Searching over 5,500,000 cases.


searching
Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.

In Re Bear Stearns Companies

January 19, 2011

IN RE BEAR STEARNS COMPANIES,SECURITIES, DERIVATIVE, AND ERISA LITIGATION INC.


The opinion of the court was delivered by: Sweet, D.J.

OPINION

This Document Relates To:

Securities Action, 08 Civ. 2793

Derivative Action, 07 Civ. 10453

ERISA Action, 08 Civ. 2804

TABLE OF CONTENTS

I. PRIOR PROCEEDINGS 2

II. THE MOTION OF THE BEAR STEARNS DEFENDANTS TO DISMISS THE SECURITIES COMPLAINT IS DENIED 4

A. The Parties 4

B. Summary of the Securities Complaint 6

1. Bear Stearns History 7

2. Bear Stearns Securitization 13

3. Leveraging 17

4. The Hedge Funds 18

5. Valuation and Risk 24

6. False and Misleading Statements 31

a) GAAP Overview 71

b) Fraud Risk Factors 74

c) Audit Risk Alerts 77

d) Internal Controls 80

e) Financial Statements 84

7. Accounting Standards Violations 71

8. Banking Regulations Violations 100

a) Capital Requirements 101

b) Incorrect Marks 104

c) VaR Misrepresentations 104

9. Scienter 105

10. Loss Causation 117

11. Additional Allegations 120

C. The Applicable Standards 121

1. Pleading Scienter 124

2. Pleading Liability under Exchange Act § 20A 129

3. Pleading Control Person Liability under Exchange Act § 20(a) 129

4. Pleading Loss Causation 130

D. The Allegations of Materially False and Misleading Statements by the Bear Stearns Defendants Are Adequate 131

1. Statements Regarding Asset Values 131

2. Statements Regarding Risk Management 133

3. Statements Regarding the BSAM Write-downs 151

4. Statements Regarding Bear Stearns' Liquidity 154

E. The Alleged Misstatements by the Bear Stearns Defendants are Material 155

F. The Securities Complaint Has Adequately Pleaded Scienter Against the Bear Stearns Defendants 159

i

1. Motive and Opportunity 160

2. Conscious Misbehavior or Recklessness 165

G. The Allegations of Loss Causation are Adequate 176

H. The Securities Complaint Has Adequately Pleaded a § 20A Claim 183

I. The Securities Complaint Has Adequately Pleaded Control Person Liability under § 20(a) 186

III. THE MOTION BY DELOITTE TO DISMISS THE SECURITIES COMPLAINT IS DENIED 189

A. The Allegations 190

B. The Applicable Standard 191

C. The Securities Complaint Has Adequately Alleged

Deloitte's Misstatements and Scienter 193

1. Valuation Models and Fair Value Measurements 195

2. The Hedge Funds 206

3. The Collapse of Bear Stearns Is Evidence Of Scienter 207

4. Reckless Disregard Rather Than Hindsight 210

D. The Securities Complaint Has Adequately Alleged Material Misstatements 212

E. The Securities Complaint Has Adequately Alleged Loss Causation 216

IV. THE MOTION TO DISMISS THE DERIVATIVE COMPLAINT IS GRANTED 222

A. The Parties 222

B. Summary of the Derivative Complaint 226

1. Bear Stearns' Acquisition of Encore Credit Corp. 227

2. The Hedge-Fund Collapse 228

3. Individual Defendants' Allegedly False and Misleading Statements Issued During the Relevant Period 229

4. The Improper Buyback and Insider Selling 230

5. Bear Stearns' Subprime Disclosures and Their Aftermath 231

6. The Acquisition of Bear Stearns by JPMorgan 233

7. The Counts 239

C. Derivative Plaintiff Does Not Have Standing 257

1. Derivative Plaintiff Does Not Come within the "Fraud Exception" 259

ii

2. Derivative Plaintiff Fails to Establish a Double Derivative Suit 263

D. The Derivative Claims Fail to Satisfy Rule

23.1(b)(3)'s Demand Requirement 269

1. Derivative Plaintiff Fails to Establish the Futility of a Demand on the JPMorgan Board 274

E. The Class Claim is Dismissed on Res Judicata and Collateral Estoppel Grounds 280

1. Count XIII is Dismissed Under Res Judicata 280

2. Count XIII is Dismissed through Collateral Estoppel 288

F. The Derivative Defendants' Motion to Dismiss the § 10b, § 20A, § 20(a), and Common Law Claims Is Not Reached 290

V. THE MOTION TO DISMISS THE ERISA COMPLAINT IS GRANTED 291

A. The Parties 291

B. The Plan 296

C. Summary of the ERISA Complaint 303

1. The Counts 303

2. Bear Stearns Stock was an Imprudent Investment 313

3. Notice of Excessive Risk 315

4. Concealment of Risk 326

5. Failure to Provide Complete and Accurate Information 329

6. Conflicts of Interest 332

7. Causation 334

D. The Applicable Standard 335

E. The ERISA Complaint Fails to State a Prudence Claim in Count I 335

1. The Plan Agreement Does Not Establish a Duty to Divest the Plan of Bear Stearns Stock 338

2. The ESOP Committee Does Not Have the Fiduciary Duty to Diversify or Divest Plan Investments 341

a) Bear Stearns' Ability to Make Contributions to the Plan in Stock or Cash Does Not Establish a Duty of Prudence 344

b) Bear Stearns is Not Liable as an ERISA Fiduciary Through the Fiduciary Duties of its Employees 347

3. Bear Stearns is Not a Fiduciary of the Plan 343

4. Bear Stearns Had No Discretion and Duty to Divest the ESOP of Bear Stearns Stock 350

5. The ERISA Complaint Fails to Overcome the Moench Presumption 351

6. Defendants Had No Duty to Disclose and No Liability for Misleading Statements 363

iii

a) Defendants Had No Duty to Disclose Bear Stearns' Financial Condition 364

b) Defendants Were Not Acting as Plan Fiduciaries When They Allegedly Made Affirmative Misrepresentations 369

F. The ERISA Complaint Fails to State a Claim for Conflicts of Interest in Count II 372

G. There Is No Liability for Defendants' Duty to Monitor and No Co-Fiduciary Liability 378

VI. LEAD PLAINTIFF'S MOTIONS TO MODIFY THE STAY AND STRIKE EXTRANEOUS DOCUMENTS ARE DENIED 380

A. Lead Plaintiff's Motion to Modify the Stay of Discovery is Denied as Moot 380

B. Lead Plaintiff's Motion to Strike Extraneous Documents is Denied 381

VII. CONCLUSION 389

iv

By Order dated August 18, 2008, the MDL Panel assigned a number of actions filed in United States District Courts for the Southern and Eastern Districts of New York to this Court. An Order dated January 6, 2009 consolidated the actions, appointed lead counsel, and scheduled the filing of consolidated complaints in the actions captioned In Re Bear Stearns Companies, Inc. Securities, Derivative and ERISA Litigation.

These actions arose out of the March 2008 collapse of Bear Stearns, a well-regarded investment bank founded in 1923. This was an early and major event in the turmoil that has affected the financial markets and the national and world economies.

Motions to dismiss pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6) have been made by the Defendants with respect to each of the three consolidated complaints. The motions to dismiss the Securities Complaint are denied, and the motions to dismiss the Derivative Complaint and the ERISA Complaint are granted. The Lead Securities Plaintiff's motions to modify the PSLRA stay and to strike certain documents are denied.

I.PRIOR PROCEEDINGS

The Consolidated Class Action Complaint for Violations of the Federal Securities Laws (hereinafter "Securities Complaint" or "Sec. Compl.") and the Verified Amended Third Derivative and Class Action Complaint (hereinafter "Derivative Complaint" or "Deriv. Compl.") were both filed on February 27, 2009. The Corrected Amended Consolidated Complaint for Violations of the Employee Retirement Income Security Act (hereinafter "ERISA Complaint" or "ERISA Compl.") was filed on July 21, 2009.

Defendants The Bear Stearns Companies Inc. ("Bear Stearns" or the "Company"), James E. Cayne, Alan D. Schwartz, Warren J. Spector, Alan C. Greenberg, Samuel L. Molinaro, Jr., Michael Alix, Jeffrey M. Farber (collectively, the "Bear Stearns Defendants"), and Deloitte & Touche LLP ("Deloitte") have moved to dismiss the Securities Complaint pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6).

Defendants Henry S. Bienen, James E. Cayne, Carl D. Glickman, Michael Goldstein, Alan C. Greenberg, Donald J. Harrington, Frank T. Nickell, Paul A. Novelly, Frederic V. Salerno, Alan D. Schwartz, Vincent Tese, Wesley S. Williams, Jr., Jeffrey M. Farber, Jeffrey Mayer, Michael Minikes, Samuel L. Molinaro, and Warren J. Spector, and Nominal Defendants Bear Stearns and JPMorgan Chase & Co. ("JPMorgan") have moved to dismiss the Derivative Complaint pursuant to Federal Rules of Civil Procedure 9(b), 12(b)(6), and 23.1.

Defendants Bear Stearns, Henry S. Bienen, James E. Cayne, Carl D. Glickman, Michael Goldstein, Alan C. Greenberg, Donald J. Harrington, Frank T. Nickell, Paul A. Novelly, Frederic V. Salerno, Alan D. Schwartz, Vincent Tese, Wesley S. Williams, Jr., Jeffrey Mayer, Samuel L. Molinaro, Warren J. Spector, Kathleen Cavallo, Stephen Lacoff, and Robert Steinberg have moved to dismiss the ERISA Complaint pursuant to Federal Rule of Civil Procedure 12(b)(6).

The State of Michigan Retirement System, Lead Plaintiff in the Securities Action, has moved to modify the automatic stay of discovery imposed by the PSLRA, 15 U.S.C. § 78u-4(b)(3)(B) and to strike certain documents submitted by the Bear Stearns and Deloitte Defendants.

The motion to strike was marked fully submitted on July 14, 2009. The motions to dismiss the Securities and Derivative Complaints and the motion to modify the automatic stay were marked fully submitted on July 30, 2009. The motion to dismiss the ERISA Complaint was marked fully submitted on April 28, 2010.

II.THE MOTION OF THE BEAR STEARNS DEFENDANTS TO DISMISS THE SECURITIES COMPLAINT IS DENIED

What follows is a description of the parties, a summary of the allegations of the Securities Complaint, the standards applicable to the motion, and the conclusions reached with respect to the adequacy of the allegations of false and misleading statements, materiality, scienter and loss causation.

A. The Parties

The Lead Plaintiff, State of Michigan Retirement Systems ("Securities Lead Plaintiff") serves four systems: the Public School Employees Retirement System; the State Employees' Retirement System; the State Police Retirement System; and the Judges Retirement System. With combined assets of nearly $64 billion, the Securities Lead Plaintiff is the fourteenth largest public pension system in the United States, the twentieth- largest pension system in the United States, and the thirty-ninth largest pension system in the world. (Sec. Compl. ¶ 19.)

