Liability for Lehman? — “Our Capital Position at the Moment is Strong”

[WSJ_law_blog]

Lehman Brothers employees signed in green a portrait of Lehman Brothers CEO Richard Fuld, Jr.,outside the New York headquarters, Sept. 15, 2008 in New York. (AP Photo/Mary Altaffer)

It’s a common scenario: Company is in trouble. Behind the scenes, management scrambles to right the ship while reassuring the public that everything will be just fine. Company crumbles. Investors claim they wouldn’t have bought — or would’ve sold — but for the public statements of strength. Questions of civil and criminal liability follow. (Remember Bear?)

And so it goes for Lehman Brothers, whose CEO, Richard Fuld, testified today before the House Oversight and Government Reform Committee. In a front-page story entitled “The Two Faces of Lehman’s Fall,” the WSJ reports that the FBI has launched a preliminary inquiry into whether Lehman or its executives committed fraud by misrepresenting the firm’s condition to investors. Meanwhile, prosecutors from the U.S. Attorney’s office in New York’s Eastern District are examining, among other things, whether Lehman execs misled investors by making upbeat comments to investors and research analysts on Sept. 10 — five days before the firm filed for bankruptcy protection.

Were Lehman execs talking out of both sides of their mouths? Here, according to the WSJ, is a summary of the events under scrutiny:

• On September 9, Lehman’s stock plunged 45% on news that a potential deal with Korea Development Bank fell through.
• As Lehman’s “clearing bank,” J.P. Morgan acted as the financial middleman between Lehman and its clients. Steven Black, co-CEO of J.P. Morgan’s investment bank, told Fuld that in order to protect itself and its clients, JPM needed $5 billion in additional collateral — over and above the $5 billion J.P. Morgan had demanded five days earlier, which had yet to be paid. Fuld persuaded Black to settle for $3 billion right away.
• That evening, top Lehman execs discussed the need to raise between $3 billion and $5 billion to shore up capital by early 2009. That evening, discussions with outside bankers about possible capital raising ended without any formal plan. Lehman execs arranged a conference call for the next day to announce earnings ahead of schedule and to disclose plans for a restructuring. The bankers counseled Lehman against holding the call, warning there were too many open questions about the firm’s finances.
• On next day’s conference call, the firm announced that it expected its largest quarterly loss ever, $3.9 billion, driven largely by declines in real-estate valuations. CEO Fuld said the firm intended to sell a majority stake in its investment-management division and would cut its dividend. Lehman executives didn’t say anything about needing to raise capital.
• On the call, a Deutsche Bank analyst asked whether Lehman would need to raise $4 billion as part of the plan. Lehman’s CFO, Ian Lowitt, replied: “We don’t feel that we need to raise that extra amount.” At another point, Lowitt said: “Our capital position at the moment is strong.”
• By Sunday, Sept. 14, Lehman, its lawyers and officials from the New York Fed determined that Lehman must file for bankruptcy.

Fuld and Lowitt declined to comment. One Lehman executive says the firm determined sometime during the night prior to the conference call that additional capital wouldn’t be needed because Lehman hoped to raise more money by selling additional assets.

Loyal LB’ers: Surely, more info will emerge on what occurred prior to Lehman’s fall. But based on what we know so far, will the government — or shareholders — have a case?