Case 1:09-md LAK Document 733 Filed 02/17/12 Page 1 of 35

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1 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 1 of 35 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK Inre LEHMAN BROTHERS SECURITIES AND ERISA LITIGATION This Document Applies To: Civil Action 09 MD 2017 (LAK) ECF Case Fifty-Ninth Street Investors LLC and Arthur N. Abbey v. Fuld, et al., 11 Civ (LAK) AviSchron and Adina Schron, JTWROS v. Fuld et al., 11 Civ (LAK) PLAINTIFFS FIFTY-NINTH STREET INVESTORS LLC ET AL. OPPOSITION TO DEFENDANTS' MOTIONS TO DISMISS ABBEY SPANIER RODD & ABRAMS, LLP 212 East 39 th Street New York, New York (212) Attorneys for Plaintiffs Dated: February 13,2012

2 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 2 of 35 TABLE OF CONTENTS TABLE OF AUTHORITIES... iii INTRODUCTION... 1 STATEMENT OF FACTS... 1 ARGUMENT LEGAL STANDARDS ON A MOTION TO DISMISS... 4 A. The Rule 12(b)(6) Standard... 4 B. Pleading Requirements under Rule 9(b)... 4 II. PLAINTIFFS HAVE ADEQUATELY ALLEGED VIOLATIONS OF SECTION 10(b) AGAINST ALL OF THE DEFENDANTS... 5 A. The Amended Complaints Adequately Allege that Defendants Made Materially False and Misleading Statements and Omissions The Individual Defendants E&Y Made Materially False and Misleading Statements B. Plaintiffs' Factual Allegations Give Rise to A Strong Inference of Defendants' Scienter Applicable Standards Plaintiffs' Claims Satisfy The Scienter Requirement a. Plaintiffs Have Plead Facts Evidencing Conscious Misbehavior or Recklessness Against The Individual Defendants b. Plaintiffs Have Plead Facts Evidencing Conscious Misbehavior or Recklessness and Motive and Opportunity Against E& Y C. The Amended Complaints Sufficiently Allege Reliance D. The Amended Complaints Adequately Plead Loss Causation E. Th~ Amended Complaints Adequately Allege Control Person Liability

3 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 3 of 35 III. PLAINTIFFS HAVE SUFFICIENTL Y ALLEGED V ALID COMMON LA W FRAUD CLAIMS IV. PLAINTIFFS SHOULD BE GRANTED LEAVE TO AMEND CONCLUSION

4 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 4 of 35 TABLE OF AUTHORITIES Cases Page Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972) Andrew M Cuomo v. Ernst & Young LLP, Index No /2010 (Sup. Ct. N.Y. Co.) Anwar v. Fairfield Greenwich Ltd, 728 F. Supp. 2d 372 (S.D.N.Y. 2010) Bui v. Indus. Enters. of Am., Inc., 594 F. Supp. 2d 364 (S.D.N.Y. 2009) Burstyn v. Worldwide Xceed Grp., Inc., No. 01 Civ (GEL), 2002 U.S. Dist. LEXIS (S.D.N.Y. Sept. 30,2002) Castellano v. Young & Rubicam, Inc., 257 F.3d 171 (2d Cir ) Central Bank, NA. v. First Interstate Bank, NA., 511 U.S. 164 (1994) Foman v. Davis, 371 U.S. 178 (1962) Fraternity Fund, Ltd v. Beacon Hill Asset Mgmt. LLC, 376 F. Supp. 2d 385 (S.D.N.Y. 2005) Gold v. DCL Inc., 399 F. Supp (S.D.N.Y. 1973) In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410 (3d Cir. 1997) In re Complete Mgmt Inc. Sec. Litig, 153 F. Supp. 2d 314 (S.D.N.Y. 2011)... 21,22 In re Globalstar Sec. Litig., No. 01 Civ (SHS), 2003 U.S. Dist. LEXIS (S.D.N.Y. Dec. 12,2003) In re Lehman Bros. Sec. & ERISA Litig., 799 F. Supp. 2d 258 (S.D.N.Y. 2011)... passim 111

5 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 5 of 35 In re Leslie Fay Cos. Inc., Sec. Litig., 835 F. Supp. 167 (S.D.N.Y. 1993) In re Livent, Inc. Sec. Litig., 78 F. Supp. 2d 194 (S.D.N.Y. 1999) In re NYSE Specialists Sec. Litig., 503 F.3d 89 (2d Cir. 2007)... 4 In re Omnicom Group, Inc. Securities Litigation, 597 F.3d 501 (2d Cir. 2010) In re Refco, Inc. Sec. Litig., 503 F. Supp. 2d 611 (S.D.N.Y. 2007)... 4, 12, 15 In re Scottish Re Group Sec. Litig., 524 F. Supp. 2d 370 (S.D.N.Y. 2007)... 4, 15 In re Winstar Comm., No. 01-CV-3014 (GBD), 01-CV-11522, 2006 U.S. Dist. LEXIS 7618 (S.D.N.Y. Feb. 24, 2006)... 16,20 In re WorldCom Inc. Sec. Litig., No. 02-CIV-3288 (DLC), 2003 U.S. Dist. LEXIS (S.D.N.Y. June 24, 2003) " 17 Iqbal v. Hasty, 490 F.3d 143 (2d Cir. 2007)... :... 4 Jacobs v. Coopers & Lybrand, L.L.P., No. 97 Civ (RPP), 1999 U.S. Dist. LEXIS 2102 (S.D.N.Y. Mar. 1, 1999) Janus Capital Group, Inc. v. First Derivative Traders, -- U.S. --,131 U.S (2011)... 7,8 Lattanzio v. Deloitte & Touche LLP, 476 F. 3d 147 (2d. Cir. 2007) Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161 (2d Cir. 2005), cert denied, 546 U.S. 935 (2005)... 22,26,27 Marbury Mgmt., Inc. v. Kohn, 629 F.2d 705 (2d Cir. 1980) Munoz v. China Expert Tech., Inc., No. 07 Civ (AKH), 2011 U.S. Dist. LEXIS (S.D.N.Y. Nov. 4,2011).. 8 IV

