District court: Former Lehman officials must defend investor claims

By Caroline Salls

Pittsburgh, July 29 - Former Lehman Brothers directors and officers, underwriters and an outside auditor will have to defend several of the claims included in a federal securities law violation class action lawsuit filed against them by a group of investors, according to a ruling made by the U.S. District Court for the Southern District of New York.

According to the 106-page opinion filed Wednesday by judge Lewis A. Kaplan, the plaintiffs are pension funds, companies and individuals that purchased some of the more than $31 billion of debt and equity securities issued by Lehman between June 12, 2007 and Sept. 15, 2008.

The investors are suing Lehman's former officers, directors and auditors, as well as underwriters of the securities, alleging that the offering materials were false and misleading.

The insider defendants include former Lehman chief executive officer Richard S. Fuld Jr., as well as former officers Christopher M. O'Meara, Joseph M. Gregory, Erin Callan and Ian Lowitt.

The lawsuit also names nine former directors as defendants, as well as outside auditor Ernst & Young LLP and 51 securities underwriters, including UBS Financial Services Inc.

Specifically, the plaintiffs said the offering documents incorporated by reference Lehman's financial statements, which in turn contained misleading statements and omissions concerning the company's use of "Repo 105" transactions and their effect on Lehman's reported net leverage, risk management policies, liquidity risk, concentrations of credit risk and the value of Lehman's commercial real estate holdings.

The lawsuit also alleges that some of Lehman's former officers made false and misleading statements about most of these subjects.

The defendants asked the court to dismiss the lawsuit "for failure to state a claim upon which relief may be granted."

Court findings

Specifically, Kaplan ruled:

• The allegations that specified transactions were used at the end of each reporting period to present a financial metric that allegedly was significant to investors, credit rating agencies and analysts "support a strong inference" that the officers and directors knew, or were reckless in not knowing, that use of the Repo 105 transactions and the way they were accounted for "painted a misleading picture of the company's finances;"

• Alleged facts sufficiently infer that the defendants involved in setting Lehman's risk policies knew that the statements concerning enforcement of risk management policies were false;

• Insider defendants Fuld, O'Meara and Gregory can be tied to allegations related to disclosure of a significant concentration of credit risk;

• The lawsuit fails to allege that auditor Ernst & Young made any false or misleading GAAS compliance statements in the company's 2007 10-K or subsequent quarterly reports;

• The lawsuit does sufficiently allege that that the auditor made a false or misleading statement in Lehman's second-quarter 2008 statements "in that it professed ignorance of facts warranting material modifications to Lehman's balance sheet when in truth it had received information concerning Lehman's use of Repo 105s temporarily to move $50 billion of inventory off that balance sheet.

The ruling said that information cast into doubt the balance sheet's consistency with GAAP; and

• The plaintiffs are entitled to an opportunity to attempt to prove that some amount of the losses they suffered was attributable to the allegedly false picture of relative security attributed to misstatements and omissions.

New York-based Lehman Brothers Holdings Inc. was the fourth-largest investment bank in the United States. The company filed for bankruptcy on Sept. 15, 2008 in the U.S. Bankruptcy Court for the Southern District of New York. Its Chapter 11 case number is 08-13555.

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