Full opinion text
OPINION LEWIS A. KAPLAN, District Judge. Table of Contents Facts ..'........................................................................265 Parties........................... 265 Plaintiffs ...................... 265 Defendants............................................................265 Relevant Non-Party....................................................266 Prior Proceedings..........................................................266 The TAC..................................................................267 Repo 105 ..................................................................268 Allegedly Misleading Statements.............................................269 Net Leverage Ratio.....................................................269 “Securities Sold Under Agreements to Repurchase ”........................270 Risk Approach.........................................................270 Liquidity.............................................................271 Accounting Practices...................................................271 Discussion .....................................................................272 I. Legal Standard............................................................272 II. Standing..................................................................273 III. Exchange Act Claims.......................................................274 A. The Standard..........................................................274 B. Individual Defendants..................................................275 1. Existence of materially false and misleading statements or omissions.....275 a. Repo 105 and net leverage .......................................276 (1) SFASUO..................................................277 (2) Compliance with GAAP......................................279 (3) Treating Repo 105 transactions as sales........................281 (I)Failure to disclose Repo 105 transactions......................282 b. Risk management policies.......................................283 (1) Exceeding risk limits........................................284 (2) Adequacy ofmitigants.......................................285 (3) Stress tests.................................................285 (I) Value-at-Risk..............................................286 c. Liquidity......................................................287 d. Concentrations of credit risk.....................................290 2. Scienter................................... 292 a. Motive and opportunity.........................................293 b. Circumstantial evidence of conscious misbehavior or recklessness.....294 (1) Repo 105 Transactions.......................................294 (2) Risk management...........................................297 (3) Concentrations of credit risk..................................297 C. E&Y................................................................298 1. Statements regarding GAAS.........................................299 2. Statements regarding GAAP.........................................303 D. Loss Causation........................................................304 E. The Other Exchange Act Claims .........................................307 1. Section 20(a).......................................................307 2. Section 20A........................................................307 IV.Securities Act 308 A. Timeliness............................................................308 B. Statutory standing under Section 12......................................310 C. Existence of actionable material misstatements and omissions in the Offering Materials...................................................311 1. Valuation of commercial real estate...................................311 2. Structured products offering materials and PPNs......................313 D. Section 11 claims against Callan....................................!... .315 E. Affirmative defenses ofnon-E & Y defendants.............................317 1. Availability of the affirmative defenses on a motion to dismiss...........317 2. Applicability of defenses.............................................317 F. Securities Act claims against E &Y......................................318 G. Section 15 claims ......................................................319 Conclusion.....................................................................319 The September 2008 collapse of Lehman Brothers Holdings Inc. (“Lehman”) disrupted the entire economy and greatly affected owners of the company’s securities. This case concerns more than $31 billion in Lehman debt and equity securities issued pursuant to a May 30, 2006 shelf registration statement (the “Registration Statement”), a base prospectus of the same date, and various prospectus, product, and pricing supplements (collectively, the “Offering Materials”), which incorporated by reference several of Lehman’s SEC filings. Plaintiffs are pension funds, companies, and individuals, each of which purchased some of these securities. They sue Lehman’s former officers, directors, and auditors, as well as underwriters of the securities, under Sections 11, 12, and 15 of the Securities Act of 1933 (“Securities Act”) and Lehman’s former officers and auditors under Sections 10(b), 20(a), and 20A of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 thereunder. The complaint alleges that the Offering Materials were false and misleading because they incorporated by reference Lehman’s financial statements, which in turn contained misleading statements and omissions concerning Lehman’s (1) use of “Repo 105” transactions and their effect on Lehman’s reported net leverage, (2) risk management policies, (3) liquidity risk, (4) concentrations of credit risk, and (5) the value of Lehman’s commercial real estate holdings. It alleges also that certain of Lehman’s former officers made false and misleading oral statements about most of these subjects. The matter is before the Court on defendants’ motions to dismiss the TAC for failure to state a claim upon which relief may be granted. Facts Parties Plaintiffs Plaintiffs are pension funds, companies, and individuals each of which purchased Lehman common stock or other Lehman securities, including structured products like principal protection notes (“PPNs”), issued pursuant to the Offering Materials. The Court has appointed the Alameda County Employees’ Retirement Association (“ACERA”), the Government of Guam Retirement Fund (“GGRF”), the Northern Ireland Local Government Officers’ Superannuation Committee (“NILGOSC”), the City of Edinburgh Council as Administering Authority of the Lothian Pension Fund (“Lothian”), and the Operating Engineers Local 3 Trust Fund (“Operating Engineers”) as lead plaintiffs. They sue both under (1) the Securities Act, purportedly on behalf of all persons who purchased the securities listed in TAC Appendices A and B, and (2) the Exchange Act, allegedly on behalf of all persons who purchased or otherwise acquired Lehman common stock and call options, or who sold put options, between June 12, 2007, and September 15, 2008 (the “Class Period”). Defendants There are four categories of defendants in this case. The Insider Defendants are five of Lehman’s former officers: Richard S. Fuld, Jr., Christopher M. O’Meara, Joseph M. Gregory, Erin Callan, and Ian Lowitt. Fuld was