6 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 6 of 35 Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000) Overton v. Todman & Co., 478 F.3d 479 (2d Cir. 2007) Rothman v. Gregor, 220 F.3d 81 (2d Cir. 2000) Stevelman v. Alias Research, Inc., 174 F.3d 79 (2d Cir. 1999)... 4 Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008)... 7, 9, 10,24 Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87 (2d Cir. 2001) Varghese v. China Shenghuo Pharm. Holdings, 672 F. Supp. 2d 596 (S.D.N.Y. 2009) Rules 17 CFR b-5(b)... 7 Fed. R. Civ. P. 12(b)(6)... 3 Fed. R. Civ. P. 15(a) v

7 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 7 of 35 INTRODUCTION Plaintiffs Fifty-Ninth Street Investors LLC, Arthur N. Abbey, Avi Schron and Adina Schron, JTWROS (collectively the "Plaintiffs"), respectfully submit this memorandum of law in opposition to dismiss the Plaintiffs' amended complaints (the "Amended Complaints") submitted by Defendants: (1) Richard S. Fuld, Jr. ("Fuld") and Christopher M. O'Meara ("O'Meara")(together the "Individual Defendants"); and (2) Ernst & Young LLP ("E& Y"). 1 STATEMENT OF FACTS "The September 2008 collapse of Lehman Brothers Holdings Inc. ("Lehman" or the "Company") disrupted the entire economy and greatly affected owners of the company's securities." In re Lehman Bros. Sec. & ERISA Litig., 799 F. Supp. 2d 258, 264 (S.D.N.Y. 2011). One of these securities included 5-Year Cash-Settled Call Warrants (the "Warrants") that were issued by Lehman for the purpose of raising approximately $27.8 million for general corporate purposes. In June 2007, Plaintiffs, as account holders at JPMorgan Securities, Inc., ("JPMorgan") were solicited to purchase in an unregistered offering, issued by Lehman, to purchase Warrants which, although issued by Lehman and representing unsecured obligations of Lehman, were designed to track the performance of a JPMorgan owned hedge fund, Highbridge Capital, L.P. ("Highbridge"), for a five year period between June The Memorandum of Law in Support of Richard S. Fuld's and Christopher M. O'Meara's Motion to Dismiss the Amended Complaints filed on January 6, 2012 is referenced to herein as the "Br. _." On January 6, 2012, defendant E&Y filed its Memorandum of Law in Support of Motions to Dismiss and Joinders in Motions to Dismiss Certain Individual Actions, referenced herein as "E&Y Br. _." E&Y joined the Individual Defendants, "insofar as it seeks dismissal of plaintiffs' claims under Section loeb) of the Exchange Act and New York state law on the ground that plaintiffs have failed to plead actual reliance on any alleged misrepresentation." E&Y Br. at 8. 1

8 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 8 of 35 29, 2007 and August 17, ~~1, 20.z The Warrants were to be paid off to Plaintiffs and other Warrant purchasers at the end of the five years, in an amount that depended on the performance of Highbridge over that period. ~21. Plaintiffs did not look to the financial condition or financial results of Lehman for a return on this investment. Rather they looked to the full faith and credit of Lehman to back the payoff of the Warrants at the end of the five years. ~20. The Warrants were extremely illiquid. ~22. They were not listed on any exchange and there was no representation that a secondary market would develop. ~22. There was a limited ability for Warrant holders to request a buyback by Lehman during the 5 year period, but Lehman was not obligated to purchase the Warrants before the end of the entire period. ~22. Each of the Plaintiffs purchased approximately $1,000,000 of the Warrants pursuant to an Offering Memorandum, which incorporated by reference several of Lehman's SEC filings. ~~5, 25. The Amended Complaints allege that the Offering Memorandum was false and misleading because it incorporated by reference Lehman's financial statements, which in tum contained misleading statements and omissions concerning the use of an accounting device referred to internally by Lehman as Repo 105 and Repo 108 programs and their effect on Lehman's publicly reported net leverage. Defendant Fuld served as Chairman and Chief Executive Officer of Lehman during the relevant period and certified the veracity of Lehman's 2006 Annual Report filed with the SEC on February 13, 2007 (the "2006 lo-k") and first quarter 2007 lo-q filed with the SEC on April 9, 2007 (the Q). ~8. Defendant O'Meara served as 2 All references to "~_" are to paragraphs of the November 29,2011 Amended Complaint filed by plaintiffs Fifty-Ninth Street Investors, LLC, and Arthur N. Abbey. 2

9 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 9 of 35 Lehman's Chief Financial Officer, Controller, and Global Head of Risk Management during the relevant period and certified the K and Q. ~9. Defendant E&Y served as Lehman's independent auditors during the 2006 and 2007 fiscal years, as well as for many years prior to that. ~~6, 71. Plaintiffs have alleged that Defendants knowingly engaged in an intentional and systematic scheme, commencing years before Plaintiffs purchased their Warrants, to manipulate Lehman's balance sheet in order to present a false picture of the Company's liquidity and leverage whenever it was required to publicly file its financial statements. At the same time, starting prior to Plaintiffs' purchase of the Warrants and continuing thereafter until Lehman entered bankruptcy, the Defendants caused or permitted Lehman to undertake an increasingly aggressive plan involving acquisition of highly leveraged and increasingly risky mortgage derivatives, including Collateralized Debt Obligations ("CDO's") and Collateralized Mortgage Obligations ("CMO's"). ~41. As the sub-prime mortgage crisis deepened, this strategy caused the fragile liquidity condition of Lehman to fail, and the Company entered bankruptcy in September ~4. Despite the Defendants' attempt to causally isolate the downfall of Lehman from its investment strategy in prior years, Plai~tiffs submit that there can be no serious debate that knowledge of such conduct was not only material to Lehman's investors, but that its concealment was in fact egregious. Plaintiffs have clearly alleged that neither E& Y nor the Individual Defendants made any disclosure whatsoever that would have alerted investors to the deceptive conduct or the reasons for it. This is a classic case of securities fraud primarily through intentional concealment of conduct and omission of material information. There is no 3

