March 12 (Bloomberg) -- JPMorgan Chase & Co. and Citigroup Inc. helped cause the failure of Lehman Brothers Holdings Inc. by demanding more collateral and changing guarantee agreements,
according to a report on the biggest bankruptcy in U.S. history.

“The demands for collateral by Lehman’s lenders had direct impact on Lehman’s liquidity,” said Anton Valukas, the bankruptcy examiner, in a 2,200-page document filed yesterday in
Manhattan federal court. “Lehman’s available liquidity is
central to the question of why Lehman failed.”

Former Lehman Chief Executive Officer Richard Fuld, ex- Chief Financial Officer Erin Callan, former Executive Vice President Ian Lowitt and former Managing Director Christopher
O’Meara certified misleading statements about the bank’s
finances, according to the report. Fuld, 63, was “at least
grossly negligent,” Valukas said. New York-based Lehman
collapsed in September 2008 with $639 billion in assets.

In addition to his conclusions regarding New York-based Citigroup and JPMorgan, Valukas said of London-based Barclays Plc’s purchase of Lehman’s North American brokerage that a
“limited amount of assets” belonging to Lehman were
“improperly transferred to Barclays.” He added that the value
of the assets may not be “material.”

Kerrie Cohen, a Barclays spokeswoman in New York, and Brian Marchiony, a JPMorgan spokesman, declined to comment.

Preliminary Review

Danielle Romero-Apsilos, a spokeswoman for Citigroup, said in an e-mailed statement that the bank is reviewing the report, and that a preliminary analysis shows the examiner “has not
identified any wrongdoing on Citi’s part.”

Lewis Liman, a lawyer for Lowitt, who is now at Barclays, said in an e-mailed statement his client did nothing wrong.

“In the three months during which he held the job, Mr. Lowitt worked diligently and faithfully to discharge all of his duties as Lehman’s CFO,” Liman said. “Any suggestion that Mr.
Lowitt breached his fiduciary duties is baseless.”

Barclays is Britain’s second-biggest bank. Citigroup is the third biggest U.S. bank, and JPMorgan is second. Bank of America Corp. is the biggest U.S. bank by assets.

Fuld was warned months before the bankruptcy by Treasury Secretary Henry Paulson that Lehman might fail if it continued to report losses without finding a buyer or formulating a
survival plan, according to Valukas’s report.

‘Grossly Negligent’

Fuld was “at least grossly negligent in causing Lehman to file misleading periodic reports” while its risks were rising because of long-term assets financed with short-term debt,
Valukas said in the report.

Lehman’s executives engaged in conduct ranging from “non- culpable errors of business judgment” to “actionable balance sheet manipulation,” as they used “accounting gimmicks” to
move assets off the balance sheet without disclosing that to the
government, rating-agencies, investors or Lehman’s board.

Fuld’s lawyer, Patricia Hynes, disputed the examiner’s allegation that the Lehman estate has a claim against him relating to transactions called “Repo 105 transactions.”

“Mr. Fuld did not know what those transactions were -- he didn’t structure or negotiate them, nor was he aware of their accounting treatment,” Hynes said in a statement. She also said
none of Lehman’s senior financial officers, lawyers or outside
auditors raised concerns about the transactions with Fuld.

Michael Chepiga, a lawyer who represents O’Meara in Lehman- related securities lawsuits, declined to comment.

‘Unimpeachable Loyalty’

“Any claim that Ms. Callan breached her fiduciary duties or was somehow liable for the failure of Lehman Brothers is baseless and misguided,” Robert Cleary, Callan’s lawyer, said
today in a phone interview. “During her brief tenure as CFO,
she served the firm diligently and with unimpeachable loyalty in
the face of extraordinary circumstances that she did not
create.”

Valukas, 66, a judge’s son, is chairman of the Chicago- based law firm Jenner & Block LLP, where his clients have included David Radler, Hollinger International Inc.’s former
president. As U.S. Attorney in Chicago from 1985 to 1989, he was
dubbed the Midwest’s Rudolph Giuliani for his hard line on
white-collar crime, according to a 1989 New York Times profile.

In his report, he said that Ernst & Young LLP, Lehman’s auditing firm, failed to question inadequate disclosures by the Lehman executives.

The examiner said Lehman’s directors are “immunized from personal liability” concerning the way the company handled risk because management hadn’t presented any “red flags” to them.

Last Audit

“Our last audit of the company was for the fiscal year ending Nov. 30, 2007,” said Charlie Perkins, a spokesman for Ernst & Young, in an e-mailed statement. “Our opinion indicated
that Lehman’s financial statements for that year were fairly
presented in accordance with Generally Accepted Accounting
Principles (GAAP), and we remain of that view.”

Valukas spent a year and $38 million producing the report. He interviewed more than 100 people including U.S. Treasury Secretary Timothy Geithner, Federal Reserve Chairman Ben
Bernanke and former U.S. Securities and Exchange Commission
Chairman Christopher Cox, and scrutinized more than 10 million
documents, plus 20 million pages of e-mails from Lehman,
according to filings in U.S. Bankruptcy Court in New York.

