Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 101 of 347 operations; (ii) Reliability of financial reporting; (iii) Compliance with applicable laws and regulations. 352. Moreover, COSO emphasizes the importance of a strong control environment, which sets a positive "tone at the top" and then flows down through the Company. The COSO Framework Executive Summary identifies the pervasive influence that the control environment has on the Company, as follows: The control environment sets the tone of an organization, influencing the control consciousness of its people. It is the foundation for all other components of internal control, providing discipline and structure. Control environment factors include the integrity, ethical values and competence of the entity's people; management's philosophy and operating style; the way management assigns authority and responsibility, and organizes and develops its people; and the attention and direction provided by the board of directors. 353. In addition, the COSO Framework, Ch. 2, establishes that management's philosophy and operating style directly affects the manner in which the company is managed, the amount of risk that the company accepts and ultimately the success of the company. Chapter 2 of the COSO Framework states: Management's philosophy and operating style affect the way the enterprise is managed, including the kinds of business risks accepted...Other elements of management's philosophy and operating style include attitudes toward financial reporting, conservative or aggressive selection from available alternative accounting principles, conscientiousness and conservatism with which accounting estimates are developed, and attitudes toward data processing and accounting functions and personnel. . . . The impact of an ineffective control environment could be far reaching, possibly resulting in a financial loss, a tarnished public image or a business failure. 354. Section 404 of the Sarbanes-Oxley Act of 2002 ("the Sarbanes-Oxley Act") requires management to assess the effectiveness of the internal control structure and the financial reporting for procedures. Management is responsible for performing this assessment in the 86 EFTA00316814

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 102 of 347 context of a top-down risk assessment, which requires management to base both the scope of its assessment and the evidence gathered on risk. Management's conclusion of its assessment of the effectiveness of the Company's internal control must be included in the Company's annual report. Moreover, it was crucial for Bear Steams to regularly monitor those controls to verify their operating effectiveness. 355. Further, SEC rules require management to report publicly all material weaknesses in the Company's internal controls. 356. Beginning in 2002, the Officer Defendants were required under Rule 302 of the Sarbanes-Oxley Act to provide assurances relating to the Company's "internal control over financial reporting." Rule 302 states as follows: [E]ach annual report ... [should] contain an internal control report, which shall: (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) contain an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting. 357. In connection with the Company's 2006 Form 10-K, Defendants Cayne and Molinaro executed the applicable Rule 302 certification. 358. Defendants Schwartz and Molinaro filed identical certifications with respect to the Company's 2007 Form 10-K. 359. As explained above and in the Company's regulatory filings, in doing so the Officer Defendants represented to the marketplace that their assessment of internal controls over financial reporting was based upon the framework established by COSO. Also, the Officer Defendants represented in the Company's Form 10-K filings that "management concluded that the Company's internal control over financial reporting was effective as of the years ended November 30, 2006 and November 30, 2007. These statements were false because Bear Stearns 87 EFTA00316815

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 103 of 347 concealed its lax risk management efforts which enabled vastly increased exposure to securities inextricably linked to subprime risk. Furthermore, the lax risk management permitted incomplete and deficient pricing models, which was a material weakness that ultimately resulted in the overstatement of the fair value of its financial instruments as well as reported revenues and earnings. As a result, management's reports on internal control over financial reporting, required by Rule 302 of the Sarbanes-Oxley Act, were materially false and misleading because Bear Stearns' internal controls were ineffective. The Officer Defendants' statements were false and misleading because Bear Stearns' internal controls were significantly deficient and ineffective to prevent or detect errors or misstatements in its operations, underwriting practices or financial reporting. 360. Management's assessment of internal control over financial reporting was a critical metric for investors because it provided assurance that the Company's financial statements were reliable and in compliance with applicable laws. However, during the Class Period, as alleged herein, Bear Stearns did not properly assess its internal controls over financial reporting, thus it violated the "Internal Control-Integrated Framework" issued by COSO and various other requirements found in the SEC regulations and Sarbanes-Oxley Act. a. Risk Management 361. In light of the 2008 OIG Report's specific criticisms of Bear Stearns' risk management program, the Company's assertion that it maintained effective internal controls was materially false and misleading. 362. In the midst of the housing crisis in 2007, the Company's risk management department had virtually disappeared. As set out in the 2008 OIG Report, [t]here was also turnover of Bear Stearns' risk management personnel at critical times. Bear Steams' head of model validation resigned around March 2007, precisely when the 88 EFTA00316816

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 104 of 347 subprime crisis was beginning to hit and the first large writedowns were being taken." 363. Moreover, the 2008 OIG Report explains that: there are indications...that the risk manager who left had difficulty communicating with senior managers in a productive manner. In the opinion of the OIG expert, difficulties in communication are a potential red flag indicating that a risk manager could be telling the traders to take on less risk that they would otherwise choose to do (i.e., information that the traders presumably would not want to hear)." 364. Even before 2007, the few risk management analysts the Company did have were ill-suited to assess the risks facing Bear Steams. According to the 2008 OIG Report, In 2006...Bear Steams' business was becoming increasingly concentrated in mortgage securities, an area in which its model review still needed much work. The OIG expert concluded that, at this time, the risk managers at Bear Stearns did not have the skill sets that best matched Bear Stearns' business model." See also, Id., "Given the risk managers' lack of expertise in mortgages, it would have been difficult for risk managers at Bear Steams to advocate a bigger focus on default risk in its mortgage models. 365. The Company had little interest in addressing the chaos in the risk management department, as it understood that effective risk management might reveal the actual extent of its exposure to the housing declines. 366. As a result, according to the 2008 OIG Report, the OIG expert concluded that the reviews of the mortgage models that should have taken place before the subprime crisis erupted in February 2007 appear to have never occurred, in the sense that it was still a work in progress when Bear Steams collapsed in March 2008. b. Pricing Models and VaR Systems 367. The Company's assertion that it maintained effective internal controls was also materially false and misleading in light of the Company's decision to use valuation and risk models that did not reflect the impact of the housing crisis on its most important assets: MBS. 89 EFTA00316817

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 105 of 347 368. As set out in the 2008 OIG Report, TM concluded that Bear Steams model review process lacked coverage of mortgage-backed and other asset-backed securities, in part because the models were not used for pricing and in part because the sensitivities to various risks implied by the models did not reflect risk sensitivities consistent with price fluctuations in the market. 369. The 2008 GIG Report stated that "Bear Steams VaR models did not capture risks associated with credit spread widening...These fundamental factors include housing price appreciation, consumer credit scores, patterns of delinquency rates, and potentially other data. These fundamental factors do not seem to have been incorporated into Bear Steams' models at the time Bear Stearns became a CSE." 370. Because Bear Steams did not update its VaR models on a timely basis, it was not possible for Bear Steams to have effective internal controls over financial reporting, despite its certifications otherwise. 5. GAAP Violations Relating to the Company's Financial Statements6 a. Bear Stearns Misstated Its Exposure to Loss from the Failed Hedge Funds 371. As described above, in June of 2007, Bear Steams loaned $1.6 billion to the BSAM "High Grade" fund in a last-ditch attempt to salvage the entity. At that time, despite their 6 The failures described herein apply to Bear Stearns' annual and interim financial statements. APB No. 28, Interim Financial Reporting ("APB 28"), states "Interim financial information is essential to provide investors and others with timely information as to the progress of the enterprise." (APB 28 9) In addition, in interim periods "Contingencies and other uncertainties that could be expected to affect the fairness of presentation of financial data at an interim date should be disclosed in interim reports in the same manner required for annual reports. Such disclosures should be repeated in interim and annual reports until the contingencies have been removed, resolved, or have become immaterial." (APB 28122) Bear Stearns' interim financial reporting was required to be on the same basis as its annual financial reporting (APB 28 1 10). 90 EFTA00316818

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 106 of 347 internal concerns otherwise, Bear Steams' representatives claimed to the SEC that those loans were purportedly sufficiently collateralized by $1.7 to 2.0 billion of the fund's assets. 372. During June of 2007, the loan balance was reduced to $1.345 billion through the funds sale of certain assets for repayment purposes. However, in the same period, the value of the collateral had been reduced to an amount approximately equal to the size of the then- outstanding loan. 373. This predicament implied that the collateral assets had lost at least $100 to $400 million of purported value in less than one month. 374. In actuality, as a result of its inside knowledge of the asset composition comprising the collateral and the rapid loss of value of those assets even in June of 2007, Bear Steams knew that the collateral of the assets provided by the hedge funds was clearly insufficient to guarantee the value of the loans it had extended. Moreover, Bear Steams knew that the hedge funds were otherwise incapable of repaying those loans. 375. Statement of Financial Accounting Standards No. 5, Accounting for Contingencies ("SFAS 5") was issued in March 1975 by the FASB. The principles described in SFAS 5 set forth the standards of financial accounting and reporting for loss contingencies. SFAS 5 sets forth the standards Bear Steams was required to adhere to in order to properly account for loss contingencies. 376. SFAS 5 provides in paragraph 8: An estimated loss for loss contingency ... shall be accrued by a charge to income if both of the following conditions are met: a. Information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss. 91 EFTA00316819