10 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 10 of 35 doubt that any rational investor would have wanted to know about the concealment of the Repo 105 and 108 transactions and Lehman's risky investment plan before deciding to entrust funds to Lehman. Plaintiffs submit that they have adequately plead each of the elements of a Section 1 O(b) claim under the Exchange Act and that for the reasons set forth herein the Defendants' motions should be denied. ARGUMENT I. LEGAL STANDARDS ON A MOTION TO DISMISS A. The Rule 12(b)(6) Standard When deciding a defendant's motion to dismiss under Fed. R. Civ. P. 12(b)(6), the court "must accept all of the allegations in the complaint as true and draw all inferences in the light most favorable to the non-moving party's favor." In re NYSE Specialists Sec. Litig., 503 F.3d 89, 95 (2d Cir. 2007). The complaint need not provide detailed factual allegations but must amplify a claim with some factual allegations to render the claim plausible. In re Scottish Re Group Sec. Litig., 524 F. Supp. 2d 370,382 (S.D.N.Y. 2007) (citing Iqbal v. Hasty, 490 F.3d 143, (2d Cir. 2007). B. Pleading Requirements under Rule 9(b) Rule 9(b) of the Federal Rules of Civil Procedure imposes particularity pleading requirements on Section 1 O(b) complaints, mandating that plaintiffs "(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent." In re Refco, Inc. Sec. Litig., 503 F. Supp. 2d 611, 641 (S.D.N.Y. 2007) (citing Stevelman v. Alias Research, Inc., 174 F.3d 79, 84 (2d Cir. 1999)). 4

11 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 11 of 35 II. PLAINTIFFS HAVE ADEQUATELY ALLEGED VIOLATIONS OF SECTION lo(b) AGAINST ALL OF THE DEFENDANTS The Amended Complaints are brought pursuant to Section 1 O(b) of the Exchange Act and Rule 10b-5 against the Defendants. In order to state a claim under Section 1 O(b) of the Exchange Act and Rule lob-5, Plaintiffs must allege that the Defendants "in connection with the purchase or sale of securities, made a materially false statement or omitted a material fact, with scienter, and that the plaintiffs reliance on the defendant's action caused injury to the plaintiff." Lehman Bros., 799 F. Supp. at 275. The Amended Complaints satisfy each of these requirements with respect to all Defendants. A. The Amended Complaints Adequately Allege that Defendants Made Materially False and Misleading Statements and Omissions 1. The Individual Defendants The Exchange Act claims are based on the Individual Defendants' materially false statements and omissions made in Lehman's financial statements with respect to Lehman's use of and accounting for Repo 105 and Repo 108 transactions and their effect on net leverage ratios and liquidity. As alleged in the Amended Complaints, leverage ratios are a key measure of liquidity (i.e., an entity's ability to pay its debt and meet its financial obligations as they become due). ~29. A lower leverage ratio implies greater liquidity because there is less debt in relation to assets and therefore debt service is easier to maintain. ~30. During the relevant period, Lehman's reported leverage ratio, defined by Lehman as total assets divided by total stockholders' equity, was 26.2 times in the 2006 lo-k, comparable and even stronger to some of its peers for the same period. ~29. Lehman also emphasized in its financial reports its "net leverage ratio" (14.5 times), which was defined as net assets divided by tangible equity capital. ~30. The reported net 5

12 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 12 of 35 leverage ratio was lower than Lehman's standard leverage ratio and lower than its peers, which had the effect of making Lehman appear more liquid because a lower ratio implies greater liquidity. ~31. Lehman's liquidity was especially important to investors like Plaintiffs, who were not concerned with whether Lehman's profits would be large or small, but rather whether it would have sufficient liquidity to payout the Warrants at their calculated value on August 17, ~29. Unknown to Plaintiffs, starting in 2001 and throughout the relevant period, Lehman, with the approval of E&Y, repeatedly used Repo 105 transactions to temporarily remove billions of dollars of securities inventory off of its balance sheet just days before it was required to file its financial reports with the SEC. ~~ This enabled Lehman to systematically manipulate its balance sheet by reducing liabilities and assets which artificially reduced its reported net leverage. Id. There is no question that these sham transactions lacked economic substance and hid from the Plaintiffs and investing public the true financial and liquidity condition of Lehman. Utilization of the Repo 105 transactions should have been disclosed in Lehman's financial filings to fairly present its financial position. If Plaintiffs had known that Lehman was purposely concealing its liabilities and manipulating its net leverage via the Repo 105 and Repo 108 programs, they would never have purchased the Warrants --- which are now worthless. This Court has already determined that the Individual Defendants' statements regarding Lehman's net leverage ratios were "materially misleading because they omitted to disclose the fact that Lehman's reported net leverage was temporarily and artificially reduced as a result of the Repo 105 transactions." See Lehman Bros., 799 F. Supp. 2d at 283. In an effort to escape liability in this case, the Individual Defendants challenge 6

