OPINION

LEWIS A. KAPLAN, District Judge.

                                     Table of Contents

Facts ..................................................................................265
      Parties ..........................................................................265
          Plaintiffs ...................................................................265
          Defendants ...................................................................265
          Relevant Non-Party ...........................................................266
      Prior Proceedings ................................................................266
      The TAC ..........................................................................267
      Repo 105 .........................................................................268
      Allegedly Misleading Statements ..................................................269
           Net Leverage Ratio ..........................................................269
           "Securities Sold Under Agreements to Repurchase" ............................270
            Risk Approach ..............................................................270
            Liquidity ..................................................................271
            Accounting Practices .......................................................271
Discussion .............................................................................272

I. Legal Standard ......................................................................272

II. Standing ...........................................................................273

III. Exchange Act Claims ...............................................................274
     A. The Standard ...................................................................274
     B. Individual Defendants ..........................................................275
        1. Existence of materially false and misleading statements or omissions ........275
           a. Repo 105 and net leverage ................................................276
              (1) SFAS 140 .............................................................277
              (2) Compliance with GAAP .................................................279
              (3) Treating Repo 105 transactions as sales ..............................281
              (4) Failure to disclose Repo 105 transactions ............................282
           b. Risk management policies .................................................283
              (1) Exceeding risk limits ................................................284
              (2) Adequacy of mitigants ................................................285
              (3) Stress tests .........................................................285
              (4) Value-at-Risk ........................................................286
           c. Liquidity ................................................................287
           d. Concentrations of credit risk ............................................290
        2. Scienter ....................................................................292
           a. Motive and opportunity ...................................................293
           b. Circumstantial evidence of conscious misbehavior or recklessness .........294
               (1) Repo 105 Transactions ...............................................294
               (2) Risk management .....................................................297
               (3) Concentrations of credit risk .......................................297
     C. E & Y ..........................................................................298
        1. Statements regarding GAAS ...................................................299
        2. Statements regarding GAAP ...................................................303
     D. Loss Causation .................................................................304
     E. The Other Exchange Act Claims ..................................................307
        1. Section 20(a) ...............................................................307
        2. Section 20A .................................................................307

IV. Securities Act .....................................................................308

     A. Timeliness .....................................................................308
     B. Statutory standing under Section 12 ............................................310
     C. Existence of actionable material misstatements and omissions in the
           Offering Materials ..........................................................311
         1. Valuation of commercial real estate ........................................311
         2. Structured products offering materials and PPNs ............................313
     D. Section 11 claims against Callan ...............................................315
     E. Affirmative defenses of non-E & Y defendants ...................................317
         1. Availability of the affirmative defenses on a motion to dismiss ............317
         2. Applicability of defenses ..................................................317
     F. Securities Act claims against E & Y ............................................318
     G. Section 15 claims ..............................................................319

Conclusion .............................................................................319

The September 2008 collapse of Lehman Brothers Holdings Inc. ("Lehman") disrupted the entire economy and greatly affected owners of the company's securities. This case concerns more than $31 billion in Lehman debt and equity securities issued pursuant to a May 30, 2006 shelf registration statement (the "Registration Statement"), a base prospectus of the same date, and various prospectus, product, and pricing supplements (collectively, the "Offering Materials"), which incorporated by reference several of Lehman's SEC filings.

Plaintiffs are pension funds, companies, and individuals, each of which purchased some of these securities. They sue Lehman's former officers, directors, and auditors, as well as underwriters of the securities, under Sections 11, 12, and 15 of the Securities Act of 19331 ("Securities Act") and Lehman's former officers and auditors under Sections 10(b), 20(a), and 20A of the Securities Exchange Act of 19342 ("Exchange Act") and Rule 10b-5 thereunder.3 The complaint4 alleges that the Offering Materials were false and misleading because they incorporated by reference Lehman's financial statements, which in turn contained misleading statements and omissions concerning Lehman's (1) use of "Repo 105" transactions and their effect on Lehman's reported net leverage, (2) risk management policies, (3) liquidity risk, (4) concentrations of credit risk, and (5) the value of Lehman's commercial real estate holdings. It alleges also that certain of Lehman's former officers made false and misleading oral statements about most of these subjects.

The matter is before the Court on defendants' motions to dismiss the TAC for failure to state a claim upon which relief may be granted.5

Facts

Parties

Plaintiffs

Plaintiffs are pension funds, companies, and individuals each of which purchased Lehman common stock or other Lehman securities, including structured products like principal protection notes ("PPNs"), issued pursuant to the Offering Materials. The Court has appointed the Alameda County Employees' Retirement Association ("ACERA"), the Government of Guam Retirement Fund ("GGRF"), the Northern Ireland Local Government Officers' Superannuation Committee ("NILGOSC"), the City of Edinburgh Council as Administering Authority of the Lothian Pension Fund ("Lothian"), and the Operating Engineers Local 3 Trust Fund ("Operating Engineers") as lead plaintiffs.6 They sue both under (1) the Securities Act, purportedly on behalf of all persons who purchased the securities listed in TAC Appendices A and B, and (2) the Exchange Act, allegedly on behalf of all persons who purchased or otherwise acquired Lehman common stock and call options, or who sold put options, between June 12, 2007, and September 15, 2008 (the "Class Period").

Defendants

There are four categories of defendants in this case.

The Insider Defendants are five of Lehman's former officers: Richard S. Fuld, Jr., Christopher M. O'Meara, Joseph M. Gregory, Erin Callan, and Ian Lowitt. Fuld was Lehman's chairman and chief executive officer at all relevant times.7 O'Meara was its chief financial officer, controller and executive vice president from 2004 until December 1, 2007, when he became global head of risk management.8 Gregory was Lehman's president and chief operating officer until June 12, 2008.9 Callan served as its chief financial officer and executive vice president from December 1, 2007, until June 12, 2008.10 Lowitt succeeded Callan as chief financial officer on June 12, 2008, and served in that capacity until Lehman filed for bankruptcy on September 15, 2008.11 Fuld and O'Meara signed the Registration Statement.12

The Director Defendants are nine former Lehman directors,13 each of whom signed the Registration Statement in that capacity.14

Defendant Ernst & Young LLP ("E & Y") was Lehman's outside auditor.15 It audited Lehman's financial statements for the 2007 fiscal year and reviewed Lehman's interim financial statements during the Class Period.16

The Underwriter Defendants are fifty-one entities, each of which allegedly underwrote one or more of the offerings in which the securities at issue were purchased.17 UBS Financial Services Inc. ("UBS"), one of the Underwriter Defendants, underwrote all of the structured product securities listed in TAC Appendix B, as well as some securities listed in TAC Appendix A. UBS is the only entity sued under Securities Act Section 12.

Relevant Non-Party

Lehman was a global investment bank, headquartered in New York, the common stock of which was traded on the New York Stock Exchange. It filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code on September 15, 2008.18 It is not a defendant in this case.

Prior Proceedings

Plaintiffs have filed many complaints in this multidistrict proceeding,19 the most significant of which was Second Amended Class Action Complaint for Violations of the Federal Securities Laws ("SAC").20 The SAC asserted claims under Sections 11, 12, and 15 of the Securities Act as well as under Exchange Act Sections 10(b), 20(a), 20A, and Rule 10b-5 against the Insider Defendants, the Director Defendants, and the Underwriter Defendants, principally on the theory that the Offering Materials were misleading in that they overstated Lehman's financial condition by failing to disclose properly the value and allegedly risky nature of Lehman's exposure to mortgage and real-estate related assets. It did not name E & Y as a defendant.

On April 27, 2009, the defendants moved to dismiss the SAC for failure to state a claim on which relief could be granted. On January 26, 2010, after the motions were briefed fully, the Court heard oral argument and reserved decision.

On March 11, 2010, while the motions to dismiss were pending, the court-appointed examiner in the Lehman bankruptcy proceeding issued a nine-volume report on his investigation of Lehman.21 At a subsequent conference, the Court learned that plaintiffs intended to amend the SAC in light of the report. Consequently, the Court denied without prejudice the then-pending motions to dismiss and granted plaintiffs leave to amend the SAC.22 Plaintiffs filed the TAC on April 23, 2010.

The TAC

The Securities Act and Exchange Act claims both allege that the Offering Materials and the financial statements they incorporated by reference23 contained false and misleading statements with respect to Lehman's:

The Exchange Act claims allege also that former Lehman officers made false and misleading statements of the same character,28 while the Securities Act claims allege also two additional bases of Securities Act liability—that the Offering Materials29 overvalued Lehman's commercial real estate holdings30 and, insofar as they related to PPNs, were materially misleading because they promised but did not provide "principal protection."31

The Exchange Act Section 10(b) and Rule 10b-5 claims are asserted against the Insider Defendants and E & Y.32 The TAC asserts also Section 20(a) Exchange Act claims against the Insider Defendants33 and a Section 20A insider trading claim against Fuld alone.34

The Securities Act claims are premised on Sections 11, 12(a)(2) and 15. The Section 11 claims are asserted against all defendants except Gregory and Lowitt.35 The Section 12(a)(2) claims are asserted against only defendant UBS and are based on the alleged misstatements in the Structured Product Offering Materials only.36 The Section 15 claims are asserted against former Lehman officers Fuld, O'Meara, Callan, Gregory, and Lowitt.37

Repo 105

Allegations concerning a type of transaction known as a "Repo 105," and its effect on Lehman's net leverage, are critical to many of the TAC's claims.

"Repo" is short for repurchase agreement. A repo is a two-step transaction that may be used to obtain short-term funding.38 In the first step, the entity needing funds—the transferor—transfers securities or other assets to a counterparty in exchange for cash. It concurrently agrees to reacquire the transferred assets at a future date for an amount equal to the cash exchanged plus an agreed-upon charge that may be analogized to, and are here referred to, as interest.39 In the second stage, the transferor pays the counter-party the original cash amount plus the agreed-upon interest, and the counter-party returns the originally transferred assets. The repo thus is like a loan. In the first step, the counter-party provides cash to the transferor in exchange for a promise by the transferor to repurchase the transferred assets. In the second step, the transferor repays the counter-party with interest and gets its collateral back. The length of time between the initial transfer and the repurchase date can vary, as can the interest and the transferee's ability to use the assets while the repo is in place.40

The TAC alleges that Lehman used two types of repo transactions.41 It calls the first an "Ordinary Repo." It alleges that Lehman accounted for the Ordinary Repos as financings, recording the cash it received from counter-parties as assets and its obligations to repurchase the securities plus the interest as liabilities.42 The collateral—the transferred assets—remained on Lehman's balance sheet as assets. Hence, Ordinary Repos, depending upon whether Lehman held the financing proceeds or used them to reduce other debt, increased or did not change Lehman's reported net leverage.43 The effect of this accounting was to keep the transferred assets on Lehman's balance sheet and increase its reported net leverage.

The second type of repo transaction was known as a "Repo 105." Repo 105 transactions involved the same two steps as Ordinary Repos.44 But Lehman treated them differently for financial reporting purposes.45 The asset that was the collateral of a Repo 105 was treated as though it actually had been sold and therefore removed from Lehman's balance sheet.46 Further, Lehman then used the cash received from Repo 105 transactions to pay down other existing liabilities. This practice decreased its net leverage ratio because it reduced the numerator in the ratio (net assets) by (a) the "sale" of the "collateral," and (b) the use of the cash thus obtained to pay down other debt, while having no effect on the denominator (tangible equity).47

Plaintiffs allege that Lehman repeatedly used Repo 105 transactions near the ends of its quarterly reporting periods solely to lower its net leverage.48 They allege also that Lehman's net leverage was an important financial metric because it was an indicator of the company's ability to absorb any losses sustained by its riskiest assets.49 A lower net leverage indicated that Lehman was better positioned to absorb such losses than did a higher net leverage. The effect of the Repo 105 transactions therefore allegedly was to present Lehman as being in a stronger financial position than it actually was.