The Securities Lead Plaintiff purchased Bear Stearns common stock on the open market during the class period from December 14, 2006 to March 14, 2008 (the "Class Period") and has alleged damages as a result of conduct alleged in the Securities Complaint. (Sec. Compl. ¶ 20.)

Bear Stearns was a leading publicly traded financial services institution. (Sec. Compl. ¶ 21.) Prior to its acquisition by JPMorgan on May 30, 2008, its principal business lines included institutional equities, fixed income, investment banking, global clearing services, asset management, and private client services. (Sec. Compl. ¶ 22.)

The individual Defendants were directors and/or officers of Bear Stearns before the JPMorgan merger. They are James E. Cayne, Bear Stearns' former Chief Executive Officer (CEO) and Chairman of the Board ("Cayne"); Alan D. Schwartz, former President and co-COO, and, beginning January 2008, CEO ("Schwartz"); Warren J. Spector, former co-President and co-Chief Operating Officer (COO) until August 2007 ("Spector"); Alan C. Greenberg, former Chairman of the Executive Committee ("Greenberg"); Samuel L. Molinaro, Jr., former Chief Financial Officer (CFO), and, beginning August 27, 2007, COO ("Molinaro"); Michael Alix, former Global Head of Credit Risk Management ("Alix"); and Jeffrey M. Farber, former Controller and Principal Accountant ("Farber") (collectively, the "Individual Defendants"). (Sec. Compl. ¶¶ 23-29.)

Deloitte was the independent outside auditor for Bear Stearns and provided audit, audit-related, tax and other services to Bear Stearns during the Class Period, including the issuance of unqualified opinions on the Company's financial statements for fiscal years 2006 and 2007. Deloitte also allegedly certified the Company's 10-Q Forms for the first through third quarters of 2007. (Sec. Compl. ¶ 32).

B. Summary of the Securities Complaint

The Securities Complaint consists of 834 numbered paragraphs in 218 pages, plus two exhibits. It contains three counts supported by allegations set forth in the following twelve sections:

1. Nature and Summary of the Action (Sec. Compl. ¶¶ 1-14)

2. Jurisdiction and Venue (Sec. Compl. ¶¶ 15-18)

3. Parties (Sec. Compl. ¶¶ 19-32)

4. Factual Background and Substantive Allegations (Sec. Compl. ¶¶ 33-452)

5. Defendants' Scienter (Sec. Compl. ¶¶ 453-506)

6. Additional Allegations Supporting the Officer Defendants' Scienter (Sec. Compl. ¶¶ 507-522)

7. Deloitte's Deficient Audits of Bear Stearns' Financial Statements (Sec. Compl. ¶¶ 523-588)

8. Defendants' Materially False and Misleading Statements (Sec. Compl. ¶¶ 589-794)

9. Loss Causation (Sec. Compl. ¶¶ 795-802)

10. Class Action Allegations (Sec. Compl. ¶¶ 803-808)

11. Presumption of Reliance (Sec. Compl. ¶¶ 809-811)

12. Inapplicability of Statutory Safe Harbor (Sec. Compl. ¶ 812).

The Securities Complaint contains the following three claims for relief: violation of Section 10(b) of the Exchange Act and Rule 10(b)5 against all the Defendants (Count I) (Sec. Compl. ¶¶ 813-822); violation of Section 20(a) of the Exchange Act against certain officer Defendants (Count II) (Sec. Compl. ¶¶ 823-827); and violations of Section 20(a) of the Exchange Act against Defendants Cayne, Schwartz, Spector, Molinaro, Greenberg, and Farber (the "Section 20(a) Defendants") (Count III) (Sec. Compl. ¶¶ 828-834).

1.Bear Stearns History

Bear Stearns was the fifth largest investment bank in the world and until December 2007 had never posted a loss and was known to be conservative in its approach to risk. (Sec. Compl. ¶ 33.)

As a registered broker-dealer, Bear Stearns was subject to the "Broker-Dealer Risk Assessment Program" created in 1990, under which the Division of Trading and Markets ("TM") of the Securities & Exchange Commission ("SEC") monitored the financial markets. During the Class Period, TM reviewed in detail the filings of the seven most prominent firms, including Bear Stearns, which participated in the SEC's Consolidated Supervised Entity ("CSE") program. (Sec. Compl. ¶¶ 34-35.)

Bear Stearns experienced rapid growth through the 1990s and became larger and more profitable with its business model of trading, mortgage underwriting, prime brokerage and private client services. By mid-2000, the Company increased its debt securitization, pooling and repackaging of cash flow-producing financial assets into securities that are sold to investors termed asset-backed securities ("ABS"). Bear Stearns purchased and originated mortgages to securitize and sell, and maintained billions of dollars of these assets on its own books, using them as collateral and to finance daily operations. (Sec. Compl. ¶¶ 36, 38.)

In 2005 and again in 2006, the SEC advised the Company of deficiencies in models it used to value mortgage-backed securities ("MBS") due to its failure to assess the risk of default or incorporate data about such risk, and further advised that its value at risk ("VaR") models did not account for key factors such as changes in housing prices. (Sec. Compl. ¶¶ 4, 92, 100-105, 107.)

When two hedge funds overseen by Bear Stearns collapsed in the spring of 2007, the Company's exposure to the growing housing crisis increased as it absorbed nearly two billion dollars of the hedge funds' subprime-backed assets, which were worthless within weeks. (Sec. Compl. ¶¶ 7, 205-206, 212.)

By the late fall of 2007, the Company began to write down billions of dollars of its devalued assets. The Company's lenders became unwilling to lend it the vast sums necessary for its daily operations. (Sec. Compl. ¶¶ 8, 218.) In its public statements in December 2007 and January 2008, the Company offered the public misleading accounts of its earnings and asset values. (Sec. Compl. ¶¶ 8-9.) Major shareholders began questioning Cayne's leadership and, on January 8, 2008, the Company announced that Cayne would step down as CEO. (Sec. Compl. ¶ 255.)

On March 10, 2008, rumors began to circulate on Wall Street that Bear Stearns was facing a liquidity problem, which was denied by the Company and, on March 12, 2008, by Schwartz. (Sec. Compl. ¶ 272.) The Company's liquidity fell to $2 billion on March 13, 2008 and Schwartz and JPMorgan CEO Jamie Dimon ("Dimon") began negotiations for Bear Stearns to be given access to the Federal Reserve's "window," a credit facility available to the nation's commercial banks, but not to investment banks. JPMorgan and Bear Stearns contemplated that the Company could get the facility through JPMorgan as part of a transaction in which JPMorgan bought Bear Stearns. (Sec. Compl. ¶¶ 280-284.)

On March 14, 2008, it was announced that JPMorgan would provide short-term funding to Bear Stearns while the Company worked on alternative forms of financing. Bear Stearns' stock fell on the news from $57 per share to $30 per share, a 47% one-day drop. (Sec. Compl. ¶ 11.)

On March 16, 2008, Dimon stated that Bear Stearns faced $40 billion in credit exposure, including mortgage liabilities, and made an offer to purchase the Company at a $2 per share, a price that Dimon claimed was necessary to protect JPMorgan. (Sec. Compl. ¶ 12.)

On March 17, 2008, news of Bear Stearns' exposure led the stock to close at $4.81 per share, an 85% drop from its previous close. (Sec. Compl. ¶¶ 14, 294.)

JPMorgan renegotiated the price after it discovered that a mistake in the language of its guaranty agreement with Bear Stearns obligated JPMorgan to guarantee Bear Stearns' trades even if the Company's shareholders voted down the acquisition deal. (Sec. Compl. ¶¶ 295-296.) Shareholders approved the sale to JPMorgan on May 29, 2008. Under the terms of the merger, shareholders received $10 of JPMorgan shares for every Bear Stearns share they held as of the date of the merger. (Sec. Compl. ¶ 299.)

In June 2008 the Department of Justice, through the U.S. Attorney for the Eastern District of New York, indicted Ralph Cioffi ("Cioffi"), the originator of the hedge funds, charging that he had misled investors regarding the value of MBS and collateralized debt obligations ("CDOs") containing MBS owned by the hedge funds, and had caused $1.8 billion in losses to investors. On the same day, the SEC filed a civil complaint against Cioffi. (Sec. Compl. ¶¶ 300-301.)

By July 3, 2008 the assets of Maiden Lane LLC, a holding company created to hold Bear Stearns ABS following the JPMorgan merger, had decreased in value from $30 billion to $28.9 billion. By October 22, 2008, the value of the assets had dropped another $2.1 billion, to $26.8 billion, 10.6% less than the value provided by Bear Stearns. (Sec. Compl. ¶ 302.)

After Bear Stearns' March 2008 collapse, the SEC's Office of the Inspector General ("OIG") was asked to analyze the SEC's oversight of the CSE firms, with a special emphasis on Bear Stearns. (Sec. Compl. ¶ 74.)

The OIG issued its conclusions in a September 25, 2008 Report, titled "SEC's Oversight of Bear Stearns and Related Entities: The Consolidated Supervised Entity Program" (the "OIG Report"), which stated that "[b]y November of 2005 the Company's ARM business was operating in excess of allocated limits, reaching new highs with respect to the net market value of its positions" and that the large concentration of business in this area left the Company exposed to declines in the riskiest part of the housing market. (Sec. Compl. ¶¶ 74-76.) Certain conclusions of the OIG Report are cited throughout the Securities Complaint, constituting allegations of the Bear Stearns history and practices, including details about Bear Stearns' VaR, mortgage valuation models, and its treatment of asset values.

2.Bear Stearns Securitization

Mortgages packaged together for securitization are referred to as mortgage-backed securities ("MBS"), and when the mortgages are residential, those securities are referred to as residential mortgage-backed securities ("RMBS"). RMBS are, in turn, divided into layers based on the credit ratings of the underlying assets. (Sec. Compl. ¶¶ 39-41.)

The "B-Pieces" of an RMBS, its riskier parts, were pooled together to form a collateralized debt obligation ("CDO") divided by the issuer into different tranches, or layers, based on gradations in credit quality. While the top tranche of a CDO may be rated "AAA," CDOs formed from RMBS are rated BBB or lower. Lower-rated tranches of CDOs, such as the "mezzanine" tranches, bear even greater risk of loss. The "equity" tranche bears the first risk of loss. (Sec. Compl. ¶¶ 42-44.)

Mezzanine CDOs made up more than 75% of the total CDO market by April 2007 and contained cash flows from especially risky types of residential mortgage loans, termed "subprime" or "Alt-A" made to borrowers with a heightened risk of default, such as those who have a history of loan delinquency or default. Alt-A loans were made to borrowers with problems including lack of documentation of income and assets, high debt-to-income ratios, and troubled credit histories. Subprime and Alt-A mortgages are termed "nonprime" mortgages. Between 2003 and 2007, the total proportion of nonprime loans wrapped into the majority of all mezzanine CDOs increased dramatically market-wide. (Sec. Compl. ¶¶ 45-48.)

