UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ x : In re : Chapter 11 Case No. : LEHMAN BROTHERS HOLDINGS INC., : 08‐13555 (JMP) et al., : : (Jointly Administered) Debtors. : ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ x REPORT OF ANTON R. VALUKAS, EXAMINER Jenner & Block LLP 353 N. Clark Street Chicago, IL 60654‐3456 312‐222‐9350 919 Third Avenue 37th Floor New York, NY 10022‐3908 212‐891‐1600 March 11, 2010 Counsel to the Examiner VOLUME 1 OF 9 Sections I & II: Introduction, Executive Summary & Procedural Background Section III.A.1: Risk EXAMINER’S REPORT TABLE OF CONTENTS VOLUME 1 Introduction, Sections I & II: Executive Summary & Procedural Background Introduction ...................................................................................................................................2 I. Executive Summary of The Examiner’s Conclusions ......................................................15 A. Why Did Lehman Fail? Are There Colorable Causes of Action That Arise From Its Financial Condition and Failure?..................................................................15 B. Are There Administrative Claims or Colorable Claims For Preferences or Voidable Transfers? ........................................................................................................24 C. Do Colorable Claims Arise From Transfers of LBHI Affiliate Assets to Barclays, or From the Lehman ALI Transaction?.......................................................26 II. Procedural Background and Nature of the Examination................................................28 A. The Examiner’s Authority .............................................................................................28 B. Document Collection and Review................................................................................30 C. Systems Access ................................................................................................................33 D. Witness Interview Process.............................................................................................35 E. Cooperation and Coordination With the Government and Parties ........................37 Section III.A.1: Risk III. Examiner’s Conclusions.......................................................................................................43 A. Why Did Lehman Fail? Are There Colorable Causes of Action That Arise From Its Financial Condition and Failure?..................................................................43 1. Business and Risk Management .............................................................................43 a) Executive Summary............................................................................................43 (1) The Examiner Does Not Find Colorable Claims That Lehman’s Senior Officers Breached Their Fiduciary Duty of Care by Failing to Observe Lehman’s Risk Management Policies and Procedures......................................................................................................47 i (2) The Examiner Does Not Find Colorable Claims That Lehman’s Senior Officers Breached Their Fiduciary Duty to Inform the Board of Directors Concerning The Level of Risk Lehman Had Assumed.........................................................................................................52 (3) The Examiner Does Not Find Colorable Claims That Lehman’s Directors Breached Their Fiduciary Duty by Failing to Monitor Lehman’s Risk‐Taking Activities................................................................54 b) Facts.......................................................................................................................58 (1) From Moving to Storage: Lehman Expands Its Principal Investments....................................................................................................58 (a) Lehman’s Changed Business Strategy .................................................59 (b) The Increased Risk From Lehman’s Changed Business Strategy.....................................................................................................62 (c) Application of Risk Controls to Changed Business Strategy ...........65 (i) Stress Testing Exclusions................................................................66 (ii) Risk Appetite Limit Increase For Fiscal 2007...............................70 (iii) Decision Not To Enforce Single Transaction Limit.....................73 (d) The Board’s Approval of Lehman’s Growth Strategy.......................76 (2) Lehman Doubles Down: Lehman Continues Its Growth Strategy Despite the Onset of the Subprime Crisis..................................................78 (a) Lehman’s Residential Mortgage Business...........................................82 (i) Lehman Decides to Curtail Subprime Originations but Continues to Pursue “Alt‐A” Originations..................................82 (ii) The March 20, 2007 Board Meeting...............................................90 (b) The Explosion in Lehman’s Leveraged Loan Business .....................95 (i) Relaxation of Risk Controls to Accommodate Growth of Lehman’s Leveraged Loans Business ...........................................97 (c) Internal Opposition to Growth of Leveraged Loans Business .......100 (d) Growth of Lehman’s Commercial Real Estate Business at the Start of the Subprime Crisis.................................................................103 (i) Relaxation of Risk Controls to Accommodate Growth of Lehman’s Commercial Real Estate Business..............................105 (ii) Internal Opposition to Growth of Commercial Real Estate Business ...............................................................................107 (iii) Archstone ........................................................................................108 ii a. Lehman’s Commitment............................................................108 b. Risk Management of Lehman’s Archstone Commitment..............................................................................112 (e) Nagioff’s Replacement of Gelband as Head of FID .........................114 (f) The Board of Directors’ Awareness of Lehman’s Increasing Risk Profile.............................................................................................116 (3) Early Warnings: Risk Limit Overages, Funding Concerns, and the Deepening Subprime Crisis ................................................................117 (a) Nagioff and Kirk Try to Limit Lehman’s High Yield Business......119 (b) July‐August 2007 Concerns Regarding Lehman’s Ability to Fund Its Commitments ........................................................................123 (c) Lehman Delays the Archstone Closing .............................................128 (d) Lehman Increases the Risk Appetite Limit to Accommodate the Additional Risk Attributable to the Archstone Transaction.............................................................................................131 (e) Cash Capital Concerns .........................................................................134 (f) Lehman’s Termination of Its Residential Mortgage Originations ...........................................................................................138 (g) September, October, and November 2007 Meetings of Board of Directors.............................................................................................139 (i) Risk Appetite Disclosures.............................................................139 (ii) Leveraged Loan Disclosures ........................................................144 (iii) Leverage Ratios and Balance Sheet Disclosures........................147 (iv) Liquidity and Capital Disclosures...............................................148 (4) Late Reactions: Lehman Slowly Exits Its Illiquid Real Estate Investments..................................................................................................150 (a) Fiscal 2008 Risk Appetite Limit Increase ...........................................152 (b) January 2008 Meeting of Board of Directors.....................................154 (c) Executive Turnover...............................................................................156 (d) Commercial Real Estate Sell‐Off: Too Little, Too Late ...................157 (e) Lehman’s Compensation Practices.....................................................161 iii c) Analysis ..............................................................................................................163 (1) The Examiner Does Not Find Colorable Claims That Lehman’s Senior Officers Breached Their Fiduciary Duty of Care by Failing to Observe Lehman’s Risk Management Policies and Procedures....................................................................................................164 (a) Legal Standard.......................................................................................164 (b) Background............................................................................................166 (i) Countercyclical Growth Strategy with Respect to Residential Mortgage Origination...............................................171 (ii) Lehman’s Concentration of Risk in Its Commercial Real Estate Business ...............................................................................172 (iii) Concentrated Investments in Leveraged Loans........................175 (iv) Firm‐Wide Risk Appetite Excesses..............................................179 (v) Firm‐Wide