13 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 13 of 35 plaintiffs' Section 10(b) and Rule lob-5 claims and contend the materially false and misleading information in Lehman's SEC filings, which were incorporated by reference in the Offering Memorandum, can't be attributed to them because they did not (i) participate in the offer or sale of the Warrants and/or (ii) sign the Offering Memorandum. Br. at 3-7. The Individual Defendants' arguments have no merit and should be rejected. As an initial matter, in the Equity/Debt class action, this Court determined that the Individual Defendants could be held liable for statements they made in Lehman's financial filings that were incorporated by reference in offering materials. The Equity/Debt class action concerned Lehman debt and equity securities issued pursuant to a May 30, 2006 shelf registration statement, a prospectus and other prospectus, product and pricing supplements (collectively the "offering materials), which like the situation here, incorporated by reference several of Lehman's false and misleading SEC filings. Lehman Bros., 799 F. Supp. 2d at 264. The fact that the Warrants are unregistered securities should not change the Court's analysis. Despite the Court's previous findings, the Individual Defendants rely solely on Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008) and Janus Capital Group, Inc. v. First Derivative Traders, -- U.S. --, 131 U.S (2011) to support their argument that Plaintiffs have failed to allege that they made statements in the Offering Memorandum. Both Stoneridge and Janus are distinguishable and do not support dismissal of Plaintiffs' claims. In Janus, the U.S. Supreme Court defined what it means to "make" a statement under Securities and Exchange Rule 1 Ob-5(b), holding that "the maker of a statement is the person or entity with ultimate authority over the [untrue] statement, including its content and whether and how to communicate it." 131 S. Ct. 7

14 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 14 of at 2302; see also Munoz v. China Expert Tech., Inc., No. 07 Civ (AKH), 2011 U.S. Dist. LEXIS , at *3-4 (S.D.N.Y. Nov. 4, 2011). At issue in Janus, like this case, is the provision of Rule 10b-5 making it "unlawful for any person, directly or indirectly,... [t]o make any untrue statement of a material fact" in connection with the purchase or sale of securities." 17 CFR Ob-5(b). The Janus case addressed a situation in which one legal entity, Janus Capital Management ("JCM"), served as investment adviser and administrator for another legal entity, Janus Investment Fund ("JIF"), owned entirely by mutual fund investors. The plaintiff had alleged that the investment adviser JCM had been significantly involved in preparing misleading statements contained in prospectuses filed with the SEC by mutual fund JIF. On this basis, the plaintiff maintained that the investment advisor, JCM should be held primarily liable because it "made" the statements for purposes of Rule 10b-5. The Supreme Court rejected plaintiffs' argument and determined that the investment advisor could not be considered the "maker" of the prospectus because it offered only assistance, not control over the statements. "[A]ssistance, subject to the ultimate control of [the investment fund], does not mean that [the advisor] 'made' any statements in the prospectuses." Janus, 131 S. Ct. at The Court likened the relationship to one between a speechwriter, who assists, and a speechmaker, who possesses ultimate say. Id. Here, the Individual Defendants' role in Lehman's misleading SEC Filings are in no way analogous to JCM's relationship to the statements issued by JIF. Unlike the separate legal entities in Janus, as the individuals who signed the false and misleading SEC filings, Fuld and O'Meara had ultimate authority and control over the information contained in Lehman's misleading financial filings (which were incorporated in the 8

15 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 15 of 35 Offering Memorandum) and whether and how they were communicated. ~~25; 54; see also Margolies Aff. Ex. A at p. 30 (Offering Memorandum titled 5-Year Cash-Settled Call Warrants Linked to the Limited Partnership Interests of Highbridge Capital L.P. Issued by Lehman Brothers Holdings Inc.). The fact that the Individual Defendants did not sign the Offering Memorandum or participate in the sale of the Warrants is irrelevant. In making their decision to purchase the Warrants, Plaintiffs relied on the totality of the Offering Memorandum which "incorporated by reference" and thus included all of the misleading statements and omissions made by the Individual Defendants. The Individual Defendants also rely on Stoneridge, 552 U.S. 148, and assert that the certification of the false and misleading statements contained in the K and 2007 loq were "too remote from the offering of the Warrants." Br. at 5. Defendants' reliance on Stoneridge is mistaken. The issue in Stoneridge was whether an investor could recover from a party which "neither makes a public misstatement nor violates a duty to disclose but does participate in a scheme to violate lo(b)." Stoneridge, 552 U.S In Stoneridge, which dealt primarily with deceptive conduct rather than false statements, the Court ruled that shareholders of Charter Communications, Inc. (a cable company) were prohibited from bringing suit against two of the company's vendors (defendants Scientific-Atlanta, Inc. and Motorola, Inc.) who together with Charter were alleged to have engaged in a scheme to inflate Charter's revenues via "round trip" transactions. A review of Stoneridge indicates that the Supreme Court determined that the plaintiffs failed to satisfy the Section 1 O(b) element of reliance (i.e., that there was no direct reliance by Charter's shareholders on any of the deceptive acts committed by the Scientific-Atlanta and Motorola defendants. Stoneridge, 552 U.S. at 167. Importantly, 9

16 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 16 of 35 the Stoneridge decision recognized that conduct itself, without statements or omissions, can constitute actionable deception. Id. at 158. Nothing in the Supreme Court's decision in Stoneridge should require dismissal of Plaintiffs' claims in this case. Here, Stoneridge simply further supports Plaintiffs' position. As alleged in the Amended Complaints, the Individual Defendants' conduct was clearly deceptive as they actively participated in a scheme to defraud by reviewing and approving Lehman's false and misleading SEC filings while in possession of information that contradicted the representations in these documents. More importantly, the holding in Stoneridge did not deal with the question presented here, whether the Individual Defendants should be held liable for the misleading statements and omissions they made in Lehman's financial filings that were incorporated by reference in the Offering Memorandum. Here, unlike in Stoneridge, 552 U.S. at 159, where the defendants' "deceptive acts were not communicated to the public," the Individual Defendants were at the heart of Lehman's false and misleading statements. It is neither implausible, nor too remote to find that the Plaintiffs relied on the Individual Defendants' certification of Lehman's financial statements that were incorporated in the Offering Memorandum in deciding whether or not to purchase the Warrants. Applying this Court's prior holding in the Equity//Debt class action that the Repo 105 transactions has no "material effect on Lehman's liquidity", the Defendants cherry pick language from the Amended Complaints and assert that Plaintiffs have failed to allege a material misstatement. 3 That argument has no merit. In the Equity//Debt action, class plaintiffs alleged that many of the Lehman offering materials stated that Lehman 3 Plaintiffs allege that Defendants "knew that the systematic use of deceptive accounting devices masked [Lehman's] excessive leverage and liquidity risk... and rendered [Lehman's] SEC filings that were incorporated into the Offering Memorandum... false and misleading." ~32. 10

