A Shorter Slams Lehman

HEARD ON THE STREET

Hedge Player Finds Worrying Factors; Jitters Over Results By PETER EAVIS and DAVID REILLY With Lehman Brothers Holdings' second quarter set to close next week, the Wall Street firm can't seem to put questions about its fiscal first quarter behind it. Back in mid-March when the bank reported, Bear Stearns had collapsed the day before and Lehman was in the market's cross hairs. Lehman posted a $489 million profit, calming investors. But ever since then, investors have questioned those numbers, asking whether the profit was due to some one-time, unrealized gains. Those questions became more intense on Wednesday when David Einhorn, manager of hedge fund Greenlight Capital gave a critique of the earnings in a speech to a room packed with high-profile investors. Lehman's shares fell 2.7% Thursday as word of Mr. Einhorn's speech spread around Wall Street. Mr. Einhorn, who is well respected for his detailed research, is short, or betting against, Lehman's stock. In his comments, Mr. Einhorn squared off in particular against Erin Callan, Lehman's chief financial officer and the executive who has led the public charge against the firm's critics. Mr. Einhorn met with Ms. Callan last week to discuss his research. In a statement, a Lehman spokeswoman said: "We will not continue to refute Mr. Einhorn's allegations and accusations. Mr. Einhorn cherry-picks certain specific items from our quarterly filing and takes them out of context and distorts them to relay a false impression of the firm's financial condition which suits him because of his short position in our stock. He also makes allegations that have no basis in fact with the same hope of achieving personal gain." In attacking Lehman, Mr. Einhorn took issue with large, unrealized gains the firm booked in the first quarter from marking up equity positions that don't trade in public markets. Like other brokers, Lehman has large amounts of illiquid assets that it values using management-driven financial models. In the quarter, Lehman said it had a pretax gain of $695 million related to hard-to-value equities. In the previous four quarters, the average, unrealized gain from such holdings was $69 million. The $695 million is a net number made up of roughly $1 billion of gross gains and offsetting losses, according to Lehman. The $1 billion included an unrealized gain from writing up the value of an equity investment in an Asian power company, which the firm declined to name. In his speech, Mr. Einhorn said the company was India-based KSK Energy Ventures and that Lehman told him it booked a $400 million to $600 million gain on KSK in the first quarter. The manager said Ms. Callan told him Lehman marked up its holding because a new investor had taken a stake in KSK at a valuation above Lehman's. Ms. Callan said this other investment was part of a financing round in anticipation of an initial public offering, according to Mr. Einhorn. After Mr. Einhorn further questioned the valuation process, he says Lehman changed its story. Lehman emailed him, he said, saying the firm had revalued its KSK stake based on an "expected" pre-IPO financing as well as other factors. In his speech, Mr. Einhorn also questioned the values Lehman put on many other financial assets. In particular, he said Lehman hadn't sufficiently written down $6.5 billion of complex debt securities called collateralized debt obligations, or CDOs. He added that these holdings were only recently disclosed, even though other banks and Wall Street firms disclosed similar holdings months ago and took massive write-downs on them. Mr. Einhorn noted that write-downs taken by Lehman in the first quarter on the $6.5 billion of CDOs were only about $200 million. Yet, in an April filing about the first quarter, Lehman disclosed that about 25% of the CDOs were rated BB+ or lower, which is a junk rating. "I asked them how they could justify only a $200 million write-down on any $6.5 billion pool of CDOs that included $1.6 billion of below-investment-grade pieces," he said. He added that Ms. Callan declined to explain the size of the write-down, but she added that "Lehman 'would expect to recognize further losses' in its second quarter."