea to have people on boards who have no other board or sector experience. Mr. Berlind is a member of Lehman’s Audit and Finance & Risk Management Committees. Also on the board is Marsha Johnson Evans, 60, a former Rear Admiral with the US Navy and head of the American Red Cross and Girl Scouts of the USA. Ms. Evans is a member of Lehman’s Nominating and Corporate Governance, Compensation & Benefits, and Finance & Risk Management Committees. She is also an active director of three other large US corporations: Weight Watchers International, Office Depot, and Huntsman Corporation; she is a former director of AutoZone. Michael Ainslie, who has been on the board for 12 years, is the former Chief Executive Officer Sotheby's and former President and CEO of the National Trust for Historic Preservation.
With regard to tenure, which can impair independence of judgment, this is a board with very little turnover. Roger Berlind has been on the board for 23 years and six other directors have served for over a decade.
Another point worth noting is that Lehman’s Finance & Risk Management Committee, which is chaired by 80 year old director Henry Kaufman, only met twice in 2007, and twice in 2006. Kaufman has served on the Lehman board for 14 years; he was also a member of the Freddie Mac board, from which he retired in 2004 after 13 years of service. A company in this sector should have a risk management committee that is vitally involved and has a great depth of expertise. A company that had $7 billion in losses after becoming embroiled in the global credit crisis had a risk management committee that did not understand or manage its risk.
413. Luigi Zingales, Professor of Finance at the University of Chicago, also provided testimony before Congress on October 6, 2008. He opined that, inter alia, part of Lehman’s
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downfall, and for the subprime crisis, was the relationship between investment banks and rating agencies: “instead of submitting an issue to the rating agency’s judgment, investment banks shopped around for the best ratings and even received handbooks on how to produce the riskiest security that qualified for an AAA rating.”
414. Prof. Zingales also explained that the lack of transparency of these vehicles coupled with their complexity were “such that small differences in the assumed rate of default can cause the value of some tranches to fluctuate from 50 cents on the dollar to zero.”
415. Prof. Zingales also testified that Lehman’s situation was aggravated by its very high leverage and “strong reliance on short-term debt financing.” Even though commercial banks may not leverage their assets-to-equity ratio by more than 15 to 1, Lehman’s leverage ratio was more than double that amount. As Prof. Zingales explained, with such high leverage, “a mere drop of 3.3% in the value of assets wipes out the entire value of equity and makes the company insolvent.” Prof. Zingales testified that Lehman’s leverage woes were exacerbated by its heavy reliance on short-term debt, which increased the risk of “runs” on its cash like those a bank faces when it is rumored to be insolvent.
416. Prof. Zingales testified that Lehman’s demise was not an accident, but rather the result of an “unlucky draw of a consciously-made gamble.”
417. In response to examination by Rep. John Tierney, Ms. Minow refuted Defendant
Fuld’s claim that he was a “victim of circumstances.” Addressing Defendant Fuld’s assertion,
Ms. Minow testified emphatically: “No. I think it is horrific. I can’t believe that he would have the chutzpah to say something like that. I hold him completely responsible. I hold him responsible and his board responsible for the foreseeable consequences of the decisions they made.”
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418. Prof. Zingales echoed that sentiment, testifying that Defendant Fuld was responsible for having, among other things “a too aggressive leverage policy, too much short- term debt that makes the firm sort of at risk of a background that is exactly what happened, and to have not controlled the risk that the firm was taking during this boom period.”
VII. CONDUCT CONSTITUTING DEFENDANTS’ FIDUCIARY BREACHES
419. ERISA imposes strict fiduciary duties of loyalty and prudence upon the
Defendants as fiduciaries of the Plan. Defendants breached their duties to manage the Plan’s assets prudently and loyally because, during the Class Period, Defendants knew or should have known that Company Stock was not a prudent investment for the Plan and knew or should have known that the value of Company Stock was exposed to an unacceptable risk of loss.
420. Throughout the Class Period, Defendants knew or should have known of the unreasonable risk of subprime debt loss to which the Company was exposed and the enormous risk posed by its leveraged position, as alleged herein. By the monumental collapse of Bear
Stearns onward, Lehman Stock was no longer a prudent retirement saving option for Plan participants. Nonetheless, Defendants permitted the Company Stock Fund to be offered as a retirement savings option in the Plan, did nothing to reduce the number of shares held by the
Plan or preclude Plan participants from allocating even more shares to their accounts, and failed to disclose material adverse information about the Company’s deteriorating financial condition and prospects from them, leaving the Plan and its participants heavily exposed to the subprime risk – even after the Company retained bankruptcy counsel and was preparing for a potential bankruptcy filing.
421. Upon information and belief, no Defendant conducted an appropriate investigation into whether Company Stock was a prudent retirement saving option for Plan participants in light of: (a) the collapse of Bear Stearns; (b) the Company’s extreme risk of
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subprime debt loss, or (c) whether Company Stock was a prudent retirement saving option for
Plan participants at the prices it traded during the Class Period in light of the material adverse information that was not disclosed to the investing public during the Class Period, despite the large number of shares of Company Stock held in the Company Stock Fund in the Plan during the Class Period.
