Harvey R. Miller Turnaround Management Association Berlin, Germany

1. Failure’s Footprint: Paradigms for Financial Reform In The Wake of Lehman Brothers And Other Cases Harvey R. Miller Turnaround Management Association Berlin, Germany

2. I. Is Lehman The Catalyst For Financial Reform? “Another line [of argument] consists in representing as causes things which are not causes, on the ground that they happened along with or before the event in question. They assume that, because B happens after A, it happens because of A. Politicians are especially fond of taking this line. Thus Demades said that the policy of Demosthenes was the cause of all the mischief, ‘for after it the war occurred.’” Aristotle, Rhetoric 1401b 30-33

3. I. Is Lehman The Catalyst For Financial Reform? “In most cases, federal bankruptcy laws provide an appropriate framework for the resolution of nonbank financial institutions. However, the bankruptcy code does not sufficiently protect the public’s strong interest in ensuring the orderly resolution of a nonbank financial firm whose failure would pose substantial risks to the financial system and to the economy. Indeed, after Lehman Brothers and AIG experiences, there is little doubt that we need a third option between the choices of bankruptcy and bailout for such firms.” - Ben S. Bernanke, Chairman of the Board of Governors of the Federal Reserve System, statement submitted to the Committee on Financial Services of the U.S. House of Representatives, October 1, 2009

4. I. Is Lehman The Catalyst For Financial Reform? Post hoc, ergo propter hoc September 15, 2008 – Lehman filed voluntary chapter 11 petition… • Dow Jones industrial average drops 504 points - Largest one day point loss since September 11, 2001 • Largest intra-day range (1,000+ points) • Merrill sold to Bank of America in $50 billion rescue transaction • Fears about A.I.G. heighten – shares plunge 60% • September 16, 2008: Federal Reserve loans A.I.G. $85 billion • September 20, 2008: Bush administration requests authority for Treasury to buy up to $700 billion in distressed mortgage assets • September 25, 2008: WaMu fails • September 29, 2008: • House rejects $700 billion economic rescue plan…Dow Jones industrial average falls 778 points • Citigroup agrees to takeover of collapsing Wachovia

5. I. Is Lehman The Catalyst For Financial Reform? Meanwhile…at the Bankruptcy Court… • September 15, 2008: Lehman’s chapter 11 case commences • September 15, 2008: Barclays contacts Lehman to express interest in purchase of Lehman’s North American capital markets and investment banking business • September 16, 2008: Motion filed requesting Bankruptcy Court approval of sale procedures and scheduling of sale hearing • September 17, 2008: Bankruptcy Court approves sale procedures and sets sale hearing for September 19, 2008 • September 19, 2008: As sale hearing commences, SIPC causes Lehman Brothers Inc. to be placed into proceeding under SIPA – both cases assigned to the same Bankruptcy Judge, and coordinated sale approved in both LBHI’s and LBI’s cases Within five days of Lehman’s failure, its core business was saved, jobs were preserved, and customer accounts were made accessible – all pursuant to the Bankruptcy Code, in a duly noticed, public hearing, and without the need to spend one cent of taxpayer funds!

6. I. Is Lehman The Catalyst For Financial Reform? “THE COURT: It's my job to do what the law permits in the exercise of my discretion. This week, more than any other week since I was appointed to the bench, I have felt the awesome power of this job. And it's now Saturday morning. I've given a lot of thought to the objections. I reviewed each one that I could get. They were flying in this afternoon one after another. And I categorized them in my mind and considered carefully whether it was permissible for me as a judge in this district to approve a transaction this momentous on such an extraordinarily fast schedule. And I gave consideration to the due process considerations that have been articulated in objections both orally and in writing. And I have concluded that this is really not a question of due process being denied. This is a question of due process being pursued in good faith by all parties to the transaction, even the objectors. It is a testament to the importance of this transaction that this courtroom is still packed. I have no idea what's going on in the overflow rooms. This is not an ordinary chapter 11 case. This is not simply approving the transaction because Mr. Miller is putting pressure on me to do so. This is not approving the transaction because I know it's the best available transaction. I have to approve this transaction because it's the only available transaction. I believe that one of the remarkable aspects of our Bankruptcy Code, as it has evolved, is its remarkable flexibility to different circumstances....We must close this deal this weekend not because the markets demand it, although that's certainly a part of it….I feel that I have a responsibility to all the creditors, to all of the employees, to all of the customers and to all of you.” • Tr. of Sept. 19, 2008 Hr’g at 248:14 – 249:25.