Lehman's lower reported net leverage at the end of each quarter allegedly did not last long. Shortly after each quarter closed, Lehman allegedly executed the second step of the Repo 105 transactions, transferring cash to the counter-parties in the amounts it initially had paid plus the agreed-upon interest and reacquiring the assets it had transferred. Lehman then restored the assets to its balance sheet, returning its net leverage to the pre-Repo 105 level.50 The entire process allegedly was repeated prior to the next quarterly reporting date.51

Allegedly Misleading Statements

The TAC alleges that defendants made material misstatements and omissions in the Offering Materials and Lehman SEC filings, which were incorporated in them,52 and in oral statements during telephone calls.53

Net Leverage Ratio

The TAC makes a number of allegations regarding Lehman's portrayal of its net leverage ratio at the end of each fiscal quarter. Lehman's filings and defendants O'Meara, Callan, Lowitt, and Fuld on other occasions represented the company's quarter-ending net leverage ratio at various levels, each in the range of 10.6 to 16. 1, from the summer of 2007 through the fall of 2008.54 The TAC alleges that these representations were false and materially misleading because the ratio had been reduced artificially by the Repo 105 transactions.55

"Securities Sold Under Agreements to Repurchase"

Lehman's SEC filings stated that the amounts that the company had in "securities sold under agreements to repurchase" were as follows: $153.332 billion (1Q07), $137.948 billion (2Q07), $169.302 billion (3Q07), $181.732 billion (2007 10-K), $197.128 billion (1Q08), and $127.846 billion (2Q08).56 They stated further that such securities were "treated as collateralized agreements and financings for financial reporting purposes."57 The TAC alleges that these statements were false and materially misleading because the financial statements "failed to disclose that, through Lehman's Repo 105 program, tens of billions of dollars in securities sold each quarter pursuant to agreements to repurchase were not treated as `financings for financial reporting purposes' but were treated as sales by Lehman."58

Risk Approach

A number of the alleged misrepresentations pertained to Lehman's risk practices. The 2007 quarterly reports represented that "[d]ecisions on approving transactions... take into account ... importantly, the impact any particular transaction under consideration would have on our overall risk appetite."59 They stated also that Lehman "ensure[d] appropriate risk mitigants were in place."60 On several occasions, Lehman professed to "use stress testing to evaluate risks associated with [its] real estate portfolios."61 And, throughout 2007 and 2008, the company's filings represented that Lehman "monitor[ed] daily trading net revenues compared to reported historical simulation VaR [value at risk]."62

Lehman purported to "monitor and enforce adherence to [its] risk policies."63 Specifically, the 2007 and 2008 financial reports stated that the company's "Finance Committee oversees compliance with [risk management] policies and limits."64

During a September 18, 2007 conference call, O'Meara stated that Lehman had a "strong risk management culture with regard to the setting of risk limits."65 Later, at a November 14, 2007 investor conference, Lowitt stated that Lehman showed substantial growth in challenging markets by, inter alia, having an "extremely deep risk culture" and being "very conservative around risk."66 On a December 13, 2007 call, O'Meara attributed the quarterly results, in part, to "the strength of [Lehman's] risk management culture in terms of managing [its] overall risk appetite, seeking appropriate risk reward dynamics and exercising diligence around risk mitigation."67 During the same call, Callan attributed Lehman's financial success to its "strong risk and liquidity management."68 And, on a March 18, 2008 conference call, Callan professed Lehman's "continued diligence around risk management."69

The TAC alleges that Lehman's statements about its risk policies materially misled investors because the company, while making these representations, in fact was "pursu[ing] an aggressive growth strategy that caused [Lehman] to assume significantly greater risk" "in 2006 and at the outset of 2007."70 Briefly stated, the alleged "strategy focused heavily on acquiring and holding commercial real estate, leveraged loans and private equity assets—areas that entailed far greater risk and less liquidity than Lehman's traditional lines of business."71

Liquidity

The TAC alleges that Lehman made a number of misstatements and omissions pertaining to its liquidity. Lehman's 2007 and 2008 SEC filings repeatedly stated that the company "maintain[ed] a liquidity pool . . . that covers expected cash outflows for twelve months in a stressed liquidity environment."72

Defendants allegedly spoke highly of Lehman's liquidity throughout the Class Period. During the September 18, 2007 conference call, O'Meara stated that Lehman had a "strong liquidity framework" and "strong [] liquidity management," and that Lehman's liquidity position "is now stronger than ever" and provided the company with a "competitive advantage."73 During the December 13, 2007 conference call, Callan and O'Meara each made statements assessing the strength of Lehman's liquidity position.74 On the March 18, 2008 conference call, Callan "tried to relay the strengths and robustness of [Lehman's] liquidity position," and stated that the company's liquidity pool was structured to "cover expected cash outflows for the next 12 months . . . without being able to raise new cash" and that Lehman had taken "care of [its] full year needs for capital" through a February preferred stock offering.75 And, during the June 16, 2008 conference call, Fuld and Lowitt stated that "Lehman's liquidity position had `never been stronger.'"76

Plaintiffs allege that these statements were false and misleading. Specifically, the TAC alleges that the statements failed to disclose Lehman's significant concentration of credit risks and the impact that the Repo 105 transactions had on Lehman's liquidity.77

Accounting Practices

The TAC alleges numerous misrepresentations and omissions regarding Lehman's accounting and E & Y's audit and financial statement opinions. Throughout 2007 and 2008, Lehman represented that its financial statements were "prepared in conformity with" GAAP78 and that E & Y, having reviewed Lehman's financial statements, was "not aware of any material modifications that should be made to [the statements] for them to be in conformity with" GAAP.79 E & Y's report on Lehman's fiscal 2007 financial statements stated that it had conducted its audit in accordance with GAAS and opined that they had been prepared in accordance with GAAP and that they fairly presented the financial condition of the company.80 Fuld, O'Meara and/or Callan certified that the 2007 and 2008 financials "fairly present[ed] in all material respects" Lehman's financial condition and did not contain any misleading statements or omissions.81

The TAC alleges that these statements were false or misleading.

Discussion

I. Legal Standard

In deciding a motion to dismiss, a court ordinarily accepts as true all well pleaded factual allegations and draws all reasonable inferences in the plaintiff's favor.82 In order to survive such a motion, however, "the plaintiff must provide the grounds upon which [its] claim rests through factual allegations sufficient `to raise a right to relief above the speculative level'"83 and "state a claim for relief that is plausible on its face."84

In deciding a motion to dismiss, a court considers the complaint and "any written instrument attached to the complaint, statements or documents incorporated into the complaint by reference, legally required public disclosure documents filed with the SEC, and documents possessed by or known to the plaintiff and upon which it relied in bringing the suit."85

If matters outside the pleadings are presented and not excluded, Rule 12(d) ordinarily requires a court to convert the motion to dismiss into one for summary judgment and to provide the parties with the opportunity to present all pertinent materials.86 That Rule, however, is aimed at ensuring that the plaintiff has notice of what the court might consider in deciding the motion.87 The need to convert a Rule 12(b)(6) motion into a summary judgment motion "is largely dissipated," however, when "plaintiff has actual notice of all the information in the movant's papers and has relied upon these documents in framing the complaint."88 This is particularly true for documents that are "integral to the complaint," but that the plaintiff has chosen not to attach or incorporate by reference.89 In addition, a document that is integral to a complaint in the sense that the plaintiff had actual notice of and relied upon it in framing the complaint, is properly considered, albeit not for the truth of the matters asserted,90 notwithstanding that it has not been attached to or incorporated by reference into the complaint.

The parties dispute the question whether the nine-volume Examiner's Report is properly before the Court on the theory that it effectively has been incorporated by reference in the TAC. This appears to be relevant only to the effort of some defendants to obtain dismissal based on the assertion that the facts and conclusions in the Report affirmatively demonstrate that they acted with due diligence and therefore may not be held liable under the Securities Act. In view of the fact that the Report, even if it is integral to the TAC, could not properly be considered for the truth of the matters asserted, the point is academic. In any case, for reasons discussed below, the Examiner's Report would not warrant dismissal of any claims based on the due diligence defense even if its statements and conclusions properly were considered for their truth.

II. Standing

The TAC purports to assert claims based on fifty PPN offerings in which no named plaintiff purchased a security.91 Defendants challenge plaintiffs' standing to pursue these claims.

Standing is an essential prerequisite to Article III jurisdiction. The standing inquiry has three elements: a "plaintiff must allege [1] personal injury [2] fairly traceable to the defendant's allegedly unlawful conduct and [3] likely to be redressed by the requested relief."92

As this Court previously has stated, a plaintiff does not suffer an injury in fact— and therefore has no standing to assert claims—in consequence of false or misleading statements in offering materials for securities that it did not purchase.93 As no named plaintiff is alleged to have purchased securities in these fifty PPN offerings, the plaintiffs have no standing to pursue claims based on them.

Plaintiffs argue that they have standing to assert claims based on the fifty PPN offerings notwithstanding the fact that no named plaintiff purchased them because each PPN was offered pursuant to "common prospectuses [that] incorporated the [common] SEC filings that contained the misstatements and omissions," "the false and misleading statements were the same for each Offering," and because "all investors. . . were personally injured by the same false or misleading statements made by the same defendants."94

This Court and others have rejected this argument95 and plaintiffs have provided no authority that undermines that conclusion. For the reasons stated there, the plaintiffs have no standing to bring claims with respect to the fifty PPN offerings in which they did not purchase securities.96

III. Exchange Act Claims

A. The Standard

In order to state a claim under Section 10(b) of the Exchange Act and Rule 10b-5, a plaintiff must allege that "the defendant, 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."97

A misstatement or omission is actionable only if "material." A misrepresentation is material if "there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to [act]."98 That is, "`there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available.'"99 Moreover, not every material omission violates the Exchange Act. For example, an omission is actionable only if the speaker had a duty to disclose.100 Such a duty can arise either (1) from an "affirmative legal disclosure obligation" or (2) if "necessary to prevent existing disclosures from being misleading."101 Finally, an expression of opinion is actionable only if "the complaint alleges that the speaker did not truly have the opinion at the time it was issued"102 or, perhaps, if the speaker expressed the opinion with the knowledge that, or in reckless disregard of whether, the speaker had any basis for it.

The TAC asserts primary claims against the Insider Defendants and E & Y for alleged violations of Sections 10(b) of the Exchange Act and Rule 10b-5. It advances also control person claims against the Insider Defendants under Section 20 and a claim for insider trading against Fuld under Section 20A. As the statements and omissions that form the basis of the claims against the Individual Defendants and E & Y, respectively, are different, it is convenient first to deal with the sufficiency of the allegations of falsity and scienter with respect to the individual defendants and then to deal with the same issues with respect to E & Y. The issue of loss causation is similar as to all defendants and is dealt with collectively thereafter.

B. Individual Defendants

1. Existence of materially false and misleading statements or omissions

In order to state a claim for a violation of Exchange Act Section 10(b) or Rule 10b-5, plaintiffs must allege the existence of an actionable material misstatement or omission. The allegations must satisfy the heightened pleading standards of Rule 9(b) and the Private Securities Litigation Reform Act ("PSLRA").103 Accordingly, the TAC must "(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."104

The TAC's Exchange Act claims are based on four categories of alleged misstatements and omissions. It alleges that Lehman and its officers made misleading statements with respect to Lehman's (1) use of and accounting for Repo 105 transactions and their effect on net leverage, (2) risk management policies, (3) liquidity, and (4) concentrations of credit risk.105 The misstatements and omissions allegedly were in the 2Q07, 3Q07, 2007 10-K, 1Q08, 6/9/08 8-K, 6/18/08 8-K, 2Q08 and on several specifically identified conference calls by Lehman's officers.106

a. Repo 105 and net leverage

The Offering Materials stated (1) Lehman's net leverage and amount of securities it sold under agreements to repurchase as of the end of each quarter, (2) that Lehman prepared its financial statements in accordance with GAAP, and (3) that Lehman treated securities sold under repurchase agreements as financings.107 O'Meara, Callan, Lowitt, and Fuld also made similar statements regarding Lehman's reported net leverage.108

Defendants allegedly made statements also concerning how Lehman's business practices impacted its net leverage. During a June 9, 2008 conference call, Callan stated that a large part of Lehman's quarterly net leverage reduction came from selling "less liquid asset categories" and that Lehman's deleveraging was "complete."109 In response to a question about whether the deleveraging had come from disposing of the assets that were "absolute easiest . . . to sell," she stated that the opposite was true and that Lehman had sold many riskier, less liquid assets during the quarter.110 Similarly, on a June 16, 2008 conference call, Lowitt represented that the methods Lehman had used to reduce its leverage "included a reduction of assets across the Firm, including residential and commercial mortgages."111 The 2Q08 stated also that Lehman's reduction in net leverage came, in part, from a "reduction in assets."112

The TAC alleges that these statements were false and misleading because Lehman (1) accounted for the Repo 105 transactions as sales rather than financings in violation of GAAP, (2) failed to disclose its use of Repo 105 transactions and its temporary effect of reducing Lehman's net leverage, and (3) presented a misleading picture of the company in violation of GAAP.113 The defendants argue that the claims based on these statements should be dismissed because (1) the financial statements complied with GAAP, and (2) any alleged misstatements were immaterial.

