Yesterday, the nine volume Report of Anton R. Valukas, Examiner in the Chapter 11 bankruptcy proceedings of Lehman Brothers Holdings, Inc. (In re Lehman Brothers Holdings Inc. et al.) was filed with the United States Bankruptcy Court Southern District of New York. The report has great significance as it represents the first detailed analysis of potential civil claims against the management of failed financial institutions. The report's analysis erects the framework for the arguments over duties and liabilities in future litigation involving failed institutions. In a sentence, liability arises not so much from business decisions or models that ultimately did not work as from efforts to manipulate financial statements through dubious accounting devices and from efforts to conceal these devices and adverse facts about the institution. Among the conclusions in the weighty (some 2,200 pages) report are the following:

  • Lehman's failure may be traced to three sets of circumstances: (i) poor business decisions, including the use of accounting device to shrink the balance sheet and reduce the appearance of leverage; (ii) a business model that encouraged undue risk-taking and leverage; and (iii) inadequate government oversight.
  • With respect to decision-making by Lehman management, many decisions, while incorrect, are protected by the business judgment rule.
  • Two sets of "colorable" claims exist. First, "colorable claims exist against the senior officers who were responsible for balance sheet management and financial disclosure, who signed and certified Lehman’s financial statements and who failed to disclose Lehman’s use and extent of Repo 105 transactions to manage its balance sheet." Second, "colorable claims exist that [the outside accountant] did not meet professional standards, both in investigating ... allegations [of accounting improprieties] and in connection with its audit and review of Lehman’s financial statements." The outside accounting firm for Lehman did not meet professional standards by virtue of an alleged failure to investigate claims of accounting improprieties and in connection with its review of Lehman's financial statements.

The report also is a useful source of analysis because it discusses facts that do not give rise to potential liability. Among other inferences one may draw are that adherence to an ultimately flawed business model does not create liability and that, in certain circumstances, the government's role may be a mitigating factor. It is worth noting that, since the report focuses on potential claims in bankruptcy, it necessarily does not address the public policy issues that Lehman's failure revealed and that are now part of the debate in Congress over regulatory reform, including the identification of systemically risky institutions, the role of the Federal Reserve in preventing or ameliorating the failure of a major institution, and the orderly resolution of a non-depository institution.