422. Moreover, no Defendant provided Plan participants with adequate information regarding (i) the true nature and extent of Lehman’s leverage; (ii) the risk that Lehman would not be able to fund ongoing operations; (iii) its use of Repo 105; (iv) its extraordinary subprime credit risk, or (v) its risk of collapse. As a result, Plan participants could not make informed decisions whether to allocate their Plan contributions to Company Stock as a means of saving for retirement.
423. Indeed, not one of the Defendants took any meaningful action to protect the Plan against the risk of enormous losses as a result of the Company’s very risky and inappropriate corporate misconduct.
424. On a Plan-wide and Class-wide basis, the risk of an undiversified investment in
Company Stock imposes a greater risk than that of other undiversified investments.
425. The risk associated with allocating Plan contributions to the Company Stock Fund during the Class Period was extraordinary, far above and beyond a prudent level of risk associated with retirement saving. This abnormal investment risk could not have been known by the Plan’s participants, and Defendants knew or should have known that it was not known by them because said Defendant fiduciaries never disclosed it. This extraordinary risk made any investment in Company stock inappropriate and imprudent.
426. Defendants had a heightened duty with regard to both the decision to continue
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investing in the Company Stock Fund as well as the duty to inform participants concerning the imprudence of investing in the Company Stock Fund. Ultimately, it was imprudent for
Defendants to continue to offer Company Stock in the Company Stock Fund as a Plan investment option, and that it was imprudent for Plan fiduciaries to continue to invest Plan assets in Company Stock through the Company Stock Fund.
427. Defendants breached their fiduciary duties when they (i) failed to conduct an appropriate investigation into whether Company Stock was a prudent retirement saving option;
(ii) failed to develop appropriate guidelines for allocating retirement contributions to the
Company Stock Fund; (iii) failed to divest the Plan of Company Stock; (iv) failed to discontinue further allocation of retirement contributions to Company Stock in the Plan; (v) failed to remove
Company Stock as a retirement saving option in the Plan; (vi) failed to halt the investment of
Plan assets in Company Stock; (vii) failed to consult with or appoint independent fiduciaries regarding the appropriateness of Company Stock as a retirement saving option; (viii) failed to disclose sufficient information about Lehman’s financial condition and prospects to permit Plan participants to make informed decisions whether to allocate retirement contributions to the
Company Stock Fund in the Plan; (ix) failed to provide other Plan fiduciaries with material information concerning Lehman’s prospects and true financial condition so that Plan fiduciaries could properly evaluate whether Lehman Stock should continue to be offered as a Plan investment option; and (x) failed to resign as fiduciaries of the Plan, if as a result of their employment by Lehman, they could not loyally serve the Plan and its participants.
428. Defendants breached their fiduciary duties by making direct and indirect communications with Plan participants in their fiduciary capacity which contained materially inaccurate statements that Defendants knew or should have known were inaccurate. These
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communications included statements regarding (i) Lehman’s net leverage ratio; (ii) its exposure to credit market risk; (iii) its risky lending practices; (iv) its earnings; and (v) its profitability as alleged herein that were contained in the documents specifically incorporated into the SPD, including Form 10-K annual reports, Form 10-Q quarterly reports, and Form 8-K periodic reports, Lehman’s annual reports, and the Plan’s annual reports on Form 11-K. No Defendant took any action to remedy the breaches set forth in this paragraph.
429. Moreover, Defendants knew or should have known certain well-recognized facts about the characteristics and behavior of retirement plan participants, including:
(a) out of loyalty, employees tend to invest in company stock;
(b) employees tend not to change their retirement saving allocations once made;
(c) lower income employees tend to invest more heavily in company stock than more affluent workers, though they are at greater risk; and
(d) many employees do not recognize their exposure to massive loss from failing to diversify their retirement savings.
430. Any warnings of market and diversification risks that Defendants made to Plan participants regarding Company Stock as a means of saving for retirement did not effectively inform the Plan participants of the past, immediate, and future risk of investing in Company
Stock that Defendants knew or should have known, as alleged herein.
431. Based on their actual or constructive knowledge as set forth herein, Defendants knew about Lehman’s risky exposure to the subprime credit market. Defendants knew or should have known of the affirmative misrepresentations made to Plan participants in the SEC documents and annual reports incorporated into the SPD. Defendants knew or should have
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known that the Plan participants lacked the knowledge that Defendants had or should have had concerning the unsound business practices and knew or should have known that the Plan participants would be harmed by this lack of knowledge. Defendants, on a Plan-wide and Class- wide basis, never accurately disclosed to Plaintiffs or the Plan participants the true nature, extent, and risks of these problems. Rather, Defendants failed to timely communicate accurate information to the Plan participants concerning Lehman’s true financial condition, including its net leverage ratio, use of Repo 105, and risky exposure to the subprime credit market in prior periods, when they knew or should have known that the Plan participants needed this information. Defendants or their individual fiduciary delegates, on a Class-wide and Plan-wide basis, failed to provide the Plan participants with complete and accurate information regarding
Company Stock, such that the participants could appreciate the true risks presented by investments in the Company Stock Fund and could make informed decisions, thereby avoiding the unreasonable and entirely predictable losses incurred as a result of the Plan’s investment in
Company Stock. No Defendant took any action to remedy the breaches set forth in this paragraph.