17 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 17 of 35 has a "very strong liquidity position." Class plaintiffs asserted that these statements were materially false and misleading because they failed, in violation of Item 303 of Regulation S-K ("Item 303"), to disclose Lehman's obligations to repurchase the assets used in the Repo 105 transactions immediately after each quarter closed and because Lehman had "liquidity concerns" due to its accumulation of illiquid assets. The Court determined that class plaintiffs had failed to sufficiently allege that the Repo 105 transactions had a material effect on Lehman's liquidity. In contrast, here, the Amended Complaints do not allege any violations of Item 303. The Defendants also attempt to argue, as they did in the Equity/Debt class action that the misstatements concerning Repo 105 and net leverage are immaterial because the Offering Memorandum and SEC filings "bespoke caution" that the overall size of Lehman's balance sheet would fluctuate. Br. at 6. That argument was previously made by the Defendants and rejected by this Court: The cautions to which defendants point warned only of the risk that the "size" of Lehman's balance sheet might be different at quarter or year-end than at other times. This disclosure, however, was not sufficiently specific or prominent to support a conclusion as a matter of law that no reasonable investor would have found it important to know that Lehman engaged in transactions, the effect of which was to reduce temporarily its net leverage at the end of each reporting period. Lehman Bros., 799 F. Supp. 2d at 280. Notwithstanding the previous holding, Defendants suggest that the Court should find that the cautionary language is sufficient in this case because Plaintiffs fail to allege that the Repo 105 and net leverage ratios were false and misleading due to the temporary effect of the reduction in net leverage. But that argument is absurd because that is precisely what the Plaintiffs allege. See e.g., ~35 ("...[Lehman] recorded the Repo 105 transactions as sales, therefore allowing [Lehman] 11

18 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 18 of 35 to temporarily remove billions of dollars of securities assets off of [Lehman's] balance sheet just days in advance of its SEC periodic report filings. [Lehman] would then use the proceeds from the Repo 105 transactions to pay other liabilities, which enabled [Lehman] to reduce liabilities and assets and materially impact its leverage ratios."). 2. E& Y Made Materially False and Misleading Statements E& Y' s liability arises from its improper issuance of an unqualified audit opinion rendered with respect to Lehman's 2006 lo-k and statements made in the 2007 loq. See e.g. ~~47, 61-70, 85. In Central Bank, NA. v. First Interstate Bank, NA., 511 U.S. 164, 191 (1994), the Supreme Court held: Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 are met. Id. (emphasis added). See e.g., In re Refco Inc. Sec. Litig., 503 F. Supp. 2d 611 (S.D.N.Y.2007). Because E&Y failed to conduct a GAAP audit, but nevertheless issued clean opinions on Lehman's year-end financial statements, it is responsible for the dissemination of material misinformation to the Plaintiffs. See, Lattanzio v. Deloitte & Touche LLP, 476 F. 3d 147, (2d. Cir. 2007) (accountant liable for false audit opinions certifying company's financial results) E&Y does not argue, nor can it, that Lehman's published financial statements were prepared in accordance with GAAP. Here, the Amended Complaints allege E&Y's specific departures from GAAP and sets forth sufficient facts showing that they had no reasonable basis for approving Lehman's use of Repo 105 transactions. Lehman Bros., 799 F. Supp. 2d at 303. E&Y issued an unqualified audit opinion dated February 13, 12

19 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 19 of , relating to its audits of Lehman's consolidated financial statements in the K. ~61. E& Y knew that its certification of the K would be used by Plaintiffs and other investors in securities issued by Lehman and dependent on Lehman's credit rating for the particular purpose of evaluating the financial condition of Lehman at the time their investment was made. ~62. As set forth in the Amended Complaints, E& Y' s audit opinion and statements made in the 2006 lo-k and 2007 loq were presented fairly in accordance with GAAP and that E& Y' s audits had been performed in accordance with the standards of the Public Accounting Oversight Board ("PCAOB"). ~~ E&Y's statements in its K audit opinion and the 2007 loq were false and misleading because E& Y knew it did not fairly present, in all material respects, the existence of and reason for the use of Repo 105 and Repo 108 transactions and their misleading impact on Lehman's balance sheet and net leverage. ~65. E&Y's had no reasonable basis for believing that the K and Q conformed with GAAP because Lehman's financial information omitted relevant information regarding the use of Rep and Repo 108 transactions. ~~ B. Plaintiffs' Factual Allegations Give Rise to A Strong Inference of Defendants' Scienter 1. Applicable Standards "To survive a motion to dismiss Exchange Act claims, a complaint must 'state with particularity facts giving rise to a strong inference that the defendant acted with the requisite state of mind.'" Lehman Bros., 799 F. Supp. 2d at 292 (internal citations omitted). "The requisite state of mind is an intent to 'deceive, manipulate, or defraud.'" Id. "In this circuit, allegations of recklessness - 'an extreme departure from the standards of ordinary care... to the extent that the danger was either known to the defendant or so 13