Bear Stearns originated and purchased home loans, packaged them into RMBS, collected these RMBS to form CDOs, sold CDOs to investors and thereby acquired a large exposure to declines in the housing and credit markets. (Sec. Compl. ¶ 49.)

It originated loans through two wholly-owned subsidiaries, the Bear Stearns Residential Mortgage Corporation ("BEARRES") and later through Encore Credit Corporation ("ECC"), which the Company purchased in early 2007. ECC specialized in providing loans to borrowers with compromised credit. BEARRES made Alt-A loans to borrowers with somewhat better, but still compromised credit. The Company actively encouraged its loan originator subsidiaries to offer loans even to borrowers with poor credit scores and troubled credit histories and to originate riskier loans that "cut corners" with respect to credit scores or loan to value ("LTV") ratios. While the national rejection rate of applications was 29% in 2006, the BEARRES rejection rate was 13%. (Sec. Compl. ¶¶ 50-55.)

In 2006, BEARRES and ECC originated 19,715 mortgages, worth $4.37 billion, which were securitized by Bear Stearns. Bear Stearns also purchased loans originated by other companies through its EMC Mortgage Corporation ("EMC") subsidiary, which from 1990 until 2007 purchased more than $200 billion in mortgages. (Sec. Compl. ¶¶ 55-57.) In late 2006 and early 2007, because of the potential for profits from securitizing these loans, Bear Stearns managers failed to enforce basic underwriting standards and ignored due diligence findings that borrowers would be unable to pay. (Sec. Compl. ¶¶ 58-60.)

Bear Stearns also funded and purchased closed-end second-lien ("CES") loans and home-equity lines of credit ("HELOCs") made to borrowers with poor credit secured by secondary liens on the home, which were to be paid after the first mortgage was satisfied and were at risk of not being paid in full if the value of the home dropped. By the end of 2006, EMC had purchased $1.2 billion of HELOC and $6.7 billion of CES loans. (Sec. Compl. ¶ 61.)

Through EMC, Bear Stearns also purchased mortgages already in default, so-called "scratch and dent" loans, to securitize and sell to investors. Because of its underwriting standards, the loans that the Company purchased to package into RMBS and CDOs were especially vulnerable to declines in housing prices. (Sec. Compl. ¶¶ 61-63.)

Individual nonprime home loans were wrapped into an RMBS, sold to investors, and packaged into CDOs. Especially risky tranches of RMBS were kept on the Company's books as retained interests ("RI"). The amount of RI grew throughout the Class Period, from $5.6 billion on November 30, 2006 to $9.6 billion on August 31, 2007. (Sec. Compl. ¶¶ 64-65.)

Nearly all CDOs Bear Stearns structured during the Class Period were backed by a combination of RMBS and derivatives, or "synthetic securities." These synthetic securities were effectively insurance contracts in which the party buying the insurance paid a premium equivalent to the cash flow of an underlying RMBS that it was copying, and the counterparty insured against a decline or default in the underlying RMBS. Such CDOs were called "Synthetic CDOs," and a CDO backed by other CDO notes was called a "CDO squared." (Sec. Compl. ¶¶ 66-67.)

To sell the largest possible CDOs, the Company retained on its books increasing amounts of the CDOs it packaged. By August 2007, this figure had reached $2.072 billion. (Sec. Compl. ¶¶ 68-69.)

During the Class Period, the Company's growing accumulation of subprime-backed RMBS and CDOs, combined with its leveraging practices, left it extraordinarily vulnerable to declines in the housing market. (Sec. Compl. ¶ 70.) Before the Class Period began, on multiple occasions the amount of mortgage securities held by the Company exceeded its internal concentration limits. (Sec. Compl. ¶ 71.)

3.Leveraging

In leveraging, a company takes out a loan secured by assets in order to invest in assets with a greater rate of return than the cost of interest for the loan. The potential for loss is greater if the investment becomes worthless, because of the loan principal and all accrued interest. A 4-to-1 leverage ratio increases loss potential by about 15%, while a 35-to-1 leverage ratio increases loss potential by more than 100%. (Sec. Compl. ¶¶ 77-78.)

In 2005, Bear Stearns was leveraged at a ratio of approximately 26.5-to-1. By November 2007, the Company had leveraged its net equity position of $11.8 billion to purchase $395 billion in assets, a ratio of nearly 33-to-1. Because of the interest charges required to support this leverage ratio, the amount of cash the Company needed to finance its daily operations increased dramatically during the Class Period. By the close of the Class Period, Bear Stearns' daily borrowing needs exceeded $50 billion. (Sec. Compl. ¶¶ 79-80.)

4.The Hedge Funds

In October 2003, Cioffi started the High Grade Structured Credit Strategies Fund, LP (the "High Grade Fund") as part of Bear Stearns Asset Management ("BSAM"), which was under the supervision of Spector. The High Grade Fund consisted of a Delaware partnership to raise money from investors in the United States and a Cayman Island corporation to raise money from foreign investors. (Sec. Compl. ¶ 82.)

In August 2006, Cioffi created the High Grade Structured Credit Strategies Enhanced Leverage Fund, LP ("the High Grade Enhanced Fund") (the High Grade Fund and the High Grade Enhanced Fund are collectively referred to as the "Hedge Funds"), which was structured similarly to the High Grade Fund, but with greater leverage to increase potential returns. (Sec. Compl. ¶ 83.)

Bear Stearns Securities Corporation, a wholly-owned subsidiary of the Company, served as the prime broker for the Hedge Funds, and PFPC Inc., another Bear Stearns subsidiary, was the Hedge Funds' administrator. BSAM was the investment manager for the Hedge Funds. Spector was responsible for the business of both funds. (Sec. Compl. ¶¶ 84-85.)

Because of BSAM's role as an asset manager, Bear Stearns was one of the few repurchase lenders willing to take the Hedge Funds' CDOs as collateral for short term lending facilities. The Hedge Funds, through BSAM, entered into repurchase agreements on favorable terms with Bear Stearns as the counterparty. By offering cash to the Hedge Funds in exchange for subprime mortgage-backed CDOs of questionable value, Bear Stearns increased it exposure to declines in the subprime market. (Sec. Compl. ¶¶ 89-91.)

BSAM misrepresented the Hedge Funds' subprime exposure to hedge fund investors in "Preliminary Performance Profiles" ("PPPs") by disclosing only the Hedge Funds' direct subprime RMBS holdings. The Hedge Funds also held large amounts of subprime RMBS indirectly through purchased CDOs. Returns in the subprime CDOs, and CDOs backed by CDO-squares, diminished, resulting in diminishing yield spreads, and accelerating losses for the Hedge Funds. The High Grade Enhanced Fund experienced its first negative return in February 2007. Declines in the High Grade Fund soon followed, resulting in its first negative return in March 2007. (Sec. Compl. ¶¶ 193-196.)

The Hedge Funds began to experience difficulties with margin calls and failed to disclose Bear Stearns' exposure to the declining value of the subprime-backed Hedge Fund assets it held as collateral on its own books. (Sec. Compl. ¶¶ 198-199.) They continued to deteriorate throughout the spring of 2007. On April 19, 2007, Matthew M. Tannin, COO of the Hedge Funds ("Tannin"), reviewed a credit model that showed increasing losses on subprime linked assets. On May 13, 2007, Tannin stated that the High Grade Enhanced Fund had to be liquidated. (Sec. Compl. ¶¶ 200-201.)

To avoid a forced "fire sale" of the thinly-traded CDOs held by the Hedge Funds, which would have required acknowledging huge declines in the value of the subprime-backed assets Bear Stearns held as collateral and would have revealed the Company's gross overvaluation of its thinly-traded assets, Spector decided to extend a line of credit to the High Grade Fund to allow it to liquidate in an orderly way by gradually selling assets into the market. This was done to avoid having other assets seized by repurchase agreement counterparties, who would mark the assets to their true value. Spector permitted the High Grade Enhanced Fund to fail, because its high leverage ratios left it virtually unsalvageable. (Sec. Compl. ¶¶ 202-204.)

On June 22, 2007, Bear Stearns announced that it was entering into a $3.2 billion securitized financing agreement with the High Grade Fund in the form of a collateralized repurchase agreement. In exchange for lending the funds, Bear Stearns received as collateral CDOs backed by subprime mortgages allegedly worth between $1.7 and $2 billion. Pursuant to the agreement, Bear Stearns gave up the right to collect all of the upside in the event that the collateral saw an increase in value. Molinaro stated that the Hedge Funds' problems with their subprime-backed assets did not extend to the securities that Bear Stearns itself held, but failed to disclose that even prior to the $3.2 billion securitized financing agreement, Bear Stearns held large amounts of the Hedge Funds' toxic debt as collateral. During a June 22, 2007 conference call, Molinaro made false statements with respect to asset value and stated that the value levels attributed to the collateral it had received from the Hedge Funds "are a reflection of the market value levels that we're seeing from our street counterparties." In fact, the market for such securities had become highly illiquid, providing no basis for Molinaro's statements. (Sec. Compl. ¶¶ 205-209.)

On June 26, 2007, Cayne denied any material change in the risk profile. However, because of worthless subprime-backed collateral, the risk exposure had grown substantially. (Sec. Compl. ¶¶ 210-211.)

By the end of June 2007, asset sales had reduced the loan balance to $1.345 billion, but the estimated value of the collateral securing the loan had deteriorated by nearly $350 million, approximately the value of the loan Bear Stearns had given the High Grade Fund. Any further declines in the value of the assets that Bear Stearns held as collateral would be borne directly by Bear Stearns. Instead of immediately reflecting its assumption of the declining collateral in its books, the Company delayed for months, according to the OIG Report, "to delay taking a huge hit to capital." (Sec. Compl. ¶¶ 212-213.)

On July 18, 2007, Bear Stearns informed investors in the Hedge Funds that they would get little money back after "unprecedented declines" in the value of AAA-rated securities used to invest in subprime mortgages. The more than $1.3 billion in collateral drawn from the Hedge Funds' subprime-backed assets, which the Company had effectively taken onto its books by assuming the assets as collateral just a month earlier, was nearly worthless as well. Bear Stearns did not make the actual book entries until the fall of 2007, months after the losses were actually incurred by the Company. The Company ultimately only wrote off a fraction of the worthless collateral it held and had originally valued at $1.3 billion. (Sec. Compl. ¶¶ 214-216.)

5.Valuation and Risk

The valuation of assets is governed by Statement of Financial Accounting Standards No. 157, Fair Value Measurements ("SFAS 157"). Although SFAS 157 took effect on November 15, 2007, Bear Stearns opted to comply with the standard beginning January 2007. SFAS 157 required that Bear Stearns classify its reported assets into one of three levels depending on the degree of certainty about the assets' underlying value. Assets traded in an active market were classified as Level 1 ("mark-to-market"). Level 2 ("mark-to-model") assets consisted of financial assets whose values are based on quoted prices in inactive markets, or whose values are based on models, inputs to which are observable either directly or indirectly for substantially the full term of the asset or liability. Level 3 assets, thinly traded or not traded at all, have values based on valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. To value Level 3 assets, companies rely on models developed by management. The information supplied by valuation models is incorporated into other models used to assess risk and hedge investments, such as the models measuring VaR. (Sec. Compl. ¶¶ 94-99.)