(1) SFAS 140

Plaintiffs first allege that the statements regarding Lehman's reported net leverage ratio, securities sold under agreements to repurchase, and GAAP compliance were false and misleading because Lehman accounted for the Repo 105 transactions as sales rather than as financings in alleged violation of SFAS 140.114

SFAS 140 contains "standards for accounting for securitizations and other transfers of financial assets and collateral."115 Under SFAS 140, whether a transferred asset properly is accounted for as a sale or a financing is dependent on the degree of control that the transferor has over the asset.116 If the transferor retains control, as that term is defined in SFAS 140, over the asset, it should recognize the asset on its balance sheet. If the transferor surrenders control, "those assets shall be accounted for as a sale" and "derecognize[d]."117

A transferor surrenders control over a transferred asset—and therefore may treat the transaction as a sale—only if:

Plaintiffs allege that the Repo 105 transactions did not comply with SFAS 140's requirements because (1) Lehman was obligated contractually to repurchase the Repo 105 assets,119 (2) the transactions lacked a business purpose or economic substance,120 and (3) Lehman was not able to obtain a "true sale at law" opinion from a U.S. law firm, but only from Linklaters, a U.K. law firm.121 These allegations are insufficient to make out a violation of SFAS 140 with respect to Lehman's accounting treatment of Repo 105s for three reasons.

First, although Lehman's alleged contractual obligation to repurchase the transferred Repo 105 assets initially might be thought to violate SFAS 140's requirement that the "transferor [not] maintain effective control over the transferred assets through . . . an agreement that both entitles and obligates the transferor to repurchase" them, closer inspection reveals otherwise.122 A transferor maintains effective control over an asset pursuant to such an agreement only if, inter alia, "the transferor is able to repurchase [the assets] on substantially the agreed terms, even in the event of default by the transferee."123 This occurs only if "at all times during the contract term [the transferor] ha[s] obtained cash or other collateral sufficient to fund substantially all of the cost of purchasing replacement assets from others."124 The TAC, however, fails to allege that Lehman obtained funds in the Repo 105 transactions sufficient to replace the transferred assets from others. Indeed, it alleges the opposite, as the Repo 105 transactions were over-collateralized by a minimum of five percent.125 That is, Lehman transferred at least $105 in assets to its counter-parties for every $100 in cash it received. Accordingly, Lehman did not obtain cash or other collateral in these transactions sufficient to fund "substantially all" of the cost of replacing the assets it had transferred to its counter-parties in the event of counter-party default. It therefore did not maintain effective control over them within the meaning of SFAS 140.

Second, nothing in SFAS 140 suggests that the business purpose of a transfer has any bearing on whether it should be treated as a sale or as a financing. According to SFAS 140, the guiding principle is whether the transferor has retained control over the asset.126 Thus, an allegation that Lehman had less expensive means of obtaining financing says nothing about whether its accounting treatment of the Repo 105 transactions was consistent with GAAP.

Third, the fact that Lehman allegedly was unable to obtain a "true sale at law" opinion from a U.S.-based law firm does not call into question the conclusion of U.K.-based Linklaters that the transactions were, in fact, true sales at law under U.K. law. Nothing in SFAS 140 requires the true sale at law opinion to be based on U.S. law.

As plaintiffs have failed to allege any manner in which Lehman violated SFAS 140 in treating the Repo 105 transactions as sales rather than financings, it has failed to allege a material misstatement or omission on this basis.

(2) Compliance with GAAP

The fact that Lehman's accounting for the Repo 105 transactions technically complied with SFAS 140 does not mean that Lehman's financial statements complied with GAAP. As the Court of Appeals has stated, "GAAP itself recognizes that technical compliance with particular GAAP rules may lead to misleading financial statements, and imposes an overall requirement that the statements as a whole accurately reflect the financial status of the company."127 Plaintiffs assert that this is such a case, alleging that the financial statements incorporated into Lehman's Offering Materials and the Insider Defendants' oral statements were false and misleading because the Repo 105 transactions temporarily and artificially lowered the company's reported net leverage at the end of each reporting period.128

As noted earlier, net leverage measures the ratio of net assets to tangible equity capital.129 Cash was among Lehman's net assets.130 In a Repo 105 transaction, Lehman removed the collateral from its balance sheet, thereby reducing its net assets. It then used the cash it received to pay down other liabilities. In consequence, the Repo 105 transactions reduced the amounts of Lehman's net assets while leaving its tangible equity capital unchanged. This resulted in lower net leverage.131 The TAC alleges that Lehman was obligated to, and did, repurchase the assets from the Repo 105 counter-parties in the days after each quarter ended, increasing its net assets without any change to tangible equity capital and resulting in increases in net leverage.132

This repetitive, temporary, and undisclosed reduction of net leverage at the end of each quarter is sufficient to make out a claim that the Offering Materials and oral statements about net leverage violated the overriding GAAP requirement to present the financial condition of the company accurately, assuming the changes in net leverage that resulted from the Repo 105 transactions were material.

Whether the changes in net leverage were material is a "fact-specific inquiry."133 "[I]t is not necessary to assert that the investor would have acted differently if an accurate disclosure was made."134 Instead, a fact is material if "there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to [act]" or "a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available."135 The materiality determination "depends on all relevant circumstances"136 and a "complaint may not properly be dismissed . . . on the ground that the alleged misstatements or omissions are not material unless they are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance."137

Defendants contend that the changes in net leverage due to the Repo 105 transactions were immaterial as a matter of law because (1) the Offering Materials warned that Lehman's financial statements would fluctuate, (2) the Offering Materials accurately reported Lehman's total—as opposed to net—leverage, (3) the Repo 105 transactions were insignificant as compared to Lehman's total liabilities, and (4) Lehman could have sold the assets involved in the Repo 105 transactions and used the proceeds to pay down other liabilities.138

Defendants' strongest argument is that Lehman's Offering Materials "bespoke caution," rendering the allegedly misleading net leverage figures immaterial, because they disclosed that the "overall size" of Lehman's balance sheet would "fluctuate from time to time [and might] be higher than the year-end or quarter-end amounts."139 Alleged misstatements may be immaterial, and therefore not actionable, when "it cannot be said that any reasonable investor could consider them important in light of adequate cautionary language set out in the same offering."140 Cautionary statements, however, must expressly warn of and relate directly to the risk that allegedly brought about the plaintiffs' loss.141

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.

Defendants' other materiality arguments also are insufficient. Lehman's accurate disclosures of its total leverage may have been relevant and ultimately may even have been more important to investors than net leverage. But the argument that the Offering Materials' disclosure of total leverage rendered the allegedly misleading net leverage ratios immaterial is undercut significantly by Lehman's assertions that net leverage is "a more meaningful, comparative ratio for companies in the securities industry" than total leverage ratio142 and that Lehman considered "material," for purposes of reopening its financial statements, changes in its financial reporting that affected net leverage by 0.1 or more.143

Moreover, the fact that the Repo 105 transactions were approximately six percent of Lehman's total liabilities did not render the statements immaterial as a matter of law.144 Materiality is not determined by "a single numerical or percentage benchmark," but must be considered in all relevant circumstances.145 Here, plaintiffs have alleged that net leverage was a significant financial metric for "securities analysts, credit agencies and investors" during the Class Period.146 They have alleged also that the Repo 105 transactions resulted in net leverage differences more than fifteen times the difference that Lehman itself considered material.147

Finally, the argument that the allegedly misleading net leverage numbers were immaterial because Lehman could have conducted a true sale of the assets it used in the Repo 105 transaction and used the proceeds to pay down the debt is not persuasive. Lehman perhaps could have reduced its net leverage by selling the assets it transferred in the Repo 105 transactions and using the proceeds to reduce its liabilities. But the TAC does not allege that Lehman's net leverage numbers were false and misleading because they were reduced from the pre-Repo 105 levels. It alleges that they were false and misleading because they were reduced from that level and because they returned to higher levels shortly after each quarter ended. Had Lehman engaged in true sales of those assets, it would have had no obligations to repurchase the collateral and thus undo its net leverage reductions.

(3) Treating Repo 105 transactions as sales

The financial statements incorporated into Lehman's Offering Materials stated that Lehman recorded securities sold under agreements to repurchase as "financings."148 The TAC alleges that this statement was false and misleading because Lehman treated the Repo 105 transactions as sales.149

Defendants make two arguments for dismissal of the claims based on these statements. They argue first that SFAS 140 required that the Repo 105 transactions be treated as sales.150 But the fact that SFAS 140 may have required that the Repo 105 transactions be treated as sales would not remedy the allegedly misleading nature of Lehman's statement that it treated assets sold under agreements to repurchase as financings.

Defendants next argue that the Offering Materials disclosed, on the page immediately prior to the alleged misstatements, that Lehman would treat transfers of assets as sales when it had surrendered effective control in accordance with SFAS 140.151 But that statement does not save the day, at least in the present posture of the case. First, it purported to describe Lehman's treatment of "[s]ecuritization activities," not transfers pursuant to repurchase agreements, which were discussed in a separate and subsequent section.152 Second, the statement complained of was more general than the allegedly misleading statement, which expressly dealt with repurchase agreements and said that securities "sold" under repurchase agreements were treated as financings. At this stage, the Court cannot conclude as a matter of law that this disclosure sufficiently warned that an asset transferred pursuant to a repurchase agreement might be treated as a sale.153

(4) Failure to disclose Repo 105 transactions

Plaintiffs next allege that the Offering Materials and officers' oral statements were materially false and misleading because they omitted to disclose the Repo 105 transactions.

An omission is actionable only if the speaker had a duty to disclose.154 Such a duty exists if (1) there is an "affirmative legal disclosure obligation" or (2) disclosure is "necessary to prevent existing disclosures from being misleading."155 Plaintiffs allege that Lehman was required to disclose the Repo 105 transactions because (1) its reported net leverage was materially misleading without the disclosure,156 and (2) Item 303 of Regulation S-K ("Item 303") in this case required it.157 Defendants contend that Lehman had no duty to disclose the Repo 105 transactions.

The federal securities laws impose an obligation on speakers to be both accurate and complete.158 While a corporation "is not required to disclose a fact merely because a reasonable investor would very much like to know" it, it has an obligation to do so when "secret information renders prior public statements materially misleading."159 Thus, a speaker has a duty to disclose if "disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information available."160 Accordingly, a statement of principal investment risks does not create an obligation to disclose the commonly understood risks associated with securities.161 By contrast, a statement regarding a company's hedging strategy obliges it to disclose when it alters or suspends that strategy.162

The Offering Materials stated Lehman's net leverage ratios, as did many of the officers' oral statements. The TAC alleges that these statements 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. The TAC makes factual allegations supporting an inference that such a disclosure would have been material to a reasonable investor.163 At this stage of the litigation, such allegations are sufficient. As plaintiffs sufficiently have alleged that Lehman had a duty to disclose the Repo 105 transactions based on its statements regarding net leverage, the Court need not here address whether Item 303 of Regulation S-K would have required their disclosure.

b. Risk management policies

The Offering Materials contained disclosures about Lehman's risk management policies, including statements that Lehman "monitor[ed] and enforc[ed] adherence to [its] risk policies," "ensure[d] that appropriate risk mitigants [we]re in place," took "into account . . . the impact any particular transaction under consideration would have on [Lehman's] overall risk appetite," used "stress tests" to determine the financial consequences of an economic shock to its portfolio, and "monitor[ed] daily trading net revenues compared to reporting historical simulation VaR [value at risk] limits."164

Lehman's officers made statements with respect to Lehman's risk management polices as well. O'Meara repeatedly made statements to the effect that Lehman had "strong [] risk management" and a "strong risk management culture with regard to the setting of risk limits."165 Lowitt stated that Lehman had an "extremely deep risk culture which is embedded through the firm," that Lehman was "very conservative around risk," and tried not to "hold[] stuff on [its] balance sheet . . . but move[] it on."166 Callan similarly made statements on several occasions about Lehman's "strong risk . . . management."167

The TAC alleges that these statements were material to investors because Lehman's "risk management was critical to loss prevention," and that they were false because Lehman acquired billions of dollars of illiquid, risk assets by failing to abide by its policies.168

