On July 27, 2011, Judge Lewis Kaplan issued a ruling in the case In re Lehman Brothers Securities and ERISA Litigation, in which the plaintiffs include pension funds, companies and individuals that were purchasers of various classes of equity and debt securities issued by Lehman Brothers Holdings Inc.13 The claims relating to approximately 50 series of Lehman principal-protected notes had previously been consolidated with this case involving other securities. Among other claims, the plaintiffs allege that the offering materials related to the principal-protected notes were “materially misleading because they promised but did not provide ‘principal protection’.”

Judge Kaplan’s decision addressed a number of matters relating to the issuer’s disclosures and other issues raised in the litigation. In respect of the principal-protected notes, the decision notes that none of the named plaintiffs actually purchased securities in the principal-protected notes offerings, and as a result have no standing to bring Section 10(b) and Rule 10b-5 claims in respect of offerings in which they did not purchase securities. However, the Court concluded that the plaintiffs’ other allegations in respect of the principal-protected notes were sufficient to state a claim and should be allowed to proceed. Plaintiffs argued that the statements included in the offering materials were “false and misleading because (1) the PPNs did not protect investors’ principal and were no different than ordinary bonds, and (2) the PPN Offering Materials failed to disclose that repayment of principal depending on Lehman’s solvency.” Although the Court noted that there were disclosures regarding credit risk and that the “statements would have made the nature of these securities clear to a careful and intelligent reader,” on balance the statements regarding principal protection were more prominent and frequent than the statements regarding Lehman credit risk.

The Court was addressing a motion to dismiss for failure to state a claim, and was not resolving the question of whether the Lehman Brothers offering documents were in fact misleading as a matter of law. However, the decision serves as another warning to market participants that disclosures about “principal protection” must be appropriate and balanced. Disclosures as to the related credit risk of the issuer that investors face should be as prominent, or even more so. Issuers and underwriters of structured products have been making an effort to do so during the last several years, and it remains advisable to be cautious about these disclosures.