Lehman’s chairman and chief executive officer at all relevant times. O’Meara was its chief financial officer, controller and executive vice president from 2004 until December 1, 2007, when he became global head of risk management. Gregory was Lehman’s president and chief operating officer until June 12, 2008. Callan served as its chief financial officer and executive vice president from December 1, 2007, until June 12, 2008. Lowitt succeeded Callan as chief financial officer on June 12, 2008, and served in that capacity until Lehman filed for bankruptcy on September 15, 2008. Fuld and O’Meara signed the Registration Statement. The Director Defendants are nine former Lehman directors, each of whom signed the Registration Statement in that capacity. Defendant Ernst & Young LLP (“E & Y”) was Lehman’s outside auditor. It audited Lehman’s financial statements for the 2007 fiscal year and reviewed Lehman’s interim financial statements during the Class Period. The Underwriter Defendants are fifty-one entities, each of which allegedly underwrote one or more of the offerings in which the securities at issue were purchased. UBS Financial Services Inc. (“UBS”), one of the Underwriter Defendants, underwrote all of the structured product securities listed in TAC Appendix B, as well as some securities listed in TAC Appendix A. UBS is thfe only entity sued under Securities Act Section 12. Relevant Non-Party Lehman was a global investment bank, headquartered in New York, the common stock of which was traded on the New York Stock Exchange. It filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code on September 15, 2008. It is not a defendant in this case. Prior-Proceedings Plaintiffs have filed many complaints in this multidistrict proceeding, the most significant of which was Second Amended Class Action Complaint for Violations of the Federal Securities Laws (“SAC”). The SAC asserted claims under Sections 11, 12, and 15 of the Securities Act as well as under Exchange Act Sections 10(b), 20(a), 20A, and Rule 10b-5 against the Insider Defendants, the Director Defendants, and the Underwriter Defendants, principally on the theory that the Offering Materials were misleading in that they overstated Lehman’s financial condition by failing to disclose properly the value and allegedly risky nature of Lehman’s exposure to mortgage and real-estate related assets. It did not name E & Y as a defendant. On April 27, 2009, the defendants moved to dismiss the SAC for failure to state a claim on which relief could be granted. On January 26, 2010, after the motions were briefed fully, the Court heard oral argument and reserved decision. On March 11, 2010, while the motions to dismiss were pending, the court-appointed examiner in the Lehman bankruptcy proceeding issued a nine-volume report on his investigation of Lehman. At a subsequent conference, the Court learned that plaintiffs intended to amend the SAC in light of the report. Consequently, the Court denied without prejudice the then-pending motions to dismiss and granted plaintiffs leave to amend the SAC. Plaintiffs filed the TAC on April 23, 2010. The TAC The Securities Act and Exchange Act claims both allege that the Offering Materials and the financial statements they incorporated by reference contained false and misleading statements with respect to Lehman’s: • use of “Repo 105” transactions, which it alleges Lehman used to reduce artificially its net leverage, • risk management practices, • liquidity risk, and • significant concentrations of credit risk. The Exchange Act claims allege also that former Lehman officers made false and misleading statements of the same character, while the Securities Act claims allege also two additional bases of Securities Act liability — that the Offering Materials overvalued Lehman’s commercial real estate holdings and, insofar as they related to PPNs, were materially misleading because they promised but did not provide “principal protection.” The Exchange Act Section 10(b) and Rule 10b-5 claims are asserted against the Insider Defendants and E & Y. The TAC asserts also Section 20(a) Exchange Act claims against the Insider Defendants and a Section 20A insider trading claim against Fuld alone. The Securities Act claims are premised on Sections 11, 12(a)(2) and 15. The Section 11 claims are asserted against all defendants except Gregory and Lowitt. The Section 12(a)(2) claims are asserted against only defendant UBS and are based on the alleged misstatements in the Structured Product Offering Materials only. The Section 15 claims are asserted against former Lehman officers Fuld, O’Meara, Callan, Gregory, and Lowitt. Repo 105 Allegations concerning a type of transaction known as a “Repo 105,” and its effect on Lehman’s net leverage, are critical to many of the TAC’s claims. “Repo” is short for repurchase agreement. A repo is a two-step transaction that may be used to obtain short-term funding. In the first step, the entity needing funds — the transferor — transfers securities or other assets to a counter-party in exchange for cash. It concurrently agrees to reacquire the transferred assets at a future date for an amount equal to the cash exchanged plus an agreed-upon charge that may be analogized to, and are here referred to, as interest. In the second stage, the transferor pays the counter-party the original cash amount plus the agreed-upon interest, and the counter-party returns the originally transferred assets. The repo thus is like a loan. In the first step, the counter-party provides cash to the transferor in exchange for a promise by the transferor to repurchase the transferred assets. In the second step, the transferor repays the counter-party with interest and gets its collateral back. The length of time between the initial transfer and the repurchase date can vary, as can the interest and the transferee’s ability to use the assets while the repo is in place. The TAC alleges that Lehman used two types of repo transactions. It calls the first an “Ordinary Repo.” It alleges that Lehman accounted for the Ordinary Repos as financings, recording the cash it received from counter-parties as assets and its obligations to repurchase the securities plus the interest as liabilities. The collateral — the transferred assets — remained on Lehman’s balance sheet as assets. Hence, Ordinary Repos, depending upon whether Lehman held the financing proceeds or used them to reduce other debt, increased or did not change Lehman’s reported net leverage. The effect of this accounting was to keep the transferred assets on Lehman’s balance sheet and increase its reported net leverage. The second type of repo transaction was known as a “Repo 105.” Repo 105 transactions involved the same two steps as Ordinary Repos. But Lehman treated them differently for financial reporting purposes. The asset that was the.collateral of a Repo 105 was treated as though it actually had been sold and therefore removed from Lehman’s balance sheet. Further, Lehman then used the cash received from Repo 105 transactions to pay down other existing liabilities. This practice decreased its net leverage ratio because it reduced the numerator in the ratio (net assets) by (a) the “sale” of the “collateral,” and (b) the use of the cash thus obtained to pay down other debt, while having no effect on the denominator (tangible equity). Plaintiffs allege that