Case 1:08-cv-02804-RWS Document 88 Filed 07/21/09 Page 1 of 202 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK IN RE BEAR STEARNS COMPANIES Master File No.: 08 MDL No. 1963 (RWS) ERISA LITIGATION, ECF Case This Document Relates To: ERISA Action, No. 08 Civ. 2804 (RWS) CLASS ACTION CORRECTED AMENDED CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE EMPLOYEE RETIREMENT INCOME SECURITY ACT Case 1:08-cv-02804-RWS Document 88 Filed 07/21/09 Page 2 of 202 Table of Contents I. INTRODUCTION ............................................................................................................ 1 II. NATURE AND SUMMARY OF THE ACTION............................................................ 1 III. JURISDICTION AND VENUE....................................................................................... 7 IV. PARTIES .......................................................................................................................... 8 A. Plaintiffs................................................................................................................ 8 B. Defendants. ........................................................................................................... 8 1. Bear Stearns.............................................................................................. 8 2. Director Defendants.................................................................................. 9 3. Executive Committee Defendants........................................................... 14 4. The Employee Stock Ownership Plan Committee Defendants. ............................................................................................. 15 5. Additional Defendants............................................................................ 16 V. THE PLAN..................................................................................................................... 16 A. Background......................................................................................................... 16 B. Participation, Eligibility and Vesting of Benefits............................................... 17 C. Right To Divest Plan Account. ........................................................................... 19 D. ESOP Fiduciaries Are Bound by Core ERISA Fiduciary Duties. ...................... 20 E. The Plan Incurred Significant Losses During the Class Period.......................... 21 VI. DEFENDANTS’ FIDUCIARY STATUS ...................................................................... 22 A. The Nature of Fiduciary Status........................................................................... 22 B. Bear Stearns’s Fiduciary Status. ......................................................................... 23 C. Director Defendants’ Fiduciary Status................................................................ 24 D. The Executive Committee Defendants’ Fiduciary Status................................... 25 i Case 1:08-cv-02804-RWS Document 88 Filed 07/21/09 Page 3 of 202 E. ESOP Committee Defendants’ Fiduciary Status. ............................................... 26 VII. FACTS BEARING ON FIDUCIARY BREACH........................................................... 27 A. Bear Stearns Stock Was an Imprudent Investment for the Plan During the Class Period Because of, inter alia, Bear Stearns’s Reckless Business Practices, Undisclosed Failure of Risk Management, and Mis-Handling of Its Subprime and Alt-A Mortgage Assets.................................................................................................. 27 1. Summary................................................................................................. 27 2. Bear Stearns’s Once-Functional Business Model Became Unsustainable.......................................................................................... 31 a. The Beginning............................................................................. 31 b. Bear Stearns Increasingly Depended On Risky Subprime, Alt-A, MBS and Structured Financial Product Exposure........................................................................ 33 c. Bear Stearns Took Advantage of Scant Regulation and Low Capital Requirements To Increase Leverage and Grow Its Debt-Security Business. ........................ 36 3. The Rise and Fall of the Subprime and Alt-A Lending Industry, Debt Securitization, and the U.S. Housing Market..................................................................................................... 39 a. The Boom in Subprime and Alt-A Loan Origination. ................................................................................. 40 b. The Warnings About Foreclosures. ............................................ 43 c. High Volumes of Mortgage-Backed Securities Compounded the Effects of Foreclosures................................... 49 4. Bear Stearns Sought Full Vertical Integration into the Subprime and Alt-A Lending and Securitization Industry as the Housing and MBS Markets Collapsed.............................................. 57 5. The Volume of Bear Stearns’s Securitizations and Holdings Backed by Risky Mortgages Made the Company Vulnerable to Collapse............................................................................ 63 a. Securitization. ............................................................................. 63 b. Off-Balance Sheet MBS Exposure. ............................................ 65 ii Case 1:08-cv-02804-RWS Document 88 Filed 07/21/09 Page 4 of 202 c. Variable Interest Entities (“VIEs”). ............................................ 70 d. MBS Were a Significant Portion of Bear Stearns’s Total Assets................................................................................. 72 e. Bear Stearns Relied on Credit Derivatives to Hedge Against its MBS Vulnerabilities. ................................................ 73 6. Bear Stearns Relied on Inadequate Risk Management Practices. ................................................................................................. 74 a. Presentation of Risk and Risk Management in Financial Statements. .................................................................. 75 b. Risk Modeling............................................................................. 76 (i) Asset Valuation Modeling. ............................................. 77 (ii) Value-at-Risk Modeling..................................................79 c. The Securities Exchange Commission Office of Inspector General Has Documented Severe Flaws in Bear Stearns’s Risk Management and Use of VaR. ................... 86 7. Bear Stearns Was Extremely Leveraged and Had Insufficient Capital and Liquidity........................................................... 89 a. Leverage...................................................................................... 89 b. Bear Stearns Lacked Sufficient Capital and Liquidity...................................................................................... 96 (i) Capital............................................................................. 96 (ii) Liquidity.......................................................................... 98 8. Bear Stearns’s Reliance on Overnight Repo Loans Was a Liquidity Crisis Waiting to Happen...................................................... 101 9. Bear Stearns Accelerated Its Dependence on the Mortgage Industry During the Housing Bubble Bust, Yet the Company Persistently Denied the Resulting Deterioration of Its Financial Condition and Made Misleading Statements............................................................................................. 104 a. Third Quarter 2006. .................................................................. 104 b. Fourth Quarter 2006.................................................................. 105 iii Case 1:08-cv-02804-RWS Document 88 Filed 07/21/09 Page 5 of 202 c. First Quarter 2007..................................................................... 107 d. Second Quarter 2007................................................................. 110 e. Third Quarter 2007. .................................................................. 112 (i) Bear Stearns Increased Its Exposure to the Subprime and Alt-A Mortgage Market by Backing Its Hedge Funds.............................................. 113 (ii) Bear Stearns’s Hedge Funds Collapsed and the Company Scrambled to Revamp Senior Leadership..................................................................... 116 (iii) Bear Stearns Maintained Its Opportunistic Focus on MBS and Insisted “The Worst Is Largely Behind Us.” ..................................................... 121 f. Fourth Quarter 2007.................................................................. 124 10. Bear Stearns’s Housing-Bubble-Related “Risk Factors” Were Disclosed Too Late...................................................................... 131 11. Bear Stearns Crumbled, But Kept Reassuring the Flock...................... 134 12. Bear Stearns’s Recklessness Made the Company a Catalyst in the Global Liquidity Crisis, Not a Victim......................................... 144 13. Bear Stearns’s Practices Violated Accounting Standards..................... 150 14. Bear Stearns’s Internal Controls Were Materially Deficient................ 153 15. Bear Stearns’s Practices Violated Banking Regulations. ..................... 155 16. Post-Collapse Events............................................................................ 156 17. Bear Stearns’s Stock Price Was Artificially Inflated...........................