(1) Exceeding risk limits

The Offering Materials stated that Lehman "monitor[ed] and enforc[ed] adherence to [its] risk policies" and that "[m]anagment's Finance Committee oversees compliance with policies and limits."169 O'Meara, Lowitt, and Callan also made statements regarding Lehman's allegedly "strong" and "conservative" risk management policies.170 The TAC alleges that these statements were materially false and misleading because Lehman "routinely" overruled and disregarded its risk policy limits on the company's total risk appetite and its balance sheet,171 concentration,172 and single transaction limits.173 Plaintiffs claim that Lehman exceeded its risk appetite limit every month from July 2007 to February 2008,174 committed to many deals exceeding the single transaction limit thresholds, and imposed no limit on its leveraged loan bridge equity commitments.175 They further allege that Lehman's fixed income division ("FID") and global real estate group ("GREG") exceeded their balance sheet limits at the ends of many quarters within the class period.176

Defendants argue that these allegations fail to state a claim because the alleged excesses complied with Lehman's risk management policies. They contend that those policies were not static, but could be altered by management. They rely on disclosures in the Offering Materials that the risk management policies were "established by management's Executive Committee," which "balanc[ed] risks and returns" in their formulation.177 They note also that the Offering Materials disclosed that specific "transactions and/or situations [were] addressed and discussed with management's Executive Committee when appropriate."178

Even assuming that Lehman's risk management policies were not static and properly could be altered by the Executive Committee in a way that would permit the previous policies to be exceeded, the TAC sufficiently alleges that the statements that Lehman "enforc[ed] adherence to [its] risk policies" and that "[m]anagment's Finance Committee oversees compliance with [risk] policies and limits" arguably were materially misleading. The TAC's allegations, assumed here to be true, establish that Lehman routinely exceeded various risk limits it had created. The (assumed) fact that Lehman's Executive Committee routinely revised the established risk limits to permit these excesses is at best in considerable tension with its statement that Lehman "enforc[ed] adherence to [its] risk policies." Stated differently, it would be materially misleading for a company to claim that it "enforce[d] adherence" to its risk management policies while failing to disclose that it "routinely" alters them as the TAC alleges Lehman to have done.179 Moreover, given the allegations of frequent, significant departures from Lehman's internally stated policies, there is enough in the TAC to permit the inference that its senior officers' statements to the effect that Lehman had "strong" and "conservative" risk management were false in the sense that these individuals knew or recklessly disregarded their misleading effect.

(2) Adequacy of mitigants

The Offering Materials stated that Lehman "ensure[d] that appropriate risk mitigants" were in place.180 The TAC alleges that this statement was false and misleading because Lehman failed to do so, as evidenced by its accumulation of Alt-A residential mortgage assets that could not be directly hedged, its failure to increase its "macro hedges" on its leveraged loan and commercial real estate portfolios, and its relaxation of risk controls to accommodate the growth of its commercial real estate business.181 These allegations are insufficient to state a claim.

The question whether a particular risk mitigant was appropriate when implemented is inherently a matter of judgment or opinion.182 In order sufficiently to allege that Lehman's statement that it ensure[d] appropriate risk mitigants were in place was false, plaintiffs were obliged to allege facts that would support a plausible inference that Lehman did not believe that it had done so or, at least, that it was reckless in believing that it had appropriate measures in place.183 The TAC is devoid of any such allegations and therefore fails to state a claim on this basis.

(3) Stress tests

The Offering Materials stated that Lehman used "stress testing to evaluate risks associated with [its] real estate portfolios."184 Plaintiffs contend that this statement was materially false and misleading because "Lehman excluded some of its most risky principal investments—including commercial real estate investments, private equity investments, and leveraged loan commitments—from its stress tests."185

Defendants' sole responsive argument is that these statements, considered in context, were not false or misleading because the Offering Materials disclosed that Lehman used stress testing only with respect to "certain products."186 This argument is insufficient to dismiss the claims based on these statements at this stage for at least two reasons.

First, the "certain products" statement on which defendants rely was not made in each of the financial statements containing the allegedly misleading statement.187 It did not qualify the alleged misstatement in those Offering Materials in which it was not made.

Second, the Court cannot conclude as a matter of law that the disclosure on which defendants' rely rendered the allegedly misleading statement not misleading. The full text of the purported warning stated that "[s]tress testing, which measures the impact on the value of existing portfolios of specific changes in market factors for certain products, is performed with regularity."188 It was located within a paragraph on a different page from the allegedly misleading statement. That paragraph contained a discussion of the various qualitative and quantitative measures that Lehman used to measure risk. It stated, essentially, that stress testing was used for certain products and that other method were used for others.189 One of the products for which stress testing was said to have been used was Lehman's "real estate portfolios." But plaintiffs have alleged that Lehman excluded, among others, its commercial real estate investments— inarguably part of its real estate portfolio—from stress testing. This sufficiently alleges an actionable misstatement at this stage.

(4) Value-at-Risk

Value-at-Risk ("VaR") is "a statistical measure of the potential loss in the fair value of a portfolio due to adverse movement in the underlying risk factors."190 The Offering Materials stated that, "[a]s part of [its] risk management control processes, [Lehman] monitor[ed] daily trading net revenues, compared with reported historical simulation VaR as of the end of the prior business day."191 They stated also that, in the 2007 fiscal year, there were "four days . . . when [Lehman's] daily net trading loss exceeded [its] historical simulation VaR as measured at the close of the previous business day" and that "[i]n the quarter ended February 29, 2008, there were no days when daily net trading loss exceeded historical simulation VaR as measured at the close of the previous business day."192 The TAC alleges that these statements were false and misleading because Lehman and at least three of its business lines—High Yield, FID, and GREG—"routinely exceeded" their respective VaR limits, and Lehman breached its firm-wide VaR limit on 44 occasions, during the class period.193

The factual allegations of routine breaches of VaR limits by these business lines and of more than two-score breaches by the firm as a whole are sufficient to permit a reasonable trier of fact to conclude that the statements in the Offering Materials were materially misleading, particularly in light of the suggestion in Lehman's 2007 10-K that breaches of VaR limits were infrequent.

c. Liquidity

Many of the Offering Materials stated that Lehman had a "very strong liquidity position" and "maintain[ed] a liquidity pool . . . that covers expected cash outflows for twelve months in a stressed liquidity environment."194 O'Meara, Callan, Lowitt, and Fuld each made similar statements on investor conference calls.195

Plaintiffs allege 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 closed196 and because Lehman had "liquidity concerns" due to its accumulation of illiquid assets.197

With respect to liquidity, Item 303 required a registrant to disclose commitments and off-balance sheet arrangements only if they were reasonably likely to affect its liquidity in a material way.198 To state a claim, therefore, plaintiffs were required to allege that the Repo 105 transactions had a material effect on Lehman's liquidity. Plaintiffs have failed to do so.

Plaintiffs argue that the Repo 105 transactions affected Lehman's liquidity in a material way because their dollar value exceeded the size of Lehman's liquidity pool during the Class Period and that Lehman materially decreased its liquidity pool by exchanging cash for assets in the Repo 105 transactions.199 It is true that plaintiffs allege that the size of the Repo 105 transactions exceeded the size of the liquidity pool during the Class Period.200 Lehman's liquidity pool, however, did not comprise cash alone. It contained also "highly liquid instruments, including cash equivalents, G-7 government bonds and U.S. agency securities, investment grade asset and mortgage—backed securities and other liquid securities that [it] believe[d had] a highly reliable pledge value."201 The TAC alleges that the assets Lehman used as collateral in the Repo 105 transactions were "highly liquid."202 Consequently, even assuming that Lehman used liquidity pool resources in the Repo 105 transactions—an assumption unsupported by any factual allegations—it is alleged only to have exchanged cash for the sorts of "highly liquid" assets held before the transactions were effected. The TAC accordingly fails to allege that the Repo 105 transactions had a material effect on Lehman's liquidity.

Plaintiffs' allegations with respect to the strength and sufficiency of Lehman's liquidity and the size of the liquidity pool also are insufficient. The TAC claims that those statements were false and misleading because Lehman (1) had predicted monthly cash deficits,203 (2) needed to provide additional collateral to Citibank and JP Morgan by June 9, 2008,204 and (3) had encumbered twenty-four percent of its liquidity pool by September 2008.205

The complaint does not allege any facts contradicting the statements that Lehman's liquidity position was sufficient to cover its liquidity needs at the time any particular statement was issued. The allegation that Lehman "by the start of the Class Period in July 2007 . . . had already internally determined that its liquidity pool was short $400 million to meet commitments looking out one year forward"206 is insufficient. This statement, while perhaps supporting an inference that Lehman's liquidity pool was insufficient on the date of that particular determination, says nothing about the sufficiency of Lehman's liquidity pool at the time any of the alleged misstatements in this action was made.207 The allegation that Lehman had encumbered twenty-four percent of its liquidity pool by September 2008 is insufficient for the same reason.

Nor do the allegations with respect to Lehman's collateral postings at JP Morgan and Citi call the truth of its alleged statements into question.208 First, as those collateral postings occurred in June 2008, they had no relevance to any earlier statement with respect to liquidity.209 Second, the TAC alleges that Lehman was "technically free" to withdraw its deposit at Citi, though doing so would have caused practical problems. It thus concedes that Lehman could have used the assets if necessary.210 Third, even assuming that Lehman would not have been able to liquidate the collateral it had posted at Citi and JP Morgan had the need arisen, there are no allegations that the remainder of the liquidity pool—the unencumbered seventysix percent—was insufficient for Lehman's expected needs after June 2008.

Finally, the statements that Lehman's liquidity pool was sufficient to meet its expected needs over the next twelve months and that its liquidity position was "strong" were statements of opinion. They were based on models and assumptions, some of which were disclosed in the Offering Materials,211 about what would happen in the future. Such statements are not actionable unless it is alleged sufficiently that the speaker did not truly believe them when they were made.212 There are no such allegations here. Accordingly, the TAC fails to state a claim based on the alleged liquidity misstatements.

d. Concentrations of credit risk

The TAC next alleges that the Offering Materials were false and misleading because they did not disclose adequately Lehman's significant concentrations of credit risk related to "mortgage and real estate related assets" in violation of GAAP,213 specifically its exposure to (1) Alt-A mortgage-related assets,214 (2) commercial real estate,215 and (3) leveraged loans.216 They argue that it was required to do so based on AICPA Statement of Position No. 94-6, Disclosures of Certain Significant Risks and Uncertainties ("SOP 94-6"), and SFAS No. 107, Disclosures about Fair Value of Financial Instruments, as amended by SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (together, "SFAS 107").217

The disclosure requirements of SOP 94-6 did not apply to Alt-A assets, commercial real estate assets, or leveraged loans. Rather, they required disclosure of risks and uncertainties, existing, as of the date of each financial statement, in the following areas: "(1) nature of operations, (2) use of estimates in the preparation of financial statements, (3) certain significant estimates, and (4) current vulnerability due to certain concentrations."218 As the first three areas are facially inapplicable,219 the only issue requiring discussion is whether disclosure was required by category (4).

The "certain concentrations" that must be disclosed under SOP 94-6 are limited to those in (1) "the volume of business transacted with a particular customer, supplier, lender, grantor, or contributor," (2) "revenue from particular products, services, or fund-raising events," (3) "the available sources of supply of materials, labor, or services, or of licenses or other rights used in the entity's operations," and (4) "the market or geographic area in which an entity conducts operations."220 Moreover, "[c]oncentrations of financial instruments, and other concentrations not described in" the above list are specifically excluded.221 SOP 94-6 did not require Lehman to disclose concentrations of Alt-A, commercial real estate, and leveraged loans.