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 107 of 347 b. The amount of loss can be reasonably estimated. 377. As described above, on July 18, 2007, Bear Stearns informed Hedge Fund investors that "unprecedented declines" in the value of the investments had been sustained. The letters to the investors also disclosed that there was "effectively no value left" in the High Grade Enhanced Fund and "very little value left" in the High Grade Fund. As a result, in accordance with SFAS 5, Bear Steams should have taken an immediate loss on the remaining value of the loan of $1.345 billion in the quarter ended August 31, 2007. 378. Instead of recording a loss of $1.345 billion, Bear Steams recorded a mere $200 million in the quarter ended August 31, 2007 without providing any explanation for the determination of the amount of the loss or its justification for maintaining the remaining $1.1 billion of the loan value in its reported financial statements. In fact, Bear Steams' disclosures were vague as to whether the write-down was attributable to the loan or to the accrued income from management fees of the fund. Specifically, it disclosed, "Included in the 2007 quarter results are losses of approximately $200 million representing the write-off of the Company's investment and fees receivable from the Funds, losses from the closure of the $1.6 billion secured financing agreement provided to the High Grade Fund and other directly related expenses." 379. These issues concerning the rapid de-valuation of the collateral should also have raised alarm bells that any similar assets maintained by Bear Steams needed to be subjected to similar fair value write-downs. Bear Steams permitted one trading desk, its hedge funds, to recognize valuation losses related to CDOs at the same time other trading desks, such as those in its prime brokerage business, used alternative valuation methods on similar assets to avoid such write-downs. 92 EFTA00316820

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 108 of 347 380. Bear Steams provided no further public disclosure about the losses it incurred related to its loans to the hedge funds. 381. As more fully set forth below, Deloitte knew or should have known of an additional auditing red flag in the Company's related party transactions. 382. The primary literature for related party transactions is FAS 57, Related Party Disclosures. Related party transactions include transactions between affiliates, which are defined as "a party that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with an enterprise" (FAS 571 1). 383. FAS 57 paragraph 3 states: Transactions involving related parties cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, freemarket dealings may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions unless such representations can be substantiated." 384. Under FAS 57, Deloitte was obliged to evaluate related party transactions with a high degree of professional skepticism. If the parties to the transaction are related, it cannot be assumed that the recorded amounts properly reflect the true economic substance of the transaction. 385. Indeed, GAAP provides detailed guidance as to specific disclosure requirements and audit procedures in SAS 45 and AU section 334, entitled Related Parties, that must be followed in order to provide the market with a better understanding of the transaction. 386. Bear Stearns' related party transactions included the loans it provided to its failing High Grade Hedge Funds. Accordingly, with respect to that transaction, Bear Stearns was required to disclose (FAS 57 1 2): (a) The nature of the relationship(s) involved, 93 EFTA00316821

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 109 of 347 (b) A description of the transactions for each of the periods for which income statements were presented, and such other information deemed necessary to an understanding of the effects of the transactions on the financial statements, (c) The dollar amounts of transactions for each of the periods for which income statements are presented and the effects of any change in the method of establishing the terms from that used in the preceding period, and (d) Amounts due from or to related parties as of the date of each balance sheet presented and, if not otherwise apparent, the terms and manner of settlement. 387. Furthermore, Bear Stearns should have provided specific disclosure concerning the outcome of the write-downs to the loans provided to the hedge-funds. This obligation to disclose to investors did not expire at the time when, or if, Bear Stearns assumed the collateral onto its consolidated financial statements. 388. As described above, however, the 2008 OIG Report observed that Bear Steams eventually wrote down the value of collateral it acquired by at least $500 million in the fall of 2007. Thus, it is clear that Bear Stearns failed to disclose at least $300 million of write-downs. Moreover, notwithstanding the fact that the Company should have written off the entire value of the loan in the quarter ended August 31, 2007, Bear Stearns' financial statements failed to comply with GAAP because investors were inappropriately left in the dark about how the losses on the remaining $845 million exposure were ultimately recorded, or if those losses were in fact ever recognized prior to its collapse. b. Bear Stearns' Financial Statements Misrepresented its Exposure to Decline in the Value of RIs 389. Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities ("SFAS 140"), was issued in 94 EFTA00316822

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 110 of 347 September 2000 by the FASB. The principles described in SFAS 140 set forth "the standards for accounting for securitizations and other transfers of financial assets and collateral." In particular, SFAS 140 sets forth the standards to properly assess the fair value for RIs. For purposes of Bear Stearns' financial statements, RIs were components of the revenue line item Principal Transactions and reported on the balance sheet as a component of financial instruments at fair value. 390. Once RIs were initially recorded, Bear Stearns was required to determine the fair value of the RIs in each subsequent quarter. For purposes of its 2006 financial statements, the methods prescribed by SFAS 140 for measuring the fair value of financial assets and liabilities were similar to those in SFAS 157, which required that the valuation assumptions be consistent with those that market participants would use in their estimates of values, including assumptions about interest rates, default, prepayment, and volatility. (FAS 140, 11 68-70) SFAS 157 defined the fair value requirements for purposes of the 2007 financial statements. In all periods from the quarter ended February 28, 2007 to February 29, 2008, Bear Steams reported with respect to RIs "The assumptions used for pricing variables are based on observable transactions in similar securities and are further verified by external pricing sources, when available." This disclosure indicates that RIs were classified by Bear Steams as Level 2 assets (see further discussion below). 391. As the issuer of many securitizations, Bear Stearns often maintained the riskiest tranche (the one in the first loss position) on its books as RIs. RIs provided Bear Steams with an opportunity to receive additional cash flows if specific loan performance criteria were met. Bear Steams' valuation of its RI from securitizations was a critical metric for investors because it 95 EFTA00316823

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 111 of 347 indicated the financial health of the Company, given that the valuation of its RI was directly linked to Principal Transactions revenue and, ultimately, net income. 392. In the fall of 2006, Bear Stearns represented to the SEC that it was (i) "moving away from holding residuals in its portfolio; (ii) attempting to sell aging residuals, and (iii) aware that its residuals on second lien mortgage securitizations were very risky." Nevertheless, Bear Stearns' holdings of RIs continued to increase during this period, rising from $5.6 billion as of November 30, 2006 to $7.1 billion as of February 28, 2007. This trend indicated either an increasing difficulty in selling RIs or that Bear Steams' representations to the regulators were unreliable. 393. By February of 2007, Bear Stearns had been forced to write-down nearly 30% of a portion of its RIs that were worth $300 million. In the following quarter, losses on RIs rose to a total of $168 million on second lien inventory and $240 million on RMBS and structured products. The 2008 OIG Report observed that Bear Steams had been unable to predict these losses. Bear Steams' inability to predict such losses was in all probability attributable to its deficient pricing models. Bear Stearns failed to make any disclosure of these losses in its Form 10-Q for the quarter ended May 31, 2007 or any other SEC filing. 394. In fact, in its May 2007 Form 10-Q, Bear Steams continued to tell users of its financial statements "Actual credit losses on retained interests have not been significant," which was entirely misleading. Bear Stearns repeated this disclosure through the time of its collapse. 395. Despite these escalating losses, Bear Stearns holdings of RIs continued to grow in both the quarter ended May 31, 2007 and August 31, 2007, ultimately reaching $9.6 billion — nearly two times the levels at which it had reported to the SEC that it was planning to take the opposite course. 96 EFTA00316824

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 112 of 347 396. One of the important disclosures made by Bear Steams concerning its RIs was that it quickly divested the related risks to the market. For example, it disclosed that the weighted average holding period for RIs was 150 days as of November 30, 2006. Accordingly, it is important to put the losses Bear Steams was incurring in the context of the brief reported holding period. 397. Specifically, if Bear Stearns had incurred total losses on RIs in excess of $400 million by May 31, 2007 even though its holding periods were only 150 days, Bear Stearns should have given appropriate consideration to the loss implications of potentially longer holding periods. The reality confronting Bear Steams at that moment in time was that the market liquidity for RIs was evaporating. For example, in the quarter ended February 28, 2007, Bear Stearns reported that the new issue volume had decreased 11.9% compared to the prior year. Although Bear Steams did not measure the decline in volume in the May 2007 quarter, it observed revenues from its mortgage-related business "decline significantly." 398. Moreover, as an originator of the mortgages underlying the RIs, Bear Stearns knew that valuation of the RIs was at serious risk because it was contingent on the assumption of home prices staying level or in any event not decreasing. Specifically, because of the risk of payment shock at the time of the initial interest rate reset (e.g., the risk described in both the ARA and broadly by the federal financial regulatory agencies), it was well-understood that borrowers would need to be able to refinance, which would at a minimum avoid principal losses to RI holders. The ability to refinance rested on the continued availability of nonprime financing or an accumulation of equity in the home. Even in early 2007, neither of these conditions was evident. 97 EFTA00316825

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 113 of 347 399. In fact, as described above, Bear Steams knew that (1) losses would rise higher into the RMBS tranche structures than initially expected; (2) RMBS (and CDO) credit ratings were no longer valid, because each tranche was not as far removed from real loss as its originally-assigned ratings indicated; and (3) the consequences would actually be most drastic for RIs (i.e., the aspect of the structured financing closest to encroaching mortgage losses). 400. The market for residential mortgage-related securities in these periods was in systematic decline by February of 2007. This decline suggested that Bear Steams' holdings of RIs were already illiquid. Moreover, at least until the quarter ended May 31, 2007, Bear Steams continued to originate risky non-agency related mortgages pursuant to its relaxed lending standards. Accordingly, when the balance of RIs grew from November of 2006 through May of 2007, the resulting RIs generated were of the highest risk of loss. 401. In addition to the general economically adverse valuation factors for RIs, Bear Steams' pricing models for mortgage securities, which would have included Rh, were not reliable, and yielded overstated valuations. In particular, its "Non-Investment Grade" RIs, which included those RIs with credit ratings below BBB-, were overstated (i.e., amounts of at least $1.3 billion in all periods from February 28, 2007 onwards). As an example of the faulty credit ratings, Bear Steams reported in February of 2008 that it held $2.0 billion of retained interest in subprime ARM loans. Nevertheless, the Non-Investment Grade RIs totaled only $1.3 billion. Therefore, even assuming that all of the subprime ARM loans were Non-Investment Grade, Bear Steams attributed Investment Grade or higher credit ratings to at least $700 million of subprime RIs. 98 EFTA00316826