Before the Class Period began, the Company knew that declining housing prices and rising default rates were not reflected in the mortgage valuation models that were critical to the valuation of its Level 3 assets. According to the OIG Report, prior to the Company's approval as a CSE in November of 2005, "Bear Stearns used outdated models that were more than ten years old to value mortgage derivatives and had limited documentation on how the models worked." As a result, during the 2005 CSE application process, TM told Bear Stearns that "[w]e believe that it would be highly desirable for independent Model Review to carry out detailed reviews of models in the mortgage area." (Sec. Compl. ¶¶ 100-102.)

According to the OIG Report, in November 2005, the SEC Office of Compliance Inspections and Examinations ("OCIE") found that "Bear Stearns did not periodically evaluate its VaR models, nor did it timely update inputs to its VaR models." (Sec. Compl. ¶ 123.)

Bear Stearns was warned of these deficiencies in a December 2, 2005 memorandum from OCIE to Farber, the Company's Controller and Principal Accountant. According to the OIG Report, "Bear Stearns' VaR models did not capture risks associated with credit spread widening." (Sec. Compl. ¶¶ 124-125.)

In September 2006, TM concluded after a meeting with Bear Stearns risk managers that the Company still had failed to improve the accuracy of the models it used to hedge against risk. As the housing crisis spread during the Class Period, the Company knew that fundamental indicators of housing market decline, including falling housing prices and rising delinquency rates, were not reflected in the VaR figures it disclosed to the public. (Sec. Compl. ¶¶ 126-128.)

According to the OIG Report, in 2006, Bear Stearns' trading desks had gained ascendancy over the Company's risk managers, TM found that model review at Bear was less formalized than at other CSE firms and had devolved into a support function and Bear Stearns reported different VaR numbers to OIG regulators than its traders used for their own internal hedging purposes. (Sec. Compl. ¶¶ 129-131.)

Traders were able to override risk manager marks and enter their own, more generous, marks for some assets directly into the models used for valuation and risk management by manipulating inputs into Bear Stearns' WITS system - which was the repository for raw loan data, including such crucial information as a borrower's credit score, prepayments, delinquencies, interest rates and foreclosure history - and did so to alter the value of pools of loans to enhance their profit and loss positions. (Sec. Compl. ¶ 132.) According to TM memoranda, the risk management department was persistently understaffed, and the head of the Company's model review program "had difficulty communicating with senior managers in a productive manner." (Sec. Compl. ¶ 134.)

According to the OIG Report, TM, in the fall of 2006, concluded that Bear Stearns' "model review process lacked coverage of mortgage-backed and other asset-backed securities," that "the sensitivities to various risks implied by the models did not reflect risk sensitivities consistent with price fluctuations in the market," and that TM's discussions with risk managers in 2005 and 2006 indicated that Bear Stearns' pricing models for mortgages "focused heavily on prepayment risks" but that TM documents did not reflect "how the Company dealt with default risks." (Sec. Compl. ¶¶ 103-105.)

Though Cayne and Molinaro were aware of the SEC's concerns about Bear Stearns' risk management program, the Company made no effort to revise its mortgage valuation models to reflect declines in the housing market. The head of the Company's mortgage trading desk was "vehemently opposed" to the updating of the Company's mortgage valuation models. (Sec. Compl. ¶¶ 106-107.)

As the housing market declined throughout 2007 and into 2008, Bear Stearns continued to rely on its flawed valuation models. Level 3 assets, including retained interests in RMBS and the equity tranches of CDOs, made up 6-8% of the Company's total assets at fair market value in 2005, and increased to 20-29% of total assets between the fourth quarter of 2007 and the first quarter of 2008. According to the Company's Form 10-K for the period ending November 30, 2007, the majority of the growth in the Company's Level 3 assets in 2007 came from "mortgages and mortgage-related securities," the assets that the Company was valuing using misleading models. As of August 31, 2007, the Company carried $5.8 billion in Level 3 assets backed by residential mortgages, a figure that grew close to $7.5 billion by November 30, 2007. (Sec. Compl. ¶¶ 110-111.)

Risk is defined as the degree of uncertainty about future net returns, and is commonly classified into four types:

(1) credit risk, relating to the potential loss due to the inability of a counterpart to meet its obligations; (2) operational risk, taking into account the errors that can be made in instructing payments or settling transactions, and including the risk of fraud and regulatory risks; (3) liquidity risk, caused by an unexpected large and stressful negative cash flow over a short period; and (4) market risk, estimating the uncertainty of future values, due to changing market conditions. The most prominent of these risks for investment bankers is market risk, since it reflects the potential economic loss caused by the decrease in the market value of a portfolio. Because of the crucial role that market losses can play in the financial health of investment banks, they are required to set aside capital to cover market risk. (Sec. Compl. ¶¶ 113-114.)

VaR is a method of quantifying market risk, defined as the maximum potential loss in value of a portfolio of financial instruments with a given probability over a certain horizon. If the company's VaR is high, it must increase the amount of capital it sets aside in order to mitigate potential losses or reduce its exposure to high risk positions. (Sec. Compl. ¶¶ 115-117.)

The Basel Committee on Banking Supervision, an international banking group that advises national regulators (the "Basel Committee"),*fn1 determined that investors and regulators needed more accurate ways to gauge the amount of capital that firms needed to hold in order to cover risks. The Basel Committee allowed Bear Stearns and other Wall Street figures to use their internal VaR numbers for this purpose. This use of VaR was incorporated into the requirements for CSE program participants when the CSE program was launched in 2004. Companies participating in the program were required to regularly supply their VaR numbers to federal regulators and to the public. (Sec. Compl. ¶¶ 118-121.)

The resignation of the head of model review at the Company in March 2007 gave trading desks more power over risk managers and by the time a new risk manager arrived in the summer of 2007, the department was in a shambles and risk managers were operating in "crisis mode." (Sec. Compl. ¶¶ 134-135.) By October 2007, the entire model valuation team had evaporated, except for one remaining analyst. (Sec. Compl. ¶ 136.)

According to the OIG Report, it was not until "towards the end of 2007" that Bear Stearns "developed a housing led recession scenario which it could incorporate into risk management and use for hedging purposes." The mortgage-backed asset valuation inputs to the VaR models employed by the Company were never updated during the Class Period and remained a "work in progress" at the time of the Company's March 2008 collapse. (Sec. Compl. ¶¶ 106-109.)

6.False and Misleading Statements

The Securities Complaint describes allegedly materially false and misleading statements with which the Director Defendants are charged. They include statements relating to fiscal year 2006 and fourth quarter 2006 (Sec. Compl. ¶¶ 589), including the December 14, 2006 press release (Sec. Compl. ¶¶ 590-591), the fourth quarter 2006 earnings conference call (Sec. Compl. ¶¶ 592-605), the Form 10-K for fiscal year 2006 (Sec. Compl. ¶¶ 589-629); statements relating to fiscal year 2007 and fourth quarter 2007, including the first quarter press release (Sec. Compl. ¶¶ 630-637), the first quarter conference call (Sec. Compl. ¶¶ 638-645), the first quarter 2007 Form 10-Q (Sec. Compl. ¶¶ 646-661), the second quarter 2007 press release (Sec. Compl. ¶¶ 662-665), the second quarter 2007 conference call (Sec. Compl. ¶¶ 669-671), the June 22, 2007 press release (Sec. Compl. ¶¶ 672-675), the second quarter 2007 Form 10-Q (Sec. Compl. ¶¶ 676-695), the August 3, 2007 press release and conference call (Sec. Compl. ¶¶ 696-703), the third quarter 2007 press release (Sec. Compl. ¶¶ 704-710), the third quarter 2007 conference call (Sec. Compl. ¶¶ 711-715), the third quarter 2007 Form 10-Q (Sec. Compl. ¶¶ 719-735), the November 14, 2007 statements (Sec. Compl. ¶¶ 736-739), the fourth quarter and fiscal year 2007 press release (Sec. Compl. ¶¶ 740-748), the fourth quarter 2007 conference call (Sec. Compl. ¶¶ 749-754), and the fiscal year 2007 Form 10-K (Sec. Compl. ¶¶ 755-781); and the 2008 statements (Sec. Compl. ¶¶ 782-794).

Beginning in early 2006, record numbers of subprime loans began to go bad as borrowers failed to make even their first payment ("First Payment Default" or "FPD"), or failed to make their first three payments ("Early Payment Default" or "EPD"). During 2005, only one in every 10,000 subprime loans experienced an FPD. During the first half of 2006, the FPD rate had risen by a multiple of 31; nationwide, about 31.5 out of every 10,000 subprime loans originated between January and June 2006 had a delinquency on its first monthly payment, according to Loan Performance, a subsidiary of First American Real Estate Solutions. (Sec. Compl. ¶¶ 138-140.)

Bear Stearns was well aware of the growth in EPDs. In April 2006, Bear Stearns' EMC Mortgage, reputed to be a primary EPD enforcer, sued subprime originator Mortgage IT over approximately $70 million in EPD buyback demands. (Sec. Compl. ¶ 141.)

In May 2006, the California Association of Realtors lowered expectations for California home sales from a 2% decline (2006 sales v. 2005 sales) to a 16.8% decline. Between April and June 2006, the Company faced repeated crises in its United Kingdom subsidiary as a result of poor performance of U.K. loans due to weak underwriting standards. As a result, the Company was left holding some $1.5 billion in unsecuritized whole loans and commitments from this subsidiary. Management at Bear Stearns was deeply concerned about the U.K. developments, and Spector made calls to investigate the crisis. However, the Company did not "use this experience to add a meltdown of the subprime market to its risk scenarios." (Sec. Compl. ¶¶ 141-145.)

In May 2006, after recent data demonstrated dramatically slowing sales, the highest inventory of unsold homes in decades, and stagnant home prices, the chief economist for the National Association of Realtors ("NAR"), admitted that "hard landings" in certain markets were probable. The monthly year-over-year data provided by the NAR showed that by August 2006, year-over-year home prices had in fact declined for the first time in 11 years. Sales of existing homes were down 12.6% in August from a year earlier, and the median price of homes sold dropped 1.7% over that period. Sales of new homes were down 17.4% in August 2006. As 2006 progressed, data aggregated in the NAR's monthly statistical reports on home sales activity, home sales prices, and home sales inventory revealed (1) accelerating declines in the numbers of homes sold during 2006, which continued and deepened throughout 2007; (2) steadily decreasing year-over-year price appreciation in early 2006, no year-over-year price appreciation by June 2006, and nationwide year-over-year price declines beginning in August 2006 and continuing thereafter; and (3) steadily rising amounts of unsold home "inventory," expressed in the form of the number of months it would take to sell off that inventory, rising 50% by August 2006 and doubling by late 2007. (Sec. Compl. ¶¶ 145-147.)

