4. Regulator InactionLehman’s opera

4. Regulator Inaction
Lehman’s operations were subject to supervision by a number of governmental and industry
organizations, including its primary regulator, the SEC, the Chicago Mercantile Exchange (CME), which
regulated certain derivatives, the Office of Thrift Supervision, which supervised Lehman’s thrift
subsidiary, and the New York Federal Reserve Bank (NYFED)6
. After it filed for bankruptcy, many
questions were raised about the efficacy of these agencies’ oversight. YPFS case studies Wiggins and
Metrick 2014B and Wiggins and Metrick 2014C consider the actions of the regulators and many of these
questions.
Following the near collapse of Bear Stearns in March 2008, the SEC and the NYFED stepped up their
supervision of Lehman; both agencies placed employees on site and required daily reports. Despite
reviewing daily reports regarding Lehman’s leverage and liquidity, neither agency took any preventive or
corrective action pursuant to its authority.
In the aftermath of Lehman’s bankruptcy filing, Anton Valukas, the bankruptcy examiner, criticized the
agencies for not taking a more active role in preventing the firm’s failure: “So the agencies were
concerned. They gathered information. They monitored. But no agency regulated.” (Valukas Statement, 6).
He was particularly critical of the SEC, Lehman’s primary regulator:
The SEC knew that Lehman was reporting sums in its reported liquidity pool that the SEC did
not believe were in fact liquid; the SEC knew that Lehman was exceeding its risk control limits;
and the SEC should have known that Lehman was manipulating its balance sheet to make its
leverage appear better than it was. Yet even in the face of actual knowledge of critical
shortcomings, and after Bear Stearns’ near collapse in March 2008 following a liquidity crisis, the
SEC did not take decisive action.” (Ibid, 7-8).
(For additional information on this topic see: Examiner’s Report, Vol. 4, pages 1482-1536 for a
thorough analysis of the government’s oversight of Lehman; SEC Press Release, September 15, 2008,
regarding Lehman and the later Statement of Christopher Cox, chairman, regarding the SEC’s
supervision of Lehman; and Statement of Federal Reserve Bank of New York (NYFED) EVP and General
Counsel Thomas Baxter Jr. regarding its response to Lehman.)
The Lehman Weekend and the Bankruptcy Filing
On the weekend of September 12-14, 2008, amid repeated pronouncements that the government would
not bail out the firm, Timothy Geithner, president of the NYFED, collaborated with Henry (Hank)
Paulson, U.S. treasury secretary, and Christopher Cox, chairman of the SEC, to host a meeting of the
CEOs of the major Wall Street investment banks to hammer out a private sector solution for Lehman,
which ideally would not involve any government or central bank funding.7 The idea was similar to the
6 Although the NYFED did not regulate Lehman, Lehman was a primary dealer required to bid at Treasury auctions and trade
directly with the NYFED. The NYFED was also potentially a lender to Lehman and reviewed the bank in that capacity.
7 In attendance at the emergency meeting called by the NYFED were: John, Mack, CEO, Morgan Stanley; John Thain, CEO of
Merrill Lynch; Jamie Dimon, CEO of J.P. Morgan Chase; Lloyd Blankfein, CEO of Goldman Sachs Group; Vikram Pandit, CEO
of Citigroup Inc.; Robert Wolf, CEO of UBS, and representatives from the Royal Bank of Scotland Group PLC and Bank of New
York Mellon Corp., among others.
10 LEHMAN BROTHERS BANKRUPTCY A: OVERVIEW
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1998 private industry solution reached to save the hedge fund Long-Term Capital Management, after its
main fund, Long-Term Capital Portfolio L.P. collapsed.8

Despite interest from Bank of America and Barclays, the discussions at the NYFED failed in part because
of the government’s refusal to assist with funding Lehman’s toxic assets.9 And in the case of Barclays, the
potential deal was subject to a shareholder vote, which could not be secured in the available time, and
which U.K. authorities declined to waive.10
After failure of the emergency meeting, Lehman realized that it would not be able to raise enough funds to
open for business the next day; there just were not enough banks willing to lend it sufficient funds against
the assets that it could offer. The Lehman board of directors voted to file for Chapter 11 bankruptcy
protection, which was done on September 15, 2008. By so doing, Lehman was granted an opportunity to
have certain parts of its operations dismantled in an orderly fashion overseen by a bankruptcy court.
However, large blocks of its business, such as its estimated 900,000 derivatives contracts, were not
subject to bankruptcy supervision. Counterparty efforts to protect themselves resulted in fire sales
amounting to the loss of billions of dollars. (See YPFS case studies McNamara and Metrick 2014F and
Wiggins and Metrick 2014G for more discussion on this point.)
In the Examiner’s Report, Anton Valukas found that there existed colorable claims against several Lehman
officers for filing misleading financial reports.11 (See Section 5. Lehman Personnel.) However, on May
24, 2012, it was reported that the SEC would close the Lehman file without pursuing action against the
firm or any of its former officers. (Gallu 2012) Mary Shapiro, the new SEC chairperson, did not confirm
the reports. As of early 2014, no government agency has brought any case against any former Lehman
officer or director. The bankruptcy case remains ongoing. (See Examiner’s Report, Vol. 4, 1516-39 for a
description of the Lehman weekend; See Gallu 2012 regarding the SEC closing its Lehman case and see
Larson 2014 regarding the bankruptcy case.)
8 Following the Asian Financial Crisis in 1997 and the Russian Financial Crisis in early 1998, LTCM’s main fund lost $4.6
billion in less than four months during 1998. Concerned about the fund’s failure causing a chain reaction and spreading to
others, the NYFED worked with the heads of the major Wall Street firms to find a solution. Meeting at the NYFED’s offices, on
September 23, 1998 fourteen investment and commercial banks (notably excluding Bear Stearns) reached an agreement for a
$3.65 billion recapitalization of LTCM. Even so, the fund liquidated and dissolved in early 2000.
9 Bank of America considered buying Lehman but terminated acquisition talks. The government’s willingness to take
responsibility for Bear Stearns’ most troubled assets led some parties to believe that the government would act in a like manner
with respect to Lehman. The U.S. government’s refusal to assist with Lehman’s most troubled assets led Bank of America to pull
out of the talks. The next day, Bank of America announced that it would acquire a different investment bank, Merrill Lynch.
10 Barclays plc pulled out of talks to buy Lehman because of the U.S. government’s refusal to guarantee future losses on Lehman’s
trading positions. (It was also speculated that Barclays used the threat of withdrawal as a negotiating tactic.) A consortium of
other investment banks, however, did agree to take up to $40 billion in Lehman’s toxic assets to help the deal along, but to no
avail. Barclays needed a shareholder vote to approve the deal, a requirement for U.K. publicly listed firms. The only exception was
if the U.K. authorities waived the shareholder vote, which the Chancellor of the Exchequer refused to do, killing the deal.
Nevertheless, on September 20, 2008, just days after Lehman filed for bankruptcy, Barclays acquired most of Lehman’s U.S.
assets for $1.35 billion, a deal that the bankruptcy court judge approved only reluctantly.
11 Valukas also found that similar claims existed against Lehman’s independent audit firm, Ernst &Young, which is discussed in
YPFS case study Wiggins, et al. 2014 D.