20 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 20 of 35 obvious that the defendant must have been aware of it' - are sufficient." Id. "A complaint may plead scienter 'by alleging facts (1) showing that the defendants had both motive and opportunity to commit the fraud or (2) constituting strong circumstantial evidence of conscious misbehavior." Id. at 293. "To establish a strong inference of scienter via motive and opportunity, plaintiffs must allege that defendants benefited in some concrete and personal way from the purported fraud." Id. (internal quotation marks omitted). If plaintiffs have not alleged "motive and opportunity" sufficiently, they may rely successfully upon allegations of strong circumstantial evidence of conscious misbehavior or recklessness. "A complaint sufficiently may allege strong circumstantial evidence of scienter when it alleges that defendants (1) benefited in a concrete and personal way from the purported fraud, (2) engaged in deliberately illegal behavior, (3) knew facts or had access to information suggesting that their public statements were not accurate, or (4) failed to check information they had a duty to monitor." Id. For recklessness on the part of an accountant, to satisfy securities fraud scienter, such recklessness must be conduct that is highly unreasonable, representing "an extreme departure from the standards of ordinary care. It must in fact, approximate an actual intent to aid in the fraud being perpetrated by the audited company." Rothman v. Gregor, 220 F.3d 81, 98 (2d Cir. 2000). The complaint must allege "an egregious refusal to see the obvious, or to investigate the doubtful, or that the accounting judgments which were made were such that no reasonable accountant would have made the same decisions if confronted with the same facts." Scottish Re, 524 F. Supp. 2d at 385; Refco, 503 F. Supp. 2d at

21 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 21 of Plaintiffs' Claims Satisfy The Scienter Requirement a. Plaintiffs Have Plead Facts Evidencing Conscious Misbehavior or Recklessness Against The Individual Defendants The Individual Defendants argue that the plaintiffs have failed to allege facts giving rise to a strong inference of scienter. Br. at Defendants are wrong, because Plaintiffs have sufficiently alleged scienter by showing that the Individual Defendants "knew or recklessly failed to know about the misleading nature of the manner in which [the Repo 105 and 108 transactions] were reported." Lehman Bros., 799 F. Supp. 2d at 294. Similar to the allegations made by the plaintiffs in Lehman Bros., 799 F. Supp. 2d at 296, Plaintiffs allege that the Fuld (Lehman'S Chairman and CEO) and O'Meara (Lehman'S CFO who had primary responsibility for overseeing Lehman's finances) knew or were reckless in not knowing that Lehman managed its balance sheet by engaging in approximately $20 to $25 billion in Repo 105 and 108 transactions per reporting period through mid-2007 (~~39, 43), and more than doubled the size of the period-ending Repo 105 transactions to $50 billion between late 2007 and ~45. The Amended Complaints assert that the Individual Defendants were aware of Lehman's use of the Repo 105 transactions (~58), which moved $ billion, nearly 5% of Lehman's purported total assets, off of Lehman's balance sheet just days in advance of the filing of the K and $ billion days in advance of the filing of 2007 loq. The Individual Defendants knew that such transactions served no legitimate business purpose other than to reduce liabilities and assets and materially reduce its leverage ratios. ~~35, 50, 52. Taken as a whole, these allegations raise a strong inference of scienter sufficient 15

22 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 22 of 35 to defeat the Individual Defendants' motions to dismiss Plaintiffs' 10(b) claims. 4 b. Plaintiffs Have Plead Facts Evidencing Conscious Misbehavior or Recklessness and Motive and Opportunity Against E& Y E& Y' s briefing is silent as to any challenge against Plaintiffs' allegations of scienter. The reason for its silence is that the Amended Complaints properly plead facts that give rise to a strong inference of scienter against E& Y. Defendant E&Y was Lehman's principal independent accountant for the relevant period, 2001 through September ~6. E&Y was specifically informed about Lehman's use of Repo 105 transactions on numerous occasions. For example, as detailed in the March 11, 2010 Report of Anton R. Valukas, Examiner (hereinafter, the "Examiner's Report"), since as early as 2001, E&Y had intimate knowledge of Lehman's Repo 105 program and transactions ~72. In fact, in 2001 E& Y helped adopt the policy that enunciated Lehman's intention to use Repo 105 transactions. See Margolies Aff. Ex. B at ~11 (Andrew M Cuomo v. Ernst & Young LLP, Index No /2010 (Sup. Ct. N.Y. Co.). E&Y performed numerous quarterly reviews and annual audits between 2001 and 2008 and during that time had ongoing discussions with Lehman about its use of the Repo 105 program. Id. The Examiner's Report explains that E&Y and William Schlich ("Schlich") (E&Y's lead partner on the audit team responsible for the Lehman account) had intimate knowledge of the Repo 105 program and transactions. ~71. As a result of its audit services and access to Lehman, E& Y was very knowledgeable about the purpose 4 In an attempt to invoke the "auditor signed off on it" defense, the Individual Defendants argue that E&Y's approval of Lehman's use of Repo 105 transactions negates any inference of scienter. Br. at 11. But since the Individual Defendants have "a well-defmed obligation to ensure the accuracy of the information filed with the SEC," reliance on E& Y does not absolve them of responsibility. In re Winstar Comm., No. 01-CV-3014 (GBD), 01-CV-11522, 2006 U.S. Dist. LEXIS 7618, at *26 (S.D.N.Y. Feb. 24, 2006). While even in the numerous notable large frauds of the last decade, e.g. Enron, WorldCom, Tyco, the auditors' "sign-off' failed to absolve the company defendants oftheir liability. 16