By the end of 2006, EPD rates for 2006 subprime mortgages had risen to ten times the mid-2006 FPD rate; 3% of all 2006 subprime mortgages were going bad immediately. The 2006 subprime mortgages from First Franklin Financial, Long Beach Savings, Option One Mortgage Corporation and Countrywide Financial had EPD rates of approximately 2%; those originated by Ameriquest, Lehman Brothers, Morgan Stanley, New Century and WMC Mortgage had EPD rates of 3-4%; and those originated by Fremont General had EPD rates higher than 5%. (Sec. Compl. ¶¶ 145-148.)

On December 14, 2006, Bear Stearns issued a press release regarding its fourth quarter and year end results for the fiscal year 2006, which closed on November 30, 2006.*fn2 The release reported diluted earnings per share of $4.00 for the fourth quarter ended November 30, 2006, up 38% from $2.90 per share for the fourth quarter of 2005. It stated that net income for the fourth quarter of 2006 was $563 million, up 38% from $407 million for the fourth quarter of 2005. It is alleged that the Company achieved these results by using valuation models that ignored declining housing prices and rising default rates. These inaccurate models enabled the Company to avoid taking losses on its Level 3 assets, thereby increasing revenues and earnings per share and allegedly falsely inflating the value of its stock. (Sec. Compl. ¶¶ 150-151.)

At the time of the statements, the Company's Level 3 assets represented 11% of its total assets held at market value, or a total of about $12.1 billion. Because these assets were highly leveraged, even a small decline in value would have been vastly magnified. Accordingly, the values the Company assigned to this large group of assets were significantly higher than they should have been, violating GAAP. (Sec. Compl. ¶¶ 589-596).

Bear Stearns also announced its fiscal year 2006 results In the same press release, Bear Stearns reported that its earnings per share (diluted) for the 2006 fiscal year were a record $14.27, its net income was $2.1 billion and its net revenues were $9.2 billion. These figures were allegedly false and misleading for the same reasons set forth above. (Sec. Compl. ¶ 590).

On December 14, 2006, Bear Stearns held its fourth quarter 2006 earnings conference call, conducted by Molinaro. During the call, Molinaro repeated the financial results set out in the Securities Complaint at ¶ 590 and made statements that are alleged to be materially false and misleading when made, because the Company understood that the unusually risky loans it continued to purchase through its EMC subsidiary were not limited to any particular "vintage." (Sec. Compl. ¶¶ 598, 601).

During a press conference on the same day, Molinaro was asked whether the increased defaults threatened to make the securitization of those mortgages, which were increasingly being originated by Bear Stearns, a risky business. Molinaro responded "Well, I don't -- no, it doesn't. Because essentially we're originating and securitizing." This statement is alleged to be false, as the Company faced significant exposure through the retained CDO tranches it kept on its books and the agreements it maintained with counterparties and CDOs. Based on the Company's artificially inflated results and the allegedly false assurances by Molinaro, the Company's stock rose by $4.07, closing at $159.96. (Sec. Compl. ¶¶ 150-153.)

Molinaro understated Bear Stearns' exposure to increasing defaults in the subprime market because Bear Stearns retained on its books $5.6 billion of the riskiest tranches of subprime-backed RMBS on its books. (Sec. Compl. ¶ 65.) Bear Stearns' underwriting standards were not higher in 2006 than in previous years, and the Company understood that the loans it was continuing to purchase through its EMC subsidiary during the latter part of 2006 and the beginning of 2007 were unusually risky, and in fact EMC was not tightening its underwriting standards. (Sec. Compl. ¶¶ 602-605.)

Nonetheless, Bear Stearns continued to expand its subprime business aggressively. On February 12, 2007, the Company completed its acquisition of ECC, a major originator of subprime loans. (Sec. Compl. ¶¶ 158-159.)

The Asset Backed Securities index ("ABX"), launched in January 2006, and the TABX index, standardized tranches of ABX indices, introduced in February 2007, synthesized subprime mortgage performance, refinancing opportunities, and housing price data into efficient market valuation of CDOs' primary assets - subprime RMBS tranches, via the ABX and mezzanine CDO tranches, via the TABX - providing observable market indicators of CDO value. In February 2007, the ABX, which tracked CDOs on certain risky subprime loans (those rated BBB), declined from above 90 in early February to 72.71 on February 22, 2007, and down to 69.39 on February 23, 2007. TABX tranches also materially declined upon launch, indicating that the value of many CDOs had plunged. The Senior TABX Tranche dropped from a price of nearly $100 in mid-February 2007 to around $85 by the end of February 2007. The TABX continued to fall significantly in the months after February 2007. (Sec. Compl. ¶¶ 154-157.)

On February 13, 2007, Bear Stearns filed its Form 10-K for the annual and quarterly period ended November 30, 2006. The 10-K was signed by, among others, Defendants Greenberg, Cayne, Schwartz, Spector and Farber. It is alleged that the Form 10-K made misrepresentations regarding the Company's financial results, risk management practices, exposure to market risk, compliance with banking capital requirements, and internal controls. Finally, the 2006 Form 10-K contained allegedly false and misleading statements by the Company's auditor, Deloitte, relating to its review and certification of the Company's reported financial results. As a result, on February 13, 2007, Bear Stearns' stock closed at $160.10 per share, up from a close of $157.30 per share the day before. The following day, February 14, 2007, Bear Stearns' shares closed at $165.81. (Sec. Compl. ¶¶ 606-607).

The financial results, including revenues, earnings, and earnings per share reported by the Company in the Form 10-K for 2006 were misleading for the same reasons set forth above, relating to the Company's announced results for fiscal year 2006. Moreover, the Company's assertions about the value of assets corresponding to Level 3 were allegedly materially false and misleading. (Sec. Compl. ¶¶ 608-609).

As set forth above, by the date of this statement, the Company's Principal Accountant and Controller had already been informed that the models the Company used to value the mortgage-backed securities in this asset category failed to reflect dramatic declines in the housing market. (Sec. Compl. ¶¶ 606-610.)

It is alleged that Bear Stearns' 2006 Form 10-K also misled investors with respect to the Company's use of its VaR models and the accuracy of its valuation models for assets linked to subprime mortgages. Bear Stearns' 2006 Annual Report to Stockholders, attached as an Exhibit to the Form 10-K, misrepresented Bear Stearns' risk control philosophy when it stated that "the Company's Risk Management Department and senior trading managers monitor exposure to market and credit risk for high yield positions and establish limits and concentrations of risk by individual issuer." (Sec. Compl. ¶¶ 611-616).

Bear Stearns' 2006 Form 10-K also misled investors with respect to the Company's risk management procedures by stating that "comprehensive risk management procedures have been established to identify, monitor and control [its] major risks." (Sec. Compl. ¶ 617).

Bear Stearns' 2006 Form 10-K also stated that "[t]he Treasurer's Department is independent of trading units and is responsible for the Company's funding and liquidity risk management. . . [m]any of the independent units are actively involved in ensuring the integrity and clarity of the daily profit and loss statements," and that:

The Risk Management Department is independent of all trading areas and reports to the chief risk officer. . . [t]he department supplements the communication between trading managers and senior management by providing its independent perspective on the Company's market risk profile."

As set forth above, in this period Bear Stearns' risk managers had little independence from its trading desk, and no ability to rein in the Company's accumulation of risk. (Sec. Compl. ¶¶ 619-620.)

Because of the deficiencies in its VaR models, the Company's representation in its 2006 Form 10-K that it had an aggregate VaR of just $28.8 million, which was far lower than its peers, was materially false and misleading. In fact, the Company knew that its VaR numbers failed to reflect its exposure to declining housing prices. (Sec. Compl. ¶¶ 160-161, 621-624.)

In its 2006 Form 10-K Bear Stearns stated that "the Company is in compliance with CSE regulatory capital requirements." This statement was allegedly materially false and misleading when made because the Company had misled regulators into believing that it was meeting capital requirements only by repeatedly violating banking regulations relating to the appropriate calculation of net capital. (See Sec. Compl. ¶¶ 427-452.) As set forth above, Defendants Cayne and Molinaro each made allegedly false and misleading statements when they executed Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") certifications, annexed as an exhibit to the Form 10-K filing.

The Company also asserted in its Form 10-K that it marked all positions to market on a daily basis and independently verified its inventory pricing and assessed the value of its Level 3 assets as $12.1 billion. The Company allegedly knew that the models it used to value its Level 3 mortgage-backed assets were badly out of date and did not reflect crucial data about housing prices and default rates and that its risk managers had little power to provide any independent review of these figures. Because of the failure to take appropriate losses on its Level 3 assets, the revenues and earnings per share it reported in its 2006 Form 10-K are alleged to be false and misleading. Cayne and Molinaro executed a certification of these statements, and knew of the Company's improper risk management and valuation practices, and the harmful consequences this deception would have on investors. As a result of the Company's continuing misrepresentations about its 2006 results and its VaR exposure, its stock rose $5.71 on February 14, 2007, to close at $165.81. (Sec. Compl. ¶¶ 168-171.)

The Company's auditor, Deloitte, certified Bear Stearns' 2006 Form 10-K as required by the Sarbanes-Oxley Act and, in so doing, knowingly and recklessly offered a materially misleading opinion as to the financial statements' accuracy. (Sec. Compl. ¶ 629.)

On March 15, 2007, Bear Stearns issued a press release regarding its first quarter 2007 results. As a result, on March 15, 2007, Bear Stearns' stock closed at $148.50 per share, up from a close of $145.29 per share the day before. The following day, March 16, 2007, Bear Stearns' shares closed at $145.48. The press release allegedly misstated Bear Stearns' earnings per share, net income, and net revenues, and falsely inflated the financial results for the Company's Capital Markets division, specifically Fixed Income. These statements were allegedly false and misleading because Bear Stearns achieved these results by using misleading mortgage valuation models to value its Level 3 assets as described above. (Sec. Compl. ¶¶ 631-634.)

At the time of the statements, the Company's Level 3 assets represented 11.64% of the its total assets held at market value, or a total of about $15 billion. For the reasons set forth above, the highly-leveraged nature of these assets would have magnified even a small decline in value. Accordingly, the values assigned to these assets were artificially inflated by the accounting violations described above. (Sec. Compl. ¶¶ 173-174, 635, 637.)

During the March 15, 2007 conference call, Molinaro repeated the financial results and it is alleged these statements were false and misleading (Sec. Compl. ¶¶ 633-636). During the latter part of 2006 and the beginning of 2007 EMC was "buying everything" without regard for the risk of the loan and Bear Stearns' origination platforms were seriously flawed and were not accurately measuring the risk of the loans issued. (Sec. Compl. ¶¶ 638-640.)

Molinaro also made allegedly false and misleading statements regarding the Company's exposure to risk connected with the Hedge Funds. When asked to give details regarding Bear Stearns' exposure to subprime CDOs, Molinaro refused, saying "I think that we feel like we've got the situation in hand. We think it's well hedged." This statement was alleged to be false and misleading, in that Molinaro was aware that the VaR and valuation models, essential to meaningful hedging of risk, failed to reflect key data about housing declines. (Sec. Compl. ¶¶ 641-645.)

