Report of Anton R. Valukas, Examiner, In re Lehman Brothers Holdings Inc., et al. — Volumes 1 and 3

Background

What it found

1. The examiner finds that Lehman failed because it lost the confidence of the lenders it borrowed from every day, and that the blame is shared between its executives, the investment bank business model and Government agencies. p. 2 p. 3

   “There are many reasons Lehman failed, and the responsibility is shared. Lehman was more the consequence than the cause of a deteriorating economic climate.”

2. From 2006 Lehman chose to grow aggressively, taking on commercial real estate, leveraged loans and private equity that it could not sell in a downturn, and kept going after the subprime crisis began, repeatedly exceeding its own risk limits. The examiner concludes that these decisions, though poor in hindsight, were within the business judgment rule, and finds no colorable claims against Lehman's officers or directors over risk management. p. 4 p. 43 p. 47

3. Repo 105 transactions were ordinary short-term repo borrowings that Lehman booked as sales, the report finds, so that securities left its balance sheet for seven to ten days around each quarter-end. At quarter-end Lehman's net balance sheet was about $38.6 billion lower than it would otherwise have been in late 2007, $49.1 billion in early 2008 and $50.38 billion in mid-2008. Unable to find a U.S. law firm to support the accounting, Lehman ran the programme through its London broker-dealer under an English-law opinion from Linklaters. p. 732 p. 739 p. 740

4. The examiner finds that the transactions had no business purpose beyond the accounting effect. They cost more than ordinary repos, Lehman ran them above its own internal caps at every quarter-end from mid-2007, and its own staff called them "window‐dressing" and "another drug we r on". p. 746 p. 740 p. 742

   “Repo 105 transactions were not used for a business purpose, but instead for an accounting purpose: to reduce Lehman's publicly reported net leverage and net balance sheet.”

5. Lehman disclosed Repo 105 to no one, the report finds, while telling analysts it was cutting leverage by selling assets. Its directors, the rating agencies and regulators told the examiner they would have wanted to know, and the examiner concludes that a trier of fact could find the omission made Lehman's financial statements materially misleading. p. 739 p. 749 p. 747

   “In this way, unbeknownst to the investing public, rating agencies, Government regulators, and Lehman's Board of Directors, Lehman reverse engineered the firm's net leverage ratio for public consumption.”

6. Lehman also overstated its liquidity. The pool it reported as $41 billion held, two days later, less than $2 billion that could readily be turned into cash. p. 9

   “By 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.”

7. The examiner finds colorable claims of breach of fiduciary duty against CEO Richard Fuld and three chief financial officers, Chris O'Meara, Erin Callan and Ian Lowitt, for filing reports that hid Repo 105, and finds Fuld knew or should have known of the $49.1 billion figure by March 2008. Fuld told the examiner he did not recall Repo 105, which the report says a fact-finder would have to weigh against other evidence. Separately, the examiner finds colorable claims of malpractice against the auditor Ernst & Young, which a Lehman senior vice president, Matthew Lee, told about the $50 billion in June 2008, and which did not tell the Board's Audit Committee; the report notes it may have valid defences. p. 750 p. 998 p. 959

8. In the final weekend the Government concluded that it had no legal authority to put capital into Lehman, and a rescue by Barclays collapsed when the U.K. regulator would not waive a shareholder vote. p. 11 p. 12

Where to start reading

Short on time? These sections carry the report's argument. Each opens at the start of the section.

1. Introduction p. 1 · Read →

   The whole story in fourteen pages, from record earnings in January 2008 to bankruptcy in September.

   “But to buy itself more time, to maintain that critical confidence, Lehman painted a misleading picture of its financial condition.”

2. Why Did Lehman Fail? Are There Colorable Causes of Action That Arise From Its Financial Condition and Failure? p. 16 · Read →

   The examiner's conclusions in brief, including Repo 105 and the case against Ernst & Young, and what he means by a "colorable" claim.

3. Repo 105 p. 733 · Read →

   The examiner's full analysis of Repo 105, the core of the report at some 320 pages, opening with a summary of how the device worked, the e-mails that show what it was for, and the claims against Lehman's officers and Ernst & Young.

   “Lehman employed off‐balance sheet devices, known within Lehman as ‘Repo 105’ and ‘Repo 108’ transactions, to temporarily remove securities inventory from its balance sheet, usually for a period of seven to ten days, and to create a materially misleading picture of the firm's financial condition in late 2007 and 2008.”

4. Business and Risk Management p. 44 · Read →

   How Lehman overrode its own risk limits, removed a senior manager judged not aggressive enough, and committed to the Archstone deal.

   “Months later, Antoncic, for example, reflected back on the general consensus that the markets were in trouble: ‘every one saw the train wreck coming. 64k question is why didn't anyone get out of the way???’”

5. Document Collection and Review p. 31 · Read →

   The scale of the investigation, from three petabytes of Lehman data down to the 34 million pages the examiner reviewed.