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 114 of 347 c. GAAP Violations Related to Failure to Appropriately Determine the Fair Value of Financial Instruments 402. In December of 1993, the FASB issued SFAS No. 115 Accounting for Certain Investments in Debt and Equity ("SFAS 115"). SFAS 115 addresses the accounting and reporting for all investments in debt securities. Those investments are to be classified in three categories: (1) trading, (2) available-for-sale, and (3) held for investment (SFAS 115 1 6). The accounting treatment for the specific investments depended upon its classification. 403. Bear Stearns treated its financial instruments as trading securities. As a result, Bear Stearns was required to report its financial instruments at fair value and included all unrealized gains and losses in earnings (SFAS 115 1 12). Bear Stearns reported the periodic fluctuations in the fair value of its financial instruments in its income statements within the revenue line-item Principal Transactions. In the MD&A portion of its SEC filings, Bear Steams further stratified revenue from Principal Transactions into (a) Fixed Income and (b) Equities. Bear Stearns reported revenue from mortgage securitizations as well as the unrealized gains and losses from the fluctuations in the fair value of its financial instruments in the Fixed Income component of Principal Transactions. 404. When the fair value of an investment is not readily available, there are several methods available to financial statement preparers to determine the fair value, including the use of pricing models (FASB Staff Implementation Guide for SFAS 115, Question 59). In these instances, GAAP observes that it is important for a preparer to use the best information available in the circumstances to determine fair value. 405. As a basis for its conclusions, SFAS 115 observed "Measuring investments at fair value is relevant and useful to present and potential investors, creditors, and others in making rational investment, credit, and similar decisions — the first objective of financial reporting as 99 EFTA00316827

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 115 of 347 discussed in FAS Con No.1, Objectives of Financial Reporting in Business Enterprises." (SFAS 115 1 39) Moreover, SFAS 115 noted "...some depository institutions have failed, or experienced impairment of earnings or capital, because of speculative securities activities and that other institutions have experienced an erosion of the liquidity of their securities portfolios as a result of decreases in the market value of those securities. In a liquidity shortage, the fair value of investments, rather than their amortized cost, is the amount available to cover an enterprise's obligations." (SFAS 115 1 41) This characterization of the need to reliably determine and report fair value was consistent with the predicament of Bear Stearns. In other words, market participants knew that Bear Stearns held speculative securities. And, once the market began to doubt the legitimacy of Bear Stearns' valuation claims, its liquidity evaporated. 406. In September of 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), which became effective for financial statements issued for fiscal years beginning after November 15, 2007. However, early adoption was permitted if the entity had not yet issued financial statements for that fiscal year. In its 2006 Form 10-K, Bear Steams disclosed that it would adopt SFAS 157 early in the first quarter of fiscal 2007. 407. SFAS 157 established a definition of fair value within GAAP as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." (SFAS 157 1 5) This standard also clarified that a fair value measurement assumes that the asset or liability is exchanged in an orderly transaction between market participants to sell the asset or transfer the liability at the measurement date. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. (SFAS 157 1 7) Nevertheless, 100 EFTA00316828

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 116 of 347 this definition of fair value was not conceptually different than the definition found in previous accounting literature in that it remained focused on the assumptions marketplace participants would use in pricing the asset or liability. 408. This standard also established a framework for measuring fair value and required enhanced disclosures about fair value measurements. It also requires companies to disclose the fair value of its financial instruments according to a fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial instruments carried at fair value are required to be classified and disclosed in one of the three categories of the hierarchy (SFAS 157 22-30): (a) Level 1: Quoted market prices for identical assets or liabilities in active markets. (b) Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data. (c) Level 3: Unobservable inputs that are not corroborated by market. 409. Companies such as Bear Steams that reported Level 3 assets or liabilities were required to provide enhanced disclosure regarding the activities of those financial instruments. 410. In its 2006 Form 10-K, Bear Stearns disclosed that it did not expect the adoption of SFAS 157 to have a material impact on the consolidated financial statements of the Company. In part, this particular disclosure was likely attributable to the fact that Bear Steams had previously reported in its SEC filings that it aggregated its financial instruments in three broad categories, each of which resembled the stratifications subsequently required by SFAS 157. Bear Stearns had also provided specific disclosure of the aggregate dollar value of financial instruments aggregated into the third category (i.e., "Financial Instruments Whose Fair Value Is 101 EFTA00316829

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 117 of 347 Estimated Based on Internally Developed Models or Methodologies Utilizing Significant Assumptions or Other Data That Are Generally Less Readily Observable from Objective Sources"). 411. In October 2007, the Center for Audit Quality ("CAQ"), which is associated with the AICPA, published an audit alert ("whitepaper") entitled "Measurements of Fair Value in Illiquid (Or Less Liquid) Markets." This whitepaper similarly observed that the implementation of SFAS 157 was likely to have only a minimal effect on most entities. 412. Throughout the Class Period, "Financial instruments owned, at fair value" was the largest balance sheet line item in Bear Steams' financial statements, typically comprising one third of the Company's total assets. "Mortgages, mortgage- and asset-backed" securities, in turn, were the largest component of Financial instruments owned, making up at least thirty percent of the Company's financial instruments from the first quarter of 2005 onwards. This proportion peaked at 39.1% of Bear Steams' total financial instruments, or about $57.5 billion, as of February 28, 2007. 413. Bear Steams' leverage caused its fair value measurements to have significant implications to its financial instruments. Specifically, even minor adverse changes in its fair value assumptions had potentially devastating consequences for Bear Stearns' reported revenues. As an example, during all periods from the first quarter of 2006 to the second quarter of 2007, Bear Stearns' revenue from Principal Transactions ranged from $1.1 billion to $1.5 billion. These amounts were critically important to Bear Stearns' reported revenues during these periods, typically one-third of amounts reported. However, if the fair value of only its mortgage-related financial instruments was reduced by an amount of even 3%, all of its reported Principal Transactions revenue would have been wiped out. Any adverse adjustment to the fair value of 102 EFTA00316830

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 118 of 347 mortgage-related securities in excess of 3% would have caused reported revenue from Principal Transactions to turn negative. 414. As described further below, starting at least by November of 2004, Bear Steams consistently disclosed the dollar value of certain assets whose value had been established using internally-developed models (consistent with Level 3 in SFAS 157 vernacular). As a percentage of total financial instruments, the Company's total Level 3 assets grew rapidly from 11% of its total financial instruments in the fourth quarter of 2006 to 29% of its total financial instruments by the first quarter of 2008. Accordingly, throughout the Class Period, Bear Stearns was valuing at least 11%, and up to 29%, of its financial instruments using valuation models devised by the Company and dependent upon significant assumptions established by management. 415. Bear Stearns revealed for the first time in its quarterly results for the fourth quarter of 2007 that mortgage securities, valued using the Company's mortgage valuation models, comprised approximately 70% of all its Level 3 financial instruments. Level 3 residential mortgage-related assets totaled at least $5.8 billion and $7.5 billion as of August 31, 2007 and November 30, 2007, respectively. 416. In addition, in all periods from at least the first quarter of 2007 through its collapse in March of 2008, Bear Steams reported that Level 2 assets were in excess of $60 billion and comprised at least 50% of reported financial instruments owned. Bear Steams disclosed that Level 2 assets consisted of "financial instruments for which the Company does not receive quoted prices; therefore, models or other methodologies are utilized to value these financial instruments." Since the reported fair value of Level 2 assets was also significantly dependent on valuation models, any flaws in those models had potentially devastating ripple 103 EFTA00316831

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 119 of 347 effects. As of November 30, 2007, Bear Stearns reported that it held $28.9 billion of Level 2 mortgage-related securities. 417. As described above, the SEC determined that Bear Stearns' mortgage valuation models, among other things, failed to incorporate indicators of declines in the house market. In light of these defects and the downturn of the housing market during the Class Period, it was virtually inevitable that an overstatement of these assets, especially those Level 3 assets, would occur. d. Bear Stearns Failed to Provide Adequate Disclosure About Risk and Uncertainties 418. Bear Steams was also required to provide disclosure about risk and uncertainties related to its financial statements. These disclosures were guided in part by the AICPA's Statement of Position 94-6, Disclosure of Certain Significant Risks and Uncertainties ("SOP 94- 6"). In particular, Bear Steams was required to disclose any vulnerability or risk inherent to its financial statements as a result of concentrations of risk. (SOP 94-6 1 20) The concentrations highlighted include "revenue from particular products, services, or fund-raising events. The potential for the severe impact can result, for example, from volume or price changes or the loss of patent protection for the particular source of revenue." (SOP 94-6 1 22) 419. These concentration disclosures are related precisely to the issues constituted by Bear Stearns' holdings of mortgage-related securities, and specifically subprime and CDO- related securities. During 2007, Bear Steams' periodic SEC filings contain only fleeting references to its concentration of exposure to subprime investments. For example, in the first quarter of 2007, Bear Stearns reported that it subprime activities "have historically represented only a small portion of the Company's mortgage activities." 104 EFTA00316832

