by Matt Taibbi
But in another sense, it was a thoroughly common occurrence. Every day on Wall Street, money is stolen, embezzled, burgled, and robbed. But the mechanisms of these thefts are often so arcane and idiosyncratic that they don’t fit neatly into the criminal code, which is written for the dumb crimes committed by common stick-up artists and pickpockets.
Wall Street crime, in part, is a confidence game in which the criminal justice system itself is the mark. Much like common street grifters, who bank on the victim’s feelings of shame and guilt preventing him from going to the police, Wall Street criminals bank on the terminal intellectual insecurity of their regulators. They dare prosecutors to call what they’ve done crimes, knowing they’ll be hesitant to disagree with the hotshot defense lawyers from New York and Washington who make forty or fifty times what they do.
So a foreign bank steals billions of dollars from dozens of American towns like Long Beach, but when the bank’s lawyers call the transaction not theft but “clarification,” American law enforcement is mesmerized by the semantics. It then declares the issue a civil matter and kicks the problem to the civil courts, where the best hope for the victims now is not for justice but mere remuneration.
From there it’s just math. The civil battle almost always devolves into a war of resources, and here, inevitably, the richer party wins.
In December 2008, a few months after the sale, Luc Despins, the lead Milbank counsel representing one group of Lehman creditors, decided to leave Milbank, Tweed for a job at a new firm, Paul Hastings. On the way out the door, he called up Susheel Kirpalani at Quinn Emanuel, who represented the other major group of Lehman creditors. He told Kirpalani that even though the Lehman case was no longer going to be his problem, he wanted someone to follow through with it.
“He told me, basically, we never got all the documents,” says Kirpalani. “And we think there’s a five-billion-dollar hole there.”
Kirpalani had already come to the conclusion that something was wrong with the Lehman sale. He was troubled by some language in a JPMorgan-Barclays dispute that he was asked to take a look at that referred back to the Barclays-Lehman deal. So he started asking questions.
Parallel to Kirpalani’s inquiry, the other main firm representing the Lehman estate, Alvarez & Marsal, began asking its own questions on behalf of the Lehman creditors. “Issues started to bubble up,” said the firm’s CEO, Bryan Marsal. As A&M was crunching the numbers on the estate, Marshal said, they couldn’t see “how the assets equaled the liabilities,” and “questions were coming up” about “whether the transaction was really a wash.”
So in January 2009 A&M formed a team to look into the transaction. They had just started work when they, and the rest of Wall Street, were hit with a bombshell. Tucked into Barclays’s SEC filing for the fourth quarter of 2008 was the following sentence regarding the purchase of the Lehman assets:
The excess of the fair value of net assets acquired over consideration paid [to Lehman] resulted in £2,262 m of gain on acquisition.
Two billion, two hundred sixty-two million pounds was about $4.2 billion at that time. Barclays was announcing to the world that it made more than $4 billion “on acquisition” of Lehman.
Remember, just a few months before, the bank had represented to the world, and to the court, that it was buying a matched set of assets and liabilities—a wash. In the week of the sale, nobody on the Barclays side said anything to anybody about making $4.2 billion on the deal. Now, a few months later, Barclays was quietly announcing it had made this massive, year-saving windfall on the Lehman deal.
“We were like, ‘What the fuck?’ ” says one lawyer involved with the case.
“The [earnings statement], that was like that Robert Conrad ad where he’s daring you to knock the battery off his shoulder,” laughs another creditor attorney. “I mean, they come out five months after the sale, and they’re like, ‘Oh, by the way, we made four billion dollars on the deal.’ And we’re like ‘Oh yeah? How?’ It was the red flag of red flags.”
Furious, the creditor attorneys pounded down the door of the Barclays-Lehman attorneys, demanding answers. How did you make $4 billion on the deal? Where had the gain come from? But they got bubkes. The Barclays attorneys refused to give them any information about the sale. Bryan Marsal, the partner at A&M, personally reached out to Barclays general counsel Jonathan Hughes and suggested some kind of mistake had been made. He got no answer, at least not a satisfactory one.