SFAS 107 is broader than SOP 94-6 in that it requires an entity to "disclose all significant concentrations of credit risk arising from all financial instruments, whether from an individual counterparty or groups of counterparties."222 But the SFAS 107 disclosure obligation runs only to "significant" concentrations of credit risk. The question whether a particular concentration of credit risk is "significant" within the meaning of SFAS 107 is a matter of judgment.223 Consequently, in order to state a claim that an entity's failure to disclose a concentration of credit risk violated SFAS 107, a plaintiff must plead facts that would permit findings that the entity in fact had "significant concentrations of credit risk" and that the entity believed that to be so.224

Most of plaintiffs' allegations regarding the Alt-A assets pertain to the quality but not the concentration of these holdings.225 While quality of course goes to the issue whether they represented credit risks, it does not address the questions whether those holdings amounted to concentrations of such risk that were significant to Lehman overall, let alone whether Lehman so perceived them. Nevertheless, the TAC does allege that a Lehman employee on February 20, 2008 wrote, "I remain concerned as a lehman shareholder about our resi[dential] and cmbs [commercial mortgage-backed securities] exposure . . . . having 18b of tangible equity and 90b in resi[dential] (including alt a) and cmbs (including bridge equity) scares me."226 This email suffices, for present purposes, to permit an inference that at least one responsible official at Lehman then believed that its Alt-A assets represented a significant concentration of credit risk. Thus, its failure to disclose these alleged concentrations in the reports following this email arguably violated SFAS 107.227

With respect to the alleged commercial real estate concentration, the TAC alleges that, in November 2007, "GREG made a presentation to Lehman's Executive Committee that recognized the significant risks inherent in the over-concentration of its global commercial real estate portfolio" and "recommended reducing the global GREG balance sheet from $58 billion to $43.7 billion by March 31, 2008."228 Plaintiffs therefore have alleged facts supporting an inference that, as of that meeting, Lehman believed that it had significant concentrations in commercial real estate. Those allegations, however, support claims only with respect to the alleged omissions in the 2007 10-K, issued in December 2007. Plaintiffs concede that, beginning with the 1Q08, Lehman disclosed the amounts and locations of its commercial real estate mortgage holdings.229

The allegations regarding leveraged loans, however, are insufficient. The core of this claim is the allegation that "Lehman's lending pace . . . had . . . doubled. . . for high grade and high yield [loans] combined."230 Even if Lehman's leveraged loans had increased as plaintiffs allege, each of Lehman's financial statements disclosed the quantity of "high grade" and "high yield" lending commitments that Lehman had made.231 Plaintiffs have pointed to no authority obliging Lehman to make more granular disclosures about its lending commitments, even assuming that the positions amounted to sufficient concentrations of credit risk.

Accordingly, plaintiffs have alleged sufficiently that Lehman, in violation of SFAS 107, failed adequately to disclose significant concentrations of credit risk in (1) its Alt-A holdings in the pertinent documents after February 20, 2008 and (2) commercial real estate holdings in its 2007 Report on Form 10-K in violation of SFAS 107.

2. Scienter

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."232 The requisite state of mind is an intent to "deceive, manipulate, or defraud."233 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 obvious that the defendant must have been aware of it"—are sufficient.234

In evaluating whether a complaint pleads a "strong inference of scienter," courts must consider all the facts alleged, inferences favoring plaintiffs rationally drawn from the facts, as well as "plausible, nonculpable explanations for the defendant's conduct."235 A complaint will survive a motion to dismiss "only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged."236 Generally, the plaintiffs must allege facts sufficient to show that each defendant "personally knew of, or participated in, the fraud."237 That is, the plaintiff must allege that each defendant had the requisite scienter.238

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."239 To establish a strong inference of scienter via "motive and opportunity," plaintiffs must allege that defendants "benefitted in some concrete and personal way from the purported fraud."240 Motives common to most corporate officers are insufficient.241

If plaintiffs have not alleged "motive and opportunity" sufficiently, they may rely successfully upon allegations of "strong circumstantial evidence," "`though the strength of the circumstantial allegations must be correspondingly greater' if there is no motive."242 A complaint sufficiently may allege strong circumstantial evidence of scienter when it alleges that defendants (1) "benefitted 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."243

a. Motive and opportunity

The only allegations arguably suggesting a motive are that (1) ratings agencies and analysts focused on Lehman's leverage ratios, and (2) Lehman could not have deleveraged by selling illiquid real estate and mortgage related assets without negatively impacting earnings or confidence, so (3) Lehman engaged in the Repo 105 transactions to "create the illusion that it was delivering on its promise to the market to deleverage."244 But a complaint does not sufficiently allege motive where it alleges only goals "`possessed by virtually all corporate insiders' such as the desire to maintain a high credit rating for the corporation or otherwise sustain the appearance of corporate profitability."245 The TAC fails to allege that any of the defendants had a motive to commit the alleged fraud and fails also to allege that any of them benefitted from the alleged misrepresentations and omissions in a concrete way.246 Accordingly, it fails to allege scienter on a motive-and-opportunity basis.

b. Circumstantial evidence of conscious misbehavior or recklessness

(1) Repo 105 Transactions

A complaint may allege facts sufficient to give rise to an inference of scienter with respect to a misleading financial statement where it alleges that a corporate officer knew of or recklessly failed to learn of "red flags" indicating that the officer's public statements were false or misleading.247 Red flags may exist if the complaint alleges the existence of transactions that were large, recurrent, timed near the end of a reporting period, and obviously lacking in business purpose.248 This may be true even if the registrant's outside auditor has opined that the company's financial statements were presented in accordance with GAAP.249

The TAC alleges sufficient red flags to give rise to an inference of scienter with respect to the Repo 105 transactions for any Insider Defendant who, because of his or her corporate role, responsibilities, and actions, knew or recklessly did not know of the misleading nature of the financial reporting of those transactions. The TAC's principal allegations focus on the size of the Repo 105 transactions, their temporary effect on net leverage, their timing at the end of each reporting period, and their lack of a true business purpose. Specifically, Lehman allegedly engaged in between $31.9 and $50.3 billion in Repo 105 transactions at the end of each quarter from the second quarter of 2007 until the second quarter of 2008, with the amount increasing each quarter.250 Those transactions allegedly reduced Lehman's net leverage ratio by at least 1.5 each quarter.251 This reduction in net leverage allegedly was temporary, as Lehman was obligated contractually to repay its Repo 105 counter-parties and return the collateral assets to its balance sheet "just days" after each quarter ended.252 In consequence, Lehman's net leverage increased immediately after each reporting period ended.253 The TAC alleges, moreover, that the Repo 105 transactions lacked any business purpose other than to reduce net leverage in this manner.254 Consequently, the TAC alleges facts supporting an inference of scienter to whatever extent that it alleges that the Insider Defendants knew or recklessly failed to know about the misleading nature of the manner in which these transactions were reported.255

The TAC's allegations in this regard are strongest with respect to O'Meara, Callan, and Lowitt. Each was Lehman's chief financial officer at one point during the class period and therefore had primary responsibility for overseeing Lehman's finances.256 From April to September 2008, each received daily reports called "Daily Balance Sheet and Disclosure Scorecards," which contained "frequent references" to Repo 105 and noted the "daily benefit that Repo 105 transactions provided to Lehman's balance sheet."257 This would have enabled them to see the daily increase and decrease of the Repo 105 usage and its effect on Lehman's net leverage. It would have demonstrated also the greatly increased usage at the end of each reporting period. Finally, O'Meara, Callan, and Lowitt each was exposed to Repo 105 transactions in their work. O'Meara "actively managed" Lehman's Repo 105 program from the start of the class period until December 1, 2007, and was responsible for setting the Repo 105 usage limits.258 Lowitt admitted to the Examiner that he was aware of the Repo 105 program for many years and that "Lehman used the transactions to meet balance sheet targets."259 Several "senior Lehman executives brought Repo 105 to Callan's attention" while she was CFO.260 These allegations are sufficient at this stage to give rise to an inference of scienter on the part of these defendants.261

The TAC's allegations with respect to Gregory and Fuld are somewhat different. Nevertheless, the TAC alleges that Gregory (1) received reports from O'Meara about the impact of the Repo 105 transactions on Lehman's balance sheet,262(2) assisted in setting balance sheet targets and received materials related to Lehman's use of Repo 105 to manage its balance sheet prior to a meeting about them,263 and (3) was a member of Lehman's executive committee.264 It alleges that Fuld was Lehman's chairman and chief executive officer and served on its executive committee,265 and that O'Meara had a duty to report the impact of the Repo 105 transactions on Lehman's balance sheet to him.266 It alleges further that, in June 2008, Bart McDade, Lehman's "balance sheet czar," had specific discussions with Fuld about Lehman's quarter-end Repo 105 usage and that Fuld admitted to the Examiner that he was focused on reducing the company's net leverage and balance sheet.267 Accordingly, the TAC sufficiently alleges facts giving rise to an inference of scienter on the part of Gregory and Fuld as well.

The question remains whether that inference is sufficiently "strong"—that is, whether it is "cogent and at least as compelling as any opposing inference one could draw from the facts alleged."268

Defendants argue that the "more compelling inference is that the[y] had an honest belief that the [Repo 105] transactions were legal, as well as accounted for and disclosed in accordance with GAAP, and were legitimate sales transactions for business units to obtain funding and stay within their balance sheet targets."269 They point to the fact that E & Y knew about Lehman's Repo 105 transactions and approved of their use and the accounting for them, and to the fact that Linklaters provided a "true sale at law" legal opinion, purportedly satisfying one of SFAS 140's requirements.270 They point also to the fact that the transactions were used by many of the firm's business units271 and that Lehman could have reduced its net leverage to the same extent by selling the collateral assets outright, but that Repo 105 was less costly.272

The suggestions that defendants believed that the Repo 105 transactions were permissible in and of themselves and that the financial reporting for them, in and of itself, complied with GAAP does not address the core of plaintiffs' claims—that they were used to reduce temporarily and artificially Lehman's net leverage and paint a misleading picture of the company's financial position at the end of each quarter. The allegations that these transactions were used at the end of each reporting period, in amounts that increased as the economic crisis intensified, to affect a financial metric that allegedly was material to investors, credit rating agencies, and analysts support a strong inference that the Insider Defendants knew, or were reckless in not knowing, that use of the Repo 105 transactions and the manner in which they were accounted for painted a misleading picture of the company's finances.

(2) Risk management

The TAC alleges facts sufficient to give rise to an inference of scienter with respect to the first category of risk management misstatement. It alleges that Lehman's executive committee established the company's overall risk limits and risk management policies, that Lehman's risk committee "determined `overall risk limits and risk management policies, including establishment of risk tolerance levels . . . on a weekly basis, or more frequently as needed,'" and that Fuld, Gregory, Callan, Lowitt, and O'Meara sat on those committees.273 It therefore sufficiently alleges facts giving rise to an inference that these defendants were involved in setting Lehman's risk policies and knew that the statements concerning enforcement of risk management policies were false.

The Insider Defendants contend that the alleged facts support an inference that Lehman's and the Insider Defendants' decisions with respect to risk management were business decisions, based on internal reports and discussions, and that the limits were altered pursuant to an established process.274 The suggestion is that such an inference would be inconsistent with, or at least not as plausible as, an inference of fraudulent intent. For present purposes, however, the Court does not agree. While a trier of fact ultimately might not agree, it is more plausible, in all the circumstances, that Fuld, Gregory, Callan, Lowitt, and O'Meara knew that Lehman routinely altered or knowingly tolerated alteration of Lehman's risk management policies even as the company stated it would monitor and enforce them. Accordingly, the TAC adequately has alleged a strong inference of scienter on the part of Fuld, Gregory, Callan, Lowitt, and O'Meara with respect to the risk management policies.

The TAC makes stress testing statement scienter allegations only with respect to O'Meara. Specifically, it alleges that O'Meara told the Examiner that Lehman "did not even start taking steps to include private equity transactions in its stress tests until 2008."275 The TAC, however, fails to allege that Lehman's "private equity transactions" involved commercial real estate. To the contrary, it lists "private equity" assets or transactions separately from "commercial real estate" in the context of stress testing.276 In consequence, the allegation that O'Meara knew that "private equity" assets were excluded from stress testing does not give rise to an inference that O'Meara knew that Lehman's commercial real estate assets were excluded from the stress testing.

(3) Concentrations of credit risk

Plaintiffs have alleged sufficiently that Lehman violated SFAS 107's disclosure obligations by failing to disclose in particular financial statements discussed above known significant concentrations of credit risk with respect to its holdings of Alt-A and commercial real estate assets. But Lehman is not a defendant in this case. It therefore remains to consider whether the TAC sufficiently pleads scienter with respect to these claims as to each Insider Defendant.

The internal February 2008 email discussing Lehman's Alt-A holdings is the only basis supporting an inference that anyone at Lehman knew of significant concentrations of credit risk with respect to these assets. But plaintiffs do not allege which if any of the Insider Defendants received, saw, or otherwise knew of this email. Consequently, there are no allegations supporting an inference of scienter on the part of the Insider Defendants with respect to these alleged undisclosed concentrations of credit risk.

The only basis for an inference that Lehman knew that it was obliged by SFAS 107 to disclose a significant concentration of credit risk with respect to commercial real estate assets in its 2007 10-K is the report at the November 6, 2007 Executive Committee meeting.277 Fuld, O'Meara and Gregory all were members of that committee. Callan and Lowitt, however, did not become members until later.278 Accordingly, the TAC sufficiently alleges scienter in respect of this claim on the part of Fuld, O'Meara and Gregory but not Callan and Lowitt.

