Lehman examiner blames bad judgment, lack of confidence for downfall

By Caroline Salls

Pittsburgh, March 11 - Lehman Brothers Holdings, Inc. examiner Anton R. Valukas said the responsibility for the company's failure is shared, and that "Lehman was more the consequence than the cause of a deteriorating economic climate," according to the examiner's report, which was unsealed and filed with the U.S. Bankruptcy Court for the Southern District of New York on Thursday.

"Lehman's financial plight, and the consequences to Lehman's creditors and shareholders, was exacerbated by Lehman executives, whose conduct ranged from serious but non-culpable errors of business judgment to actionable balance sheet manipulation; by the investment bank business model, which rewarded excessive risk taking and leverage; and by government agencies, who by their own admission might better have anticipated or mitigated the outcome," Valukas said in his report.

According to the report, Lehman deliberately decided in 2006 to embark upon an aggressive growth strategy, to take on significantly greater risk and to substantially increase leverage on its capital.

In 2007, as the sub-prime residential mortgage business progressed from problem to crisis, Valukas said Lehman was "slow to recognize the developing storm and its spillover effect" on commercial real estate and other business lines.

"Rather than pull back, Lehman made the conscious decision to double down, hoping to profit from a counter-cyclical strategy," Valukas said.

"As it did so, Lehman significantly and repeatedly exceeded its own internal risk limits and controls."

With the near collapse of Bear Stearns in March 2008, the examiner said Lehman's survival was in jeopardy and it tried numerous strategies to avoid demise.

However, Valukas said the company "painted a misleading picture of its financial condition" to maintain confidence and buy time.

In his report, the examiner said Lehman failed because it was not able to retain the confidence of its lenders and counterparties and because it did not have enough liquidity to meet its current obligations.

Specifically, Valukas said the company was unable to maintain confidence because a series of business decisions had left it with heavy concentrations of illiquid assets with deteriorating values, and confidence further eroded when the failure of efforts to form strategic partnerships to bolster stability became public.

"The business decisions that brought Lehman to its crisis of confidence may have been in error but were largely within the business judgment rule," the examiner reported.

However, Valukas said the decision not to disclose the affects of those judgments "does give rise to colorable claims against the senior officers who oversaw and certified misleading financial statements."

The examiner said these officers include Lehman's chief executive officer Richard S. Fuld Jr., and its chief financial officers Christopher O'Meara, Erin M. Callan and Ian T. Lowitt.

Valukas said Lehman also has potential claims against external auditor Ernst & Young for its failure to question and challenge improper financial statement disclosures.

Despite these findings, the examiner said he ultimately concluded that, while some of Lehman's risk decisions reflect poor judgment, they were within the business judgment rule and do not give rise to potential claims.

However, Valukas said those judgments and related facts provide context for other subjects that do lead to claims, including the company's practice of turning to "Repo 105" transactions to manage its balance sheet and reduce its reported net leverage "after saddling itself with an enormous volume of illiquid assets that it could not readily sell."

New York-based Lehman Brothers Holdings is the fourth largest investment bank in the United States. The company filed for bankruptcy on Sept. 15. Its Chapter 11 case number is 08-13555.

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