Lehman repeatedly used Repo 105 transactions near the ends of its quarterly reporting periods solely to lower its net leverage. They allege also that Lehman’s net leverage was an important financial metric because it was an indicator of the company’s ability to absorb any losses sustained by its riskiest assets A lower net leverage indicated that Lehman was better positioned to absorb such losses than did a higher net leverage. The effect of the Repo 105 transactions therefore allegedly was to present Lehman as being in a stronger financial position than it actually was. Lehman’s lower reported net leverage at the end of each quarter allegedly did not last long. Shortly after each quarter closed, Lehman allegedly executed the second step of the Repo 105 transactions, transferring cash to the counter-parties in the amounts it initially had paid plus the agreed-upon interest and reacquiring the assets it had transferred. Lehman then restored the assets to its balance sheet, returning its net leverage to the pre-Repo 105 level. The entire process allegedly was repeated prior to the next quarterly reporting date. Allegedly Misleading Statements The TAC alleges that defendants made material misstatements and omissions in the Offering Materials and Lehman SEC filings, which were incorporated in them, and in oral statements during telephone calls. Net Leverage Ratio The TAC makes a number of allegations regarding Lehman’s portrayal of its net leverage ratio at the end of each fiscal quarter. Lehman’s filings and defendants O’Meara, Callan, Lowitt, and Fuld on other occasions represented the company’s quarter-ending net leverage ratio at various levels, each in the range of 10.6 to 16. 1, from the summer of 2007 through the fall of 2008. The TAC alleges that these representations were false and materially misleading because the ratio had been reduced artificially by the Repo 105 transactions. “Securities Sold Under Agreements to Repurchase ” Lehman’s SEC filings stated that the amounts that the company had in “securities sold under agreements to repurchase” were as follows: $153.332 billion (1Q07), $137.948 billion (2Q07), $169.302 billion (3Q07), $181.732 billion (2007 10-K), $197.128 billion (1Q08), and $127.846 billion (2Q08). They stated further that such securities were “treated as collateralized agreements and financings for financial reporting purposes.” The TAC alleges that these statements were false and materially misleading because the financial statements “failed to disclose that, through Lehman’s Repo 105 program, tens of billions of dollars in securities sold each quarter pursuant to agreements to repurchase were not treated as ‘financings for financial reporting purposes’ but were treated as sales by Lehman.” Risk Approach A number of the alleged misrepresentations pertained to Lehman’s risk practices. The 2007 quarterly reports represented that “[decisions on approving transactions ... take into account ... importantly, the impact any particular transaction under consideration would have on our overall risk appetite.” They stated also that Lehman “ensure[d] appropriate risk mitigants were in place.” On several occasions, Lehman professed to “use stress testing to evaluate risks associated with [its] real estate portfolios.” And, throughout 2007 and 2008, the company’s filings represented that Lehman “monitor[ed] daily trading net revenues compared to reported historical simulation VaR [value at risk].” Lehman purported to “monitor and enforce adherence to [its] risk policies.” Specifically, the 2007 and 2008 financial reports stated that the company’s “Finance Committee oversees compliance with [risk management] policies and limits.” During a September 18, 2007 conference call, O’Meara stated that Lehman had a “strong risk management culture with regard to the setting of risk limits.” Later, at a November 14, 2007 investor conference, Lowitt stated that Lehman showed substantial growth in challenging markets by, inter alia, having an “extremely deep risk culture” and being “very conservative around risk.” On a December 13, 2007 call, O’Meara attributed the quarterly results, in part, to “the strength of [Lehman’s] risk management culture in terms of managing [its] overall risk appetite, seeking appropriate risk reward dynamics and exercising diligence around risk mitigation.” During the same call, Callan attributed Lehman’s financial success to its “strong risk and liquidity management.” And, on a March 18, 2008 conference call, Callan professed Lehman’s “continued diligence around risk management.” The TAC alleges that Lehman’s statements about its risk policies materially misled investors because the company, while making these representations, in fact was “pursuing] an aggressive growth strategy that caused [Lehman] to assume significantly greater risk” “in 2006 and at the outset of 2007.” Briefly stated, the alleged “strategy focused heavily on acquiring and holding commercial real estate, leveraged loans and private equity assets — areas that entailed far greater risk and less liquidity than Lehman’s traditional lines of business.” Liquidity The TAC alleges that Lehman made a number of misstatements and omissions pertaining to its liquidity. Lehman’s 2007 and 2008 SEC filings repeatedly stated that the company “maintain[ed] a liquidity pool ... that covers expected cash outflows for twelve months in a stressed liquidity environment.” Defendants allegedly spoke highly of Lehman’s liquidity throughout the Class Period. During the September 18, 2007 conference call, O’Meara stated that Lehman had a “strong liquidity framework” and “strong [ ] liquidity management,” and that Lehman’s liquidity position “is now stronger than ever” and provided the company with a “competitive advantage.” During the December 13, 2007 conference call, Callan and O’Meara each made statements assessing the strength of Lehman’s liquidity position. On the March 18, 2008 conference call, Callan “tried to relay the strengths and robustness of [Lehman’s] liquidity position,” and stated that the company’s liquidity pool was structured to “cover expected cash outflows for the next 12 months ... without being able to raise new cash” and that Lehman had taken “care of [its] full year needs for capital” through a February preferred stock offering. And, during the June 16, 2008 conference call, Fuld and Lowitt stated that “Lehman’s liquidity position had ‘never been stronger.’ ” Plaintiffs allege that these statements were false and misleading. Specifically, the TAC alleges that the statements failed to disclose Lehman’s significant concentration of credit risks and the impact that the Repo 105 transactions had on Lehman’s liquidity. Accounting Practices The TAC alleges numerous misrepresentations and omissions regarding Lehman’s accounting and E & Y’s audit and financial statement opinions. Throughout 2007 and 2008, Lehman represented that its financial statements were “prepared in conformity with” GAAP and that E & Y, having reviewed Lehman’s financial statements, was “not aware of any material modifications that should be made to [the statements] for them to.be in conformity with” GAAP. E & Y’s report on Lehman’s fiscal 2007 financial statements stated that it had conducted its audit in accordance with GAAS and opined that they had been prepared in accordance with GAAP and that they fairly presented the financial condition of the company. Fuld, O’Meara and/or Callan certified that the 2007 and 2008 financials “fairly presented] in all material respects” Lehman’s financial condition and did not contain any misleading statements or omissions. The TAC alleges that these statements were false or misleading. Discussion I. Legal Standard In deciding a motion to dismiss, a court ordinarily accepts as true all well pleaded factual allegations and draws all reasonable inferences in the plaintiffs favor. In order to survive such a motion, however, “the plaintiff must provide the grounds upon which [its] claim rests through factual allegations sufficient ‘to raise a right to relief above the speculative level’ ” and “state a claim for relief that is plausible on its face.” In deciding a motion to dismiss, a court considers the complaint and “any written instrument attached to the complaint, statements or documents incorporated into the complaint by reference, legally required public disclosure documents filed with the SEC, and documents possessed by or known to the plaintiff and upon which it relied in bringing the suit.” If matters outside the pleadings are presented and not excluded, Rule 12(d) ordinarily requires a court to convert the motion to dismiss into one for summary judgment and to provide the parties with the opportunity to present all pertinent materials. That Rule, however, is aimed at ensuring that the plaintiff has notice of what the court might consider in deciding the motion. The need to convert a Rule 12(b)(6) motion into a summary judgment motion “is largely dissipated,” however, when “plaintiff has actual notice of all the information in the movant’s papers and has relied upon these documents in framing the complaint.” This is particularly true for documents that are “integral to the complaint,” but that the plaintiff has chosen not to attach or incorporate by reference. In addition, a document that is integral to a complaint in the sense that the plaintiff had actual notice of and relied upon it in framing the complaint, is properly considered, albeit not for the truth of the matters asserted, notwithstanding that it has not been attached to or incorporated by reference into the complaint. The parties dispute the question whether the nine-volume Examiner’s Report is properly before the Court on the theory that it effectively has been incorporated by reference in the TAC. This appears to be relevant only to the effort of some defendants to obtain dismissal based on the assertion that the facts and conclusions in the Report affirmatively demonstrate that they acted with due diligence and therefore may not be held liable under the Securities Act. In view of the fact that the Report, even if it is integral to the TAC, could not properly be considered for the truth of the matters asserted, the point is academic. In any case, for reasons discussed below, the Examiner’s Report would not warrant dismissal of any claims based on the due diligence defense even if its statements and conclusions properly were considered for their truth. II. Standing The TAC purports to assert claims based on fifty PPN offerings in which no named plaintiff purchased a security. Defendants challenge plaintiffs’ standing to pursue these claims. Standing is an essential prerequisite to Article III jurisdiction. The standing inquiry has three elements: a “plaintiff must allege [1] personal injury [2] fairly traceable to the defendant’s allegedly unlawful conduct and [3] likely to be redressed by the requested relief.” As this Court previously has stated, a plaintiff does not suffer an injury in fact— and therefore has no standing to assert claims — in consequence of false or misleading statements in offering materials for securities that it did not purchase. As no named plaintiff is alleged to have purchased securities in these fifty PPN offerings, the plaintiffs have no standing to pursue claims based on them. Plaintiffs argue that they have standing to assert claims based on the fifty PPN offerings notwithstanding the fact that no named plaintiff purchased them because each PPN was offered pursuant to “common prospectuses [that] incorporated the [common] SEC filings that contained the misstatements and omissions,” “the false and misleading statements were the same for each Offering,” and because “all investors ... were personally injured by the same false or misleading statements made by the same defendants.” This Court and others have rejected this argument and plaintiffs have provided no authority that undermines that conclusion. For the reasons stated there, the plaintiffs have no standing to bring claims with respect to the fifty PPN offerings in which they did not purchase securities. III. Exchange Act Claims A. The Standard In order to state a claim under Section 10(b) of the Exchange Act and Rule 10b-5, a plaintiff must allege that “the defendant, in connection with the purchase or sale of securities, made a materially false statement or omitted a material fact, with scienter, and that the plaintiffs reliance on the defendant’s action caused injury to the plaintiff.” A misstatement or omission is actionable only if “material.” A misrepresentation is material if “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to [act].” That is, “ ‘there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.’ ” Moreover, not every material omission violates the Exchange Act. For example, an omission is actionable only if the speaker had a duty to disclose. Such a duty can arise either (1) from an “affirmative legal disclosure obligation” or (2) if “necessary to prevent existing disclosures from being misleading.” Finally, an expression of opinion is actionable only if “the complaint alleges that the speaker did not truly have the opinion at the time it was issued” or, perhaps, if the speaker expressed the opinion with the knowledge that, or in reckless disregard of whether, the speaker had any basis for it. The TAC asserts primary claims against the Insider Defendants and E & Y for alleged violations of Sections 10(b) of the Exchange Act and Rule 10b-5. It advanees also control person claims against the Insider Defendants under Section 20 and a claim for insider trading against Fuld under Section 20A. As the statements and omissions that form the basis of the claims against the Individual Defendants and E & Y, respectively, are different, it is convenient first to deal with the sufficiency of the allegations of falsity and scienter with respect to the individual defendants and then to deal with the same issues with respect to E & Y. The issue of loss causation is similar as to all defendants and is dealt with collectively thereafter. B. Individual Defendants 1. Existence of materially false and misleading statements or omissions In order to state a claim for a violation of Exchange Act Section 10(b) or Rule 1 Ob-5, plaintiffs must allege the existence of an actionable material misstatement or omission. The allegations must satisfy the heightened pleading standards of Rule 9(b) and the Private Securities Litigation Reform Act (“PSLRA”). Accordingly, the TAC must “(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent.” The TAC’s Exchange Act claims are based on four categories of alleged misstatements and omissions. It alleges that Lehman and its officers made misleading