On March 15, 2007, Molinaro also stated that there would be no change in trends in the Company's VaR, that the subprime market was a small part of Bear Stearns' overall business, that the Company had reduced the number of subprime mortgages it was purchasing and securitizing and that it was well-hedged in the market for subprime-backed securities, all of which were allegedly false. As a result of these statements and quarterly results, Bear Stearns' share price rose $2.10, to close at $148.50. (Sec. Compl. ¶¶ 172-179.)

On April 9, 2007, Bear Stearns filed its Form 10-Q for the quarter ending February 28, 2007 and again made various representations concerning Bear Stearns' risk management and mortgage-related operations. The Form 10-Q was false and misleading because, as set forth above, Bear Stearns was able to achieve these results only by avoiding taking losses on its Level 3 assets, by using misleading valuation models that did not accurately reflect declines in the housing market. This avoidance of loss permitted the Company to increase its revenues and asset values, inflating the value of its stock. Because the Level 3 assets the Company reported for the period stood at $15.64 billion, the Company's leveraging practices magnified its knowing use of materially deficient models, which did not reflect key declines in the market, to value assets. (Sec. Compl. ¶¶ 180, 647-650.)

The first quarter 2007 10-Q also stated that the Company's net revenues for Capital Markets increased 15.4% to $1.97 billion for the quarter and that its total assets at February 28, 2007 increased to $394.5 billion from $350.4 billion at November 30, 2006. These statements are alleged to be false and misleading, because the Company only avoided taking losses on its Level 3 assets by using improper valuation models. Cayne and Molinaro once again certified these statements. (Sec. Compl. ¶ 186.)

The first quarter 2007 Form 10-Q also misled investors with respect to its assessment of risk exposure by asserting that "[t]he Company regularly evaluates and enhances such VaR models in an effort to more accurately measure risk of loss." Bear Stearns reported the reassuringly low VaR numbers it had calculated for the first quarter of 2007, including an aggregate risk of just $27.9 million - far lower than its peers. This statement was misleading, in that the Company knew that its VaR modeling failed to reflect its exposure to declining housing prices. (Sec. Compl. ¶¶ 651-654.) In the same filing, Bear Stearns misrepresented its risk control philosophy for the reasons set forth above, when it stated that "the Company's Risk Management Department and senior trading managers monitor exposure to market and credit risk for high yield positions and establish limits and concentrations of risk by individual issuer." (Sec. Compl. ¶¶ 654-656). In addition, its statement that "the Company is in compliance with CSE regulatory capital requirements" was also allegedly materially false and misleading when made because Bear Stearns was only able to meet the CSE program's minimum capital requirements by repeatedly violating CSE rules relating to the appropriate calculation of net capital. (Sec. Compl. ¶ 657).

Cayne and Molinaro each made allegedly false and misleading statements when they executed Sarbanes-Oxley Act certifications, annexed as an exhibit to the first quarter 2007 Form 10-Q. These statements are alleged to have been false and misleading, because the Company had made no effort to address deficiencies that went to the heart of the its ability to assess the value of its assets and its exposure to risk, despite repeated warnings from the SEC. Moreover, the encouraging revenue growth and earnings per share Bear Stearns reported in its certified statements were only made possible by the fact that Bear Stearns was avoiding taking losses by relying on misleading valuation models that failed to reflect the declining value of its highly illiquid Level 3 assets. (Sec. Compl. ¶¶ 658-660).

Deloitte again certified Bear Stearns' first quarter 2007 Form 10-Q and, in so doing, knowingly and recklessly falsely offered an opinion as to the financial statement's accuracy. As set forth above, it is alleged that Deloitte knew or recklessly disregarded that these statements and certifications were materially false and misleading when made, and perpetrated a fraud on Bear Stearns investors as a result. (Sec. Compl. ¶ 661.)

On June 14, 2007, Bear Stearns issued a press release regarding its second quarter 2007 results. The following day, June 15, 2007, Bear Stearns' shares closed at $150.09. In the press release, Bear Stearns allegedly misrepresented its earnings per share, net income, and net revenues - specifically its financial results for Capital Markets. These statements were allegedly misleading and false because Bear Stearns achieved these results by using misleading mortgage valuation models to value its Level 3 assets, as described above. (Sec. Compl. ¶¶ 662-665.)

At the time of the statements, the Company's Level 3 assets represented 10.55% of the Company's total assets held at market value, or a total of about $14.39 billion. Because these assets were highly leveraged, even a small decline in value would be vastly magnified. (Sec. Compl. ¶¶ 77-80, 666.)

In its report for the second quarter of 2007, signed by Farber, the Company materially misrepresented its financial results, its exposure to risk, its compliance with regulatory capital requirements, its internal controls, and the effects of its repurchase agreement with the High Grade Fund. Deloitte also filed an allegedly materially false and misleading certification in connection with the Form 10-Q. As a result, on July 10, 2007, Bear Stearns' stock closed at $137.96 per share, down from a close of $143.89 per share the day before. The following day, July 11, 2007, Bear Stearns' shares closed at $138.03. (Sec. Compl. ¶¶ 676-677.)

These statements are alleged to be false and misleading as set forth above. Bear Stearns avoided taking losses on its Level 3 assets by using misleading mortgage valuation models, which did not accurately value its Level 3 assets. At the time, the Level 3 assets the Company reported for the period stood at $14.38 billion. Just four months later, the residential mortgage component of the Company's Level 3 assets stood at $5.8 billion. The Company's assertion that its Level 3 assets stood at $14.38 billion was itself allegedly materially false and misleading, given that it was a product of a valuation model that did not reflect key declines in the market. (Sec. Compl. ¶¶ 676-682.)

The second quarter 2007 Form 10-Q misled investors with respect to its assessment of risk exposure because Bear Stearns' VaR models failed to include critical variables such as "housing price appreciation, consumer credit scores, patterns of delinquency rates, and potential other data." In the Form 10-Q Bear Stearns reported the reassuringly low VaR numbers it had calculated for the second quarter of 2007, including an aggregate risk of just $28.7 million - far lower than its peers. This statement was materially misleading, in that the Company knew that its VaR modeling failed to reflect its exposure to declining housing prices. (Sec. Compl. ¶¶ 683-686.)

The second quarter 2007 Form 10-Q also misled investors with respect to Bear Stearns' risk control philosophy when it stated that "the Company's Risk Management Department and senior trading managers monitor exposure to market and credit risk for high yield positions and establish limits and concentrations of risk by individual issuer." (Sec. Compl. ¶¶ 687-688.) In the same filing, Bear Stearns' statement that "the Company is in compliance with CSE regulatory capital requirements" was allegedly materially false and misleading for the reasons set forth above. (Sec. Compl. ¶ 689.)

Cayne and Molinaro each made allegedly false and misleading statements when they executed Sarbanes-Oxley Act certifications, annexed as an exhibit to the second quarter 2007 Form 10-Q filing. (Sec. Compl. ¶¶ 690-691.)

The encouraging revenue growth and earnings per share Bear Stearns reported in its certified statements were only possible because Bear Stearns was avoiding taking losses by relying on misleading valuation models that failed to reflect the declining value of its highly illiquid Level 3 assets. (Sec. Compl. ¶ 692.)

The second quarter 2007 Form 10-Q also contained allegedly false and misleading information about the financial impact of Bear Stearns' support of the High Grade Fund because Bear Stearns' management knew that the High Grade Fund did not have sufficient assets available to fully collateralize the facility and the collateral that Bear Stearns took in the repurchase agreement were the same CDOs that had lost so much value, causing other lenders to make the margin calls that severely threatened the hedge fund's liquidity. (Sec. Compl. ¶¶ 693-694.) Again, Deloitte certified these results and, in doing so, allegedly knew or recklessly disregarded that the statements and certifications in the filing were materially false and misleading when made. (Sec. Compl. ¶ 695.)

On June 14, 2007, Bear Stearns held its second quarter 2007 earnings conference call, conducted by Molinaro. During the call, Molinaro repeated the allegedly false and misleading financial results described above. (Sec. Compl. ¶¶ 669-671.)

On June 22, 2007, the Company issued a press release and held a conference call to announce its repurchase agreement with the High Grade Fund in which the Company would provide a $1.6 billion credit line to the fund, secured by collateral worth more than $1.6 billion. Bear Stearns reported that asset sales had reduced the loan balance to $1.345 billion. However, by the time of this statement the estimated value of the collateral securing the loan had deteriorated by nearly $350 million - that is, to approximately the value of the loan Bear Stearns had given the High Grade Fund. Moreover, the High Grade Fund had no assets other than the collateral Bear Stearns already held. (Sec. Compl. ¶¶ 672-673.)

At the same time, the Company shifted its funding model from unsecured to secured financing, using its mortgage-backed assets as collateral. In May 2007, Bear Stearns' short term borrowing was 60% secured. Just four months later, in September 2007, it was 74% secured. By March 2008 it was 83% secured. (Sec. Compl. ¶¶ 218-219.)

Bear Stearns' principal source of secured financing was the market for repurchase or "repo" agreements. By the end of the Class Period, Bear Stearns was funding its $50 billion daily needs by using 71% of its mortgage-backed assets as collateral for repo agreements. Because the Company's mortgage-backed assets were serving to prop up the cash needs of the entire Company, Bear Stearns could not afford to reveal that they were rapidly losing value. (Sec. Compl. ¶¶ 220-221.)

According to the OIG Report, mark disputes between Bear Stearns and its counterparties became more common beginning in the summer of 2007. According to the OIG Report, during July 2007, shortly after the $3.2 billion Hedge Fund financing agreement, Bear Stearns told the SEC that there were two large dealers with whom it had mark disputes in excess of $100 million each. Because Bear Stearns knew its assets were overvalued, it was frequently obliged to settle these disputes by paying money to its repo counterparties. Nonetheless, because it could not afford to reveal the declining value of its mortgage-backed collateral was rapidly declining in value, Bear Stearns continued to carry the assets on its books at full value even while privately acknowledging the declining value to its counterparties. (Sec. Compl. ¶¶ 222-225.)

By failing to record the assets at the lower compromise price, the Company was able to hide from investors the extent of its losses on the value of its mortgage-backed assets. (Sec. Compl. ¶¶ 218-226.)

On July 31, 2007, Standard & Poor's analysts downgraded the Company's stock because, among other things, "widening credit spreads and increasing risk aversion may cause a slowdown in its investment banking operation." The Company's stock fell $6.03 as a result, closing at $121.22. (Sec. Compl. ¶ 227.)

On August 3, 2007, Standard & Poor's Ratings Services said it had revised its outlook on Bear Stearns from stable to negative. Notwithstanding the Company's denials, the ratings firm explained that Bear Stearns has material exposure to holdings of mortgages and mortgage-backed securities (MBS), the valuations of which remain under severe pressure. It also has exposure to debt it has taken up as a result of unsuccessful leveraged finance underwritings, and it has significant further underwriting commitments. That same day, Bear Stearns denied the impact of these events and any broader implications. (Sec. Compl. ¶¶ 228-231.)