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 120 of 347 420. The 2006 Form 10-K stated that Bear Steams' "Maximum Exposure to Loss" to CDOs was $211.1 million. In its Form 10-Q for the first quarter of 2007, Bear Steams reported that its maximum exposure to CDOs had been reduced to $174.2 million. And, at the end of the second quarter of 2007, the Company's Form 10-Q still only quantified $270.6 million of exposure to CDOs. 421. By the third quarter of 2007, however, simultaneous to the initial public disclosure of its valuation markdowns, Bear Steams stated that its maximum exposure to loss on CDOs had risen to $631 million. This exposure was present even after $700 million of markdowns to mortgage-related assets had been recorded in the quarter ended August 2007. Bear Steams' exposure to CDOs was growing at a time when its risk management function when prudent risk management should have been reducing CDO exposure. 422. In contrast to its quantifications of reported maximum exposure, the Company recorded writedowns of $2.3 billion in the fourth quarter of 2007, of which CDOs were a "large component." Even assuming that 50% of the markdowns were a "large component," the implication is that Bear Steams understated its disclosed exposure to CDOs by a factor of two (i.e., $631 million maximum exposure at August 31, 2007 and a $1.2 billion write-down). After those write-downs, Bear Steams reported that its maximum remaining exposure to CDOs as of November 30, 2007 was $409 million. Yet, once again, in the first quarter, Bear Stearns recorded $600 million of valuation markdowns although the Company's disclosure of the specific assets subject to the markdowns was ambiguous. 423. Bear Steams' failure to provide meaningful disclosures of the concentrations of risk it had to the subprime and CDO market were particularly glaring in light of the failures of its hedge funds, which as described above, focused on CDO and CDO-related investments. Thus, it 105 EFTA00316833

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 121 of 347 is logical that the SEC pursued more detailed disclosure from Bear Steams via its comment letter related to its financial filings shortly after the failure of those hedge funds. In all likelihood, the SEC sought to ensure that public investors, unlike the hedge fund investors, were aware of risk concentrations present in the Company's financial statements. Indeed, this finding was presented in the 2008 DIG Report. e. Bear Stearns Failed to Provide Reliable Disclosures to Investors in Accordance with SEC Regulations 424. In addition to the financial statement disclosures described above, Bear Stearns was also required to provide certain additional information in the Management's Discussion & Analysis ("MD&A") section of its SEC filings. (Regulation S-K §229.303(a)) The SEC required, among other considerations that "The registrant's discussion and analysis shall be of the financial statements and of other statistical data that the registrant believes will enhance a reader's understanding of its financial condition, changes in financial condition and results of operations." (Instruction 1) The SEC also required "The purpose of the discussion and analysis shall be to provide to investors and other users information relevant to an assessment of the financial condition and results of operations of the registrant. (Instruction 2) " 425. MD&A is also required to "focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition." 426. As described above, Bear Steams' MD&A included disclosures of the amounts it reported as VaR as well as certain accompanying details, which as described above was among the most closely watched performance indicators by users of its financial statements. As reported, Bear Stearns' VaR was lower than that of its peers, which suggested that Bear Steams' financial statements reflected relatively low levels of risk. In fact, the amounts Bear Steams' 106 EFTA00316834

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 122 of 347 management reported as VaR were materially misleading because its VaR models were defective. Thus, Bear Stearns' VaR failed to comply with SEC Regulations. N. Bear Stearns' Practices Violated Banking Regulations 427. In its Forms 10-K filed for fiscal years 2006 and 2007, Bear Steams stated that "the Company is in compliance with CSE regulatory capital requirements." This statement was materially false and misleading. 428. In fact, during the Class Period, while Bear Steams offered regulators data showing that it apparently met the CSE program's 10% minimum net capital requirements, the Company was only able to achieve this result by repeatedly violating regulatory requirements relating to the appropriate calculation of net capital. As set out in the 2008 OIG Report, the Company violated these rules by (i) failing to take appropriate capital charges related to its collapsed hedge funds; (ii) inflating its profit and its capital by using inflated marks on assets subject to mark disputes; and (iii) falsely inflating its net capital by using misleading VaR models to calculate capital requirements. 1. Overview of Capital Requirements 429. Net capital, the value of a firm's assets less the value of its liabilities, is at the core of any bank's operations. The more net capital a firm has, the better equipped it is to cover any unexpected losses. 430. Capital requirements are one way of ensuring that banks hold sufficient net capital at all times to meet unexpected losses. The principal sources of loss are market risks, credit risks and operational risks. Capital requirements provide that a certain amount be set aside to cover potential risk for each kind of loss. These amounts, taken together with adjustments for hedging or diversification, are called capital charges. If the total capital charge is greater than the firm's 107 EFTA00316835

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 123 of 347 minimum required net capital, the firm needs either to raise more capital or reduce some of its risk. 431. Registered broker-dealers are subject to the Net Capital Rule (Rule 15c3-1) (the "Net Capital Rule") under the Exchange Act. The Net Capital Rule, which specifies minimum net capital requirements for registered broker-dealers, was designed to measure the general financial integrity and liquidity of broker-dealers and requires that at least a minimal portion of a broker-dealer's assets be kept in relatively liquid form. 432. Under the Net Capital Rule, Bear Stearns was required to maintain a minimum net capital ratio of 10% — that is, Bear Steams was required to maintain at least ten percent of its assets in cash or in securities that could be easily converted to cash. If the overall value the assets Bear Steams maintained on its books went up, then its net capital requirements went up as well. 433. Upon Bear Steams' approval as a CSE on December 1, 2005, the SEC permitted Bear Stearns to use a specified alternative method for calculating net capital in exchange for Bear Stearns' compliance with requirements of the CSE program. 434. According to the SEC's Release No. 34-49830 "[u]nder the alternative method, firms with strong internal risk management practices may utilize mathematical modeling methods already used to manage their own business risk, including value-at-risk ("VaR") models and scenario analysis, for regulatory purposes," The release explains that the purpose of the alternative method of computing net capital is "to permit regulated companies to align their supervisory risk management practices and regulatory capital requirements more closely." 435. The conditions of Bear Steams' participation in the program and the alternative manner in which it was permitted to calculate net capital is set out in Appendices E and G to the 108 EFTA00316836

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 124 of 347 Net Capital Rule. Appendices E and G permit the calculation of capital charges for market risk and derivative-related credit risk based on mathematical models, in a manner "consistent with the standards (`Basel Standards') adopted by the Basel Committee on Banking Supervision (`Basel Committee')".7 2. Bear Stearns Failed to Take Timely and Adequate Capital Charges 436. As the 2008 OIG Report points out, Bear Stearns' treatment of its hedge fund bailout ran afoul of the Basel II standards relating to capital charges. In light of Appendix E's adoption of this standard, the Company's treatment of the hedge fund bailout violated the SEC's Net Capital Rule 1 as well. 437. Basel II requires that "[w]hen a bank has been found to provide implicit support to a securitization, it will be required to hold capital against all of the underlying exposures associated with the structure as if they had not been securitized." 438. The 2008 GIG Report pointed out that the High Yield Fund was financially distressed, and that the terms of the bailout repo agreement had resulted in the Company's assumption of all of the risk, and none of the possible upside, relating to the collateral it had received in the transaction. Accordingly, the 2008 GIG Report concluded, "Bear Stearns' financing of the BSAM funds is conceptually similar to implicit support." 439. The GIG explained that: Since Bear Stearns bore all of the downside risks, sound risk management (consistent with Basel II) requires that the impact on Bear Stearns' capital associated with these reports should have 7 The Basel Committee on Banking Supervision is an institution created by the central bank Governors of the Group of Ten nations. It was created in 1974 and meets regularly four times a year. The Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. (http://www.bis.org/bcbs0 109 EFTA00316837

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 125 of 347 been at least as great as the impact Bear Steams would incur if it held that assets in its own trading book at the end of June 2007. 440. Bear Steams failed to take an appropriate charge against capital when it provided the credit facility to the High Grade Fund. The 2008 OIG Report states "TM memoranda summarizing discussions with Bear Steams' risk managers suggest that the capital charge incurred by Bear Steams at the end of June 2007 was far less than the capital charge consistent with sound risk management." 441. That is to say, by failing to include the Hedge Fund collateral on its books, Bear Steams was able to avoid having to increase the amount of net capital it needed to maintain in order to meet the CSE's program's 10% ratio. 3. Inflation of Capital By Using Incorrect Marks 442. The 2008 OIG Report also explains that Bear Steams' accounting treatment of certain assets subject to mark disputes resulted in violations of capital rules. 443. As the 2008 OIG Report explains, fair values of positions relating to derivative transactions are used in estimating the capital charges and capital requirements corresponding to the transactions. 4.44. As set out in paragraphs 222 to 226 above, in the summer of 2007, mark disputes between Bear Steams and its repo counterparties became more and more common. As a result of these disputes, the Company made repeated concessions to its counterparties regarding the value of assets it offered as collateral. These amounts were sometimes very large, as in Company's March 12, 2008 payment of $1.1 billion to its counterparties detailed in paragraph 278 above. 445. The 2008 GIG Report explains that "there are indications in the TM memoranda that Bear Stearns tended to use the traders' more generous marks for profit and loss purposes, even when Bear Steams conceded to the counterparty for collateral valuation purposes." This 110 EFTA00316838

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 126 of 347 permitted Bear Steams to record a gain on its books even while it conceded a loss in the dispute with the counterparty. 446. The OIG states that "it is inconsistent with the spirit of Basel II for two firms to use a mark dispute as an occasion to increase their combined capital, as would occur when both parties to a trade book profit at the expense of the other simply because they each mark positions favorably for themselves." In such a circumstance neither party would be acknowledging the reduction in the value of the disputed asset. 447. As a result of its inflation of the value of the disputed assets, Bear Steams was able to overstate its capital for the purposes of calculating its net capital requirement. 4. Misrepresentations to Regulators Relating to VaR 448. Because net capital turns on an accurate assessment of the risks facing a company, the reliability of models used to estimate risk, such as VaR, are crucial to determining appropriate capital charges and the calculation of net capital. 449. Appendix E to the Net Capital Rule required Bear Steams to submit to the SEC, on a monthly basis, "[a] graph reflecting, for each business line, the daily intra-month VaR." 450. Moreover, under Appendix E of the Net Capital Rule, Bear Steams was obliged to review its VaR models both periodically and annually. The periodic review could be conducted by the broker's or dealer's internal audit staff, but the annual review had to be conducted by a registered public accounting firm. 451. As described in paragraphs 100 to 105 above, the SEC repeatedly warned Bear Steams that the VaR models it used to calculate net capital did not consider fundamental factors including changes in housing prices, consumer credit scores, patterns of delinquency rates, and other key data. Accordingly, throughout the Class Period the net capital the Company reported to the regulators was misleading and inaccurate. 111 EFTA00316839