432. The Director Defendants failed in their fiduciary responsibilities in monitoring, which includes the provision of material information, the Compensation Committee Defendants and the Benefit Committee Defendants (including any additional “John Doe” Defendants).
433. The Director Defendants breached their fiduciary duties because they did not have procedures in place so that they could review and evaluate on an ongoing basis whether the
Compensation Committee Defendants and the Benefit Committee Defendants (including any additional “John Doe” Defendants) were performing their duties adequately and in accordance with ERISA’s fiduciary provisions.
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434. The Director Defendants failed to adequately review the performance of the
Compensation Committee Defendants and the Benefit Committee Defendants (including any additional “John Doe” Defendants) to: (i) ensure that they were fulfilling their fiduciary duties under the Plan and ERISA; (ii) ensure that they had adequate information to do their job of overseeing the Plan’s investments; (iii) ensure that they had adequate access to and use of impartial advisors when needed; and (iv) ensure that they reported regularly to the Board.
435. The Director Defendants breached their fiduciary duties to remove the
Compensation Committee Defendants and the Benefit Committee Defendants (including any additional “John Doe” Defendants) when they knew they had breached their fiduciary duties.
436. The Compensation Committee Defendants failed adequately to review the performance of the Benefit Committee Defendants (including any additional “John Doe”
Defendants) to: (i) ensure that they were fulfilling their fiduciary duties under the Plan and
ERISA; (ii) ensure that they had adequate information to do their job of overseeing the Plan’s investments; (iii) ensure that they had adequate access to and use of impartial advisors when needed; and (iv) ensure that they reported regularly to the Board.
437. To the extent that the Director Defendants, including the Compensation
Committee Defendants, appointed members of the Benefit Committee who were insufficiently informed to determine when, at the beginning of the Class Period, the Company Stock had become imprudent for retirement savings, the Director Defendants, including the Compensation
Committee Defendants, breached their fiduciary duty by failing to appoint fiduciaries who were able to act in the best interests of the Plans and their participants.
438. To the extent that the Director Defendants, including the Compensation
Committee Defendants, failed to provide sufficient material, non-public information about
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Lehman’s deteriorated financial condition and its imminent collapse to the members of the
Benefit Committee who were otherwise insufficiently informed to determine when the Company
Stock had become imprudent for retirement savings, the Director Defendants, including the
Compensation Committee Defendants, breached their fiduciary duty by failing to monitor and supervise appointed fiduciaries to act in the best interests of the Plans and their participants.
439. By virtue of their seniority, and their membership in Board committees such as the Audit Committee, Finance and Risk Committee, Nominating and Corporate Governance
Committee, and the Executive Committee, the Compensation Committee Defendants knew, or should have known, that the Company Stock Fund was not a prudent retirement investment for
Plan Participants. Despite this knowledge, Defendants breached their fiduciary duties to the Plan and its participants by failing to take action to protect them from the subprime collapse and
Lehman’s subsequent decline into bankruptcy, continuing to allow the Plan and its participants to acquire and hold over-valued Company Stock in the Company Stock Fund and failing to disclose material adverse information about the Company’s financial condition and prospects from them.
440. Similarly, the Benefit Committee Defendants were comprised of individuals highly placed in the Company, see supra ¶¶ 62-68, who knew, or should have known of the huge risk of failure facing Lehman, from the date of Bear Stearns’ collapse until Lehman’s bankruptcy, and yet failed to take the necessary steps to protect Plan Participants.
441. Throughout the entire Class Period, as Lehman headed towards financial ruin, the
Benefit Committee only met on two occasions prior to Lehman’s bankruptcy, and never considered whether Lehman Stock was a prudent retirement savings option, and never considered whether to eliminate or curtail the Company Stock Fund as a retirement savings option.
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442. Throughout the entire Class Period, as Lehman headed towards financial ruin, the
Benefit Committee only met on two occasions prior to Lehman’s bankruptcy, and never considered whether to disclose the true facts about Lehman’s rapidly deteriorating financial and operating condition and prospects, and never considered whether to correct the misstatements or omissions of the Company, Defendant Fuld, Ms. Callan, and others alleged herein.
443. As is clear from the enormous trading volumes from September 8th through the
15th, the public was aware of the threat of a Lehman bankruptcy. Indeed, despite action taken by many in the market to protect themselves from catastrophic losses, Plan fiduciaries nevertheless took no action to protect the Plan or Plan participants.
444. An internal Lehman document (LEHMAN-ERISA0000371), sets forth the shares of Company Stock bought and sold by the Plan prior to, and during, the Class Period. Among other things, it shows that in the week immediately preceding Lehman’s bankruptcy, the Plan bought Company Stock three times. More importantly, however, it shows that only following the announcement of Lehman’s bankruptcy, did the Benefit Plan Committee bestir itself to sell
2,333,951 shares of Lehman Stock for a mere $403,710.63, doing too little and acting too late to protect Plan participants’ substantial investment in Company Stock:
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VIII. REMEDY FOR BREACHES OF FIDUCIARY DUTY
445. Defendants breached their fiduciary duties in that they knew or should have known the facts as alleged above, and therefore knew or should have known that the Plan’s assets should not have been invested in Company Stock through the Company Stock Fund,
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during the Class Period. As a consequence of Defendants’ breaches, the Plan suffered significant losses.