23 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 23 of 35 of the Repo 105 transactions, had a complete picture of Lehman's finances, operations and business as well as extensive unfettered access to the internal documents and underlying books and records. ~~ See In re WorldCom Inc. Sec. Litig., No. 02- CIV-3288 (DLC), 2003 U.S. Dist. LEXIS 10863, at *22 (S.D.N.Y. June 24, 2003) (plaintiffs adequately allege scienter with allegations that auditor had access to company's books and records and had an obligation to review records). As Lehman increased the timing and volume of its Repo 105 activities, on several occasions, E& Y was informed that the failure to disclose these transactions was misleading to investors. For example, in September 2006, after a review of Lehman's policy guidelines concerning the Repo 105 transactions, one of the E& Y ILehman team auditors became concerned about the volume of Repo 105 transactions. ~71; Margolies Aff. Ex. B at ~43. In a September 7, to his senior manager, the E&Y auditor noted that he would "like to know what is our thought process behind how much of these Lehman should do from reputational risk, etc. perspective. Are we comparing to other competitors, are we referring to any industry publications, any regulatory guidance, etc.?" Id. After the senior manager received the she viewed it as raising serious issues and took the issue of the Repo 105 transactions up with the E& Y engagement partner to who she reported. Margolies Aff. Ex. B at ~45. As part of a standard practice, E& Y received a document from Lehman entitled "Accounting Policy Review Balance Sheet Netting and Other Adjustments," which was dubbed the "Netting Grid" by the Lehman and E&Y finance teams. ~74. The Netting Grid contained data related to Lehman's balance sheet adjustments, including data related to the effects of the Repo 105 transactions on the balance sheet. E& Y used the data in 17

24 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 24 of 35 connection with E& Y' s year-end audits. In August 2007, Lehman transmitted to E& Y for its review a Netting Grid that contained Repo 105 data from November 30, 2006 (Lehman's fiscal year-end) and February 28, 2007 (Lehman's lq 2007). According to that Netting Grid that E&Y reviewed, Lehman had moved $ billion in Repo 105 transactions off of its balance sheet just prior to the filing of the K and had moved $ billion in advance of the lq 2007 Report. The August 2007 transmission of the Netting Grid to E&Y is a strong inference that each time E&Y audited or reviewed Lehman's financial statements it was provided with information relating to the Repo 105 transactions and the effects on Lehman's balance sheet. By 2007, E& Y was clearly on notice that the Lehman financial statements that it had certified were false and misleading and therefore had a duty to take reasonable steps to correct its opinions. In Overton v. Todman & Co., 478 F.3d 479, 485 (2d Cir. 2007), the Second Circuit addressed the notion that an accountant who issues a public audit opinion has a responsibility to those who rely on that opinion. Overton v. Todman & Co., 478 F.3d 479, 485 (2d Cir. 2007)("[a]ccounting firms 'do have a duty to take reasonable steps to correct misstatements they have discovered in previous financial statements on which they know the public is relying. "'). 5 The Overton Court also observed that, "an accountant violates the 'duty to correct' and becomes primarily liable under loeb) and Rule 10b-5 when it (1) makes a statement in its certified opinion that is false or misleading when made; (2) subsequently learns or was reckless in not learning that the See Goldv. DeL Inc., 399 F. Supp. 1123, 1127 (S.D.N.Y. 1973), cited in Overton, which held that where an auditor "gives an opinion or certifies statements, an auditing firm publicly assumes a role that carries a special relationship of trust vis-a-vis the public. The auditor in such a case holds itself out as an independent professional source of assurance that the audited company's fmancial presentations are accurate and reliable." 18

25 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 25 of 35 earlier statement was false or misleading; (3) knows or should know that potential investors are relying on the opinion and financial statements; yet (4) fails to take reasonable steps to correct or withdraw its opinion and/or the financial statements; and (5) all the other requirements for liability are satisfied." Id. at In June 2008, E&Y was given a copy of a letter by Matthew Lee (a Senior VP at Lehman) which raised serious questions about Lehman's improper use of the Repo 105 transactions.,-[73. See Lehman Bros., 799 F. Supp. 2d at 304 ("E&Y arguably was on notice by June 2008 that Lehman had used Repo los's to portray its net leverage more favorably than its financial position warranted, a circumstance that could well have resulted in the published balance sheet for that quarter being inconsistent with GAAP's overall requirement of fair presentation."); Jacobs v. Coopers & Lybrand, L.L.P., No. 97 Civ (RPP), 1999 U.S. Dist. LEXIS 2102, at *44 (S.D.N.Y. Mar. 1, 1999) (upholding allegation where alleged GAAP violations were alleged in detail and suggested that auditor should have been aware of the underlying fraud). Despite access to all the information described above indicating that Lehman's financial statements materially misrepresented its financial condition, during the relevant period, E&Y issued clean audit opinions stating that Lehman's audited financial statements "present[ ed] fairly, in all material respects, the consolidated financial position of the Company...in conformity with U.S. generally accepted accounting principals.",-[61. Clearly, the details of the way that Lehman was using the Repo 105 program to manipulate its balance sheet to reduce its net leverage were not hidden from E&Y. To the contrary, E&Y was aware or recklessly disregarded that the investing public was being misled about Lehman's deceptive strategy of using the Repo 105 transactions to 19

26 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 26 of 35 manage its balance sheet and lower its leverage ratio.,-r,-r See In re Globalstar Sec. Litig., No. 01 Civ (SHS), 2003 U.S. Dist. LEXIS 22496, at *17 (S.D.N.Y. Dec. 12, 2003) ("[s]ecurities fraud claims typically have sufficed to state a claim based on recklessness when they have specifically alleged defendants' knowledge of facts or access to information contradicting their public statements. Under such circumstances, defendants knew or, more importantly, should have known that they were misrepresenting material facts related to the corporation." (emphasis added)). If E&Y had properly audited Lehman's financial statements and conducted its audit in conformity with GAAP, it would have obligated Lehman to disclose the use of the Repo 105 transactions. By turning a blind eye to Lehman's improper use of the Repo 105 program, E&Y actively participated in the dissemination of Lehman's false and misleading financial statements and should be held accountable for the losses incurred by Plaintiffs as a result of this fraud. The magnitude of the misstatements and omissions In Lehman's financial statements also supports E&Y's scienter. The 2006 Annual Report was silent as to the Repo 105 and Repo 108 transactions, which caused (i) the balance sheet to be misstated by $25 billion; and (ii) Lehman's leverage ratios to be materially understated.,-r63. Many courts have held that the magnitude of the fraud is relevant to an analysis of scienter on the part of auditors. In re Livent, Inc. Sec. Litig., 78 F. Supp. 2d 194, (S.D.N.Y. 1999) ("the magnitude of the alleged fraud will be considered in weighing whether the Complaint meets the pleading standard for scienter."); Burstyn v. Worldwide Xceed Grp., Inc., No. 01 Civ (GEL), 2002 U.S. Dist. LEXIS 18555, at *18 (S.D.N.Y. Sept. 30, 2002) (court denied defendants' motion to dismiss, noting that the "magnitude" of the 20