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 127 of 347 452. Moreover, neither the Company nor its auditor, Deloitte, performed adequate reviews of key inputs into VaR during the Class Period. Indeed, according to the DIG, "reviews of mortgage models that should have taken place before the subprime crisis erupted in February of 2007 appear to have never occurred." V. DEFENDANTS' SCIENTER A. James E. Carne 453. As Chief Executive Officer, Chairman of the Board, and director, Defendant Cayne participated in the issuance of, signed and certified Bear Steams' materially false and misleading SEC filings, as required by Sarbanes-Oxley, issued during the Class Period through January 8, 2008, when he was forced to resign as CEO. 454. Specifically, in connection with the Forms 10-K for 2006 and 2007, Cayne certified that he had put in place disclosure controls and procedures to ensure the accuracy of the Company's filings, and that he had: Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared. 455. Also in connection with the Forms 10-K for 2006 and 2007, Cayne certified that he had: Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles[.] 112 EFTA00316840

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 128 of 347 456. These disclosure controls, together with his position as the Company's CEO, meant that Cayne was aware that the Company had been warned by the SEC in 2005 and 2006 that its mortgage valuation and VaR modeling failed to reflect key indicators in the housing market. 457. Indeed, according to a February 8, 2008 presentation by Defendant Molinaro to a Credit Suisse Financial Services Forum, the Company's CEO was "intimately engaged in the risk management process." 458. Throughout the Class Period, Defendant Cayne also made a number of materially false and misleading statements regarding Bear Steams' ABS exposure as well as the effectiveness of its risk monitoring procedures. 459. Bear Stearns' acquisition and aggressive trading of risky ABS assets was fostered by Cayne who implemented a business strategy that required Bear Stearns to become an industry leader in the origination and securitization of ABS, including MBS. It was Cayne who guided Bear Stearns' entrance into debt securitization. However, as Bear Steams was increasing its exposure to risk, Cayne knew it was doing so without effective policies and controls to ensure that Bear Stearns' exposure to risk was accurately communicated to its investors in direct contrast to its public statements. Cayne was aware, or recklessly disregarded, the weaknesses in Bear Steams' reporting and risk management processes. 460. While Defendants told shareholders and investors that Bear Stearns' growth and concomitant expanding risk were prudent and keeping with sound risk control practices, Cayne knew, or was reckless in not knowing, that Bear Steams' risk control models were severely flawed and not up-to-date. Moreover, Cayne knew, or was reckless in not knowing that, according to the SEC Inspector General, Bear Stearns' own risk managers did not have an 113 EFTA00316841

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 129 of 347 expertise in the very assets upon which Bear Stearns had focused its investment strategy. Further, Cayne knew, or was reckless in disregarding, the fact that Bear Steams publicly disclosed VaR was far below the industry average, even as Bear Steams' concentration of risky ABS was the highest in the investment banking community. 461. Cayne was aware of the Company's $1.3 billion bailout of the High Grade Fund. Cayne knew of the toxic assets housed in the High Grade Fund and knew, or recklessly disregarded, that the Company should have taken an immediate charge against net capital after it took the High Grade Fund's collateral onto its own books. As alleged in paragraph 216, instead of immediately reflecting its assumption of the declining collateral onto its books, the Company waited months. By doing so, the SEC Inspector General stated, Bear Steams was able "to delay taking a huge hit to capital." 462. Cayne also knew of Bear Steams' stated reliance on GAAP accounting, and banking standards such as the Basel II Standards, but either ignored them or recklessly disregarded them. For example, Cayne was aware of the FAS 157 requirement to accurately mark values to their market prices, and was further aware that Bear Steams was not in compliance, because it either had no way of doing so, or had flawed models which rendered its financial statements false and misleading. Likewise, although Bear Steams maintained a capital cushion which was barely compliant with SEC guideliness, Cayne was aware that this cushion was the bare minimum required and, due to Bear Stearns' tremendous leverage, would not protect Bear Steams in the event that creditors made margin calls caused by declining asset values. 8 Schwartz testified to Congress that their capital cushion was, at times, well above the SEC requirement. 114 EFTA00316842

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 130 of 347 463. Cayne was so involved in the Company's failed business strategy — a business strategy that he knew, but failed to disclose to the market, was flawed — that when his resignation was announced, Bear Steams share price plunged nearly 7%. B. Alan D. Schwartz 464. As Chief Executive Officer, Co-President, Co-Chief Operating Officer, and director of Bear Steams, Defendant Schwartz participated in the issuance of, and signed and certified as accurate and complete as required by Sarbanes-Oxley, Bear Steams' materially false and misleading SEC filings issued during the Class Period. Schwartz became sole President on August 5, 2007, and remained in that position until January of 2008, when he replaced Cayne as CEO. Throughout the Class Period, Defendant Schwartz signed the Company's materially false and misleading Forms 10-K for the 2006 and 2007 fiscal years. 465. According to a February 8, 2008 presentation by Defendant Molinaro to a Credit Suisse Financial Services Forum, Schwartz, the Company's CEO, was "intimately engaged in the risk management process." Accordingly, Schwartz was aware that the Company had twice been warned by the SEC that its mortgage valuation and risk modeling failed to reflect key indicators in the housing market. Despite this knowledge, Schwartz signed SEC filings setting out, among other things, the value of level three assets and the Company's VaR, as described in paragraphs 589 to 790 below. 466. Moreover, as alleged in 1 274 to 278 above, Schwartz offered false reassurances to the public while the Company's liquidity plummeted the week of March 10, 2008. On March 10, 2008, the Company's liquidity pool had stood at $18.1 billion. By the close of March 11, 2008, it had declined to $11.5 billion - a one-day loss of more than $6 billion. 467. Feeling pressure to dupe the market into that Bear Steams did not have a liquidity problem, Schwartz appeared on CNBC the morning of March 12, 2008. As alleged in 115 EFTA00316843

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 131 of 347 paragraph 274, Schwartz stated, "We finished the year, and we reported that we had $17 billion of cash sitting at the bank's parent company as a liquidity cushion. As the year has gone on, that liquidity cushion has been virtually unchanged." Schwartz added, "We don't see any pressure on our liquidity, let alone a liquidity crisis." 468. The next day, the Company's liquidity stood at about $2 billion. Accordingly, while Schwartz was speaking, nearly ten billion dollars of liquidity was evaporating from Bear Stearns. 469. Moreover, Schwartz also knew, or was reckless in not knowing, that Bear Stearns' counterparties were deserting the Company. As alleged in paragraphs 266, 269, and 271, NG Groep NV informed Bear Stearns that it was pulling about $500 million in financing; banks were refusing to issue any further credit protection on the Company's debt; and Goldman Sachs, once a principal source of cash for the Company, had at least temporarily halted covering any more Bear Stearns risk. This in turn lead other Bear Steams counterparties to refuse to lend to the Company. 470. Moreover, as the Company's CEO, Schwartz knew or was reckless in not knowing that on March 6, 2008, Rabobank Group, one of Bear Stearns' European lenders, told the brokerage that it wouldn't renew a $500 million loan coming due later that week. C. Samuel L. Molinaro, Jr. 471. As Chief Financial Officer during the Class Period, and as of August 5, 2007 Chief Operating Officer of Bear Stearns, Defendant Molinaro participated in the issuance of, signed and certified as accurate and complete as required by the Sarbanes-Oxley Act, Bear Stearns' materially false and misleading SEC filings issued during the Class Period. 116 EFTA00316844

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 132 of 347 472. Specifically, in connection with the Forms 10-K for 2006 and 2007, Molinaro certified that he had put in place disclosure controls and procedures to ensure the accuracy of the Company's filings, and that he had: Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared. 473. Also in connection with the Forms 10-K for 2006 and 2007 Molinaro certified that he had: Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles[.] 474. Moreover, according to a February, 2008 presentation given by Molinaro himself to Credit Suisse analysts, the Company's risk management structure reported directly to him. 475. As alleged above in paragraphs 106,167 and 175, Molinaro knew, or recklessly disregarded, that Bear Stearns' internal controls were virtually non-existent with respect to risk management over MBS valuation and VaR. As CFO of the Company and the head of its risk management structure, Molinaro knew about, or recklessly disregarded the existence of, the SEC's warnings about serious deficiencies in the Company's mortgage valuation and VaR models. As alleged in paragraph 102, during the CSE application process, the SEC told Principal Accounting Officer Jeffrey Farber — Molinaro's direct report — that "Is* believe that it would be highly desirable for independent Model Review to carry out detailed reviews of models in the mortgage area." These concerns were again communicated to the Company in a December 2, 2005 memorandum from the SEC Office of Compliance Inspections and Examinations ("OCIE") 117 EFTA00316845

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 133 of 347 to Defendant Farber, who reported directly to Molinaro. The disclosure controls and procedures that Molinaro purportedly put in place should have informed him that the SEC found the Company's risk management metrics deficient. 476. The degree to which the SEC Inspector General found Bear Steams' internal controls to be deficient raises the strong inference that Molinaro could not have believed, or recklessly disregarded the truth of, his Sarbanes-Oxley Act certification of the Company's internal controls. 477. As Bear Steams' CFO, and COO starting August 5, 2007, Defendant Molinaro participated in the issuance of, signed and certified Bear Stearns' materially false and misleading SEC filings as accurate and complete, as required by Sarbanes-Oxley. During the Class Period, Molinaro signed and certified Bear Steams' Form 10-Qs and Form 10-Ks filed with the SEC, and throughout the Class Period, Molinaro conducted quarterly earnings conference calls with shareholders and investors and made a number of materially false and misleading statements regarding Bear Stearns' ABS exposure as well as its risk-monitoring infrastructure. 478. As Bear Stearns' CFO, Molinaro was responsible for monitoring Bear Stearns' internal controls and reporting the Company's risks. In an investment bank such as Bear Stearns, a CFO must be fully aware of the bank's own securities because the CFO is responsible for obtaining the financing to purchase them. Therefore, Molinaro could not have been ignorant about the existence, size and nature of Bear Stearns risky positions without having been reckless in his ignorance. As the CFO of a major investment bank, Molinaro was acutely aware of the Fair Value reporting requirements and had purportedly implemented them at Bear Stearns. During the Class Period, Molinaro knowingly and recklessly caused Bear Stearns to issue and file financial statements and reports with the SEC that stated that Bear Stearns had implemented 118 EFTA00316846