statements with respect to Lehman’s (1) use of and accounting for Repo 105 transactions and their effect on net leverage, (2) risk management policies, (3) liquidity, and (4) concentrations of credit risk. The misstatements and omissions allegedly were in the 2Q07, 3Q07, 2007 10-K, 1Q08, 6/9/08 8-K, 6/18/08 8-K, 2Q08 and on several specifically identified conference calls by Lehman’s officers. a. Repo 105 and net leverage The Offering Materials stated (1) Lehman’s net leverage and amount of securities it sold under agreements to repurchase as of the end of each quarter, (2) that Lehman prepared its financial statements in accordance with GAAP, and (3) that Lehman treated securities sold under repurchase agreements as financings. O’Meara, Callan, Lowitt, and Fuld also made similar statements regarding Lehman’s reported net leverage. Defendants allegedly made statements also concerning how Lehman’s business practices impacted its net leverage. During a June 9, 2008 conference call, Callan stated that a large part of Lehman’s quarterly net leverage reduction came from selling “less liquid asset categories” and that Lehman’s deleveraging was “complete.” In response to a question about whether the deleveraging had come from disposing of the assets that were “absolute easiest ... to sell,” she stated that the opposite was true and that Lehman had sold many riskier, less liquid assets during the quarter. Similarly, on a June 16, 2008 conference call, Lowitt represented that the methods Lehman had used to reduce its leverage “included a reduction of assets across the Firm, including residential and commercial mortgages.” The 2Q08 stated also that Lehman’s reduction in net leverage came, in part, from a “reduction in assets.” The TAC alleges that these statements were false and misleading because Lehman (1) accounted for the Repo 105 transactions as sales rather than financings in violation of GAAP, (2) failed to disclose its use of Repo 105 transactions and its temporary effect of reducing Lehman’s net leverage, and (3) presented a misleading picture of the company in violation of GAAP. The defendants argue that the claims based on these statements should be dismissed because (1) the financial statements complied with GAAP, and (2) any alleged misstatements were immaterial. (1) SFAS U0 Plaintiffs first allege that the statements regarding Lehman’s reported net leverage ratio, securities sold under agreements to repurchase, and GAAP compliance were false and misleading because Lehman accounted for the Repo 105 transactions as sales rather than as financings in alleged violation of SFAS 140. SFAS 140 contains “standards for accounting for securitizations and other transfers of financial assets and collateral.” Under SFAS 140, whether a transferred asset properly is accounted for as a sale or a financing is dependent on the degree of control that the transferor has over the asset. If the transferor retains control, as that term is defined in SFAS 140, over the asset, it should recognize the asset on its balance sheet. If the transfer- or surrenders control, “those assets shall be accounted for as a sale” and “derecognize[d].” A transferor surrenders control over a transferred asset — -and therefore may treat the transaction as a sale — only if: “a. The transferred assets have been isolated from the transferor — put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership ... “b. Each transferee ... has the right to pledge or exchange the assets ... it received, and no condition both constrains the transferee (or holder) from taking advantage of its right to pledge or exchange and provides more than a trivial benefit to the transferor ... [and] “e. The transferor does not maintain effective control over the transferred assets through either (1) an agreement that both entitles and obligates the transferor to repurchase or redeem them before their maturity ... or (2) the ability to unilaterally cause the holder to return specific assets, other than through a cleanup call.” Plaintiffs allege that the Repo 105 transactions did not comply with SFAS 140’s requirements because (1) Lehman was obligated contractually to repurchase the Repo 105 assets, (2) the transactions lacked a business purpose or economic substance, and (3) Lehman was not able to obtain a “true sale at law” opinion from a U.S. law firm, but only from Linklaters, a U.K. law firm. These allegations are insufficient to make out a violation of SFAS 140 with respect to Lehman’s accounting treatment of Repo 105s for three reasons. First, although Lehman’s alleged contractual obligation to repurchase the transferred Repo 105 assets initially might be thought to violate SFAS 140’s requirement that the “transferor [not] maintain effective control over the transferred assets through ... an agreement that both entitles and obligates the transferor to repurchase” them, closer inspection reveals otherwise. A transferor maintains effective control over an asset pursuant to such an agreement only if, inter alia, “the transferor is able to repurchase [the assets] on substantially the agreed terms, even in the event of default by the transferee.” This occurs only if “at all times during the contract term [the transferor] ha[s] obtained cash or other collateral sufficient to fund substantially all of the cost of purchasing replacement assets from others.” The TAC, however, fails to allege that Lehman obtained funds in the Repo 105 transactions sufficient to replace the transferred assets from others. Indeed, it alleges the opposite, as the Repo 105 transactions were over-collateralized by a minimum of five percent. That is, Lehman transferred at least $105 in assets to its counter-parties for every $100 in cash it received. Accordingly, Lehman did not obtain cash or other collateral in these transactions sufficient to fund “substantially all” of the cost of replacing the assets it had transferred to its counter-parties in the event of counter-party default. It therefore did not maintain effective control over them within the meaning of SFAS 140. Second, nothing in SFAS 140 suggests that the business purpose of a transfer has any bearing on whether it should be treated as a sale or as a financing. According to SFAS 140, the guiding principle is whether the transferor has retained control over the asset. Thus, an allegation that Lehman had less expensive means of obtaining financing says nothing about whether its accounting treatment of the Repo 105 transactions was consistent with GAAP. Third, the fact that Lehman allegedly was unable to obtain a “true sale at law” opinion from a U.S.-based law firm does not call into question the conclusion of U.K.