C E & Y

The TAC alleges that E & Y's statements in (1) Lehman's 2007 10-K concerning its audit and Lehman's financial statements, and (2) Lehman's quarterly reports on Form 10-Q for the second and third quarters of 2007 and the first two quarters of 2008 concerning its review of Lehman's financials were materially false and misleading.279 While the TAC quotes selectively from those statements, it is useful to quote them more fully.

Insofar as is relevant here, the statements in the 2007 10-K were these:

The pertinent statement in each of the 10-Q's was this:

Plaintiffs mount parallel attacks on E & Y's statements in the 10-K and the 10-Qs. They allege that the audit, or GAAS, opinion in the 10-K—i.e., the statement that E & Y "conducted [its] audits in accordance with the standards of the Public Company Accounting Oversight Board"—was false because E & Y did not conduct its audits in accordance with those standards.282 They contend also that the GAAP opinion in the 10-K—i.e., the statement that, in E & Y's "opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lehman Brothers Holdings Inc. at November 30, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended November 30, 2007, in conformity with U.S. generally accepted accounting principles"—was false because that statement did not conform to GAAP.283 Similarly, they assert that the statements in the 10-Qs—first that E & Y conducted its "review in accordance with the standards of the" PCAOB and, second, that E & Y, "[b]ased on [its] review, [was]. . . not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S." GAAP—were false for substantially the same reasons.284

1. Statements regarding GAAS

E & Y contends that an auditor's statements of GAAS compliance is an assertion of opinion that is not a misstatement unless the auditor believed it to be false when it was made.285 As the TAC is devoid of allegations that E & Y subjectively believed that its statements of GAAS compliance were false, it argues, the Exchange Act claims relating to its GAAS opinions must be dismissed.

Plaintiffs tacitly acknowledge that the TAC does not allege that the GAAS opinion was subjectively false, arguing instead that subjective falsity is not required for purposes of Section 11 of the Securities Act286 and, by logical extension, to make out a false statement (as distinct from scienter) for purposes of Section 10(b) and Rule 10b-5 of the Exchange Act. This, they say, is the logical import of the fact that the Securities Act provides auditors and others with a due diligence defense to Section 11 claims, which affords them the opportunity to avoid strict liability by proving that they exercised due diligence. Although plaintiffs do not say so in as many words, their position amounts to the proposition that a complaint that alleges that an auditing firm issued a "clean" audit opinion in circumstances in which one might conclude that the audit had not been conducted in accordance with PCAOB standards sufficiently alleges a false statement even if others reasonably might have agreed with the auditor. That argument is not persuasive.

As an initial matter, the argument, to the extent it rests on Section 11 of the Securities Act, assumes the very point at issue. It is true, as plaintiffs contend, that Section 11's purposes include holding auditors and others strictly liable, subject to the due diligence defense, for materially false or misleading statements in the portions of registration statements "expertised" by them.287 But that says nothing about what constitutes a false or misleading statement. So we must look carefully at precisely what the TAC alleges was wrong with the GAAS opinion—in other words, at the precise respects in which the audit allegedly was not conducted in accordance with PCAOB standards—in order to determine whether E & Y's statement that it had conducted a GAAS-compliant audit may be understood as "false."

The TAC points to several General Standards ("GS"), interpretive Statements on Auditing Standards ("AU"), and Statements of Fieldwork that allegedly are part of GAAS and that E & Y allegedly violated.288 Many of those standards are couched in rather general and in some cases inherently subjective terms. They require, for example, that the auditor plan the audit engagement properly, use "due professional care," exercise "professional skepticism," and "assess the risk of material misstatement due to fraud"289—all matters as to which reasonable professionals planning or conducting an audit reasonably and frequently could disagree.290 Bearing in mind that E & Y's GAAS opinion, just like those rendered by all or substantially all accounting firms, is explicitly labeled as just that—an opinion that the audit complied with these broadly stated standards—more is necessary to make out a claim that the statement of opinion was false than a quarrel with whether these standards have been satisfied.

In this case, most of plaintiffs' allegations in that respect are conclusory and do not contain factual matter sufficient to support a plausible claim for relief.291 But the TAC claims also that E & Y violated GS 3's and AU § 230's requirements of "due professional care" and "professional skepticism" in that E & Y ignored or failed to respond adequately to three "red flags": (1) Lehman's inability to obtain from a U.S.-based law firm a true sale opinion regarding Lehman's accounting treatment of Repo 105s, (2) a netting grid that identified and described the Repo 105s, and (3) E & Y's June 12, 2008 interview with Matthew Lee, the senior vice president in charge of Lehman's Global Balance Sheet and Legal Entity Accounting.292

Lehman's use of a true sale at law opinion letter from a U.K.-based law firm was not a red flag. First, given that our legal system sprung from the English one, it would be odd indeed to conclude that the use of an opinion from a well known U.K.based law firm on a question of common law—whether a true sale at law had occurred—calls into question the accuracy of the opinion's conclusion. Second, and more importantly, the letter is not said to have provided E & Y any indication that Lehman improperly increased its use of the Repo 105 transactions at the end of each reporting period because the opinion that a Repo 105 involved a true sale did not address the issue that is pertinent here. That opinion went only to the question whether the Repo 105s were properly accounted for as sales under SFAS 140, not the question whether the financial statements nevertheless were misleading because the manner in which the Repo 105s were used presented a deceptive picture as to Lehman's net leverage.

Nor was the netting grid a "red flag" that Lehman used the Repo 105 transactions at the end of each quarter to manipulate its reported net leverage ratio. The netting grid disclosed the volumes of Repo 105 transactions on Lehman's balance sheet on November 30, 2006, and February 28, 2007.293 But it did not disclose to E & Y when these transactions were entered into or that they were unwound promptly after the end of each reporting period.294 The grid therefore could not have alerted E & Y to the possibility that Lehman was using these transactions to manipulate its net leverage (and overall financial position) at the close of each reporting period.

The Lee interview, but for its timing, would have been different. Lee allegedly told E & Y that Lehman had used Repo 105 transactions to remove temporarily $50 billion from its balance sheet at the end of the second quarter of 2008.295 Although Lehman's audit committee allegedly had instructed E & Y to report to it any allegations of financial improprieties, E & Y allegedly failed to relay Lee's concerns or investigate them itself.296 In these circumstances, and bearing in mind that the issue might appear differently on a fuller record, a trier of fact reasonably might find that E & Y knew by June 2008, when it interviewed Lee, that the Repo 105s may have been used to manipulate the balance sheet, at least at the end of the second quarter of that year. Had E & Y subsequently issued a "clean" audit opinion, knowing that it had not followed up appropriately on Lee's allegations, that opinion could well have been false. But the only audit opinion at issue here is the one E & Y expressed with respect to its 2007 audit and that appeared in the 2007 10-K, issued on January 28, 2008.297

The Court is mindful of the fact that some courts have considered the sufficiency of securities claims against auditors based upon statements as to the compliance of financial statements with GAAP without regard to the significance of the fact that such statements have been couched as opinions and thus without regard to the importance of the fact-opinion distinction.298 But the distinction is important. E & Y's statement regarding GAAS compliance inherently was one of opinion. In order for the TAC sufficiently to have alleged that it was false, it had to allege facts that, if true, would permit a conclusion that E & Y either did not in fact hold that opinion or knew that it had no reasonable basis for it.299

The scienter analysis with respect to this claim is substantially the same. As with other defendants, in order to state an Exchange Act claim against an auditor, a complaint must "state with particularity facts giving rise to a strong inference" of scienter.300 The standard for evaluating assertions of an auditor's scienter, however, is "demanding."301 The complaint must allege that the auditor's conduct was "`highly unreasonable,'" representing "`an extreme departure from the standards of ordinary care'" and "`approximat[ing] an actual intent to aid in the fraud being perpetrated by the audited company.'"302 The "accounting judgments which were made [must have been] such that no reasonable accountant would have made the same decisions if confronted with the same facts."303 Plaintiffs' allegations respecting "red flags" therefore bear not only on whether E & Y violated the pertinent GAAS requirements, but also on whether it did so with the requisite state of mind.304 For the reasons discussed above, the true sale opinion and netting grid were not red flags, the disregard of which could be called highly reckless. And while E & Y's alleged failure to follow up on the Lee interview arguably would have been a departure from GAAS, the only subsequent E & Y statement at issue is the report on the interim financials in the 2Q08, which contained no statement of a GAAS-compliant audit. Accordingly, the TAC fails to allege that E & Y made any false or misleading statements with respect to GAAS compliance either in the 2007 10-K or in any of the subsequent 10-Q's, much less that it did so with scienter.

2. Statements regarding GAAP

Plaintiffs argue also that E & Y's opinions as to Lehman's preparation of its financial statements in accordance with GAAP were statements of fact and that they were false because those financial statements in fact did not comply with GAAP.

"The representation in the auditor's standard report regarding fair presentation, in all material respects, in conformity with [GAAP] indicates the auditor's belief that the financial statements, taken as a whole, are not materially misstated."305 Thus, allegations that a company violated GAAP in preparing its financial statements are not sufficient, in and of themselves, to state a claim that an auditor's opinion of GAAP compliance is a factual misstatement. For reasons already discussed, the complaint must allege specific departures from GAAP and, in addition, set forth facts sufficient to warrant a finding that the auditor did not actually hold the opinion it expressed or that it knew that it had no reasonable basis for holding it.

The only alleged departure from GAAP relied upon by plaintiffs in connection with its claim against E & Y relates to Lehman's use of Repo 105s.306 The only such departure that the Court finds sufficient is the claim that Lehman's use of such transactions at each quarter-end to reduce its net leverage temporarily resulted in the financial statements portraying the company's leverage in a misleading way, this notwithstanding that plaintiffs have not sufficiently alleged that the accounting treatment of those transactions, in and of itself, was inconsistent with GAAP.307 As there is no claim that E & Y did not in fact hold the opinion that it expressed with respect to Lehman's compliance with GAAP, the question thus becomes whether plaintiffs have sufficiently alleged that E & Y had no reasonable basis for believing that Lehman's financial statements were prepared in accordance with GAAP. In other words, have plaintiffs sufficiently alleged that E & Y knew enough about Lehman's use of Repo 105s to "windowdress" its period-end balance sheets to permit a finding that E & Y had no reasonable basis for believing that those balance sheets fairly presented the financial condition of Lehman?

Plaintiffs rely for this purpose on precisely the same alleged red flags discussed previously in connection with E & Y's GAAS opinion—the "true sale" opinion, the netting grid, and the Lee interview. The first two are no stronger in this context than in that. The Lee interview, however, is a different matter.

The TAC alleges that Lee told E & Y in June 2008 "that Lehman moved $50 billion of inventory off its balance sheet at quarter-end through Repo 105 transactions and that these assets returned to the balance sheet about a week later."308 Assuming that is so, E & Y arguably was on notice by June 2008 that Lehman had used Repo 105s 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. Accordingly, the TAC adequately alleges that E & Y misrepresented in the 2Q08 that it was "not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles" notwithstanding Lee's disclosure to it.

* * *

In sum, the TAC sufficiently alleges that E & Y, with the requisite scienter, made a false or misleading statement in Lehman's 2Q08 in that it professed ignorance of facts warranting material modifications to Lehman's balance sheet when in truth it had received information concerning Lehman's use of Repo 105s temporarily to move $50 billion of inventory off that balance sheet—information that cast into doubt the balance sheet's consistency with GAAP.

D. Loss Causation

Defendants next argue that the TAC fails adequately to plead loss causation.

Loss causation "is the causal link between the alleged misconduct and the economic harm ultimately suffered by the plaintiff."309 To make out loss causation, "a plaintiff must allege . . . that the subject of the fraudulent statement or omission was the cause of the actual loss suffered."310 In the Second Circuit, loss causation may be established either by (1) a corrective disclosure or (2) a materialization of a concealed risk.311 On the latter theory, the complaint must allege that the loss was (1) foreseeable and (2) caused by the materialization of the concealed risk.312 A loss is foreseeable if it is "within the zone of risk concealed by the misrepresentations and omissions alleged by the disappointed investor."313

Plaintiffs claim that Lehman's misstatements and omissions with respect to the Repo 105 transactions, risk mitigation policies, and concentrations of credit risk caused their losses. The essence of the argument is that Lehman's financial statements and related communications understated its net leverage, concealed the negative balance sheet impact of its inventory of "sticky" and illiquid assets, misstated its practices with respect to risk management, understated the extent of its exposures on Alt-A and commercial real estate holdings and, more broadly, portrayed Lehman as financially stronger than it was.314 They contend that the "massive write-downs that Lehman took in June and September 2008, and the rating agency downgrades that naturally followed,"315 all of which were followed by declines in the price of Lehman's shares, were the beginnings of the materialization of those risks, risks that ultimately culminated in the ratings downgrades and liquidity crisis that followed and led to Lehman's bankruptcy.316

Defendants argue that this fails sufficiently to allege loss causation because Lehman's stock steadily declined through the class period and the company ultimately failed in consequence of a market-wide phenomenon, the "crisis in the subprime market that . . . spread to the rest of the real estate market, collapse of the financial markets generally, [and] market-wide liquidity crisis" that affected Lehman's industry generally.317 While defendants of course are right about the climate in which Lehman's demise occurred, their argument is not persuasive for reasons previously expressed by this Court.

