"" SUMMARY OF THE CASE
1. Plaintiffs sue for over 60 Class members (Annex A) that collectively have committed to invest at least $53,750,000 as limited partners of the Partnerships, and have joined in the Agency Agreement (form attached as Annex B) to seek damages for losses incurred due to Defendants‟ misrepresentations and failures to disclose their scheme to use Plaintiffs‟ funds to acquire real estate from Lehman, during its financial crisis, at prices far above Fair Value, without adequate disclosure or informed consent.
Said misrepresentations and omissions were made in very similar Private Placement Memoranda (“PPMs”) related to sales of limited partnership interests in several Lehman real estate limited partnerships.
A sample PPM is attached as Annex C. Plaintiffs here allege violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), SEC Rule 10b-5; bad faith breach of fiduciary duty, the Delaware securities anti-fraud statute; and common law claims for fraud and breach of contract, including Sections 6.8, 6.13 and 8.1 of the Limited Partnership Agreements (“LPAs”) for the Partnerships. An LPA for Fund III is attached as Annex D. LPAs for all Parallel Funds are essentially identical in all material respects incident to this litigation.
2. The commercial real estate market worldwide declined substantially from mid-2007 through 2008. While others booked sizable real estate losses in 2007, Lehman recorded only modest writedowns, despite having multiplied its high exposure to real estate investments that year with highly-leveraged and unadvised purchases.
Lehman‟s real estate portfolio held for sale grew from $9.4 billion as of its 2006 year-end to over $21.9 billion at its 2007 year-end. As the real estate market declined in 2007, Lehman failed to adequately write down these assets and continued to overvalue them in violation of Generally Accepted Accounting Principles (“GAAP”).
Lehman‟s situation was aggravated by very high leverage and reliance on short-term debt financing.
Although commercial banks may not leverage their assets-to-equity ratio by more than 15-to-1 for safety reasons, Lehman‟s leverage ratio was more than double that amount, and rose to an estimated 44-times equity, according to a well-respected financial authority, David Einhorn (L. McDonald, “A Colossal Failure of Common Sense,” p.287, Crown Publ., 2009).
With such high leverage, “a mere 3.3% drop in the value of assets wipes out the entire value of equity and makes the company insolvent,” according to Luigi Zingales, Professor of Finance, University of Chicago. (Id.).
Lehman‟s failure to write down its real estate holdings as required by GAAP was due to Defendants‟ desire to conceal Lehman‟s virtual insolvency long before its bankruptcy on September 15, 2008.
3. The PPMs were issued to prospective investors by October, 2007, during the broad market decline. They uniformly spoke of future market opportunities, and stated that Lehman‟s experts would, at a later date, identify and evaluate the “investments to be made by
LBREP III,” but omitted relevant material facts. The PPMs represented that Lehman‟s team would “monitor changing economic conditions, anticipate the impact on real estate markets and act quickly and decisively on compelling investment opportunities.”
Investment decisions would aim to maximize the value of LBREP III assets and “to provide its investors with attractive risk-adjusted returns.” But these statements omitted the material fact that Defendants intended to transfer legacy Lehman properties to LBREP III along with their accumulated losses.
The PPMs stated that the “General Partner will create an Investor Advisory Committee” that is “unaffiliated with the General Partner”(PPM at Section V, p.27) and the LPAs said the “General Partner shall endeavor in good faith to appoint members . . . who, as a group, are representative of the Limited Partners.” (LPAs Section 6.8(c)).
The PPMs and LPAs both stated that the IAC would objectively review transactions in which the General Partner had conflicts of interest, and would also be consulted concerning any write-down of property valuations. But they omitted to state that Defendants would not form an IAC until after the transfers had been made.
4. The omissions in the PPMs were “group-published information,” resulting from the efforts of all Defendants in outlining, drafting, reviewing, revising and publishing the PPM contents for promulgation to investors such as Plaintiffs.