-based Linklaters that the transactions were, in fact, trae sales at law under U.K. law. Nothing in SFAS 140 requires the true sale at law opinion to be based on U.S. law. As plaintiffs have failed to allege any manner in which Lehman violated SFAS 140 in treating the Repo 105 transactions as sales rather than financings, it has failed to allege a material misstatement or omission on this basis. (2) Compliance with GAAP The fact that Lehman’s accounting for the Repo 105 transactions technically complied with SFAS 140 does not mean that Lehman’s financial statements complied with GAAP. As the Court of Appeals has stated, “GAAP itself recognizes that technical compliance with particular GAAP rules may lead to misleading financial statements, and imposes an overall requirement that the statements as a whole accurately reflect the financial status of the company.” Plaintiffs assert that this is such a case, alleging that the financial statements incorporated into Lehman’s Offering Materials and the Insider Defendants’ oral statements were false and misleading because the Repo 105 transactions temporarily and artificially lowered the company’s reported net leverage at the end of each reporting period. As noted earlier, net leverage measures the ratio of net assets to tangible equity capital. Cash was among Lehman’s net assets. In a Repo 105 transaction, Lehman removed the collateral from its balance sheet, thereby reducing its net assets. It then used the cash it received to pay down other liabilities. In consequence, the Repo 105 transactions reduced the amounts of Lehman’s net assets while leaving its tangible equity capital unchanged. This resulted in lower net leverage. The TAC alleges that Lehman was obligated to, and did, repurchase the assets from the Repo 105 counter-parties in the days after each quarter ended, increasing its net assets without any change to tangible equity capital and resulting in increases in net leverage. This repetitive, temporary, and undisclosed reduction of net leverage at the end of each quarter is sufficient to make out a claim that the Offering Materials and oral statements about net leverage violated the overriding GAAP requirement to present the financial condition of the company accurately, assuming the changes in net leverage that resulted from the Repo 105 transactions were material. Whether the changes in net leverage were material is a “fact-specific inquiry.” “[I]t is not necessary to assert that the investor would have acted differently if an accurate disclosure was made.” Instead, a fact is material if “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to [act]” or “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” The materiality determination “depends on all relevant circumstances” and a “complaint may not properly be dismissed ... on the ground that the alleged misstatements or omissions are not material unless they are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance.” Defendants contend that the changes in net leverage due to the Repo 105 transactions were immaterial as a matter of law because (1) the Offering Materials warned that Lehman’s financial statements would fluctuate, (2) the Offering Materials accurately reported Lehman’s total — as opposed to net — leverage, (3) the Repo 105 transactions were insignificant as compared to Lehman’s total liabilities, and (4) Lehman could have sold the assets involved in the Repo 105 transactions and used the proceeds to pay down other liabilities. Defendants’ strongest argument is that Lehman’s Offering Materials “bespoke caution,” rendering the allegedly misleading net leverage figures immaterial, because they disclosed that the “overall size” of Lehman’s balance sheet would “fluctuate from time to time [and might] be higher than the year-end or quarter-end amounts.” Alleged misstatements may be immaterial, and therefore not actionable, when “it cannot be said that any reasonable investor could consider them important in light of adequate cautionary language set out in the same offering.” Cautionary statements, however, must expressly warn of and relate directly to the risk that allegedly brought about the plaintiffs’ loss. The cautions to which defendants point warned only of the risk that the “size” of Lehman’s balance sheet might be different at quarter or year-end than at other times. This disclosure, however, was not sufficiently specific or prominent to support a conclusion as a matter of law that no reasonable investor would have found it important to know that Lehman engaged in transactions, the effect of which was to reduce temporarily its net leverage at the end of each reporting period. Defendants’ other materiality arguments also are insufficient. Lehman’s accurate disclosures of its total leverage may have been relevant and ultimately may even have been more important to investors than net leverage. But the argument that the Offering Materials’ disclosure of total leverage rendered the allegedly misleading net leverage ratios immaterial is undercut significantly by Lehman’s assertions that net leverage is “a more meaningful, comparative ratio for companies in the securities industry” than total leverage ratio and that Lehman considered “material,” for purposes of reopening its financial statements, changes in its financial reporting that affected net leverage by 0.1 or more. Moreover, the fact that the Repo 105 transactions were approximately six percent of Lehman’s total liabilities did not render the statements immaterial as a matter of law. Materiality is not determined by “a single numerical or percentage benchmark,” but must be considered in all relevant circumstances. Here, plaintiffs have alleged that net leverage was a significant financial metric for “securities analysts, credit agencies and investors” during the Class Period. They have alleged also that the Repo 105 transactions resulted in net leverage differences more than fifteen times the difference that Lehman itself considered material. Finally, the argument that the allegedly misleading net leverage numbers were immaterial because Lehman could have conducted a true sale of the assets it used in the Repo 105 transaction and used the proceeds to pay down the debt is not persuasive. Lehman perhaps could have reduced its net leverage by selling the assets it transferred in the Repo 105 transactions and using the proceeds to reduce its liabilities. But the TAC does not allege that Lehman’s net leverage numbers were false and misleading because they were reduced from the pre-Repo 105 levels. It alleges that they were false and misleading because they were reduced from that level and because they returned to higher levels shortly after each quarter ended. Had Lehman engaged in true sales of those assets, it would have had no obligations to repurchase the collateral and thus undo its net leverage reductions. (S) Treating Repo 105 transactions as sales The financial statements incorporated into Lehman’s Offering Materials stated that Lehman recorded securities sold under agreements to repurchase as “financings.” The TAC alleges that this statement was false and misleading because Lehman treated the Repo 105 transactions as sales. Defendants make two arguments for dismissal of the claims based on these statements. They argue first that SFAS 140 required that the Repo 105 transactions be treated as sales. But the fact that SFAS 140 may have required that the Repo 105 transactions be treated as sales would not remedy the allegedly misleading nature of Lehman’s statement that it treated assets sold under agreements to repurchase as financings. Defendants next argue that the Offering Materials disclosed, on the page immediately prior to the alleged misstatements, that Lehman would treat transfers of assets as sales when it had surrendered effective control in accordance with SFAS 140. But that statement does not save the day, at least in the present posture of the case. First, it purported to describe Lehman’s treatment of “[sjecuritization activities,” not transfers pursuant to