Lehman Brothers

and Corporate Governance failure

By Adnan Qatinah Mohammed Ghiath Agha

 Introduction. Brief history of Lehman Brothers. The Board Structure on Lehman Brother. Causes of Lehman Brothers failure. o Corporate Governance Failure. o Technical Causes of Lehman Brothers failure.

o Other Causes.
Conclusion.

On September 15, 2008, Lehman Brothers Holdings Inc filed for bankruptcy. It filed for protection under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York. It filed with $639 billion in assets and $619 billion in debt, Lehman's bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees worldwide. In this presentation we will focus in the corporate governance failure.

http://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp#ixzz1fMgLOtOn

1844 1850 1858 1860s 1887 1889 1929

Henry Lehman, an immigrant from Germany, opens a small dry goods store in Montgomery, Alabama, in 1844. Henry is joined by brothers Emanuel and Mayer and they name the business Lehman Brothers. The Lehmans -- who take cotton from farmers to settle accounts and trade the cotton for money and merchandise -- open a New York office.` After the Civil War, they move to New York and establish the New York Cotton Exchange. Become members of the New York Stock Exchange Lehman underwrites its first public offering, for the International Steam Pump Company. The Lehman Corporation is created, a closed-end investment company.

Source: http://www.reuters.com/article/2008/09/13/us-lehman-factbox-idUSHAR27520620080913

1930s 1950s 1960 1962 1972

Lehman underwrites the IPO of DuMont, the first television manufacturer. Underwrites the IPOs of Digital Equipment and Hertz Rent-a-Car Opens a Paris office. With Salomon Brothers, Merrill Lynch and Blyth and Company, Lehman forms an association nicknamed the "fearsome foursome" that challenges the major firms for underwriting business. Becomes one of the first investment banks to open an office in London to take advantage of the booming bond market in Europe.

1975
1984 1986

Lehman acquires Abraham & Co.

American Express acquires Lehman Brothers and merges it with Shearson. Seat on the London Stock Exchange

Source: http://www.reuters.com/article/2008/09/13/us-lehman-factbox-idUSHAR27520620080913

1988 1993 1994 1994 1998 1999 2001

Seat on the Tokyo Stock Exchange American Express divests Shearson, and the independent firm once again becomes known as Lehman Brothers. Lehman becomes independent through a public stock offering and Lehman Brothers Holding Inc common stock begins trading on the New York & Pacific stock exchanges. Richard Fuld Jr takes the top job at Lehman. Fuld fights off rumors that the near collapse of Long Term Capital Management had caused a cash crunch at Lehman. Lehman establishes an alliance with Bank of Tokyo-Mitsubishi for Japanese mergers and acquisitions. Under pressure to cut costs, Fuld decides to pay staff less and in stock, rather than lay off employees.

Source: http://www.reuters.com/article/2008/09/13/us-lehman-factbox-idUSHAR27520620080913

2002 2003

Lehman establishes its wealth and asset management division and acquires Lincoln Capital Management's fixed income business. Lehman acquires Neuberger Berman and The Crossroads Group. Lehman posts record-high net revenues, net income and earnings per common share (diluted) for a fourth consecutive year and the highest volume of trade on the London Stock Exchange for a third year in a row. On September15, 2008 Lehman Brothers Filed for Chapter 11 bankruptcy with about $613 billion in bank debt

2007

2008

Source: http://www.reuters.com/article/2008/09/13/us-lehman-factbox-idUSHAR27520620080913

As glorious as this past may seem Lehman could not resist the subprime markets. In August of 2007 Lehman closed its subprime lender BNC Mortgage which left 1,200 positions gone. This clearly was only the beginning for Lehman and their mortgage and credit problems. In 2008 Lehman was posting unprecedented losses. For the most part their problems arose from holding onto lower grade tranches and holding on too long to subprime mortgages. It is up in the air whether they held onto to these assets because of a foolish investment move or whether their simply wasnt a market for these assets. For the 2nd quarter the frim had $2.8 billion in losses and was forced to liquidate $6 billion in assets. It is simply stunning to see the stock movement for the firm:

Structural Attribute Chairman

: Lehman Brothers
: Richard S. Fuld, Jr : Richard S. Fuld, Jr : 10 members :3 : 3 retired, average 12 years : 8 members

CEO
Number of board members Number of current CEOs/Chairmen/President Number of retired CEOs and years since their retirement Independent board members (according to NYSE)

www.afcar.net 9 http://www.gsb.stanford.edu/cgrp/documents/CGRP03-LehmanBoard.pdf

Professional background of independent board members

Name ICHAEL L. AINSLIE Experience Former CEO Sothebys

JOHN F. AKERS
ROGER S. BERLIND JOHNSON EVANS SIR CHRISTOPHER GENT

Former Chairman of International Business Machines Corporation

Theatrical Producer CEO American Red Cross Chairman GlaxoSmithKline Vice Chairman RKO Pictures / Actress

THOMAS H. CRUIKSHANK JOHN D. MACOMBER

Former CEO Halliburton Principal JDM Financial

www.afcar.net 10 http://www.gsb.stanford.edu/cgrp/documents/CGRP03-LehmanBoard.pdf

Average age of board members Committee meetings (2007-2008)

: 68.4 years old Audit Committee Compensation and Benefits Committee Nominating and Governance Committee Finance & Risk Committee Executive Committee :7 :8 :5 :2 : 11

11 http://www.gsb.stanford.edu/cgrp/documents/CGRP03-LehmanBoard.pdf

Numbers of Committees: Audit Committee Compensation and Benefits Committee Nominating and Corporate Governance Committee Finance and Risk Committee Executive Committee.