446. ERISA § 502(a)(2), 29 U.S.C. § 1132(a)(2), authorizes a plan participant to bring a civil action for appropriate relief under ERISA § 409, 29 U.S.C. § 1109. Section 409 requires
“any person who is a fiduciary . . . who breaches any of the . . . duties imposed upon fiduciaries .
. . to make good to such plan any losses to the plan.” Section 409 also authorizes “such other equitable or remedial relief as the court may deem appropriate.”
447. With respect to calculating the losses to the Plan, breaches of fiduciary duty result in a presumption that, but for the breaches of fiduciary duty, the Plan would not have maintained its investments in the challenged investment and, instead, prudent fiduciaries would have invested the Plan’s assets in the most profitable alternative investment available to them. The
Court should adopt the measure of loss most advantageous to the Plan. In this way, the remedy restores the Plan’s lost value and puts the participants in the position they would have been in if the Plan had been properly administered.
448. Plaintiffs and the Class are therefore entitled to relief from Defendants in the form of: (i) a monetary payment to the Plan to make good to the Plan the losses to the Plan resulting from the breaches of fiduciary duties alleged above in an amount to be proven at trial based on the principles described above, as provided by ERISA § 409(a), 29 U.S.C. § 1109(a); (ii) injunctive and other appropriate equitable relief to remedy the breaches alleged above, as provided by ERISA §§ 409(a), 502(a)(2) and (3), 29 U.S.C. §§ 1109(a), 1132(a)(2) and (3);
(iii) injunctive and other appropriate equitable relief pursuant to ERISA § 502(a)(3), 29 U.S.C.
1132(a)(3), for knowing participation by a non-fiduciary in a fiduciary breach; (iv) reasonable attorney fees and expenses, as provided by ERISA § 502(g), 29 U.S.C. § 1132(g), the common
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fund doctrine, and other applicable law; (v) taxable costs and interest on these amounts, as provided by law; and (vi) such other legal or equitable relief as may be just and proper.
449. Under ERISA, each defendant is jointly and severally liable for the losses suffered by the Plan in this case.
IX. DEFENDANTS SUFFERED FROM CONFLICTS OF INTEREST
450. As ERISA fiduciaries, Defendants are required to manage the Plan’s investments, including the investment in Company Stock, solely in the interest of the participants and beneficiaries, and for the exclusive purpose of providing benefits to participants and their beneficiaries. This duty of loyalty requires fiduciaries to avoid conflicts of interest and to resolve them promptly when they occur.
451. Conflicts of interest abound when a company that invests plan assets in company stock founders. This is because as the situation deteriorates, plan fiduciaries are torn between their duties as officers and directors for the company on the one hand, and to the plan and plan participants on the other. As courts have made clear “‘[w]hen a fiduciary has dual loyalties, the prudent person standard requires that he make a careful and impartial investigation of all investment decisions.’” Martin v. Feilen, 965 F.2d 660, 670 (8th Cir. 1992) (citation omitted).
Here, Defendants breached this fundamental fiduciary duty.
452. First, Defendants failed to investigate whether to take appropriate and necessary action to protect the Plan, and instead, chose the interests of the Company over the Plan by continuing to offer Company Stock, through the Company Stock Fund, as a Plan investment option in the Plan.
453. Second, Defendant Fuld and other Company insiders, who knew or should have known of Lehman’s artificially inflated stock price during much of the Class Period, benefited directly from this knowledge or neglect by selling their personal holdings of Company Stock for
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significant gain. In the period immediately preceding the Class Period, Defendant Fuld and other
Company insiders sold Company Stock for proceeds of over $197,564,519, as summarized below:
Date Name Title Shares Price Proceeds Sold Sold 9/18/06 Richard S. Fuld, Jr. Chairman of the Board and CEO 500,000 $69.60 $34,800,000 12/01/06 Richard S. Fuld, Jr. Chairman of the Board and CEO 74,460 $73.67 $5,485,468 06/15/07 Richard S. Fuld, Jr. Chairman of the Board and CEO 800,000 $77.56 $62,048,000 12/04/07 Richard S. Fuld, Jr. Chairman of the Board and CEO 202,587 $62.63 $12,688,024 Total 1,577,047 $115,021,492
12/01/06 Joseph M. Gregory Former President and COO 72,251 $73.67 $5,322,731 04/25/07 Joseph M. Gregory Former President and COO 495,503 $77.59 $38,446,078 12/04/07 Joseph M. Gregory Former President and COO 126,846 $62.63 $7,944,365 Total 694,600 $51,713,174
12/01/06 Christopher M. Former CFO 5,874 $73.67 $432,738 O’Meara 12/04/06 Christopher M. Former CFO 3,225 $62.63 $201,982 O’Meara Total 9,099 $634,720
10/26/06 Thomas A. Russo Chief Legal Officer 34,696 $77.83 $2,700,390 12/01/06 Thomas A. Russo Chief Legal Officer 62,700 $73.67 $4,619,109 06/19/07 Thomas A. Russo Chief Legal Officer 220,000 $78.84 $17,344,800 12/04/07 Thomas A. Russo Chief Legal Officer 57,210 $62.63 $3,583,062 Total 374,606 $28,247,361
12/01/06 Scott J. Freidheim Co-Chief Administrative Officer 6,411 $73.67 $472,298 12/04/07 Scott J. Freidheim Co-Chief Administrative Officer 2,798 $62.63 $175,239 Total 9,209 $647,537
12/01/06 Ian T. Lowitt Co-Chief Administrative Officer 13,454 $73.67 $991,156 and CFO from June 2008 to September 22, 2008 12/04/07 Ian T. Lowitt Co-Chief Administrative Officer 4,935 $62.63 $309,079 and CFO from June 2008 to September 22, 2008 Total 18,389 $1,300,235
Collective 2,682,950 $197,564,519 Total
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X. CAUSATION
454. The Plan suffered enormous losses because Defendants imprudently allowed the
Plan to acquire and hold Company Stock in the Company Stock Fund during the Class Period in breach of Defendants’ fiduciary duties.