7. I. Is Lehman The Catalyst For Financial Reform? “…the bankruptcy code does not sufficiently protect the public’s strong interest in ensuring the orderly resolution of a nonbank financial firm…” Lehman in chapter 11 - first month… • September 19, 2008: Sale of North American capital markets and investment banking business to Barclays, in an unprecedented coordination of parallel sale hearings for LBHI and LBI, with the cooperation of SIPC • September 22 and 29, 2008: Sale of European and Asian investment banking businesses to Nomura International Plc – resulted in approximately 7,000 former Lehman employees obtaining employment with Nomura • September 29, 2008: Sale of Investment Management Division and formation of new company, “Neuberger Berman Group” - As of Dec. 31, 2009, Neuberger Berman Group and its affiliates had approximately $173 billion in assets under management, and estimated revenues of approximately $280 million for year ended Dec. 31, 2009

8. Nineteen months later… Derivative Contracts Bankruptcy Court has approved expedited procedures assumption and assignment / termination and settlement Bankruptcy Court has implemented ADR procedures for resolution of termination disputes As of December 31, 2009, settled 1,358 derivative contracts and collected $8.8 billion in settlement payments; through March 31, 2010, collected more than $9 billion total from counterparties, and expect to collect $4.5 billion more. As of March 31, 2010, 86% of trades have been “reconciled,” 75% have been valued, and 25% have been settled. Real Estate and Commercial Loans Over the expected wind-down period, Lehman expects to recover approximately $12.1 billion from real estate assets and $7.2 billion from loan book Various protocols and procedures approved by the Bankruptcy Court for restructuring loans and disposition of assets Private Equity Estimated recovery approximately $10.1 billion March 15, 2010 – Joint chapter 11 plans filed and under negotiation with creditors On track to exit chapter 11 by two-year anniversary… I. Is Lehman The Catalyst For Financial Reform?

9. I. Is Lehman The Catalyst For Financial Reform? • Most people believe the Lehman case ended after the Barclays sale – they have no awareness of the formidable work that has gone into unwinding what was once the fourth largest investment bank in the world. • In retrospect - after nineteen months of Lehman’s orderly resolution in chapter 11… Was Lehman’s failure a cause, or a consequence? What “risk” to the economy has Lehman’s nineteen-month orderly liquidation posed? • Whose failure has truly posed substantial risk to the financial system and the economy? Who is to blame for the havoc that reigned in the months that followed Lehman’s bankruptcy?

10. I. Is Lehman The Catalyst For Financial Reform? • Congress has managed to blur two different and very distinct issues in the rhetoric that surrounds financial reform. These issues are • (1) the detection and prevention of the “disorderly failure” of Lehman Brothers; and • (2) the administration of failure – after failure has occurred – and avoidance of systemic consequences. • Current proposals for financial reform, including the recently proposed “Dodd Bill,” address the need for enhanced capital requirements and increased regulatory oversight of financial institutions, along with an expansion of the government’s ability to provide emergency financial assistance, if necessary, to protect the public interest. • On the other hand, Congress’s solution for dealing with the administration failure – the so-called “enhanced resolution authority” – is a misguided reaction to the Lehman Brothers cases – based on the fallacy: post hoc, ergo propter hoc.

11. II. What Is The Right Paradigm For Financial Reform? • When the Bankruptcy Code was enacted in 1978, chapter 11 addressed a credit and business environment very different from today. • Most of the credit extended to commercial or corporate entities was unsecured. • Chapter 11 was a process to deal with unsecured debt. • Allowed for a plan of reorganization that could affect all creditors – secured and unsecured – as well as equity interest holders. • Intended to provide a level playing field for debtors and creditors, balance the needs of stakeholders, in the interests of rehabilitation and reorganization of distressed business.

12. II. What Is The Right Paradigm For Financial Reform? • Chapter 11 was actively and unanimously supported by all constituencies, based on the mutually agreed principle that reorganization was favorable to liquidation because: • it preserved going concern value, • protected industries and jobs, and • projected greater recoveries for impaired creditors. • Gave debtors the protection necessary to encourage them to start a reorganization early, when the business could still be saved.