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 134 of 347 accounting standards in line with GAAP requirements when, in fact, Bear Steams was not complying with GAAP through its failure to accurately value the MBS and CDOs it carried on its books. 479. Thus, while Molinaro was assuring analysts and the market that Bear Stearns had not suffered from any adverse marks in the mortgage area and its hedging activities, he knew or was reckless in not knowing that Bear Steams was heavily exposed to deteriorating market conditions. 480. Subsequent to the Hedge Funds' collapse, on November 14, 2007, Molinaro stated that Bear Steams would write down $1.2 billion of its subprime holdings in the fourth quarter. However, Molinaro attempted to reassure investors by claiming that, in spite of the fact that Bear Stearns still bore more than a billion dollars of subprime exposure in the form of the collateral it had received from the failed High Grade Fund, Bear Steams had reduced its CDO holdings to $884 million as of November 9, 2007 from $2.07 billion at the end of August 2007. Molinaro claimed that during the period between August 31, 2007 and November 9, 2007, the Company significantly increased its short subprime exposure. However, Molinaro knew, or was reckless in not knowing, that Bear Steams' valuation models could not accurately value the CDO and subprime exposure which he was allegedly "disclosing" to the market. It became further apparent to Molinaro that the figures disclosed to the market were inaccurate when, notwithstanding Molinaro's assurance just weeks before that the Company's hedging efforts had resulted in a net negative exposure to subprime assets, on December 20, 2007, the Company wrote down $1.9 billion of its holdings in mortgages and mortgage-based securities — over $700 million more than it had announced on November 14, 2007. On November 14, 2007, Molinaro knew this additional write down was necessary, or was reckless in not knowing. 119 EFTA00316847

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 135 of 347 481. As CFO, Molinaro also knew of Bear Steams' stated reliance on GAAP accounting and banking standards such as the Basel II Standards but either ignored them or recklessly disregarded them. For example, Molinaro was aware of the SFAS 157 requirement to accurately mark values to their market prices, but was aware that Bear Steams had flawed models for doing so which necessarily rendered its financial statements false and misleading. D. Warren J. Spector 482. As Co-President and Co-Chief Operating Officer and a director of Bear Steams, Defendant Spector participated in the issuance of, signed and certified as accurate and complete as required by Sarbanes-Oxley, Bear Steams' materially false and misleading SEC filings issued during the Class Period. Spector, due to his active involvement in the collapse of the Hedge Funds, resigned his position on August 5, 2007 but remained a Bear Stearns employee and held the title of Senior Managing Director. During his tenure as Co-President and co -COO, all divisions of the firm save investment banking reported to Spector, including the Hedge Funds. Throughout the Class Period, Defendant Spector made a number of materially false and misleading statements regarding Bear Steams' ABS exposure as well as the effectiveness of its risk monitoring procedures. 483. Spector, due to his position as co -COO overseeing the Company's vertically- integrated mortgage business, was in a unique position to understand the subprime mortgage market. As alleged in paragraph 143, disasters in a U.K. mortgage subsidiary brought home to the Company the threat posed by lax underwriting standards to the values of its mortgages and mortgage-backed assets. Between April and June of 2006, the Company faced repeated crises in its United Kingdom subsidiary as a result of poor performance of U.K. loans due to weak underwriting standards. As a result, the Company was left holding some $1.5 billion in unsecuritized whole loans and commitments from this subsidiary. According to CW 7, a former 120 EFTA00316848

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 136 of 347 head of model valuation at Bear Steams at the time, top management at Bear Steams were deeply concerned about the U.K. developments and defendant Spector personally made calls to investigate the crisis. 484. As the co-COO, Spector oversaw BSAM, the subsidiary of Bear Steams that managed the Hedge Funds. Spector was fully aware of the serious problems at the Hedge Funds being concealed from both the Hedge Funds' investors and Bear Steams' investors. 485. As set out in paragraph 203 above, Spector personally made the decision to allow the High Grade Enhanced Fund to fail, while extending a $1.3 billion loan, in the form of a repurchase agreement, to the High Grade Hedge Fund. Spector knew at the time Bear Steams entered into the facility that the CDOs it had received as collateral were actually worth far less, in that he had already become aware of serious flaws in Bear Steams' valuation methodologies. 486. While Defendants told shareholders and investors that Bear Steams' growth and concomitant expanding risk were prudent and keeping with sound risk control practices, Spector knew, or was reckless in not knowing, that Bear Steams' risk control models were severely flawed and not up-to-date. The Fixed Income division dealt with ABS and MBS. The head of the Fixed Income division reported directly to Spector. Spector knew, or was reckless in not knowing that Bear Steams' own risk managers did not have an expertise in the very assets — ABS and MBS — upon which Bear Steams had focused its investment strategy. Further, Spector knew or was reckless in disregarding the fact that Bear Steams' VaR was far below the industry average, even as Bear Steams' concentration of risky ABS was the highest in the investment banking community. E. Alan C. Greenberg 487. As a director and Chairman of the Executive Committee of Bear Stearns, Defendant Greenberg participated in the issuance of Bear Steams' materially false and 121 EFTA00316849

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 137 of 347 misleading SEC filings issued during the Class Period. The Executive Committee was responsible for running the day-to-day operations of Bear Steams. 488. Greenberg also participated in weekly meetings with the Company's risk managers during the Class Period, and knew or should have known that the Company had twice been criticized by the SEC for failing to review and update its inaccurate models. 489. Throughout the Class Period, Defendant Greenberg made a number of materially false and misleading statements regarding the effectiveness of Bear Steams' risk monitoring procedures, as stated in the Forms 10-K for 2006 and 2007 that he signed. 490. On March 10, 2008, Greenberg, responding to the price liquidity rumors which caused shares of Bear Stearns to drop 10 percent in early trading, told CNBC that the liquidity rumors surrounding the Company are "totally ridiculous." Greenberg had been informed, immediately before his announcement, that la]ll of Bear Stearns') institutions are calling us, and we're in trouble." 491. Bear Stearns shares responded and initially jumped on the news, only to lose more ground later in the day. 492. Greenberg's statement that rumors of liquidity problems at Bear Steams were "totally ridiculous" was made without any basis in fact, and with the motive to prop up the falling price of Bear Steams' stock. Indeed, while on March 10, 2008, the Company's liquidity pool had stood at $18.1 billion, by the close of March 11, 2008, it had declined to $11.5 billion - a one-day loss of more than $6 billion. 493. While Defendants told shareholders and investors that Bear Steams' growth and concomitant expanding risk were prudent and keeping with sound risk control practices, 122 EFTA00316850

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 138 of 347 Greenberg knew, or was reckless in not knowing, that Bear Steams' risk control models had been failed to reflect downturns in the housing industry. 494. Moreover, Greenberg knew, or was reckless in not knowing, that Bear Stearns' own risk managers did not have an expertise in the very assets upon which Bear had based its investment strategy. Further, Greenberg knew or was reckless in disregarding the fact that Bear Stearns' VaR was far below the industry average, even as Bear Steams' concentration of risky ABS was the highest in the investment banking community. F. Michael J. Alix 495. As Chief Risk Officer of Bear Stearns during the Class Period, Defendant Alix had an intimate understanding of the risk management tools and processes in place at the Company. Alix was global head of credit risk management from 1996 until February 2006, when he became Chief Risk Officer. Alix made materially false and misleading statements during about Bear Steams' risk management on an August 3, 2007 conference call. 496. As Chief Risk Officer, Alix was ultimately responsible for the Company's VaR calculations. Indeed, as alleged in paragraph 122, in 2004 Alix touted the benefits of the CSE program's adoption of VaR as a measure of assessing the "true risks" faced by investment banks. He stated that: the framework will permit securities firms registered under it to determine the regulatory capital for their broker-dealers by means of approved Value at Risk ("VaR") models. This will better align capital requirements with the true risks of the securities business, with the added benefit of harmonizing the SEC's capital rules with global standards as represented by Basel II. 497. As alleged in paragraph 101, prior to Bear Steams' approval as a CSE in November 2005, OCIE found that Bear Stearns did not periodically evaluate its VaR models, nor did it timely update inputs to its VaR models. 123 EFTA00316851

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 139 of 347 498. As alleged in paragraph 104, after Alix became Chief Risk Officer, the SEC's TM division met with the Company's risk managers in September 2006 and concluded that the Company still had failed to improve the accuracy of the models it used to hedge against risk. In fact, it was not until the end of 2007 that Bear Steams developed a housing led recession scenario which it could incorporate into risk management and use for hedging purposes. Moreover, the SEC's Inspector General found that the mortgage-backed asset valuation component of the VaR models employed by the Company were not updated at any time before the Company's collapse. 499. While Defendants told shareholders and investors that Bear Steams' growth and concomitant expanding risk were prudent and keeping with sound risk control practices, Alix knew, or was reckless in not knowing, that Bear Steams' risk control models were seriously flawed and not up-to-date. Moreover, Alix knew, or was reckless in not knowing that, according to the SEC Inspector General, Bear Steams' own risk managers did not have an expertise in the very assets upon which Bear Steams had focused its investment strategy. Further, Alix knew or was reckless in disregarding the fact that Bear Steams' VaR was outdated, and far below the industry average, even as Bear Steams' concentration of risky ABS was the highest in the investment banking community. G. Jeffrey M. Farber 500. As Senior Vice President of Finance and Principal Accounting Officer since February 2007, and Controller of the Company since January 2004, Defendant Farber participated in the issuance of, and signed and certified as accurate and complete as required by Sarbanes-Oxley, Bear Steams' materially false and misleading SEC filings issued during the Class Period, including all Forms 10-Q and 10-K. 124 EFTA00316852