Even Lehman’s own lawyers were telling them not to bother. When a lawyer for Milbank, Tweed reached out to Lori Fife of Weil, Gotshal—this is the same Fife who helped write the clarification letter, the same lawyer who told Judge Peck about that letter—Fife, like one of those Bay City cops who’s always telling Philip Marlowe to get off a case, told the Milbank people to just lay off, why dont-cha?
“I really am at a loss to figure out why you and the other committee professionals are spending so much time on the Barclays sale,” she wrote in an email. “What could you or anyone for that matter do even if it turned out that the assets turned out to be greater? As you know, the sale has been consummated which effectively moots out any relief you might be seeking.”
In other words, why do you care if the sale was dirty? What’s done is done. Let’s not be crying over spilled legal milk, shall we?
This is Lehman’s own lawyer telling creditors they shouldn’t care if Lehman got ripped off.
Shortly after that, unsurprisingly, the creditors decided they needed different lawyers. Weil, Gotshal, they realized, was hopelessly conflicted because of its role in the sale. So Weil, Gotshal, Fife, et al. were replaced by a firm called Jones Day.
The new firm soon filed a motion to the court requesting discovery under Rule 2004 of bankruptcy law. In short, the Jones Day lawyers wanted the right to investigate the sale—to issue subpoenas and depose the men and women who had put together the deal behind closed doors.
The Jones Day motion was filed on May 18. Judge Peck, somewhat surprisingly, approved the motion on June 25.
Now, the only remedy available to the creditor lawyers was something called a Rule 60 motion, a catchall phrase that describes a legal reopening of a court-approved transaction. The Jones Day lawyers planned to file a Rule 60 motion and ask the judge to exhume the Barclays-Lehman deal, perform an autopsy on the transaction, and perhaps grant some financial relief to Lehman’s creditors.
The only problem was, a Rule 60 motion has to be filed within one calendar year of the transaction. So the Jones Day lawyers and their partners at Quinn Emanuel had roughly two and a half months to go through about 200,000 pages of documents and conduct dozens of depositions, to say nothing of preparing the actual brief.
An all-out hunt for information commenced. Lawyers at the firm worked as corporate lawyers sometimes do, unhealthily and around the clock, sorting through emails and taking depositions. They got little hints here and there that pointed to a secret, separately negotiated deal, but nothing like a smoking gun.
Then one day one of the Jones Day lawyers stumbled upon an email from Martin Kelly, Lehman’s chief financial controller. The email was dated Tuesday, September 16, and had been sent at 5:10 a.m. from Kelly to the CFO, Ian Lowitt, with Paolo Tonucci cc’d. The email read:
Well it took all night and lots of back and forth but the deal is done and ready for the Board. Final price did not change meaningfully—approx a $5b all in economic loss versus our marks and $3.6b of resi assets left behind.
Bob Gaffey, the top lawyer on the case for Jones Day, described the discovery of this email as the turning point in the case. “It was the gong-in-Rocky moment,” he says.
Translated into English, the Kelly email said that Lehman and Barclays had negotiated a discount for Barclays—that Barclays was going to get its package of inventory for $5 billion less than “our marks”—where Lehman had actually valuated the stuff.
The lawyers for the screwed creditors now knew that Barclays had managed to get a secret win
dfall baked into its takeover. Kelly had written that predawn email at the precise moment when men like Lowitt were getting their multimillion-dollar bonus offers; Lowitt said he had just gotten off the phone with Barclays exec Rich Ricci when he received this email from blabbermouth Kelly.
The attorneys kept at it. They were still taking depositions on September 12, 2009, three days before the one-year deadline. Their last deposition before filing was one of the most important, and it involved Michael Klein, the author of the manila folder.
Working right up to the wire, the Jones Day lawyers filed their motion on September 15. This original document outlined the parameters for almost the entire con for the judge, an investigative feat in itself. Many important details would surface in the trial that followed in the next year, but for the most part, it was all there in the original eighty-seven-page motion.