12

www.afcar.net

 The structure follow the one tier board structure (US model). Richard FULD hold the two positions CEO and Chairman of the company. The board consists of high portion of independent directors eight

out of ten(whom met the independence standards of the New York

Stock on the board). In addition to five committees.
13 www.afcar.net

 The board met the structural standers and there is nothing unusual. Their average age was 68 versus 61 on the large company (a little high). Directors had a diversity professional experience, but a significant lack of experience on financial issues.

14

www.afcar.net

Definition of Independent Directors at Lehman Brothers: A director is not considered independent if the director or a family member has been employed as an executive; officer at the company within the last three years; has earned a salary in excess of $100,000 from the company in the last three years; has been employed as an internal or external auditor of the company in the last three years; is an executive officer at another company where the listed companys present executives have served on the compensation committee in the last three years; or is an executive officer at a company whose business with the listed company has been the greater of 2 percent of gross revenues or $1 million within the last three years

15

Source: NYSE Corporate Governance Rules. http://www.nyse.com/pdfs/finalcorpgovrules.pdf. www.afcar.net

On 15 September 2008, Lehman Brothers Holdings filed for Chapter 11 bankruptcy protection. Its bankruptcy filing listed debts of $613bn, and named banks from Tokyo, Hong Kong, New York, Singapore, Taipei and elsewhere as unsecured creditors owed hundreds of millions of dollars.
There are many causes of Lehman Brothers failure, we could divide them to tree categories as follow:
Others

Technical causes Corporate governance failures

Lehman Brothers had weak corporate governance arrangements which failed to safeguard against excessive risk taking are partly to blame for the economic crisis. Such failures remained hidden in a prosperous market but the downturn has revealed a number of flaws. The key areas of weakness that have been highlighted are: Corporate risk management; Board of directors; Remuneration scheme; and Nomination committees.

http://www.charlesrussell.co.uk/UserFiles/file/pdf/Mergers%20&%20Acquisitions/briefing%20note%20%20corp%20gov%20since%20the%20fal l%20of%20lehman.pdf

Lehman Brothers had sex committee, one of them was a Finance and Risk Committee, which consists of the Firms Executive Committee, the CRO and the CFO, should meet weekly to discuss all risk exposures,

position concentrations and risk taking activities, but it

only met twice in both 2006 and 2007.

LEHMAN BROTHERS, Quantitative Risk Management Policy Manual, September 2007, P. 3.

Sores:- Grant Kirkpatrick, The Corporate Governance Lessons from the Financial Crisis, UNCTAD, P. 68

Timothy Geithner (Secretary Of The Treasury),said in his report, Lehmans plunge into high-risk businesses in the years before its bankruptcy has become a familiar story. During this period of aggressive growth, Lehman

developed significant exposures to risky subprime lending,

commercial real estate, structured products, and high-risk lending for leveraged buyouts. Importantly, the Valukas Report indicates that Lehman repeatedly breached its own risk concentration limits in pursuit of higher earnings. http://newsroom-magazine.com/2010/government-agencies/finance-and-banking/lehman-brothers-a-case-study-in-our-systems-failures/
Treasury Secretary Tim Geithner

NEW YORK (CNNMoney.com), Failings by Lehman Brothers executives and its auditor led to the bank collapse that unleashed the worst of the financial crisis.

According to a report by a court-appointed investigator, Lehman repeatedly exceeded its own internal risk limits and controls," and a wide range of bad calls by its

management led to the bank's failure, says the report,

authored by examiner Anton Valukas.`

Anton Valukas, (Chicago Based Lawyer) said in his report, the bankruptcy examiner's massive report on the collapse of Lehman Brothers has found "credible evidence" that top executives, including the Chief Executive, approved misleading statements and used accounting gimmicks as drugs to hide the truth from investors and the public. Worse, the report raises serious questions about the behavior of auditors and regulators, who are supposed to protect the public. Specifically, the report's revelations include:

Inside Lehman Brothers, some executives were very concerned about the firm's Enron-like accounting practices as the company headed to the brink in September 2008. In May 2008, Matthew Lee, a former Lehman senior vice president wrote a letter to senior management warning that the company may have been masking the true risks on its balance sheet. His warnings, revealed in the bankruptcy report, show that Lehman's auditors knew of potential accounting irregularities and allegedly failed to raise the issue with Lehman's board.
http://www.linkedin.com/answers/financial-markets/equity-markets/MKT_EQU/645169-6828686

Lehman Brothers adopted a new strategy to overcome their problems but this led to business risks because its investments in long term assets like the commercial real estate, private equity and leveraged loans had more vague prospects and were less liquid than its usual investments.