455. The Plan also suffered enormous losses because Defendants failed to disclose material, non-public facts to Plan participants and provided inaccurate and incomplete information to them regarding the true health and ongoing profitability of Lehman and its soundness as an investment vehicle and failed to correct the inaccurate and incomplete information. As a consequence, Plan participants did not exercise independent control over their investments in Company Stock through the Company Stock Fund, and Defendants remain liable under ERISA for losses caused by such investments.
456. Defendants are liable for the Plan’s losses in this case because they failed to take the necessary and required steps to ensure effective and informed independent participant control over the investment decision-making process, as required by ERISA § 404(c), 29 U.S.C. §
1104(c), and the regulations promulgated thereunder.
457. Defendants also are liable for losses that resulted from their decision to invest the assets of the Plan in the Company Stock Fund rather than cash or other investment options, which was clearly imprudent under the circumstances presented here.
458. Had Defendants properly discharged their fiduciary and co-fiduciary duties, including the monitoring and removal of fiduciaries who failed to satisfy their ERISA-mandated duties of prudence and loyalty and eliminating and/or curtailing the Company Stock Fund as an investment alternative when it became imprudent, the Plan would have avoided some or all of the losses that it, and indirectly, the participants suffered.
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XI. CLASS ACTION ALLEGATIONS
459. Class Definition. Plaintiffs bring this action as a class action pursuant to Rules
23(a), (b)(1), (b)(2) and (b)(3) of the Federal Rules of Civil Procedure on behalf of Plaintiffs and the following class of persons similarly situated (the “Class”):
All persons, other than Defendants, who were participants in or beneficiaries of the Plan at any time between March 16, 2008, and June 10, 2009, and who held or allocated Plan contributions to the Company Stock Fund.
460. Numerosity. The members of the Class are so numerous that joinder of all members is impracticable. While the exact number of Class members is unknown to Plaintiffs at this time, and can only be ascertained through appropriate discovery, based on the Plan’s Form
5500 for Plan year 2007, Plaintiffs believe there are or were thousands of present or former Plan participants or beneficiaries across the United States during the Class Period.
461. Commonality. Common questions of law and fact exist as to all members of the
Class and predominate over any questions affecting solely individual members of the Class.
Among the questions of law and fact common to the Class are:
(a) whether Defendants each owed a fiduciary duty to Plaintiffs and members of the Class;
(b) whether Defendants breached their fiduciary duties to Plaintiffs and members of the Class by failing to act prudently and solely in the interests of the Plan’s participants and beneficiaries;
(c) whether Defendants violated ERISA; and
(d) whether the Plan has suffered losses and, if so, what measure of damages is proper.
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462. Typicality. Plaintiffs’ claims are typical of the claims of the members of the Class because: (i) to the extent Plaintiffs seek relief on behalf of the Plan pursuant to ERISA §
502(a)(2), their claim on behalf of the Plan is not only typical to, but identical to a claim under this section brought by any Class member; and (ii) to the extent Plaintiffs seek relief under
ERISA § 502(a)(3) on behalf of themselves for equitable relief, that relief would affect all Class members equally.
463. Adequacy. Plaintiffs will fairly and adequately protect the interests of the members of the Class and have retained counsel competent and experienced in class action, complex, and ERISA litigation. Plaintiffs have no interests antagonistic to or in conflict with those of the Class.
464. Rule 23(b)(1)(B) Requirements. Class action status in this ERISA action is warranted under Rule 23(b)(1)(B) because prosecution of separate actions by the members of the
Class would create a risk of adjudications with respect to individual members of the Class which would, as a practical matter, be dispositive of the interests of the other members not parties to the actions, or substantially impair or impede their ability to protect their interests.