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 140 of 347 501. The quarterly and annual reports signed by Farber repeatedly touted the Company's risk management, including its use of internally-developed models to derive the fair value of the Company's financial instruments. 502. As alleged in paragraphs 102 to 103, during the CSE application process, the SEC told Farber that "IwIe believe that it would be highly desirable for independent Model Review to carry out detailed reviews of models in the mortgage area." These concerns were again communicated to the Farber in a December 2, 2005 memorandum from the SEC Office of Compliance Inspections and Examinations. Farber therefore knew that the valuation models used to determine fair value of MBS were deficient. 503. While Defendants told shareholders and investors that Bear Steams' growth and concomitant expanding risk were prudent and keeping with sound risk control practices, Farber knew, or was reckless in not knowing, that Bear Steams' risk control models were severely flawed and not up-to-date. Moreover, Farber knew, or was reckless in not knowing that, according to the SEC Inspector General, Bear Steams' own risk managers did not have an expertise in the very assets upon which Bear Steams had focused its investment strategy. Further, Farber knew, or was reckless in disregarding, the fact that Bear Steams' VaR was far below the industry average and failed to rise in tandem with the VaR reported by the Company's peers, even as Bear Steams' concentration of risky ABS was the highest in the investment banking community. H. Corporate Scienter 504. Bear Steams' knowledge need not be possessed by a single officer or agent; rather, the cumulative knowledge of all its agents is imputed to it. 505. The facts alleged herein create a strong inference that one or more officers of the Company acted knowingly or recklessly in violating the securities laws. 125 EFTA00316853

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 141 of 347 506. Among other things, (1) although Defendant Farber was personally told by the SEC that Bear Steams' mortgage valuation and Value at Risk models failed to reflect declines in the housing industry, he signed the Company's Forms 10-K for financial years 2006 and 2007 that set out artificially low VaR numbers and inflated asset values; (2) although Defendant Cayne was "intimately engaged" in the Company's risk management process and consequently was apprised of the SEC's criticism of Bear Steams VaR and mortgage valuation models, he signed quarterly and annual financial statements that misrepresented the Company's Value at Risk and asset values; (3) although Defendant Alix was the global head of the Company's risk management department and consequently was aware that the Company had failed to review or revise its VaR and mortgage valuation models at any time before its collapse, he represented to the public in an August 3, 2007 conference call that "we run risk analytics to demonstrate that [Bear Steams] is well protected against further deterioration in both the subprime and Alt-A sectors across both whole loans and all securitization tranches;"; and (4) although Defendant Molinaro was told by the SEC that its public disclosures of its subprime mortgage exposure omitted material information to investors, he failed to disclose this information in the Form 10-K filed for fiscal year 2007. VI. ADDITIONAL ALLEGATIONS SUPPORTING THE OFFICER DEFENDANTS' SCIENTER A. General Allegations of Scienter 507. The Officer Defendants were active participants in the fraudulent scheme alleged herein, in that: (a) each was privy to confidential proprietary information concerning Bear Stearns by virtue of their receipt of information reflecting the improper and fraudulent conduct described above and/or their failure to review information they had a duty to monitor; 126 EFTA00316854

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 142 of 347 (b) each actually issued materially false and misleading statements; or (c) each had control over the Company's materially false and misleading statements. 508. The nature of Bear Stearns' business — and the importance to it of mortgages, mortgage-backed securities, and CDOs composed of mortgage-backed securities — strongly supports the inference that the Officer Defendants knew of or recklessly disregarded the Company's sorely deficient risk management over the valuation of mortgage-backed securities. Bear Stearns' mortgage-related business was vertically integrated, allowing it a uniquely detailed perspective into the entire process from mortgage origination (of subprime, Alt-A, and prime loans) through securitization. 509. The fact that Bear Stearns suffered the first pains of the subprime mortgage meltdown — through the collapse of the Hedge Funds and the Company's subsequent assumption of the High Grade Fund's toxic assets — also raises a strong inference that the Officer Defendants knew of the need to scrutinize MBS and mortgage risk management, but knowingly or recklessly disregarded that function at the Company. 510. Moreover, the Officer Defendants knew, or recklessly disregarded, that Bear Stearns had billions of dollars of exposure to subprime mortgage defaults as a result of the CDOs that Bear Stearns carried on its own books. The Officer Defendants became aware that Bear Stearns' CDO modeling was inaccurate in June of 2007 when the Hedge Funds collapsed and Bear Stearns entered into a $1.3 billion repurchase agreement with the High Grade Hedge Fund, which required Bear Steams to take title to assets that turned out to be worth substantially less than the amount of the loan. Defendant Spector was directly responsible for the decision to extend the repurchase agreement to the High Grade Hedge Fund and was aware of the weakness 127 EFTA00316855

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 143 of 347 of the High Grade Fund's assets, which were almost identical to those assets held on Bear Steams' books at the time. 511. Each of these Officer Defendants was keenly aware of the deteriorating conditions in the U.S. subprime mortgage market and the effect of these conditions on the value of securities linked to these mortgages and other asset backed securities. As a consequence of Bear Stearns' prominence and large market share of ABS, including securities originated by Bear Steams subsidiaries BEARRES and ECC and purchased and serviced by Bear Steams subsidiary EMC and securitized by Bear Steams, the Officer Defendants knew that Bear Steams' exposure to drops in the value of ABS, including MBS and CDOs containing ABS and MBS, was far greater than otherwise disclosed. 512. Defendants Cayne, Greenberg, Molinaro, Schwartz, Spector, Alix and Farber also knew or recklessly disregarded that the materially false and misleading statements and omissions contained in Bear Steams' public statements would adversely affect the integrity of the market for Bear Steams' common stock and would cause the price of Bear Steams' common stock to be artificially inflated. Defendants Cayne, Greenberg, Molinaro, Schwartz, Spector, Alix and Farber acted knowingly or in such a reckless manner as to constitute a fraud and deceit upon Lead Plaintiff and other members of the Class. 513. Moreover, as noted below, Cayne, Greenberg, Molinaro, Schwartz, Spector, Alix and Farber were all aware that Bear Steams was unable to accurately value these assets due to weaknesses in its modeling and risk management systems. In fact, the Officer Defendants made material misstatements and omissions when asked direct questions by analysts about risk management and ABS exposure. 128 EFTA00316856

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 144 of 347 514. Each of the Officer Defendants either knew, or recklessly disregarded, the fact that the Company's disclosures relating to ABS were wholly misleading; there were billions of dollars in ABS exposure on Bear Steams' balance sheets that were unaccounted for due to Bear Stearns' inability to accurately value asset backed securities. Moreover, the Officer Defendants either knew that Bear Stearns' VaR was inaccurate because it was not reacting to the deteriorating conditions in the U.S. mortgage market or recklessly disregarded evidence that this was the case. 515. The knowledge and/or recklessness of the Officer Defendants is also evident from the rapid firings and/or resignations following the disclosure to shareholders of Bear Steams' exposure to declining ABS and CDO values. For example, on August 5, 2007, less than 60 days after the Hedge Funds collapsed, due in large part to their investment in CDOs containing subprime RMBS, Bear Steams fired Defendant Spector, who oversaw the failed Hedge Funds as head of BSAM. Likewise, on January 8, 2008, Cayne was forced to resign as CEO, in part because of Bear Stearns' potentially large exposure to risky ABS. B. Abnormal Profit Taking 516. The Class Period sales of Bear Steams stock by Defendants Cayne, Greenberg, Molinaro, Schwartz, Spector and Farber were highly unusual, and therefore suspicious, as measured by (1) the amount and percentage of shares sold, (2) comparison with these Defendants' own prior trading history and that of other insiders, and (3) the timing of the sales. Such sales therefore provide strong evidence of scienter. 517. To evaluate the selling activity of Defendants Cayne, Greenberg, Molinaro, Schwartz, Spector and Farber, Lead Plaintiff used publicly available trading data required to be reported to the SEC on Form 4. Lead Plaintiff analyzed the trading by insiders that occurred during the Class Period and during the equal-length period immediately preceding the Class 129 EFTA00316857

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 145 of 347 Period, beginning September 13, 2005 and ending December 13, 2006 (the "Control Period"). The Bear Steams' Form 4s filed during the Class Period and Control Period are hereby incorporated herein by reference, and the transactions reported therein are set forth in Exhibit B, annexed hereto. 518. The following methodologies were used to analyze these Defendants' sales. First, Lead Plaintiff calculated total sales by each of the Individual Defendants, together with the cash proceeds from such sales, during the Control and Class Periods. To calculate the amounts and percentages of shares sold, Lead Plaintiff then calculated holdings at the end of the Class Period by referencing Bear Stearns' Class Period annual proxy statements on Schedule 14A, which set forth shares owned and stock options exercisable by the Individual Defendants during the Class Period. Such data were then adjusted to the Class Period end date using the purchase and sale data set forth in Bear Stearns' Form 4s. "Holdings" were deemed to include both shares held and stock options that were vested but not yet exercised. Class Period sales were then calculated as a percentage of total shares available for sale during the Class Period, i.e., the sum of Class Period sales plus end-of-Class-Period holdings. To compare Class Period sales with prior trading history, Lead Plaintiff compared sales by the these Defendants during the Class Period with their sales during the Control Period. Lead Plaintiff also compared these Defendants' sales across the Control and Class Periods with those of lower-level (non-Defendant) reporting persons. 519. Lead Plaintiff then determined whether the Class Period sales by Defendants Cayne, Greenberg, Molinaro, Schwartz, Spector and Farber generated abnormal (that is, above- normal) profits. Abnormal profits were evaluated using an event study methodology called the "market-adjusted method," which computes cumulative shareholder returns not explained by market factors. Under this approach, if an insider buys a share of stock which then increases in 130 EFTA00316858