As an initial matter, plaintiffs need not allege that their entire loss was caused by the misstatements and omissions complained of. "To plead loss causation, the complaint must allege facts that support an inference that [the defendants'] misstatements and omissions concealed the circumstances that bear upon the loss suffered such that plaintiffs would have been spared all or an ascertainable portion of the that loss absent the fraud."318 Even granting arguendo the contribution to Lehman's demise of the market-wide circumstances to which defendants refer, the existence of such a causative factor would not of itself exclude a sufficient causal connection between the alleged misstatements and omissions and a portion of the losses plaintiffs sustained.

Nor are plaintiffs required to allege that the particular misstatements and omissions directly caused the alleged losses. In Lentell, the Court of Appeals concluded that the plaintiffs had failed to plead loss causation in relevant part because they did "not allege that the subject of [the] false recommendations" caused their losses,319 thus making clear that misstatements or omissions that conceal a risk, the materialization of which causes all or part of the plaintiffs' loss, would suffice.

In this case, the TAC, to the extent previously indicated, adequately alleges misstatements and omissions that overstated Lehman's financial strength, misstated and understated the extent to which it was leveraged, misstated its risk management practices, and understated its exposure to Alt-A and commercial real estate assets. It adequately alleges as well that it was the materialization of these risks, all minimized by the alleged misstatements and omissions, that destroyed whatever value remained in Lehman's shares. While it perhaps may be said with some assurance that Lehman, given the assets it held, would have been in trouble in any case, it is entirely plausible to conclude also from the facts alleged in the TAC that the misleading picture that Lehman portrayed played a material part in keeping its stock higher during the class period than it otherwise would have been and, in consequence that some part of the losses the plaintiffs suffered was attributable to the alleged fraud.

This point is well illustrated by In re Parmalat Securities Litigation.320 Insofar as is relevant here, that case involved the liability of auditors of a company, insiders of which, to the auditors' knowledge, engaged in a scheme involving misleading transactions and off-shore entities that created a false appearance that the company was financially strong and permitted the company to raise capital for a long period during which it actually had been losing money. The auditors gave "clean" opinions on the company's financial statements throughout. But the scheme eventually became unsustainable and the company failed. The precise causes of the failure came to light only after the failure, and the auditors contended that the plaintiffs had failed adequately to allege loss causation. But the court rejected that argument for reasons quite pertinent here:

In this case, the alleged misstatements and omissions concealed the extent of Lehman's exposure to asset classes, the precarious nature of which, a jury could find, was foreseeable and, indeed, though plaintiffs perhaps need not so prove, in fact foreseen by some.322 They created the impression that Lehman took greater steps to limit and manage its risk than in fact it allegedly did. And they overstated Lehman's financial strength generally and understated the extent to which it was leveraged. According to the TAC, it was the materialization of the risks thus concealed that ultimately killed Lehman. In consequence, plaintiffs are entitled to an opportunity to attempt to prove that some ascertainable amount of the losses they suffered was attributable to the allegedly false picture of relative security attributable to those misstatements and omissions.323

E. The Other Exchange Act Claims

1. Section 20(a)

The Insider Defendants seek dismissal of the Section 20(a) claims on the ground that the TAC lacks particularized allegations that any was a culpable participant in the alleged fraud.324

The Court recognizes that there is a difference in view as to whether such allegations—as distinct from proof at trial— are required. It is aware also that the Second Circuit's recent decision in Lehman MBS,325 a case dealing, insofar as is relevant here, only with a question under Section 15 of the Securities Act,326 cited SEC v. First Jersey Securities, Inc.,327 for the proposition that a Section 20(a) plaintiff must "show that [a] `controlling person was in some meaningful sense a culpable participant in the fraud.'" But it did not discuss, let alone resolve, the question whether a Section 20(a) complaint, in order to state a legally sufficient claim for relief, must allege culpable participation. That question remains open in this Circuit.

This Court previously has held that a Section 20(a) plaintiff need not allege culpable participation at the pleading stage and that it does not read First Jersey Securities as so requiring, for reasons set forth in greatest detail in Parmalat.328 In any case, the TAC adequately alleges scienter, and thus culpable participation, on the part of all of these defendants save that it does not do so with respect to defendants Callan and Lowitt solely with regard to the claim based upon inadequate disclosure concerning concentrations of credit risk. Accordingly, the point for the most part is academic.

2. Section 20A

Defendant Fuld seeks dismissal of the Section 20A claim against him.

A defendant violates Section 20A of the Exchange Act329 "by purchasing or selling a security while in possession of material, nonpublic information . . . to any person who, contemporaneously with the purchase or sale of securities that is the subject of [a violation of the Exchange Act], has purchased. . . or sold . . . securities in the same class."330

The TAC alleges sales by Fuld of Lehman securities contemporaneously with purchases of Lehman securities by some plaintiffs.331 The question is whether it sufficiently alleges that he had material nonpublic information at those times.

Paragraph 266 of the TAC alleges generally that Fuld possessed material, nonpublic information "[a]s detailed herein" without stating when he allegedly possessed that information or the subject of the information allegedly possessed. Plaintiffs' brief states that the subject was "the adherence to Lehman's risk management at the time he sold his Lehman stock."332 But the paragraph of the TAC it cites for that proposition does not support it. Plaintiffs thus have pointed to nothing in the complaint that supports the assertion that Fuld possessed material non-public information at the time of the sales that were contemporaneous with purchases by certain plaintiffs. Accordingly, the Section 20A claim against defendant Fuld is insufficient.

IV. Securities Act

Sections 11 and 12 of the Securities Act impose strict liability on certain enumerated categories of parties for material misstatements or omissions contained in covered financial communications.333 Only five categories of persons may be held liable under Section 11334—issuers, those who sign a registration statement, an issuer's directors, "experts" who have consented to having their reports included in the registration statement, and underwriters of the offered securities.335 Only a statutory seller—one who either transferred title to a purchaser or successfully solicited the transfer for financial gain336— may be liable under Section 12.337 Section 15 imposes liability on individuals or entities that controlled any person who committed a primary violation.338

The TAC asserts claims under Section 11 against Fuld, O'Meara, Callan, the Director Defendants, the Underwriter Defendants (the foregoing referred to collectively as the "Securities Act Defendants"), and E & Y based on allegedly false and misleading statements in Lehman's financial statements that were incorporated into the Offering Materials. It asserts claims under Section 12 against UBS with regard to the Structured Note Offering Materials. It asserts control person claims under Section 15 against Fuld, O'Meara, Callan, Gregory, and Lowitt based on their alleged control of Lehman.

A. Timeliness

The TAC includes twenty-four named plaintiffs that were not plaintiffs in the SAC. These newly added plaintiffs are the only alleged purchasers of securities in thirty-five of the challenged offerings.339 Defendants move to dismiss these plaintiffs' claims as untimely.340

"Claims under Sections 11, 12(a)(2) and 15 must be `brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence.'"341 Defendants argue that the Securities Act's one year statute of limitations bars the claims of the newly added plaintiffs that were not contained in the SAC because they were on actual or inquiry notice of the facts giving rise to the action no later than February 23, 2009, the date the SAC was filed, which was more than a year before the filing of the TAC on April 23, 2010.

Plaintiffs do not dispute defendants' argument, but contend that the claims nevertheless are timely because the running of the prescriptive period was tolled under American Pipe & Constr. Co. v. Utah,342 where the Supreme Court held that "the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action."343 Defendants counter that American Pipe tolling does not apply when the "original plaintiffs lack standing to bring claims that the new plaintiffs seek to assert."344

For reasons discussed in a recent opinion in another case,345 this Court is persuaded that the filing of a class action suspends the running of applicable statutes of limitations for all putative class members even where the putative class plaintiff did not have standing to assert the claims at issue. Accordingly, the newly added plaintiffs' claims are not barred by the Securities Act's one year statute of limitations.

The statute of repose is another matter. As this Court has noted,

Defendants argue that certain of plaintiffs' claims are barred by the three year statute of repose.347 Plaintiffs have not responded to this argument.

Although some cases have reached a different result, this Court is persuaded that neither American Pipe nor any other form of tolling may be invoked to avoid the three year statute of repose set forth in Section 13 of the Securities Act of 1933.348 The added plaintiffs here cannot avoid the statute of repose on a `relation back' theory under FED. R. CIV. P. 15(c) because the statute of repose by its terms allows no exceptions.349 Indeed, Rule 15 could not properly be construed to permit relation back because such a construction would conflict with the Rules Enabling Act, which provides in pertinent part that the rules prescribed by the Supreme Court (including Rule 15) "shall not abridge, enlarge or modify any substantive right."350

In light of these principles, several of the claims asserted by the newly added plaintiffs are time-barred. Mohan Ananda and Frank Mandell assert claims in connection with the "100% Principal Protection Notes Linked to a Global Index Basket" offering. That offering, however, occurred on March 30, 2007, and Ananda's and Mandell's purchases therein allegedly occurred on March 23, 2007.351 Roy Wiegert asserts claims in connection with the "100% Principal Protection Notes Linked to a Global Index Basket" offering. But that offering, and Wiegert's purchases therein, also occurred on March 30, 2007, and March 23, 2007, respectively.352 Consequently, all of the Securities Act claims respecting these three offerings are barred by the three year statute of repose.

B. Statutory standing under Section 12

UBS argues that all of the Securities Act Section 12 claims against it should be dismissed because plaintiffs have failed sufficiently to allege statutory standing. Their argument is premised solely on the fact that the TAC alleges that plaintiffs "purchased or otherwise acquired" the securities listed in Appendix B to the TAC353 which, they contend, is insufficient to establish that plaintiffs had standing under Section 12.

A plaintiff has standing to bring a Section 12 claim only against a "statutory seller" from which it "purchased" a security.354 A "statutory seller" is one who, in a public offering, either transferred title to the purchaser or successfully solicited the transfer for financial gain.355 A complaint that alleges that the plaintiff purchased its securities "pursuant and/or traceable to" the Offering Documents is not sufficient.356 Allegations that a plaintiff purchased securities "pursuant to" the pertinent offering documents, however, have been construed to permit proof that the plaintiff purchased his or her security "in the offering."357

Plaintiffs here have alleged that the Section 12(a)(2) claims are brought on behalf of "all persons and entities who purchased or otherwise acquired the Lehman/UBS Structured Products pursuant to the materially untrue and misleading Structured Note Offering Materials."358 They have alleged also the dates and amount of securities that they purchased.359 Assuming these factual allegations to be true, and drawing all reasonable inferences in plaintiffs' favor, UBS's statutory standing argument must be rejected.360

C. Existence of actionable material misstatements and omissions in the Offering Materials

The TAC Securities Act claims against the non-E & Y defendants are based principally on the same categories of alleged misstatements and omissions in the Offering Materials discussed in the Exchange Act section above. The TAC thus alleges misstatements and omissions sufficiently under the Securities Act to the same extent that it does so under the Exchange Act. But the TAC relies, in connection with the Securities Act claims, on two additional categories of alleged misstatements: statements concerning Lehman's valuation of its commercial real estate holdings and in the PPN Offering Materials.

1. Valuation of commercial real estate

The Offering Materials stated that Lehman's "[f]inancial instruments and other inventory positions owned . . . are presented at fair value" and that its "private equity investments are measured at fair value."361 They stated also that Lehman adopted SFAS 157 for determining "fair value"362 and defined that term as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, or an `exit' price."363 Plaintiffs allege that these statements were materially false and misleading because Lehman (1) failed to consider certain market information in the assumptions underlying the models it used to value its Archstone and Principal Transaction Group ("PTG") assets and, consequently, (2) assigned values to these assets that did not reflect their "fair value."