Corporate Governance Of Lehman Brothers, http://www.oppapers.com/essays/Corporate-Governance-Of-Lehman-Brothers/687796

The House of Representatives Committee offered the following observations on the composition of the board: Nine are retired. Four of them are over 75 years old. One is a theater producer, another a

former Navy admiral. Only two have direct

experience in the financial services industry.

Sores:- Getting Bank Governance Right -The bank board members guide to risk management oversight, Deloitte, 2009, P. 4

http://www.deloitte.com/assets/Dcom-SouthAfrica/Local%20Assets/Documents/ZA_fsi_BS_GettingBankGovernanceRight_160810.pdf

 Board of directors at Lehman Brothers were paid well for their services in fees that range from $325,000 to $397,000. Independent directors may lack the incentive and the time to take care of the corporation, because, most of them were very busy and had many responsibilities. For instance, Marsha Johnson Evans serves as a director of Weight Watchers International, Huntsman Corporation and Office Depot, as well as chairman of Lehmans nominating and governance committee and a member of both the

compensation committee and the finance and risk committee.

http://finlayongovernance.com/?p=485

A study from researchers at Harvard University, The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008, shows that the top executive managers of Lehman Brothers received about $1 billion respectively from cash bonuses and equity sales between 2000 and 2008. The Board at Lehman Brothers awarded total remuneration of close to $500 million to Chairman Fuld, just four days before

its collapse and following an announcement that the firm lost

almost $4 billion in the third quarter, Fuld told the media that "the Board's been wonderfully supportive."

http://journalistsresource.org/studies/economics/corporations/executive-compensation-at-bear-stearns-and-lehman/

http://siteresources.worldbank.org/FINANCIALSECTOR/Resources/J3-LehmanBrothersCaseStudy.pdf

 Fuld (CEO) received nearly half a billion dollars in total compensation Between 1993 and 2007. In 2007, Fuld earned a total of $22 million, including: - a base salary of $750,000; - a cash bonus of $4.25 million; and

- stock grants of $16 million.

The staff received a disproportionately high percentage of their pay in Lehman stock and options. When the firm went public, employees owned 4 per cent of the firm, worth $60m. By 2006, they owned around 30 per cent, equivalent to $11billion, at least on paper.

Four of the ten member board at Lehman Brothers were over 75 years of age and only one had current financial sector knowledge.

http://www.fide.org.my/publications/articles/0013_OECD.pdf

One of the main failure cases in Lehman Brothers was the misbehavior of top executives and the inaction of both the board and the auditing firm (Ernst & Young).

There are many similarities between the collapses of Enron in 2001 and Lehman Brothers in 2008, that they managed to reduce leverage on the right-hand side of the balance sheet and, at the same time, reduce assets on the left-hand side. In Lehman

Brothers, Repo 105 transactions doubled between late 2006 and May 2008, were
known inside the corporation, exceeded the firm's self-imposed limits and typically happened at the end of each quarter, when financial information had to be released.

Arturo Bris, THE LEHMAN BROTHERS CASE, A corporate governance failure, not a failure of financial markets, May 2010,, P. 2-3.

Lehman in the last year was unable to retain the confidence of its lenders and clients, because it did not

have sufficient liquidity to meet its current obligations,

and on two consecutive quarters with huge reported losses, $2.8 billion in second quarter 2008 and $3.9 billion in third quarter 2008, without news of any definitive survival plan.

http://lehmanreport.jenner.com/VOLUME%201.pdf

 The Wall Street equivalent of a coroners report, mention that Richard S. Fuld Jr, Lehmans former chief executive, certified the misleading accounts, the report said. Mr. Valukas (one of the examiner) wrote in the report Unbeknownst to the investing public, rating agencies, government regulators, and Lehmans board of directors, Lehman reverse engineered the firms net leverage ratio for public consumption,. The report states that Mr. Fuld was at least grossly negligent. Henry M. Paulson Jr., who was then the Treasury secretary, warned Mr. Fuld that Lehman might fail unless it stabilized its finances or found a buyer.`

Henry M. Paulson Je. Shannon Stapleton/Reuters

http://www.nytimes.com/2010/03/12/business/12lehman.html

Lehman Brothers filed for many reasons, corporate governance failures were the most important, especially risk management. Lehman Brothers failure and other failures that happened in the financial crisis will, in turn, spawn a new wave of corporate governance reforms.

http://www.law.upenn.edu/cf/faculty/jfisch/workingpapers/77UChiLRev923(2010).pdf