27 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 27 of 35 violations further supports a strong inference of scienter); In re Leslie Fay Cos. Inc., Sec. Litig., 835 F. Supp. 167, 175 (S.D.N.Y. 1993) (rejecting independent auditor's motion to dismiss where allegations of large accounting errors gave rise to inference of scienter). The Amended Complaints allege with particularity that E& Y would have uncovered the fraud perpetrated by the Individual Defendants and others if it had conducted a sufficient audit review before issuing its audit opinions relating to Lehman's financials. The extraordinary magnitude of the misstatements and omissions in Lehman's financial statements supports a strong inference that E& Y must have known, or was reckless in not knowing about the misleading nature of the manner in which the Repo 105 and 108 transactions were reported. The Amended Complaints also adequately allege E&Y's motive and opportunity to participate in Lehman's fraudulent use of Repo 105 transactions. "Motive would entail concrete benefits that could be realized by one or more of the false statements and wrongful nondisclosures alleged. Opportunity would entail the means and likely prospect of achieving concrete benefits by the means alleged." Novak v. Kasaks, 216 F.3d 300, 307 (2d Cir. 2000). Auditors have been found to have the motive and opportunity to commit fraud where, in addition to auditing services, they provide considerable consulting services to a corporate defendant. In re Complete Mgmt Inc. Sec. Litig, 153 F. Supp. 2d 314, 335 (S.D.N.Y. 2011) (finding alleged motive of auditor to earn consulting fees sufficient to survive a Rule 9(b ) challenge). Lehman was extremely valuable to E& Y not only as audit clients but also as nonaudit client. While E& Y acted as auditor for Lehman, it also rendered significant accounting, tax and advisory services. See Margolies Aff. Ex. B at ~11. Lehman was one 21

28 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 28 of 35 of E&Y's biggest clients, resulting in over $150 million in total compensation between 2001 and Lehman's bankruptcy in Id at ~~5, 71; ~75. The magnitude of the compensation from audit and non-audit services gave E& Y incentive to tum a blind eye to Lehman's fraudulent use of Repo 105 transactions. This Court has found similar motive allegations to be sufficient at the pleading stage. See Complete Mgmt., 153 F. Supp. 2d at 335 (upholding claims against Arthur Andersen). While Plaintiffs recognize that a generic desire to earn audit fees may be insufficient to allege motive against an auditor, here, E&Y earned an exorbitant amount of money, through its audits and other services provided to Lehman. See Margolies Aff. Ex. B at p. 32 (the NYAG is seeking the return of at least $150 million in fees received by E&Y from Lehman between 2001 to the present). This motive, when viewed together with the other facts alleged by Plaintiffs against E&Y, creates an inference of scienter sufficient to allow the Amended Complaints to survive the motion to dismiss stage. C. The Amended Complaints Sufficiently Allege Reliance To adequately state a claim for securities fraud, a plaintiff must plead transaction causation (i.e. reliance) which "requires a showing that 'but for the claimed misrepresentations or omissions, the plaintiff would not have entered into the detrimental securities transaction.'" Varghese v. China Shenghuo Pharm. Holdings, 672 F. Supp. 2d 596, 605 (S.D.N.Y. 2009) (citing Lentell v. Merrill Lynch & Co., 396 F.3d 161, 172 (2d Cir. 2005)). Plaintiffs here read and relied on the Offering Memorandum, in which Lehman's financial statements, including E&Y's clean audit reports of Lehman's financial statements were incorporated by reference. 6 However, regardless of what 6 Plaintiffs have alleged reliance on the Offering Memorandum. See, e.g., ~~ 26,27, 7.6, 77, 86. For the reasons set forth herein, reliance issues should not be determined adversely to Plaintiffs at the pleadings 22

29 Case 1:09-md LAK Document 733 Filed 02/17/12 Page 29 of 35 documents Plaintiffs read or could have read had they done their own due diligence, nothing would have informed them of the concealed risks in Lehman's business. From the time of their purchases in June 2007, and for almost 15 months later, no public document available about Lehman, including E&Y's report, revealed either the systematic scheme to conceal the true liquidity risk and leverage ratios of Lehman or the high risk investment strategy the company had undertaken. The Individual Defendants' analysis of the reliance element is entirely off base. The fraud on the market presumption is not invoked by Plaintiffs. Here, there was no market for the Warrants. However, individual investors are not barred from protection under Section 10(b) of the 1934 Act and New York State common law because they had no way of knowing, even with due diligence, that the seller of securities they were being sold was hiding significant financial misconduct that it had been engaged in for several years. Plaintiffs' reliance was reasonable and Defendants' do not argue and cannot show that Plaintiffs could have learned the truth about Lehman through any reasonable investigation. Under these circumstances, it would be inappropriate to dismiss Plaintiffs' claims for lack of reliance. On the current record and pleadings in this case the issue of reliance must be determined in Plaintiffs' favor. While the Amended Complaints allege fraud in terms of both misrepresentations and omissions, this case is primarily about fraudulent concealment. Regardless of the specific direct or indirect reliance by Plaintiffs on the Offering Memorandum and the Lehman documents incorporated by reference therein, the reliance element for Section 1 O(b) liability is satisfied in this case by the alleged material omissions. "We have found stage, because it is clear that had they known of the alleged omissions and misrepresentations, they would never have purchased the Warrants. To the extent that such allegations are deemed not sufficiently specific, Plaintiffs request leave to amend to provide additional facts concerning their reliance. 23