Among other things, the motion explained to the judge that virtually all the key negotiators on the Lehman side had accepted insanely lucrative employment offers as they were “negotiating” with Barclays.
The motion also laid out a variety of facts not disclosed to the court in the original sale, and it presented five possible legal reasons why Judge Peck might consider reopening the sale and granting relief to creditors in places like Long Beach and Vancouver and Milton, Australia.
Barclays, acting with appropriate alarm, brought in America’s most preeminent corporate lawyer to defend itself in that proceeding, David Boies of Boies, Schiller. You probably remember Boies as the guy who represented Al Gore in Bush v. Gore.
Some of the lawyers on the other side were jazzed by the idea that they were up against such storied legal talent. “It was the highlight of my career,” said one lawyer, “going up against David Boies.”
Most of the rest of the world, however, had no idea that in a mostly empty courtroom in Lower Manhattan, a great legal battle was about to be played out, pitting the world’s biggest name in courtroom litigation—Boies—against the aggrieved Lehman creditors, including firemen in Long Beach, wine workers in Napa, and orphans in Australia.
Beginning in April 2010 and continuing through the summer, the courtroom was treated to a parade of remarkably candid witnesses, who explained seemingly without much shame or fear of reprisal just what exactly had gone on behind closed doors during the week of the sale. The testimony of these deal makers from both Lehman and Barclays gradually brought into relief the contours of an audacious asset grab.
The secret deal, it turned out, actually had two key phases. The first was that Barclays always intended to secure a massive first-day gain on the deal. That was the $5 billion “loss” that Kelly referred to in that infamous 5:10 a.m. email, and that part of it was essentially wrapped up early that Tuesday morning, on September 16.
At trial and in depositions, one Barclays executive after another confirmed that the deal was intended to be heavily tilted in Barclays’s favor from the start. There needed to be a “delta between asset valuation and liability valuation,” said John Varley, the second-in-command at Barclays, adding that it was a “condition precedent” for the deal. Jonathan Hughes, Barclays’s general counsel, said that a huge first-day gain was “a pre-condition for Barclays” and “of huge importance.”
And the top man himself, CEO Bob Diamond, would explain it this way, using language that makes Alan Greenspan seem like Robert Frost or Richard Pryor:
So when I say capital accretive, accretive to the capital ratios, which means that the asset liability mismatch had to have a mismatch in favor of a positive capital accretion or we weren’t authorized to do a deal.
When I asked one of the lawyers in the case what “capital accretive” meant, he laughed. “The man has a way with words,” he said.
Saying that Barclays had to have “a mismatch in favor of a positive capital accretion” was just another way of saying that it had to make money on the deal.
How much money? A nice round number, to start with—$5 billion. This was confirmed not only by the Kelly email but by testimony from a number of sources, like Tonucci for instance:
Q: You understood the $5 billion all in economic loss versus our marks to be a reference to a discount off the marks, correct?
TONUCCI: Yes.
So right from the start, from the wee hours of Tuesday morning before the deal was announced to the Lehman board, Barclays had already made $5 billion.
But it wasn’t enough, as the second part of the deal showed.
In this second phase, which mostly took place that Friday, the Barclays executives decided that they weren’t satisfied with a $5 billion discount—they wanted more. So they directed their newly bought-off stooges from the Lehman side to scour the Lehman books looking for more stuff to take. They ended up grabbing so much that it actually freaked out some of the Barclays executives, who worried they were getting too greedy.
Remember, these are people who had already absconded with $5 billion, so you can imagine the kind of excess that would prompt them to worry that they’d crossed a line. After working all Friday to lift everything that wasn’t nailed down on the Lehman balance sheet, Rich Ricci, one of the key Barclays negotiators, told Lehman executive Alex Kirk—he of the mystery $15 million bonus—that “we won’t be pigs, fine, you know, let’s get on with it.”