On a conference call the same day, Alix, Bear Stearns' Chief Risk Officer and head of the Company's Global Risk Management division, made false and misleading statements in which he denied that the VaR models the company employed to assess risk and hedge purchases failed to reflect the reality of the collapsing real estate market and failed to admit that the Company had not revised or updated its defective models in years. At the time of the call, Alix and the Company had already been informed that Bear Stearns' "risk analytics" did not take into account crucial information on risk of default and volatility in housing prices and, as a result of the Hedge Fund financing agreement, Bear Stearns had just assumed as collateral more than a billion dollars worth of subprime-backed CDOs that were virtually worthless. As the Company only held approximately $11 billion in highly-leveraged net equity at the time, this was a very significant new exposure. During the same conference call, Molinaro made allegedly false and misleading statements regarding the collateral that Bear Stearns took in the repurchase agreement with the High Grade Fund, which reflected Bear Stearns' inaccurate valuation models for the Hedge Funds' subprime-backed collateral. (Sec. Compl. ¶¶ 230-232, 700-703.)

On September 20, 2007, Bear Stearns posted its results for the third quarter, ending August 31, 2007 (closing stock price $108.66), signed by Farber. It reported net income for the quarter of $171.3 million, or $1.16 a share, down from $438 million, or $3.02 a share, in the period a year earlier. Net revenue for the Company, or total revenue minus interest costs, fell 37% to $1.33 billion, while net revenue at the fixed-income division dropped 88%, to $118 million from $945 million in the third quarter of 2006. Return on equity stood at 5.3%, compared with 16% a year earlier. Again, these statements were allegedly false and misleading because Bear Stearns relied on misleading mortgage valuation models to value its Level 3 assets, as described above. (Sec. Compl. ¶¶ 704-706. At the time of the statements, the Company's Level 3 assets represented 13% percent of its total assets held at market value, or a total of about $16.6 billion. Accordingly, the values the Company assigned to this large group of assets were significantly higher than they should have been, violating relevant GAAP. (Sec. Compl. ¶¶ 324-423.) Because the Company was not reflecting these losses on its books, its revenues, earnings, and earnings per share were overstated as well. (Sec. Compl. ¶¶ 707-710.)

Molinaro conducted Bear Stearns' third quarter 2007 earnings conference call on the same day. During the call, Molinaro repeated the financial results set out above and made statements regarding Bear Stearns' valuation methodology, which were allegedly false and misleading for the reasons set forth above. (Sec. Compl. ¶¶ 711-713.)

During the call, Molinaro made statements regarding risk and write downs, all of which are alleged to have been false and misleading, because they relied on Bear Stearns' improper avoidance of losses through valuation methods that artificially boosted the values of the Company's Level 3 assets. (Sec. Compl. ¶¶ 235-240.) He stated that Bear Stearns would take "$200 million of losses associated with the failure of the high-grade funds, representing the write-off of our investment and fees receivable, losses from the liquidation of the $1.6 billion repo facility." The Company did not disclose the full amount of its losses on the collateral for fear that its lenders and counterparties would realize that it had been consistently overvaluing its assets. By the Company's own estimates regarding the write-downs associated with the Hedge Fund, the numbers revealed to investors in September 2007 were misleading. According to the OIG Report, the Company's internal documents reflect that it took a $500 million write down in connection with the bailout at some time in the fall of 2007 which was not disclosed to investors for fear that it would telegraph to the market the decline in the value of the other subprime-backed assets it carried on its books. (Sec. Compl. ¶¶ 711-718.)

In addition, the statement that the Company recognized "approximately $700 million in net inventory markdowns during the 2007 quarter primarily related to losses experienced in the mortgage-related and leveraged finance areas" is alleged to be false and misleading because it grossly underrepresented the Company's true losses, including its losses on the collateral it had received under the repurchase agreement with the High Grade Fund and the devalued and illiquid retained interests that it continued to carry on its books, as set out above. (Sec. Compl. ¶ 724.)

The third quarter 2007 Form 10-Q is also alleged to have misled investors with respect to Bear Stearns' risk control philosophy and, specifically, its risk exposure assessment, as the Company knew its VaR modeling failed to reflect accelerating exposure to declining housing prices. (Sec. Compl. ¶¶ 725-728.) The filing also stated that "the Company is in compliance with CSE regulatory capital requirements," which is alleged to be materially false and misleading when made it reflected Bear Stearns' violation of CSE rules relating to the appropriate calculation of net capital. (Sec. Compl. ¶ 731.)

As in previous filings, Cayne and Molinaro made allegedly false and misleading statements when they executed Sarbanes-Oxley Act certifications (Sec. Compl. ¶ 732), and Deloitte's knowingly and recklessly falsely offered an opinion as to the financial statements' accuracy when it certified the results in the filing. (Sec. Compl. ¶¶ 523-588, 735.)

On October 10, 2007, Bear Stearns filed its Form 10-Q for the quarterly period ended August 31, 2007, which included the same misleading financial results it reported on September 20, 2007. At the time this statement was made, the Company had been repeatedly warned that its mortgage valuation models were outdated and inaccurate, but had refused to revise them. (Sec. Compl. ¶ 241-243.)

The Company repeated the same allegedly false and misleading statements regarding its VaR modeles, when it stated that it "regularly evaluates and enhances [its] VaR models in an effort to more accurately measure risk of loss," and that its aggregate VaR was still only $35 million, well below its competitors. (Sec. Compl. ¶¶ 244-245.)

On November 14, 2007, Molinaro announced that Bear Stearns would write down $1.2 billion of its assets in the fourth quarter and that while Bear Stearns still bore more than a billion dollars of subprime exposure in the form of the collateral it had received from the failed High Grade Fund, it had reduced its CDO holdings to $884 million as of November 9, down from $2.07 billion at the end of August. Molinaro stated that during the period between August 31, 2007 and November 9, 2007, the Company significantly increased its short subprime exposures, reducing its reported August 31, 2007 net exposure of approximately $1 billion to a negative $52 million net exposure as of November 9, 2007. Molinaro stated that the balances were continuing to show improvement although the Company still had more than a billion dollars in subprime backed collateral from its Hedge Fund financing agreement to write down, and the Company's hedging efforts failed to use accurate models to assess risk. (Sec. Compl. ¶¶ 246-247, 480, 736-738.)

Molinaro's statements were also alleged to be false and misleading because the Company's faulty VaR models could not permit it to effectively hedge against risk in the subprime market. Less than a month later, the Company announced an additional $700 million write-down on its mortgage-backed assets. (Sec. Compl. ¶ 739.)

On December 21, 2007, Bear Stearns announced that it would take the first quarterly loss in the Company's 84-year history (quarter closing on November 30, 2007 at $99.70 per share). It reported that its fiscal fourth-quarter loss after paying preferred dividends was $859 million, or $6.90 per share, compared to a profit of $558 million, or $4 per share, a year earlier. The Company had negative net revenue of $379 million, compared to revenue of $2.41 billion a year earlier. The Company also announced on December 21, 2007 that it would write down $1.9 billion of its holdings in mortgages and mortgage-based securities - more than $700 million more than it had announced on November 14, 2007. On December 21, 2007, Bear Stearns' stock closed at $89.95 per share, down from a close of $91.42 per share the day before. (Sec. Compl. ¶¶ 250-252, 740-741.)

In its press release, Bear Stearns misrepresented its earnings per share, net income, and net revenues. The Company's losses in Capital Markets, specifically Fixed Income, were also understated. At the time of the statements, the Company's Level 3 assets represented 19.9% of the Company's total assets held at market value, or a total of about $24.41 billion. However, these results were achieved through the use of misleading mortgage valuation models to value its Level 3 assets, as described above. The Company also continued to fail to disclose the effect of the market downturn and the true extent of Bear Stearns' exposure from the repurchase collateral taken from the High Grade Fund. Beyond the $100 million write down in hedge fund collateral in the quarter ending August 31, 2007, the Company had disclosed no further write-downs of the $1.2 billion of toxic hedge fund assets it still held on its books. (Sec. Compl. ¶¶ 747-748.)

During Bear Stearns' conference call on December 20, 2007, Molinaro repeated the financial results described above. These statements were allegedly false and misleading for the same reasons set out above. Molinaro further stated, "[o]verall this franchise is strong; smaller and more focused on restructuring than origination going forward, but our top talent is in place and we are confident in the underlying earnings potential of the mortgage business," thereby failing to disclose the Company's undisclosed losses from the hedge fund collateral on its books. The losses were also minimized by the reliance on same misleading valuation models discussed above. Moreover, the lack of any schedule giving details regarding the nature of the write-downs left investors with no information about the Company's true exposure, and such omissions compounded Molinaro's false and misleading statements. (Sec. Compl. ¶¶ 749-754.)

On January 29, 2008, Bear Stearns filed its Form 10-K for the annual and quarterly periods ended November 30, 2007. The Form 10-K, which was signed by Defendants Greenberg, Cayne, Schwartz, Farber and Molinaro, among others, allegedly misrepresented the Company's financial results, risk management practices, exposure to market risk, compliance with banking capital requirements and internal controls. (Sec. Compl. ¶ 755.) The 2007 Form 10-K also contained allegedly false and misleading statements by the Company's auditor, Deloitte, relating to its review and certification of the Company's reported financial results.

As a result of the filing, on January 29, 2008, Bear Stearns' stock closed at $91.58 per share, up from a close of $91.10 per share the day before. The following day, January 30, 2008, Bear Stearns' shares closed at $88.26. (Sec. Compl. ¶ 755, 757.)

The Company stated that it held $24.4 billion in Level 3 assets, as of November 30, 2006. This statement was allegedly false and misleading because, by January 2008, the Company had been informed that the models it used to value the more than $7.5 billion in mortgage-backed securities in this asset category failed to reflect dramatic declines in the housing market. (Sec. Compl. ¶¶ 755-759.)

Bear Stearns' 2007 Annual Report to Stockholders, attached as an Exhibit to the Form 10-K, misled investors with respect to Bear Stearns' risk control philosophy when it stated that "the Company's Risk Management Department and senior trading managers monitor exposure to market and credit risk for high yield positions and establish limits and concentrations of risk by individual issuer." (Sec. Compl. ¶ 764.)

The 2007 Form 10-K misled investors with respect to Bear Stearns' risk management procedures when it stated that "Comprehensive risk management procedures have been established to identify, monitor and control each of [the] major risks." (Sec. Compl. ¶ 766.) The filing also stated that "The Treasurer's Department is independent of trading units and is responsible for the Company's funding and liquidity risk management. . . [m]any of the independent units are actively involved in ensuring the integrity and clarity of the daily profit and loss statements." Despite the crucial deficiencies in the models Bear Stearns used to value the Company's Level 3 assets, the Company stated in its Form 10-K that it was "marking all positions to market on a daily basis" and that it had "independent verification of inventory pricing." (Sec. Compl. ¶¶ 768-771.)