On information and belief, based on their respective positions and functions in and for Lehman and the General Partner,
(i) Defendants Fuld, Gregory, Walsh and Odrich formulated the overall plan for Lehman to “warehouse” real estate investments for subsequent transfer to the Partnerships and outlined to subordinate Lehman officials how the PPMs should describe what was to be done with investors‟ money;
(ii) Defendants O‟Meara, Callan and Lowitt compiled the financial information regarding Lehman‟s property investments, the market information regarding the overall market decline, the loss positions represented by most of the Subject Investments to be transferred to the Partnerships, and then decided to largely disregard GAAP principles regarding write-downs of investment valuation, supported the effort to conceal the fact, known to them, that investors would inevitably inherit Lehman‟s losses upon their initial investment, and continued that concealment by deciding, with the concurrence of all other Defendants, to omit the LPA-required 2nd Quarter 2008 financial statement to investors which would have disclosed the true facts of the losses;
(iii) Defendants Walsh, Bossung and Newman managed the Lehman real estate investment activity and made the actual approvals and purchases of Lehman properties to be “warehoused,” and thus intimately knew the financial information regarding the properties, the market information regarding the overall market decline, the loss positions represented by most investments to be transferred to the Partnerships, and thereafter directly managed the marketing of limited partnership interests to investors with the PPMs which they helped write, which omitted the fact, known to them, that investors would inevitably inherit Lehman‟s losses upon their initial investment, and thereafter supported the further concealment by deciding, with the concurrence of all other Defendants, to omit the LPA-required 2nd Quarter 2008 financial statement to investors which would have disclosed the true facts of the losses;
(iv) Defendant Russo led was the legal team that helped write the PPMs and LPAs and passed judgment on the legal sufficiency of those documents, who either knew of the misrepresentations or omissions of material facts, or should have known thereof but recklessly failed in the duty to conduct legal due diligence to learn and disclose all material facts that investors would consider of substantial importance concerning the Partnership interests, and failed to disclose the fact that investors could inherit Lehman‟s losses upon their initial investment, and thereafter supported the further concealment by disregarding the LPA-required 2nd Quarter 2008 financial statement to investors which would have disclosed the losses unless Insider Defendants deceptively altered accounting practices to conceal losses.
5. As Defendants well knew, these PPM omissions were misleading as to the Partnerships‟ goals, management and prior results, since Lehman had long before, near the market‟s top, made the acquisitions of properties that they intended to later transfer to the Partnerships, in self-dealing transactions at prices that would instantly evaporate 30% of Plaintiffs‟ capital without their knowledge or consent.
The PPMs were silent about the nature of such transfers. The LPAs stated that Lehman-owned properties “may be transferred” to Partnerships at “acquisition cost plus cost of carry” provided that investor consent were obtained, but omitted the fact that investors would thereby inherit a loss from properties Lehman acquired well before the Partnerships were even formed. Defendants knew this fact from the Lehman property records of inventory, such as its quarterly “Valuations Summary & Assumptions,” or its document titled “LBREP III: Investments in Progress, 33 Investments Aggregating $1.3 Billion of Committed Equity,” (together, and with other similar documents not yet produced, “Portfolio Records”) produced in a 2009 books and records action brought by Plaintiffs in the Delaware Court of Chancery.
Further, as omitted from the PPMs, no independent committee would be formed to weigh the unfairness to LBREP III investors from conflicts of interest or the excessive valuations of properties transferred in a falling market.
The PPMs also omitted to adjust the prior results of LBREP I and II, two previous partnerships, to reflect the real estate decline and diminished Fair Value of properties, and thereby overstated them. Some of the profits generated from prior sales in these Funds had actually been occasioned by Lehman repurchasing inappropriate properties it had originally sold to these Funds at a profit.
6. In October and November 2007, Plaintiffs signed Subscription Agreements and thereby committed to invest their full Capital Commitment in the Partnerships, and were admitted as limited partners on November 30, 2007. Actual payment of funds was to await their receipt of Capital Demand Notices to be sent by the General Partner.
No specific property investments were identified to the investors at that time, however, and would not be identified for another six months. Plaintiffs‟ Capital Commitments were expressly made irrevocable by the Subscription Agreements, so investors were indeed wholly dependent on Defendants to abide by the PPM‟s promise to seek “risk-adjusted returns.”
The first Capital Demand Notice of March 20, 2008 required deposits of capital by April 3, 2008, which all Plaintiffs timely made. But no property investments followed anytime soon thereafter. Lehman, meanwhile, kept its public statements positive – The “worst of the credit crisis is behind us,” Defendant Fuld told the Lehman shareholders on April 15, 2008.
7. Instead, a storm was brewing.
On May 21, 2008, financier David Einhorn gave a widely-reported speech that heavily criticized Lehman‟s failure to mark down to Fair Value its real estate portfolio as GAAP requires. Multiple attacks in the financial press quickly ensued, putting Lehman under intense pressure to write down real estate valuations.
Moreover, Lehman‟s common stock closing prices began to fall sharply. Within six weeks, by June 30th, the stock would fall 50%. Lehman‟s 2nd Quarter 2008 fiscal period was to end on May 31st, and further steep erosion in Lehman‟s stock price was expected, due to the pressure to write down real property values before May 31st, with corresponding losses on its financial statements.