465. Other Rule 23(b) Requirements. Class action status is also warranted under the other subsections of Rule 23(b) because: (i) prosecution of separate actions by the members of the Class would create a risk of establishing incompatible standards of conduct for Defendants;
(ii) Defendants have acted or refused to act on grounds generally applicable to the Class, thereby making appropriate final injunctive, declaratory, or other appropriate equitable relief with respect to the Class as a whole; and (iii) questions of law or fact common to members of the Class predominate over any questions affecting only individual members, and a class action is superior to the other available methods for the fair and efficient adjudication of this controversy.
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466. In the alternative, Plaintiffs request that the Court allow them to proceed under
ERISA Section 502(a)(2), 29 U.S.C. § 1132(a)(2). Section 502(a)(2), 29 U.S.C. § 1132(a)(2) states that “[a] civil action may be brought -- “ “by the Secretary [of Labor], or by a participant, beneficiary or fiduciary for appropriate relief under section 1109 of this title[.]” ERISA Section
409(a), 29 U.S.C. § 1109(a), sets forth that:
Any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries by this subchapter shall be personally liable to make good to such plan any losses to the plan resulting from each such breach, and to restore to such plan any profits of such fiduciary which have been made through use of assets of the plan by the fiduciary, and shall be subject to such other equitable or remedial relief as the court may deem appropriate, including removal of such fiduciary.
(Emphasis added).
COUNT I
FAILURE TO PRUDENTLY AND LOYALLY MANAGE THE PLAN’S ASSETS (BREACHES OF FIDUCIARY DUTIES IN VIOLATION OF ERISA § 404 AND § 405 BY ALL DEFENDANTS)
467. Plaintiffs incorporate paragraphs 1 through 466 above as if fully set forth herein.
468. At all relevant times, as alleged above, all Defendants were fiduciaries within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A) in that they exercised discretionary authority or control over the administration and management of the Plan or disposition of the
Plan’s assets.
469. Under ERISA, fiduciaries who exercise discretionary authority or control over management of a plan or disposition of a plan’s assets are responsible for ensuring that investment options made available to participants under a plan are prudent. Furthermore, such fiduciaries are responsible for ensuring that assets within the plan are prudently invested.
Defendants were responsible for ensuring that all investments in Company Stock, through the
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Company Stock Fund, in the Plan were prudent and that such investment was consistent with the purpose of the Plan. Defendants are liable for losses incurred as a result of such investments being imprudent.
470. A fiduciary’s duty of loyalty and prudence requires it to disregard plan documents or directives that it knows or reasonably should know would lead to an imprudent result or would otherwise harm plan participants or beneficiaries. ERISA § 404(a)(1)(D), 29 U.S.C. §
1104(a)(1)(D). Thus, a fiduciary may not blindly follow plan documents or directives that would lead to an imprudent result or that would harm plan participants or beneficiaries, nor may it allow others, including those whom they direct or who are directed by the plan, including plan trustees, to do so.
471. Defendants’ duty of loyalty and prudence also obligates them to speak truthfully to participants, not to mislead them regarding the Plan or Plan assets, and to disclose information that participants need in order to exercise their rights and interests under the Plan. This duty to inform participants includes an obligation to provide participants and beneficiaries of the Plan with complete and accurate information, and to refrain from providing inaccurate or misleading information, or concealing material information, regarding the Plan’s investment options such that participants can make informed decisions with regard to the prudence of investing in such options made available under the Plan. This duty applies to all of the Plan’s investment options, including investment in Company Stock.
472. Defendants breached their duties to prudently and loyally manage the Plan’s assets. During the Class Period, Defendants knew or should have known that, as described herein, Company Stock was not a suitable and appropriate investment for the Plan because: (i) the Company was exposed to significant risk that it would not be able to fund its ongoing
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operations as a result of changes to the credit markets or if its counterparties withdrew funds or demanded additional collateral from it, the full nature and extent of which it failed to disclose fully; (ii) the Company was exposed to significant risk of loss from trading in subprime mortgage backed derivatives, the full nature and extent of which it failed to disclose fully; (iii) the Company was the most highly leveraged of the largest remaining investment firms after Bear
Stearns’ collapse; (iv) the Company used Repo 105 to artificially and temporarily reduce
Lehman’s net leverage ratio; (v) the Company had failed to fully disclose the nature and extent of its exposure to losses incurred from CDOs, and had failed to timely write-down its positions in these securities; (vi) the Company had failed to fully disclose the nature and extent of its exposure to losses incurred from mortgage backed security originations, and had failed to timely write-down its positions in these securities; (vii) the Company had materially overvalued its positions in commercial and subprime mortgages, and in securities tied to these mortgages; (viii) the Company had inadequate reserves for its mortgage and credit related exposure; (ix) the
Company was exposed to catastrophic losses from its investments in commercial real estate, and had failed to timely write down its positions in these securities, the nature and extent of which the Company failed to disclose fully; and (x) the Company lacked adequate internal and financial controls.