The 2007 Form 10-K also mislead investors with respect to the Company's exposure to "market risk" because of the declines in assets in light of deficiencies in its VaR and mortgage valuation models, as discussed above. Furthermore, because of the deficiencies in it VaR models, the Company was allegedly false and misleading in its 2007 Form 10-K representation that it had an aggregate VaR of just $69.3 million - still far lower than its peers. (Sec. Compl. ¶¶ 772-775.)

The Form 10-K's statement that "the Company is in compliance with CSE regulatory capital requirements" was allegedly materially false and misleading as set forth above. (Sec. Compl. ¶ 776.) Cayne and Molinaro each made allegedly false and misleading statements when they executed SarbanesOxley Act certifications, annexed as an exhibit to the Form 10-K filing. (Sec. Compl. ¶ 777-780.) In addition, Deloitte certified Bear Stearns' 2007 Form 10-K, as required by the Sarbanes-Oxley Act, and, in so doing, is alleged to have knowingly and recklessly falsely offered an opinion as to the financial statement's accuracy. Deloitte knew or recklessly disregarded that these statements and certifications were allegedly materially false and misleading when made. (Sec. Compl. ¶¶ 523-588, 781.)

On January 31, 2008, Bear Stearns published a letter it had written to John Cash, Accounting Branch Chief of the SEC's Division of Corporate Finance, in response to certain concerns the SEC raised about Bear Stearns' exposure to subprime loans in its fiscal year 2006 Form 10-K. These statements made were materially false and misleading for the reason set forth above with respect to similar statements. (Sec. Compl. ¶¶ 782-784.)

On March 6, 2008, Rabobank Group, one of Bear Stearns' European lenders, stated that it would not renew a $500 million loan coming due later that week, indicating that it was unlikely to renew an additional $2 billion credit agreement set to expire the following week. Analyst reports released the same day predicted that the Company's quarterly results would be negatively impacted by problems stemming from its fixed income business; the Company's stock lost more than $5, to close at $69.90. As a result, on Friday, March 7, 2008, the cost of credit default swaps on Bear Stearns' debt surged. (Sec. Compl. ¶¶ 260-262.)

In a March 10, 2008 press release, the Company said that "[t]here is absolutely no truth to the rumors of liquidity problems that circulated today in the market" and suggested that the Company had some $17 billion in cash. The same day, Greenberg claimed during an interview with CNBC that the Company had no liquidity problems, calling such an assertion "ridiculous, totally ridiculous." (Sec. Compl. ¶ 263.)

The morning of March 11, 2008, Goldman Sachs' ("Goldman") credit derivatives group sent its hedge fund clients an e-mail announcement about Bear Stearns stating that, at least temporarily, it would not step in for Bear Stearns derivatives deals. (Sec. Compl. ¶ 266.)

Hedge funds flooded Credit Suisse's brokerage unit with requests to take over trades opposite Bear Stearns. In a mass e-mail sent out that afternoon, Credit Suisse stock and bond traders were told that all such "novation" requests involving Bear Stearns and any other "exceptions" to normal business required the approval of credit-risk managers. (Sec. Compl. ¶ 268.)

Bear Stearns' counterparties began to back away from the Company. Early in the morning on Tuesday, March 11, 2008, ING Groep NV ("ING") informed Bear Stearns that it was pulling about $500 million in financing. The same day, analysts suggested that Bear Stearns' future profits were likely to be squeezed by its exposure to "esoteric securities." The Company's stock dropped $3.75 as a result, closing at $62.97. By the end of March 11, 2008, the banks simply refused to issue any further credit protection on the Company's debt. These developments had a devastating effect on the Company's liquidity. (Sec. Compl. ¶¶ 266-272.)

On March 12, 2008, Schwartz appeared on CNBC and said that the Company's liquidity position and balance sheet had not weakened at all. "We finished the year, and we reported that we had $17 billion of cash sitting at the bank's parent company as a liquidity cushion," he said. "As the year has gone on, that liquidity cushion has been virtually unchanged." Schwartz added that "We don't see any pressure on our liquidity, let alone a liquidity crisis." Schwartz's statement is alleged to be false, in that the day before his assertion that the Company's liquidity position was unchanged Bear Stearns' liquidity pool already had fallen to an adjusted level of $15.8 billion. Moreover, as Schwartz spoke on March 12, 2008, its liquidity pool stood at nearly $5 billion less than it had on Monday, March 10, 2008, and some $13 billion of the Company's cash was evaporating. Moreover, Schwartz specifically denied that the Company's risk had scared away any counterparties. At the time he made this statement, Schwartz, as the Company's CEO, allegedly would have been aware that ING had pulled nearly half a billion in financing and that Goldman, once a principal source of cash for the Company, had at least temporarily halted covering any more Bear Stearns risk. (Sec. Compl. ¶¶ 274-277.)

According to the OIG Report, the Company informed TM on March 12, 2008, the same day as Schwartz's statement, that "Bear Stearns paid out $1.1 billion in disputes to numerous counterparties in order to squelch rumors that Bear Stearns could not meet its margin calls." On March 12, 2008 Bear Stearns' stock closed at $61.58 per share, down from a close of $62.97 per share the day before. The following trading day, March 13, 2008, Bear Stearns' shares closed at $57. (Sec. Compl. ¶¶ 788-794.)

According to a March 20, 2008 letter from SEC Chairman Cox to the Chairman of the Basel Committee on Banking Regulation, on March 11, 2008, the Company's liquidity pool stood at $15.8 billion, "adjusted for the customer protection rule." By March 13, 2008, according to the letter, the pool stood at $2 billion - a loss of more than $13 billion in two days. (Sec. Compl. ¶¶ 273, 782-784.)

7.Accounting Standards Violations

Despite its public statements to the contrary, throughout the Class Period the Company is alleged to have suffered from a pervasive weakness in its internal controls, and repeatedly and systematically violated Generally Accepted Accounting Principles ("GAAP"). (Sec. Compl. ¶ 324.)

a) GAAP Overview

SEC Regulation S-X, 17 C.F.R. § 210.4 01(a)(1), provides that financial statements filed with the SEC that are not presented in conformity with GAAP will be presumed to be misleading, despite footnotes or other disclosures. The SEC has the statutory authority for the promulgation of GAAP for public companies and has delegated that authority to the Financial Accounting Standards Board (the "FASB") and the American Institute of Certified Public Accountants ("AICPA"). GAAP consist of a hierarchy of authoritative literature, the FASB Statements of Financial Accounting Standards ("FAS"), followed by FASB Interpretations ("FIN"), FASB Staff Positions ("FSP"), Accounting Principles Board Opinions ("APB"), AICPA Accounting Research Bulletins ("ARB"), AICPA Statements of Position ("SOP"), and AICPA Industry Audit and Accounting Guides ("AAG"). GAAP provide other authoritative pronouncements including, among others, the FASB Concept Statements ("FASCON"). The AICPA issues industry specific Audit & Accounting Guides ("AAG") to provide guidance in preparing financial statements in accordance with GAAP. The AAG for Depository and Lending Institutions ("D&L AAG") was applicable to Bear Stearns with respect to its mortgage banking activities, including mortgage originations, securitizations, and holdings of investments in debt securities. The D&L AAG interpreted GAAP pronouncements on the proper methods to assess fair value for financial instruments and Retained Interests ("RIs"). In addition, there was an AAG that was applicable to Brokers and Dealers in Securities ("B&D AAG"). Among other applications, the B&D AAG provided guidance on GAAP related to Bear Stearns' trading of financial instruments. Bear Stearns was also expected to adhere to fundamental accounting principles requiring a Company's financial statements to be presented in a manner that, among other things, should:

(a) Provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit and similar decisions. (FASCON 1 ¶34.)

(b) Provide information about an enterprise's economic resources, obligations, and owners' equity. That information helps investors, creditors, and others identify the enterprise's financial strengths and weaknesses and assess its liquidity and solvency. (FASCON 1 ¶40.)

(c) Provide information about an enterprise's financial performance during a period. "Investors and creditors often use information about the past to help in assessing the prospects of an enterprise. Thus, although investment and credit decisions reflect investors' and creditors' expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance." (FASCON 1 ¶42.)

(d) Include explanations and interpretations to help users understand financial information because management knows more about the enterprise and its affairs than investors, creditors, or other "outsiders" and can often increase the usefulness of financial information by identifying certain transactions, other events, and circumstances that affect the enterprise and explaining their financial impact on it. (FASCON 1 ¶ 54.)

(e) Be reliable in that it represents what it purports to represent. That information should be reliable as well as relevant is a notion that is central to accounting. (FASCON 2 ¶¶ 58-59.)

(f) Be complete, which means that nothing material is left out of the information that may be necessary to ensure that it validly represents underlying events and conditions. (FASCON 2 ¶ 79.)

(g) Be verifiable in that it provides a significant degree of assurance that accounting measures represent what they purport to represent. (FASCON 2 ¶ 81.)

(h) Reflect that conservatism be used as a prudent reaction to uncertainty to try to ensure that uncertainties and risks inherent in business situations are adequately considered. (FASCON 2 ¶¶ 95, 97.) (Sec. Compl. ¶¶ 325-330.)

b) Fraud Risk Factors

Bear Stearns was subject to risk factors associated with depository and lending institutions. As set forth in the D&L AAG, one risk factor was "significant declines in customer demand and increasing business failures in either the industry or overall economy," including "deteriorating economic conditions . . . within industries or geographic regions in which the institution has significant credit concentrations." (Ch. 5, Audit Considerations and Certain Financial Reporting Matters, Ex. 5-1, Fraud Risk Factors). Another AICPA risk factor set forth in the D&L AAG is "[u]nrealistically aggressive loan goals and lucrative incentive programs for loan originations," as shown by, among other things, "relaxation of credit standards," and "excessive concentration of lending." Bear Stearns' 2006 Form 10-K disclosed that, "Mortgage-backed securities revenues increased during fiscal 2006 when compared with fiscal 2005 on higher origination volumes from asset-backed securities, adjustable rate mortgage ("ARM") securities . . . ." (Sec. Compl. ¶¶ 331-333.)

Bear Stearns did not disclose critical information until January 2008 pursuant to the SEC's efforts to seek expanded disclosure from the Company. These "2/28 ARMs" (see Sec. Compl. ¶¶ 346--347, 579) carried a particularly high degree of risk of misstatement, and constituted the types of risk highlighted by the D&L AAG. Bear Stearns delayed efforts to adopt stricter underwriting standards related to non-agency loan originations until the quarter ended August 31, 2007. (Sec. Compl. ¶ 334.)

Another source of industry-specific risk occurs when an institution has "assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgments or uncertainties that are difficult to corroborate (significant estimates generally include . . . fair value determinations)" and when "material amounts of complex financial instruments and derivatives held by the institutions that are difficult to value." (Sec. Compl. ¶ 335.)

The AAG identifies another risk factor for lenders as occurring when "[v]acant staff positions remain unfulfilled for extended periods, thereby preventing the proper segregation of duties," and when there exists an "[u]nderstaffed accounting or information technology department, inexperienced or ineffective accounting or information technology ...


Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.