This all had major personal consequences for the Insider Defendants, most or all of whom had personal investment portfolios with large amounts of restricted Lehman stock with recent paper value in millions of dollars, but now dropping precipitously without the ability to sell due to the restrictions.
The overvalued real estate was now a javelin aimed at the financial statements, the Lehman stock price, and ultimately, right at the Insider Defendants‟ portfolios. Of course, no loss would result for any property investments that Lehman might convey away to LBREP III before May 31st.
8. Thus, on May 28, 2008, three days before the end of Lehman's 2nd Quarter, Defendants caused 26 real estate investments, of which at least 20 were overvalued, to be transferred to Plaintiffs‟ Partnerships from Lehman Brothers itself or its affiliate, Defendant REPE. The transfers were made in exchange for payment of investors‟ money at prices far above their then-current market value.
But the PPMs had disclosed no such risk of gross overpayment, nor any risk of Lehman‟s dumping its stale, overpriced investment properties acquired long before the PPMs to diminish the consequences of its unrealistic accounting.
Yet Insider Defendants knew of the lack of GAAP-compliant writedowns, the properties carried on the Lehman inventory list, the ongoing real estate market decline in 2007 and the first half of 2008, and the overstated valuations of the inventory properties. The properties were undoubtedly overvalued, as this anecdote shows:
Three months later, Lehman attempted to sell its real estate assets that remained after transfers to the Partnerships. But real estate experts from Citigroup, Credit Suisse, Deutsche Bank and Goldman Sachs who analyzed Lehman‟s real property portfolio for possible purchase found that it was overvalued by billions of dollars, with Lehman‟s $32.6 billion in commercial real estate holdings overvalued by as much as 35%.
(Fortune, December 15, 2008)(“the assets should probably have been $12 billion lower”). Thus, there was no private buyer willing to acquire such overvalued properties, and uniquely, even the Federal Reserve refused an interim loan to Lehman “because there was insufficient collateral.”
9. For months after the May 28th property transfers to the Partnerships, the Insider Defendants delayed revealing that the transactions had occurred – even by withholding financial statements required by the LPAs – until after the last investor had paid in his capital in the final closing.
Disclosure occurred only in September, after the Lehman bankruptcy.
Upon their belated release, the financial statements, when compared with Supplemental PPMs, revealed that Defendants had spent Plaintiffs‟ funds to pay over $157 million dollars more overall than Lehman had reportedly paid for the properties.
The actual excess payment over property value acquired would substantially exceed $157 million, since the Fair Value of the properties transferred was substantially less than the valuations at which Lehman carried them.
Moreover, not only did the Partnerships‟ prices exceed the prices that Lehman had stated it had paid for the properties months before, they also exceeded the permissible limits for transfer pricing stated in the LPAs. As a result of the transfers, Plaintiffs‟ investments dropped 30% in value due to the valuations that did not comply with GAAP.
Such a loss was a consequence of the foreseeable risk of Defendants‟ failure to disclose the plan to transfer existing overvalued Lehman inventory to the Partnerships instead of “new opportunities” as represented in the PPM. Each Defendant knew of such risk of loss to Plaintiffs in describing future property acquisitions by by omitting to state the plan to transfer existing Lehman inventory instead of new investments.
Insider Defendants each had access to the confidential Lehman property inventory records at the time of writing the PPMs and knew the specific properties that Lehman had already acquired for transfer to LBREP III. Thus, Defendants engaged in dozens of improper transactions while concealing material information both in the PPM and during their scheme‟s enactment.
10. Plaintiffs would not have invested in the Partnerships had they known the material facts omitted from the PPMs, and Plaintiffs have suffered harm as a foreseeable consequence of Defendants‟ omissions which disguised the very risks to which Plaintiffs fell victim, including without limitation the omissions:
(i) that Lehman‟s “rigorous approval process” for real estate investments would not benefit Plaintiffs because most Partnership investments had already been acquired by Lehman at much higher prices than those prevailing when Plaintiffs invested;
(ii) that Defendants could transfer Lehman‟s legacy "warehoused" real estate investments in self-dealing transactions without adequate disclosure or investors‟ consent as required by the Investment Advisor Act of 1940;
(iii) that real estate investments that Defendants planned to transfer to the Partnerships included at least 20 depressed properties that represented substantial losses that new investors would have to absorb entirely; (iv) that Lehman‟s precarious but undisclosed true financial situation would prevent Lehman from marking the valuations of its real estate investments down to Fair Value as required by GAAP, since even a small reduction would have revealed Lehman‟s virtual insolvency; (v) that, moreover, writedowns or Lehman‟s conflicts of interest would not be considered for fairness to investors due to Defendants‟ blatant refusal to form an Investor Advisory Committee as required. ""
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