“There are a limited number of colorable claims for avoidance actions against JPMorgan and Citibank,” Valukas said in the report. He defined a colorable claim as sufficient
credible evidence to persuade a jury to award damages at trial.

JPMorgan and Citigroup were two of New York-based Lehman’s main short-term lenders. On Feb. 24, Lehman said it settled with JPMorgan over the last of $29 billion in claims the bank filed
against Lehman.

Collateral Transfers

Lehman’s lenders had reasons to try and protect themselves as the investment bank’s finances deteriorated and its stock dropped in late August and September 2008, Valukas said. In any
suits against the banks, he said they would have “substantial
defenses,” complicating a plaintiff’s task.

Still, both JPMorgan and Citigroup may be sued to undo the guarantees they received from Lehman in the days before its bankruptcy and reverse the transfers of collateral under those
agreements, the examiner said.

In the case of JPMorgan, there are grounds for suing to reverse almost $7 billion of the $8.6 billion in collateral that Lehman transferred to JPMorgan under an agreement called the
September Guaranty, he said. Lehman didn’t receive fair value
for additional obligations it agreed to in the September
guaranty of its subsidiaries’ debt to JPMorgan, the examiner
said. That expanded Lehman’s obligations to JPMorgan by more
than $4 billion, he said.

Lawsuit Grounds

Lehman may have gotten fair value if there had been an increase in the value of the guaranteed subsidiaries, Valukas said. However, some of the Lehman subsidiaries, including the
brokerage it sold to Barclays, “were insolvent and not likely
to generate any value” for Lehman, leaving Lehman without fair
value for its collateral. That’s grounds for a lawsuit, Valukas
said.

JPMorgan may also be subject to lawsuits for demanding excessive collateral from the weakened Lehman in September 2008, breaching good faith and fair dealing, Valukas said in the
report.

For instance, a JPMorgan analysis indicated the bank had enough cushion for its loans as late as Sept. 10, 2008, he said. Another analysis said it was over-collateralized by as much as
$6.1 billion on Sept. 12, three days before the bankruptcy
filing.

Maximum Liability

The September Guaranty Agreement between Lehman and JPMorgan provided that Lehman’s maximum liability would be $3 billion, although it gave JPMorgan the right to ask for extra
collateral, the examiner said.

While there are no precise tests of how much collateral is too much, and the bank may have been following reasonable commercial standards of protecting itself, undermining any
potential claim, there are enough competing facts in the
JPMorgan case for a “trier of fact” -- a jury -- to decide if
it acted unreasonably or not, Valukas said.

Citigroup, which handled currency trades for Lehman, received a new guarantee from Lehman when the now-bankrupt firm was already insolvent and didn’t give enough value in return,
the report said.

“The examiner concludes that a colorable claim exists to avoid the Amended Guaranty as constructively fraudulent,” Valukas’s report said. The Citigroup guaranty has the same legal
issues as JPMorgan’s guaranty, Valukas said.

Currency Trading

Citigroup extended intraday credit to Lehman in handling the currency trades, “thereby assuming a certain amount of intraday credit risk,” according to the report. The currency-
trading agreement between Lehman and Citigroup provided that any
extension of credit by Citigroup was at its “sole discretion,”
the report says.

In June, Citigroup obtained a $2 billion deposit from Lehman to reduce its intraday risk. The money was to be maintained in a Citigroup overnight call account. The deposit
was included in Lehman’s reported liquidity pool, the report
says.

In July, the two banks failed to negotiate a collateral pledge agreement after Citigroup declined the securities Lehman proposed as collateral in lieu of the cash deposit because it
“questioned whether there was a ready market for them,” the
report says.

‘Acutely Concerned’

“By early September, Citi had become acutely concerned about its claim on the $2 billion deposit,” the report says. Citigroup and Lehman amended a Guaranty Agreement and the
custodial agreement, “which provided Citi with a broad and
explicit security interest over cash, securities or other assets
held by Citi on behalf of Lehman,” the report says.

“Given the rapidly deteriorating market conditions, it was not unreasonable for Citi to seek added security from Lehman,” the report says.

Barclays bought Lehman’s brokerage for $1.54 billion. Lehman has sued Barclays for at least $5 billion, saying it made a “windfall” on the purchase. Barclays responded that it’s
owed $3 billion. A bankruptcy-court trial is set for April 26.

The assets improperly transferred to Barclays included equipment with a book value of less than $10 million and customer information of “questionable value” that Barclays
didn’t obtain in a “wrongful or unlawful” way, Valukas said.
He found “limited colorable claims” against the bank for the
transfers. The examiner found no evidence that any securities
transferred to Barclays in the sale of the brokerage were owned
by Lehman or its affiliates.

Lehman CEO Bryan Marsal said in an e-mail that he would “carefully evaluate” Valukas’s report to assess how it might help “ongoing efforts to advance creditor interests.”

The case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).