473. Investment in Company Stock during the Class Period clearly did not serve the
Plan’s stated purpose of helping participants save for retirement, and in fact caused significant losses/depreciation to participants’ retirement savings. During the Class Period, despite their knowledge or disregard of the imprudence of the investment, Defendants failed to take any meaningful steps to protect the Plan from the inevitable losses that they knew or should have
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known would ensue as the non-disclosed material problems, concerns and business slowdowns took hold and became public.
474. Defendants also breached their duties of loyalty and prudence by failing to provide complete and accurate information regarding, among other things, the risk that the
Company would not be able to fund its ongoing operations, the Company’s net leverage ration, its use of Repo 105, and the nature and extent of the risk from the Company’s positions in subprime and related securities.
475. During the Class Period, upon information and belief, Defendants fostered a positive attitude toward the Company’s Stock, and allowed participants in the Plan to follow their natural bias towards investment in the equities of their employer by not disclosing negative material information concerning investment in the Company’s stock. As such, participants in the
Plan could not appreciate the true risks presented by investments in the Company’s Stock and therefore could not make informed decisions regarding their investments in the Plan.
476. Defendants also breached their co-fiduciary obligations by, among their other failures, knowingly participating in, knowingly undertaking to conceal, or otherwise enabling the other Defendants’ failure to disclose material adverse information regarding the Company’s exposure to risk and inflation of the price of the Company Stock. Defendants had knowledge of such breaches by other Plan fiduciaries, yet made no effort to remedy them.
477. As a direct and proximate result of the breaches of fiduciary duties alleged herein, the Plan suffered losses, and indirectly the Plan’s participants lost a significant portion of their retirement savings.
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478. Pursuant to ERISA § 502(a), 29 U.S.C. § 1132(a) and ERISA § 409, 29 U.S.C. §
1109(a), Defendants in this Count are liable to restore the losses to the Plan and Plan participants caused by their breaches of fiduciary duties alleged in this Count.
COUNT II
BREACH OF DUTY TO AVOID CONFLICTS OF INTEREST (BREACHES OF FIDUCIARY DUTIES IN VIOLATION OF ERISA §§ 404 AND 405 BY ALL DEFENDANTS)
479. Plaintiffs incorporate paragraphs 1 through 466 above as if fully set forth herein.
480. At all relevant times, as alleged above, Defendants were fiduciaries within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A). Consequently, they were bound by the duties of loyalty, exclusive purpose and prudence.
481. ERISA § 404(a)(1)(A), 29 U.S.C. § 1104(a)(1)(A), imposes on a plan fiduciary a duty of loyalty, that is, a duty to discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of providing benefits to participants and beneficiaries.
482. Defendants breached their duty to avoid conflicts of interest and to promptly resolve them by, inter alia, failing to timely engage independent fiduciaries who could make independent judgments concerning the Plan’s investments in the Company’s own securities; and by otherwise placing their own or the Company’s interests above the interests of the participants with respect to the Plan’s investment in the Company’s securities.
483. As a consequence of Defendants’ breaches of fiduciary duty, the Plan suffered millions of dollars in losses. If Defendants had discharged their fiduciary duties to prudently manage and invest the Plan’s assets, and had provided complete and accurate information to Plan participants regarding the Company’s financial condition and the prudence of investing in
Company Stock, the losses suffered by the Plan would have been minimized or avoided.
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Therefore, as a direct and proximate result of the breaches of fiduciary duties alleged herein, the
Plan suffered losses, and indirectly the Plan’s participants, lost a significant portion of their retirement investments.
484. Pursuant to ERISA § 502(a), 29 U.S.C. § 1132(a), and ERISA § 409, 29 U.S.C. §
1109(a), Defendants in this Count are liable to restore the losses to the Plan and to Plan participants caused by their breaches of fiduciary duties alleged herein.
COUNT III
FAILURE TO ADEQUATELY MONITOR OTHER FIDUCIARIES AND PROVIDE THEM WITH ACCURATE INFORMATION (BREACHES OF FIDUCIARY DUTIES IN VIOLATION OF ERISA § 404 BY THE MONITORING DEFENDANTS)
485. Plaintiffs incorporate paragraphs 1 through 466 above as if fully set forth herein.
486. At all relevant times, as alleged above, the Director Defendants and the
Compensation Committee Defendants (the “Monitoring Defendants”) were fiduciaries within the meaning of ERISA § 3(21)(A), 29 U.S.C. § 1002(21)(A).
487. At all relevant times, as alleged above, the scope of the fiduciary responsibility of the Monitoring Defendants, included the responsibility to appoint, evaluate, and monitor other fiduciaries, including, without limitation, the members of the Compensation Committee and the
Benefit Committee.
488. The duty to monitor entails both giving information to and reviewing the actions of the monitored fiduciaries. In this case, that means that the Monitoring Defendants had the duty to:
(a) ensure that the monitored fiduciaries possess the needed credentials and experience, or use qualified advisors and service providers to fulfill their duties. They must be knowledgeable about the operations of the Plan, the goals of the Plan, and the behavior of the
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Plan’s participants;
(b) ensure that the monitored fiduciaries are provided with adequate financial resources to do their job;
(c) ensure that the monitored fiduciaries have adequate information to do their job of overseeing the Plan’s investments;
(d) ensure that the monitored fiduciaries have ready access to outside, impartial advisors when needed;
(e) ensure that the monitored fiduciaries maintain adequate records of the information on which they base their decisions and analysis with respect to the Plan’s investment options; and
(f) ensure that the monitored fiduciaries report regularly to the Monitoring
Defendants. The Monitoring Defendants must then review, understand, and approve the conduct of the hands-on fiduciaries.
