Former Employees’ Skepticism Cited in Investors’ Lawsuit Against Lehman

By | October 31, 2008

Aggrieved investors in Lehman Brothers Holdings Inc. have added new legal claims in what is sure to be one of the most closely watched lawsuits of the mortgage crisis, accusing company insiders and others of misleading them before the firm collapsed.

New court papers filed this week by a group of public pension funds suing to try to recover money lost on Lehman’s fall include information gleaned from more than 20 former employees at the Wall Street firm and its mortgage lending subsidiaries.

These “confidential witnesses” include a former Lehman vice president who is quoted as saying that employees were “skeptical” of the Wall Street firm’s own public statements that it was well-positioned to withstand a housing downturn.

The executive worked in the fixed income research group, and was employed by the firm from 2000 until this year, the court papers say.

Other former employees cited in the lawsuit — none of whom were named — include ex-employees at the company’s mortgage lending units Aurora Loan Services LLC and BNC Mortgage LLC, who describe what they contend were poor underwriting procedures.

The pension funds contend that these statements back up their arguments that Lehman did not adequately disclose the risks in its real estate investments. The defendants have yet to reply to the accusations with their own court papers.

Lehman filed the largest U.S. bankruptcy case last month. Because of those proceedings, the firm itself is not a defendant in the investor lawsuit, which was brought in U.S. District Court in Manhattan. A Lehman spokesman declined to comment on the case Thursday.

“Lehman assured investors, falsely, that its exposure to the real estate meltdown was well contained, due, in part, to its claimed excellence in ‘hedging’ against losses in that sector,” the 182-page court filing contends. It says the company’s financial reports “lacked transparency, masking Lehman’s exposure to mortgage-related losses.”

OTHER DEFENDANTS

Many banks and lenders face shareholder litigation stemming from the mortgage and credit market meltdown. Lehman is also the focus of three grand jury investigations by federal prosecutors, the company’s bankruptcy attorney recently disclosed in court.

The investor case “certainly will be very closely watched because Lehman was one of the few companies that the government allowed to fail, and the losses were so large and so widely distributed,” said Adam Savett, a class-action expert at shareholder advisory firm RiskMetrics Group Inc.

The Lehman lawsuit, which seeks class-action status, is led by investors including the Alameda County Employees’ Retirement Association in Oakland, California, and the Guam Retirement Fund that held common stock, preferred shares and bonds.

Total damages sought by the plaintiffs are sure to be in the “many billions of dollars,” said David Stickney, one of the lawyers for the funds.

Defendants include Lehman Chief Executive Richard Fuld and other company insiders and board members. A lawyer for Fuld was not immediately available for comment.

The new complaint also adds claims against a group of other Wall Street banks that underwrote Lehman securities offerings, including Citigroup Inc and Bank of America Corp. Both banks declined to comment.

CONFIDENTIAL WITNESSES

The new complaint includes “confidential witness” information from former employees at Lehman, as well as the company’s Aurora and BNC lending units, which both focused on mortgage lending to people with weak credit.

None of these former employees was paid for the information, Stickney said. Many shareholder lawsuits include statements from so-called confidential witnesses as plaintiffs try to build their cases.

In one instance, the complaint cites an unnamed former BNC chief operating officer who characterizes the lender’s sales and underwriting practices as “some of the things that were most egregious in terms of the mistakes the subprime mortgage industry made.”

The ex-employee also said that BNC’s sales organization had an inappropriate level of control over mortgage processing and underwriting decisions, according to the complaint. Lehman closed BNC in August 2007 and folded it into its Aurora unit.

“The confidential witnesses, I think taken collectively, show that Lehman was well aware of the serious difficulties it had with the assets related to its real estate and mortgage portfolio, at the same time it was not fully disclosing its risk of loss from those investments,” Stickney said.

(Reporting by Martha Graybow, editing by Matthew Lewis)

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