Bank of America to Lehman: Where's Our Money?

Big investment partners claim billions of dollars just disappeared when Lehman filed for bankruptcy

by Matthew Goldstein and David Henry

The Lehman Brothers bankruptcy is quickly becoming one giant mess.

Scores of hedge funds that had hundreds of millions in cash and other securities parked with Lehman's prime brokerage operation in London have had their accounts frozen. A number of these hedge funds have filed formal objections with the bankruptcy court, and at least one fund, New York's Bay Harbour Management, is mounting a legal challenge to the court's hastily approved sale of Lehman's brokerage arm to Barclays Capital.

Now an even more troubling scenario is arising: legal disputes stemming from the estimated $1 trillion in derivatives transactions that Lehman had entered into on behalf of itself and some of its customers. Already, at least three lawsuits have been filed, alleging that nearly $600 million in collateral posted by some of Lehman's trading partners in derivatives transactions hasn't been returned and is in jeopardy of disappearing as the bankruptcy process unfolds.

To date, the most publicly aggrieved of Lehman's trading partners is Bank of America (BAC), which at one time was considering buying Lehman as the investment firm was lurching toward bankruptcy. The Charlotte (N.C.) lender is seeking to recover nearly $500 million the bank posted as collateral to "support derivative transactions between BofA and the respective Lehman entities," according to a lawsuit filed in New York State Supreme Court.

Dispute over Collateral Could Grow

The suit alleges that two Lehman employees told a Bank of America official that the assets were "frozen" because Lehman's holding company filed for bankruptcy on Sept. 15. But the entities with which Bank of America was trading were not part of the bankruptcy, the suit says. In fact, Lehman was selling its brokerage business to Barclays Capital at the same time. The Sept. 26 complaint describes numerous attempts by BofA to persuade Lehman officials to unfreeze the funds, but each time the bank was rebuffed. In one e-mail exchange, a Lehman employee says: "All activity has been suspended until further notice. Since everything is frozen, we cannot return the remaining collateral at this time."

BofA contends that Lehman "has wrongfully refused" to return the collateral and is violating its agreement as a trading partner. A hearing in the case has been scheduled for Oct. 6, in Manhattan. Similar suits over collateral on derivatives trades have also been filed in the same court by Nomura Global Financial Products and Aeterno Master Fund.

Lehman Brothers declined to comment on Oct. 2.

The disputes could be the first of many since it's not uncommon for derivatives transactions to be part of a tangled web, in which one trading partner is on the hook to make payments to other trading partners. A derivative is a sophisticated contractual agreement that is dependent on the performance of an underlying index or security, such as a bond or stock.