489. Under ERISA, a monitoring fiduciary must ensure that the monitored fiduciaries are performing their fiduciary obligations, including those with respect to the investment of a plan’s assets, and must take prompt and effective action to protect a plan and its participants when they are not. In addition, a monitoring fiduciary must provide the monitored fiduciaries with complete and accurate information in their possession that they know or reasonably should know that the monitored fiduciaries must have in order to prudently manage a plan and a plan’s assets.
490. The Monitoring Defendants breached their fiduciary monitoring duties by, among other things, (i) failing to ensure that the monitored fiduciaries had access to knowledge about the Company’s business problems alleged above, which made Company Stock an imprudent
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retirement investment, and (ii) failing to ensure that the monitored fiduciaries completely appreciated the huge risk of significant investment of the retirement savings of rank and file employees in Company Stock, an investment that was imprudent and subject to inevitable and significant depreciation.
491. The Monitoring Defendants knew or should have known that the fiduciaries they were responsible for monitoring were (i) imprudently allowing the Plan to continue offering
Company Stock through the Company Stock Fund, as an investment alternative for the Plan, and
(ii) continuing to invest the assets of the Plan in Company Stock when it no longer was prudent to do so. Despite this knowledge, the Monitoring Defendants failed to take action to protect the
Plan, and concomitantly the Plan’s participants, from the consequences of these fiduciaries’ failures.
492. In addition, the Monitoring Defendants, in connection with their monitoring and oversight duties, were required to disclose to the monitored fiduciaries accurate information about the financial condition of Lehman, including, without limitation, that (i) the Company was exposed to significant risk that it would not be able to fund its ongoing operations as a result of changes to the credit markets or if its counterparties withdrew funds or demanded additional collateral from it, the full nature and extent of which it failed to disclose fully; (ii) the Company was exposed to significant risk of loss from trading in subprime mortgage backed derivatives, the full nature and extent of which it failed to disclose fully; (iii) the Company was the most highly leveraged of the largest remaining investment firms after Bear Stearns’ collapse; (iv) the
Company used Repo 105 to artificially and temporarily reduce Lehman’s net leverage ratio; (v) the Company had failed to fully disclose the nature and extent of its exposure to losses incurred from CDOs, and had failed to timely write-down its positions in these securities; (vi) the
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Company had failed to fully disclose the nature and extent of its exposure to losses incurred from mortgage backed security originations, and had failed to timely write-down its positions in these securities; (vii) the Company had materially overvalued its positions in commercial and subprime mortgages, and in securities tied to these mortgages; (viii) the Company had inadequate reserves for its mortgage and credit related exposure; (ix) the Company was exposed to catastrophic losses from its investments in commercial real estate, and had failed to timely write down its positions in these securities, the nature and extent of which the Company failed to disclose fully; and (x) the Company lacked adequate internal and financial controls.
493. By remaining silent and continuing to withhold such information from the other fiduciaries, the Monitoring Defendants breached their monitoring duties under the Plan and
ERISA.
494. The Monitoring Defendants are liable as co-fiduciaries because they knowingly participated in the each other’s fiduciary breaches as well as those by the monitored fiduciaries, they enabled the breaches by these Defendants, and they failed to make any effort to remedy these breaches, despite having knowledge of them.
495. As a direct and proximate result of the breaches of fiduciary duties alleged herein, the Plan suffered losses, and the Plan’s participants lost a significant portion of their retirement investments.
496. Pursuant to ERISA § 502(a), 29 U.S.C. § 1132(a) and ERISA § 409, 29 U.S.C. §
1109(a), Defendants in this Count are liable to restore the losses to the Plan and Plan participants caused by their breaches of fiduciary duties alleged herein.
WHEREFORE, Plaintiffs pray for:
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A. a declaration that Defendants, and each of them, have breached their ERISA fiduciary duties to the participants;
B. an Order compelling Defendants to make good to the Plan all losses to the Plan resulting from Defendants’ breaches of their fiduciary duties, including losses to the Plan resulting from imprudent investment of the Plan’s assets, and to restore to the Plan all profits
Defendants caused through use of the Plan’s assets, and to restore to the Plan all profits which the participants would have made if Defendants had fulfilled their fiduciary obligations;
C. imposition of a constructive trust on any amounts by which any defendant was unjustly enriched at the expense of the Plan as the result of breaches of fiduciary duty;
D. actual damages in the amount of any losses the Plan suffered;
E. an Order awarding costs pursuant to 29 U.S.C. § 1132(g);
F. an Order awarding attorneys’ fees pursuant to the common fund doctrine,
29 U.S.C. § 1132(g), and other applicable law; and
G. an Order for equitable restitution and other appropriate equitable and injunctive relief against Defendants.
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