repurchase agreements, which were discussed in a separate and subsequent section. Second, the statement complained of was more general than the allegedly misleading statement, which expressly dealt with repurchase agreements and said that securities “sold” under repurchase agreements were treated as financings. At this stage, the Court cannot conclude as a matter of law that this disclosure sufficiently warned that an asset transferred pursuant to a repurchase agreement might be treated as a sale. (Ip) Failure to disclose Repo 105 transactions Plaintiffs next allege that the Offering Materials and officers’ oral statements were materially false and misleading because they omitted to disclose the Repo 105 transactions. An omission is actionable only if the speaker had a duty to disclose. Such a duty exists if (1) there is an “affirmative legal disclosure obligation” or (2) disclosure is “necessary to prevent existing disclosures from being misleading.” Plaintiffs allege that Lehman was required to disclose the Repo 105 transactions because (1) its reported net leverage was materially misleading without the disclosure, and (2) Item 303 of Regulation S-K (“Item 303”) in this case required it. Defendants contend that Lehman had no duty to disclose the Repo 105 transactions. The federal securities laws impose an obligation on speakers to be both accurate and complete. While a corporation “is not required to disclose a fact merely because a reasonable investor would very much like to know” it, it has an obligation to do so when “secret information renders prior public statements materially misleading.” Thus, a speaker has a duty to disclose if “disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information available.” Accordingly, a statement of principal investment risks does not create an obligation to disclose the commonly understood risks associated with securities. By contrast, a statement regarding a company’s hedging strategy obliges it to disclose when it alters or suspends that strategy. The Offering Materials stated Lehman’s net leverage ratios, as did many of the officers’ oral statements. The TAC alleges that these statements were materially misleading because they omitted to disclose the fact that Lehman’s reported net leverage was temporarily and artificially reduced as a result of the Repo 105 transactions. The TAC makes factual allegations supporting an inference that such a disclosure would have been material to a reasonable investor. At this stage of the litigation, such allegations are sufficient. As plaintiffs sufficiently have alleged that Lehman had a duty to disclose the Repo 105 transactions based on its statements regarding net leverage, the Court need not here address whether Item 303 of Regulation S-K would have required their disclosure. b. Risk management policies The Offering Materials contained disclosures about Lehman’s risk management policies, including statements that Lehman “monitor[ed] and enforced] adherence to [its] risk policies,” “ensure[d] that appropriate risk mitigants [we]re in place,” took “into account ... the impact any particular transaction under consideration would have on [Lehman’s] overall risk appetite,” used “stress tests” to determine the financial consequences of an economic shock to its portfolio, and “monitor[ed] daily trading net revenues compared to reporting historical simulation VaR [value at risk] limits.” Lehman’s officers made statements with respect to Lehman’s risk management polices as well. O’Meara repeatedly made statements to the effect that Lehman had “strong [ ] risk management” and a “strong risk management culture with regard to the setting of risk limits.” Lowitt stated that Lehman had an “extremely deep risk culture which is embedded through the firm,” that Lehman was “very conservative around risk,” and tried not to “hold[ ] stuff on [its] balance sheet ... but move[ ] it on.” Callan similarly made statements on several occasions about Lehman’s “strong risk ... management.” The TAC alleges that these statements were material to investors because Lehman’s “risk management was critical to loss prevention,” and that they were false because Lehman acquired billions of dollars of illiquid, risk assets by failing to abide by its policies. (1) Exceeding risk limits The Offering Materials stated that Lehman “monitor[ed] and enforc[ed] adherence to [its] risk policies” and that “[m]anagment’s Finance Committee oversees compliance with policies and limits.” O’Meara, Lowitt, and Callan also made statements regarding Lehman’s allegedly “strong” and “conservative” risk management policies. The TAC alleges that these statements were materially false and misleading because Lehman “routinely” overruled and disregarded its risk policy limits on the company’s total risk appetite and its balance sheet, concentration, and single transaction limits. Plaintiffs claim that Lehman exceeded its risk appetite limit every month from July 2007 to February 2008, committed to many deals exceeding the single transaction limit thresholds, and imposed no limit on its leveraged loan bridge equity commitments. They further allege that Lehman’s fixed income division (“FID”) and global real estate group (“GREG”) exceeded their balance sheet limits at the ends of many quarters within the class period. Defendants argue that these allegations fail to state a claim because the alleged excesses complied with Lehman’s risk management policies. They contend that those policies were not static, but could be altered by management. They rely on disclosures in the Offering Materials that the risk management policies were “established by management’s Executive Committee,” which “balane[ed] risks and returns” in their formulation. They note also that the Offering Materials disclosed that specific “transactions and/or situations [were] addressed and discussed with management’s Executive Committee when appropriate.” Even assuming that Lehman’s risk management policies were not static and properly could be altered by the Executive Committee in a way that would permit the previous policies to be exceeded, the TAC sufficiently alleges that the statements that Lehman “enforced] adherence to [its] risk policies” and that “[m]anagment’s Finance Committee oversees compliance with [risk] policies and limits” arguably were materially misleading. The TAC’s allegations, assumed here to be true, establish that Lehman routinely exceeded various risk limits it had created. The (assumed) fact that Lehman’s Executive Committee routinely revised the established risk limits to permit these excesses is at best in considerable tension with its statement that Lehman “enforc[ed] adherence to [its] risk policies.” Stated differently, it would be materially misleading for a company to claim that it “enforce[d] adherence” to its risk management policies while failing to disclose that it “routinely” alters them as the TAC alleges Lehman to have done. Moreover, given the allegations of frequent, significant departures from Lehman’s internally stated policies, there is enough in the TAC to permit the inference that its senior officers’ statements to the effect that Lehman had “strong” and “conservative” risk management were false in the sense that these individuals knew or recklessly disregarded their misleading effect. (2) Adequacy ofmitigants The Offering Materials stated