13. II. What Is The Right Paradigm For Financial Reform? Over the last 32 years, two trends have affected the effectiveness of chapter 11: • First, over the past 15 years, Congress has persistently amended the Bankruptcy Code, adding “special interest” legislation and clawing back debtor protections. • Second - the way we do business has drastically changed. • Unsecured credit has diminished significantly, particularly over the last 10 years. Essentially all major financing is on a secured basis. • Debtors can only look to their existing secured creditors for debtor in possession financing. • Secured creditors can impose onerous terms, precipitating dismemberment of the business and substantially increasing costs of administration. • Syndication of debtor in possession financing now requires collateralization of debtor in possession loans.

14. II. What Is The Right Paradigm For Financial Reform? • The world has become smaller and more integrated – and business has become global. Business is conducted by multi-entity corporate groups spread across multiple jurisdictions and a patchwork legal systems. • Claims trading has alienated the parties to a chapter 11 reorganization, which were once based on longstanding business relationships between debtors and creditors, and has turned chapter 11 reorganization into a casino. The aim is no longer to rehabilitate the debtor, but rather, to buy low, and sell high. • This “casino-like” atmosphere and the dominance of secured creditors has given rise to 363 sales as the predominant means of preserving an on going business and securing employment.

15. III. Financial Reform Today • The United States House of Representatives has proposed an “Enhanced Resolution Authority”; the United States Senate has proposed a similar “Orderly Liquidation Authority.” • Both bills give the Federal Deposit Insurance Corporation (“FDIC”) the authority to seize and liquidate a failing financial firm that poses systemic risk. • Under the House bill, no judicial oversight. Senate bill establishes a “Financial Company District Court” to oversee case commencement, but most of the process remains outside the jurisdiction of the court and purely in the FDIC’s hands. • Standards and procedures under both bills are vague. • Claims are determined by the FDIC, can be challenged by the commencement of a civil action – a totally unadministrable process!

16. III. Financial Reform Today • Treatment of derivatives mirrors the Federal Deposit Insurance Act. Assumes that use of derivatives by tier 1 financial institutions mirrors that of federally insured deposit institutions. • Tier 1 financial institutions have enormous derivatives portfolios comprised of highly esoteric bespoke trades. • Trade with the most sophisticated counterparties in the world. • Must be viewed in the context of a major potential systemic failure. • With the exception of a 3-day grace period, derivatives receive even better treatment than under the Bankruptcy Code’s safe harbors. • Must contemplate hundreds of thousands of safe harbored transactions placed into default by counterparties and selected for early termination.

17. III. Financial Reform Today • Proposed legislation in the US does not solve one of the most complicating factors in resolving a tier 1 financial institution, i.e., separate regimes for broker-dealers, banks, and insurance companies. • Tier 1 financial institutions are likely to be organized in a traditional holding company structure that includes a broker-dealer and/or bank. • Such divisions may be at the core of the institution’s business and crucial to the institution’s operational structure – i.e., cash, information, and asset management. • Should make it possible for the court / trustee to oversee a unified proceeding, rather than reinforce the fragmented state of US insolvency law.

18. III. Financial Reform Today • Commencement standard creates three or more levels of bureaucracy before definitive action may be taken. • Where time is of the essence, there must be one entity or agency that can “pull the plug,” subject to judicial review. • Doubtful that the checks and balances will maintain confidentiality contemplated by the proposed legislation – in the world of financial services, rumor spreads swiftly and affects the market’s confidence. This is perhaps one of the key lessons of Lehman (and Bear Stearns).

19. III. Financial Reform Today • The FDIC does not have the expertise or experience to deal with a tier 1 financial institution that poses systemic threats to the national and global economy. • The transfer of deposit accounts from one bank to another within the very system that the FDIC regulates is very different from a Lehman-type case. • Tier 1 financial institutions are global multi-enterprise groups subject to the jurisdiction of many countries and involved in the most esoteric and novel securities devised by the imagination of business school elites.

20. IV. Practical Considerations in International Restructuring • Case Study: In re Texaco Inc. et al. • Sufficient time allotted to prepare for chapter 11 filing. • Assets and cash transferred down to subsidiaries located all over the world. • Subsidiaries were “seeded” – could begin to operate independently of the parent, such that only the parent and two financing subsidiaries went into chapter 11.