Kirk then quickly emailed McDade, telling him they could all stop looting the company for now, because Ricci had “told me he won’t blow up this trade by being a pig.”
Before they decided to stop being pigs, however, Ricci, Diamond, Klein, and the rest of the Barclays pirates succeeded in sucking somewhere between $5 billion and $7 billion, perhaps more, out of the estate.
Numerous other twists were buried in the Lehman deal. But the most ingenious revolved around the mechanism used to deliver the original $5 billion discount: the repo.
Here’s why Barclays, at the last minute, restructured its purchase deal around Lehman’s repo loan from the Fed—which it would “take over” on behalf of the Fed. In Lehman’s last-gasp repo deal with the Fed, Lehman posted $50 billion in collateral in exchange for $45 billion in cash. Barclays then took over the loan with an agreement already in place with Lehman that Lehman would later terminate the repo, allowing Barclays to keep the $50 billion in assets in exchange for $45 billion in cash—a $5 billion gain for Barclays.
Transactions of this type, used to move billion-dollar hunks of money around, are couched in language that is essentially foreign to the layperson, as foreign as Swahili or Esperanto are to most Americans. It is a difficult, frustrating, atonal, counterintuitive, and thoroughly unattractive language. This place is a foreign nation all to itself, as unique and proud of its peculiar culture as, say, France. Because of the language problem, the only people competent to prosecute the crimes committed within its borders are other French people.
Only the problem is, to stretch this strained metaphor just a little further, if you spend enough time in France, you start thinking like a French person.
If you follow enough of these Wall Street cases, you start to see this phenomenon all over the place. You go into court the first day, and everyone in the room, right down to the judge and even the plaintiffs’ attorneys, looks like Marcel Marceau. And they talk in blasé tones about acts of perversion that would shock a normal person to the point of screams.
The taking of the $5 billion by way of terminating the repo is a perfect example. The idea seems to have come from senior Lehman finance executive Gerry Reilly, who wrote to Lowitt and Tonucci and others that “defaulting on repo could be the best as discount could be taken from haircut,” he said, meaning that Barclays could get paid by wolfing down the excess collateral (the “haircut”—the difference between the $45 billion loan and the $50 billion in collateral).
Kelly later said that “I understand that that was the mechanism, defaulting on the repo was the mechanism.” Tonucci said the same: “The actual transfer of securities and cash was through the repo agreements, and essentially the terminati
on of those repo agreements.”
So by the middle of the week, by Thursday, September 18, Barclays had “stepped into the shoes of the Fed” and taken over the repo. It was ready to make this ingenious move.
But it had one final, extremely difficult obstacle to get over.
On September 19, the same Friday when Lori Fife mentioned the clarification letter, Lehman officially filed for bankruptcy. Under bankruptcy law, any bankruptcy calls for an automatic freezing of all open contracts. This is designed to protect creditors from money owed to them flying out of the dying company.
There is a specific exemption for repos. But, and this is an important but, if a repo is terminated, the creditor can liquidate the collateral to get repaid. But any excess collateral has to go to the estate.
In other words: if Barclays wanted to terminate that repo, it would have the right to liquidate Lehman’s collateral—but it could claim only the $45 billion principal of the loan, not the haircut. The excess $5 billion would have to stay in the now-bankrupt Lehman, which means it would’ve gone to pay other claimants: Long Beach, the wine workers, and the other 75,998 creditors. By law, there was no way that Barclays could terminate the repo and get all $50 billion. It was entitled to only $45 billion. The excess $5 billion should have gone to the Lehman estate.
But it didn’t.
Instead, Barclays and its lawyers huddled and came up with an ingenious gambit.
The first thing they did is they sent Lori Fife, the Weil, Gotshal lawyer, to Judge Peck’s courtroom the Friday afternoon to tell His Honor that the deal was basically done, except they were going to clarify a point or two.
This was the aforementioned “clarification letter” announcement. Her actual words:
we’ve clarified in a clarification letter which we’re hoping to finalize and actually present to Your Honor whenever it comes down here.