The essence of plaintiffs' claim is that SFAS 157 required Lehman to consider certain particular pieces of market-based information in determining the values of its Archstone and PTG assets and that the methods it used failed to do so.364 They allege that the models Lehman used to value the Archstone assets assumed (1) a rental growth rate 1.9 to 3.5 percent higher than that projected by third parties, and (2) higher REIT net operating income growth rates than the historical average. They assert also that the models failed to consider the capitalization rates of other publicly traded REITs.365 Finally, they assert that the models used to value the PTG assets (1) assumed that the real estate collateral would appreciate even as real estate prices were declining, and (2) used an incorrect yield rate that at least one employee allegedly described as based on a "gut feeling."366

The allegations that Lehman's valuation models were based on assumptions or inputs different than those used by third parties and the Examiner, or those plaintiffs would have used, is not sufficient to state a claim that Lehman's valuation methods did not comply with SFAS 157's fair value requirement or that the valuation statements based on those models otherwise were misleading. Plaintiffs have not alleged that Lehman failed to undertake the fair value analysis that it said it would undertake for the Archstone and PTC assets. They have alleged only that the methods they used somehow were wrong because they were different than the methods and assumptions that others used in other contexts or at other times.

But SFAS 157 expressly contemplates that different models, based on different assumptions and the assignment of different weight to different inputs, may be used to determine fair value.367 Lehman's decision to use certain inputs and assumptions rather than others is consistent with SFAS 157. More significantly for these motions, Lehman's determination that certain models, assumptions, and inputs were likely to provide accurate estimations of fair value was a matter of judgment. Such decisions would make Lehman's Offering Materials' statement that it valued assets at fair value in accordance with SFAS 157 false or misleading only if Lehman had not truly believed that the models, assumptions and inputs would produce fair values in accordance with SFAS 157. The TAC is devoid of any such factual allegations and, in fact, expressly disclaims any reliance on intentional wrongdoing in this regard.368 Consequently, it fails to state a claim on that basis.

Plaintiffs' reliance on Fraternity Fund Ltd. v. Beacon Hill Asset Mgmt., LLC369 and Automatic Catering, Inc. v. First Multifund For Daily Income, Inc.370 for the proposition that misstatements concerning the methodology used to value assets are actionable statements of fact is misplaced. In those cases, the offering documents described the precise methodology by which the assets' value would be determined.371 For example, in Automatic Catering, Inc., the offering documents stated that the general partner would value the securities based on current market values.372 The plaintiffs alleged that this statement was false because the company actually valued the securities using an amortized cost method.373 There is no such allegation in this pleading.

The TAC's claim that Lehman assigned incorrect values to its commercial real estate assets fails as well. The only basis for this claim is the allegation that Lehman's fair value methodology violated SFAS 157. As plaintiffs have failed to allege that Lehman violated SFAS 157, these values are not actionable.

Moreover, the values Lehman assigned to assets like Archstone and PTG were not statements of objective fact but instead reflect Lehman's judgment or opinion.374 They therefore would be actionable only if plaintiffs had alleged that Lehman did not truly believe those valuations at the time they were issued.375 But there are no such allegations in the complaint.376 Consequently, the values themselves cannot form the basis of a claim.

2. Structured products offering materials and PPNs

The TAC alleges also that the pricing supplements related to each PPN (the "PPN Offering Materials") were false and misleading for the additional reason that they stated that the PPNs would provide "100% Principal Protection" or "partial principal protection" if the PPNs were held to maturity.377 Plaintiffs claim that these statements were false and misleading because (1) the PPNs did not protect investors' principal and were no different than ordinary bonds,378 and (2) the PPN Offering Materials failed to disclose that repayment of principal depended on Lehman's solvency.379 The claims based on these statements are asserted against Fuld, O'Meara, Callan, the Director Defendants and UBS.

In determining whether the PPN Offering Materials were false or misleading, the court must "read [them] as a whole."380 The "central issue ... is not whether the particular statements, taken separately, were literally true, but whether defendants' representations, taken together and in context, would have misl[ed] a reasonable investor about the nature of the" securities.381 Accordingly, a misleading statement displayed prominently and in numerous places may not be cured by inconspicuous and scattered warnings.382

Defendants argue that the PPN Offering Materials disclosed the risk that investors might not receive their principal if Lehman went bankrupt. The Base Prospectus explained, for example, that the PPNs would "be [Lehman's] unsecured obligations."383 One pricing supplement warned that "an investment in the Notes will be subject to the credit risk of Lehman Brothers Holdings Inc, and the actual and perceived creditworthiness of Lehman Brothers Holdings Inc. may affect the market value of the Notes."384 The relevant prospectus supplement stated that Lehman's "own creditworthiness, . . . may affect the trading market value of, and trading market for, your notes," and warned further that

While these statements would have made the nature of these securities clear to a careful and intelligent reader, the principal protection statements were displayed more prominently and frequently than the warnings. The first line of the each pricing supplement submitted with the defendants' motion states "100% principal protection" in large letters.386 The first page lists the "Features" of each investment, which include "100% principal protection if held to maturity" and "[a]t maturity, you will receive a cash payment equal to at least 100% of your principal."387 Each mentions 100% principal protection at least four times on the first page. By contrast, the risk that investors could lose their principal if Lehman went bankrupt is not mentioned on that page at all. The rest of each pricing supplement continues this trend, frequently mentioning principal protection, but rarely or obliquely disclosing the risk that Lehman would not repay.

At this stage of the litigation, the Court can not conclude as a matter of law that the repeated and emphasized statements about principal protection were offset sufficiently, as a matter of law, by the inconspicuous and scattered warnings—contained in other SEC filings—about Lehman's solvency. In consequence, these allegations with respect to the PPNs are sufficient to state a claim.

* * *

Accordingly, the TAC's Securities Act claims against all non-E & Y Securities Act Defendants based on the (1) Repo 105 and net leverage, (2) risk management and (3) concentration of credit risk statements and those against the Insider Defendants, the Director Defendants, and UBS based on the PPN statements rest on legally sufficient allegations of materially false or misleading statements. The claims against E & Y are discussed below.

D. Section 11 claims against Callan

Defendant Callan concededly did not sign the Registration Statement.388 She argues that the Section 11 claims against her therefore should be dismissed. Plaintiffs, however, contend that she is subject to suit under Section 11 because she signed various SEC filings, which the Registration Statement incorporated by reference. Callan's liability therefore turns on whether signing those filings made her a "person who signed the registration statement" within the meaning of Section 11.389

Lehman's Registration Statement was filed pursuant to Rule 415 of the Securities Act, which permits delayed or continuous offerings of securities.390 A registration statement filed pursuant to Rule 415 must contain the undertakings required by Item 512(a) of Regulation S-K.391 Those undertakings require the registrant, inter alia, to file a post-effective amendment to the registration statement to include (1) any prospectus required by Securities Act Section 10(a)(3), (2) "any facts or events arising after the effective date of the registration statement which . . . represent a fundamental change in the information set forth in the registration statement," and (3) previously undisclosed material information about the plan of distribution.392 The registrant need not file a post-effective amendment, however, if the registration statement is on Form S-3 and the information required to be disclosed is "contained in reports filed with or furnished to the [SEC] by the registrant pursuant to section 13 or section 15(d) of the [Exchange Act] that are incorporated by reference in the registration statement."393

Where a registration statement "incorporates by reference any Exchange Act document filed subsequent to the effective date of the registration statement," the registrant must make additional undertakings.394 These include the undertaking that

The Registration Statement was filed on May 30, 2006, and became effective on that day.396 The base prospectus397 filed with the Registration Statement incorporated by reference Lehman's "future filings made with the SEC under Section 13(a), 13(c), 14, or 15(d) of the Securities Exchange Act of 1934," which included the 2007 10-K and the other SEC filings that Callan signed.398 Consequently, "for purposes of determining any liability under the Securities Act," each of those filings is "deemed a new registration statement." Callan therefore became a signer of "new" registration statements by virtue of her having signed those filings. Her motion to dismiss the Section 11 claim on the ground that she did not sign the Registration Statement therefore is granted in part, but denied to the extent that the claim is based on statements made in the SEC filings that she signed and that were incorporated by reference in that Statement.399

E. Affirmative defenses of non-E & Y defendants

Fuld, O'Meara, Callan, and the Director and Underwriter Defendants argue that the claims against them should be dismissed because the TAC and the Examiner's Report establish the Securities Act affirmative defenses of due diligence and reliance on an expert.400

1. Availability of the affirmative defenses on a motion to dismiss

Plaintiffs first argue that the affirmative defenses are not available on a motion to dismiss for failure to state a claim.401 This general principle, however, is subject to exceptions, and an "affirmative defense may be raised by a pre-answer motion to dismiss under Rule 12(b)(6), without resort to summary judgment procedure, if the defense appears on the face of the complaint."402

2. Applicability of defenses

In order to establish the due diligence defense, each defendant has the burden to prove that "after reasonable investigation, [he or she had] reasonable ground to believe and did believe" that the Offering Materials were true and did not contain any material misstatements or omissions.403 In order to establish the expertreliance defense, each defendant has the burden to prove that "he [or she] had no reasonable ground to believe and did not believe" that the statements in the expertized portion of the registration statement were untrue or contained material omissions.404 The statute defines "reasonableness" for these purposes as "that required of a prudent man in the management of his [or her] own property."405

Fuld, O'Meara, Callan, and the Director and Underwriter Defendants contend that Lehman's public filings and the Examiner's Report406 conclusively demonstrate that each conducted a "reasonable investigation" and had a "reasonable ground to believe" the Offering Materials were true. Fuld, O'Meara, Callan and the Underwriter Defendants likewise contend that the TAC establishes their due diligence at least with respect to the Repo 105 statements. They point to the allegations that E & Y knew about the Repo 105 transactions, issued an unqualified audit opinion certifying that Lehman's 2007 10-K was prepared in accordance with GAAP and fairly presented Lehman's financial condition in all material respects, and certified that it was "not aware of any material modifications that should be made to ... the [quarterly reports] for them to be in conformity with GAAP."407 They argue also that there were no red flags that would have put them on notice that it was not reasonable to rely on E & Y's conclusions.408

For reasons discussed previously, neither the Examiner's Report nor the various SEC filings is properly before the Court for the truth of the matters asserted. In any case, neither they nor the TAC would conclusively establish the due diligence defense on behalf of any of these defendants. The questions whether a particular defendant acted with due diligence and nevertheless was unaware of the falsity of any pertinent statement necessarily is relative and requires a determination of all relevant circumstances. Plaintiffs were not required to allege in the TAC all the circumstances necessary to negate the affirmative defense,409 but only those necessary to state a plausible claim for relief.410 Accordingly, the Court cannot conclude as a matter of law that the defendants' investigation was reasonable under the circumstances. Consequently, the motions to dismiss on this basis are denied.

F. Securities Act claims against E & Y

The Securities Act claims against E & Y are based on the same statements regarding GAAS and GAAP compliance as the Exchange Act claims. As discussed above, the TAC arguably alleges misstatements— that is, statements in which E & Y falsely represented that it had complied with GAAS and that Lehman had complied with GAAP—in connection with the 2Q08 review. Representations made in that report, however, are not actionable under the Securities Act.

Accounting firms like E & Y are subject to Securities Act Section 11 liability only if the alleged misstatement or omission occurs in a portion of a registration statement, or a report or valuation used in connection with the registration statement, prepared or certified by it.411 The SEC, by rule, has provided that "a report on an unaudited interim financial statement . . . by an independent accountant . . . shall not be considered a part of a registration statement prepared or certified by an accountant or a report prepared or certified by an accountant within the meaning of Section 11412 Accordingly, misstatements or omissions in a "report on unaudited interim financial information" cannot give rise to accountant liability under Section 11(a)(4). As E & Y made the only otherwise actionable statements in reports on unaudited interim financial information,413 plaintiffs' Securities Act claims against it fail.

G. Section 15 claims

Defendants move to dismiss the Securities Act Section 15 control person claims against the Insider Defendants on the ground that the TAC fails to assert a primary violation of the Securities Act.414 For the reasons stated above, the TAC sufficiently alleges violations of Securities Act Sections 11 and 12. Consequently, the Section 15 claims will stand.415

Conclusion

The motions to dismiss the TAC [09 MD 2017, docket items 293, 296, 299; 08 Civ. 5523, docket items 224, 227, 230] are granted in part and denied in part as set forth above. Defendants shall settle an order more fully setting forth the rulings made herein, preferably an order agreed as to form by all parties, on seven days' notice.

SO ORDERED.