that Lehman “ensure[d] that appropriate risk mitigants” were in place. The TAC alleges that this statement was false and misleading because Lehman failed to do so, as evidenced by its accumulation of Alt-A residential mortgage assets that could not be directly hedged, its failure to increase its “macro hedges” on its leveraged loan and commercial real estate portfolios, and its relaxation of risk controls to accommodate the growth of its commercial real estate business. These allegations are insufficient to state a claim. The question whether a particular risk mitigant was appropriate when implemented is inherently a matter of judgment or opinion. In order sufficiently to allege that Lehman’s statement that it ensure[d] appropriate risk mitigants were in place was false, plaintiffs were obliged to allege facts that would support a plausible inference that Lehman did not believe that it had done so or, at least, that it was reckless in believing that it had appropriate measures in place. The TAC is devoid of any such allegations and therefore fails to state a claim on this basis. (S) Stress tests The Offering Materials stated that Lehman used “stress testing to evaluate risks associated with [its] real estate portfolios.” Plaintiffs contend that this statement was materially false and misleading because “Lehman excluded some of its most risky principal investments — including commercial real estate investments, private equity investments, and leveraged loan commitments — from its stress tests.” Defendants’ sole responsive argument is that these statements, considered in context, were not false or misleading because the Offering Materials disclosed that Lehman used stress testing only with respect to “certain products.” This argument is insufficient to dismiss the claims based on these statements at this stage for at least two reasons. First, the “certain products” statement on which defendants rely was not made in each of the financial statements containing the allegedly misleading statement. It did not qualify the alleged misstatement in those Offering Materials in which it was not made. Second, the Court cannot conclude as a matter of law that the disclosure on which defendants’ rely rendered the allegedly misleading statement not misleading. The full text of the purported warning stated that “[s]tress testing, which measures the impact on the value of existing portfolios of specific changes in market factors for certain products, is performed with regularity.” It was located within a paragraph on a different page from the allegedly misleading statement. That paragraph contained a discussion of the various qualitative and quantitative measures that Lehman used to measure risk. It stated, essentially, that stress testing was used for certain products and that other method were used for others. One of the products for which stress testing was said to have been used was Lehman’s “real estate portfolios.” But plaintiffs have alleged that Lehman excluded, among others, its commercial real estate investments— inarguably part of its real estate portfolio — from stress testing. This sufficiently alleges an actionable misstatement at this stage. (k) Value-at-Risk Value-aL-Risk (“VaR”) is “a statistical measure of the potential loss in the fair value of a portfolio due to adverse movement in the underlying risk factors.” The Offering Materials stated that, “[a]s part of [its] risk management control processes, [Lehman] monitor[ed] daily trading net revenues, compared with reported historical simulation VaR as of the end of the prior business day.” They stated also that, in the 2007 fiscal year, there were “four days ... when [Lehman’s] daily net trading loss exceeded [its] historical simulation VaR as measured at the close of the previous business day” and that “[i]n the quarter ended February 29, 2008, there were no days when daily net trading loss exceeded historical simulation VaR as measured at the close of the previous business day.” The TAC alleges that these statements were false and misleading because Lehman and at least three of its business lines — High Yield, FID, and GREG — “routinely exceeded” their respective VaR limits, and Lehman breached its firm-wide VaR limit on 44 occasions, during the class period. The factual allegations of routine breaches of VaR limits by these business lines and of more than two-score breaches by the firm as a whole are sufficient to permit a reasonable trier of fact to conclude that the statements in the Offering Materials were materially misleading, particularly in light of the suggestion in Lehman’s 2007 10-K that breaches of VaR limits were infrequent. c. Liquidity Many of the Offering Materials stated that Lehman had a “very strong liquidity position” and “maintain[ed] a liquidity pool ... that covers expected cash outflows for twelve months in a stressed liquidity environment.” O’Meara, Callan, Lowitt, and Fuld each made similar statements on investor conference calls. Plaintiffs allege that these statements were materially false and misleading because they failed, in violation of Item 303 of Regulation S-K (“Item 303”), to disclose Lehman’s obligations to repurchase the assets used in the Repo 105 transactions immediately after each quarter closed and because Lehman had “liquidity concerns” due to its accumulation of illiquid assets. With respect to liquidity, Item 303 required a registrant to disclose commitments and off-balance sheet arrangements only if they were reasonably likely to affect its liquidity in a material way. To state a claim, therefore, plaintiffs were required to allege that the Repo 105 transactions had a material effect on Lehman’s liquidity. Plaintiffs have failed to do so. Plaintiffs argue that the Repo 105 transactions affected Lehman’s liquidity in a material way because their dollar value exceeded the size of Lehman’s liquidity pool during the Class Period and that Lehman materially decreased its liquidity pool by exchanging cash for assets in the Repo 105 transactions. It is true that plaintiffs allege that the size of the Repo 105 transactions exceeded the size of the liquidity pool during the Class Period. Lehman’s liquidity pool, however, did not comprise cash alone. It contained also “highly liquid instruments, including cash equivalents, G-7 government bonds and U.S. agency securities, investment grade asset and mortgage — backed securities and other liquid securities that [it] believed had] a highly reliable pledge value.” The TAC alleges that the assets Lehman used as collateral in the Repo 105 transactions were “highly liquid.” Consequently, even assuming that Lehman used liquidity pool resources in the Repo 105 transactions — an assumption unsupported by any factual allegations — it is alleged only to have exchanged cash for the sorts of “highly liquid” assets held before the transactions were effected. The TAC accordingly fails to allege that the Repo 105 transactions had a material effect on Lehman’s liquidity. Plaintiffs’ allegations with respect to the strength and sufficiency of Lehman’s liquidity and the size of the liquidity pool also are insufficient. The TAC claims that those statements were false and misleading because Lehman (1) had predicted monthly cash deficits, (2) needed to provide additional collateral to Citibank and JP Morgan by June 9, 2008, and (3) had encumbered twenty