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 146 of 347 price from $100 to $120 (20%), and the benchmark index increases from 1000 to 1010 (1%) during the same period, then the abnormal profit would be 19%. Under the same analysis, if a company's stock price declines subsequent to a sale by a greater amount than the relevant benchmark index, then the sale enabled the insider to generate an abnormal profit by avoiding the decline. For example, if an insider sells a share of stock which then declines from $100 to $80 (20%) while the relevant benchmark decreases from 1000 to 990 (1%), then the abnormal profit would again be 19%. This methodology has been used extensively in the academic literature studying the profitability of insider trading. In a typical study, abnormal profits are calculated using a 250 trading day period following the day of trade, measured against a value- weighted index of NYSE, AMEX and NASDAQ stocks for 2000-2008. Due to Bear Steams' collapse in March of 2008, the abnormal profits were calculated using a 125 trading day period following the day of trade. 520. After calculating abnormal profits for the these Defendants' Class Period sales, Lead Plaintiff then calculated the probability that such abnormal profits resulted from random chance. This probability was calculated by computing the trade-dollar-weighted residuals from the market-adjusted model for 125 trading days before and 125 trading days after the day of trade, and averaging these residuals across event days for each insider. This data was then used to compute a "t-statistic" (a statistical tool) to infer the probability that the observed cumulative abnormal profits were due to random chance. 521. By each analysis, each of these Defendants' Class Period sales was extremely large and highly unusual. For one, the amount and percentage of shares sold during the class period was extraordinary. During the Class Period, when the price of Bear Steams' shares was artificially inflated, Cayne sold 219,036 shares for a total realized value of $23,010,474. During 131 EFTA00316859

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 147 of 347 the Class Period, when the price of Bear Steams' shares was artificially inflated, Greenberg sold 371,986 shares for a total realized value of $34,594,027. Greenberg sold 40.89% of his Bear Steams shares during the two year Class Period as compared to 11.91% of his Bear Steams shares during the Control Period. During the Class Period, when the price of Bear Steams' shares was artificially inflated, Molinaro sold 38,552 shares for a total realized value of $4,230,828. During the Class Period, when the price of Bear Steams' shares was artificially inflated, Schwartz sold 91,233 shares for a total realized value of $9,867,001. During the Class Period, when the price of Bear Steams' shares was artificially inflated, Spector sold 116,255 shares for a total realized value of $19,066,373. During the Class Period, when the price of Bear Steams' shares was artificially inflated, Farber sold 3,324 shares for a total realized value of $362,000. 522. Second, Defendants Cayne, Greenberg, Molinaro, Schwartz, Spector and Farber generated enormous abnormal profits on their sales of Bear Steams stock. In all, by avoiding the declines associated with Bear Steams' falling share value and by capitalizing on the false information when it was greatest, these Defendants recognized abnormal profits of approximately 86.3%, on average. Molinaro, Farber, Cayne and Schwartz more then doubled their money by timing their sales either to days when inflation was highest or when the market declines were least. Molinaro's were an astounding 173% higher than they otherwise would have been if the shares were not falsely inflated. Farber's abnormal profit was 158%, Cayne's was 132% and Schwartz's was 115%. In addition, Greenberg's abnormal profit was 73%, while Spector's profits were 35%. These abnormal profits on the part of insiders who sold stock during a period of inflation of their own making is further evidence of scienter. 132 EFTA00316860

Case 1:08-cv-02793-RWS Document 102 Filed 02,27709 Page 148 of 347 VII. DELOITTE'S DEFICIENT AUDITS OF BEAR STEARNS' FINANCIAL STATEMENTS A. Overview of Allegations Against Deloitte 523. As more fully set forth below, during the Class Period, Deloitte's audits of the Company's financial statements were so deficient that the audit amounted to no audit at all, were an egregious refusal to see the obvious or investigate the doubtful, and/or disregarded specific "red flags" that would have placed a reasonable auditor on notice that the Company was engaged in wrongdoing to the detriment of its investors. Although auditing guidelines required that Deloitte give especially close scrutiny to the Company's fair value measurements, Deloitte deliberately or recklessly disregarded several red flags with respect to valuation, including the fact that the Company had persisted in using mortgage valuation models that the SEC had repeatedly criticized as inaccurate and outmoded. 524. Similarly, although Deloitte was obliged to evaluate the statements of VaR set out in the MD&A section of the Company's regulatory filings, Deloitte deliberately or recklessly disregarded the fact that by at least November of 2005 the Company had been warned by the SEC that its VaR models failed to reflect key indicators in the housing market. 525. Moreover, despite the fact that Deloitte was obliged to be especially skeptical of related party transactions such as the High Grade fund bailout, Deloitte deliberately or recklessly disregarded the fact that the collateral the Company had received as a result of the bailout was far less than the value of the loan Bear Stearns had offered to the High Grade Fund. 526. Finally, in spite of multiple risk alerts that related to the Company's internal controls, internal audits, and disclosures, Deloitte deliberately or recklessly disregarded significant red flags in these areas as well. 133 EFTA00316861

Case 1:08-cv-02793-RWS Document 102 Filed 02,27/09 Page 149 of 347 B. Deloitte's Certifications 527. Deloitte issued a "clean opinion" pursuant to each of its audits of Bear Steams' financial statements for the fiscal years ended November 30, 2006 and November 30, 2007, and issued similar certifications for each of the Company's quarterly statements during the Class Period. In connection with the Company's Form 10-K for fiscal year 2006 Deloitte stated: We have audited the consolidated financial statements of The Bear Stearns Companies Inc. and subsidiaries (the "Company") as of November 30, 2006 and 2005, and for each of the three years in the period ended November 30, 2006, management's assessment of the effectiveness of the Company's internal control over financial reporting as of November 30, 2006, and the effectiveness of the Company's internal control over financial reporting as of November 30, 2006, and have issued our reports thereon dated February 12, 2007; such consolidated financial statements and reports are included in your 2006 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedule (Schedule I) of The Bear Stearns Companies Inc. (Parent Company Only), listed in Item 15. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. 528. In connection with the Company Form 10-K for fiscal year 2007, Deloitte stated: We have audited the consolidated financial statements of The Bear Stearns Companies Inc. and subsidiaries (the "Company") as of November 30, 2007 and 2006, and for each of the three years in the period ended November 30, 2007, and the Company's internal control over financial reporting as of November 30, 2007, and have issued our reports thereon dated January 28, 2008 (such report on the consolidated financial statements expresses an unqualified opinion and includes an explanatory paragraph relating to the adoption of Statement of Financial Accounting Standards ("SFAS") No. 155, "Accounting for Certain Hybrid Instruments, an amendment of FASB Statements No. 133 and 140" and SFAS No. 157, "Fair Value Measurements"); such consolidated financial statements and reports are included in your 2007 Annual Report to Stockholders and are incorporated herein by reference. Our audits 134 EFTA00316862

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 150 of 347 also included the financial statement schedule (Schedule I) of The Bear Stearns Companies Inc. (Parent Company Only), listed in Item 15. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. C. Overview of GAAS 529. The Public Company Accounting Oversight Board ("PCAOB"), established by the Sarbanes-Oxley Act of 2002, is responsible for the development of auditing and related professional practice standards that are required to be followed by registered public accounting firms. On April 16, 2003, the PCAOB adopted as its interim standards GAAS as described by the AICPA Auditing Standards Board's SAS No. 95, Generally Accepted Auditing Standards, and related interpretations in existence on that date. Accordingly, an auditor's reference to "the standards of the Public Accounting Oversight Board (United States)" includes a reference to GAAS in existence as of April 16, 2003. For simplicity, all references to GAAS hereinafter include the standards of the PCAOB. 530. GAAS is comprised of ten basic standards that establish the quality of an auditor's performance and the overall objectives to be achieved in a financial statement audit. Auditors are required to follow those standards in each and every audit they conduct. 531. The GAAS standards fall into three basic categories: General Standards; Fieldwork Standards; and Reporting Standards. The General Standards require, among other things, provide guidance planning and conducting an audit, and require that the auditor exercise professional skepticism. The Field Work Standards require, among other things, that an auditor obtain a sufficient understanding of the entity's business and operating environment to properly plan an audit in accordance with GAAS. Finally, the Reporting Standards require that an auditor 135 EFTA00316863

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 151 of 347 express an opinion on the financial statements of a company taken as a whole, or an assertion to the extent that an opinion cannot be expressed. D. GAAS Required Deloitte to Consider Risk Factors as Part of Audit Planning 532. For purposes of planning and conducting its audits of Bear Steams, Deloitte was required to give special consideration to risk factors identified in "Fraud Risk Alerts" and "Audit Risk Alerts" that may have resulted in material misstatements of the Company's financial statements (AU 316.14). Fraud risk factors may be relevant to economic circumstances in general, an industry, or to a particular entity. An understanding of applicable fraud risk factors is important for an auditor to be able to appropriately determine the nature, extent, and timing of audit procedures performed (AU 316.15). Moreover, because Deloitte audited the books of the Hedge Funds and knew that BSAM had valued the Hedge Funds' assets, it should have been especially skeptical of the valuations that the Company provided for its own assets. 1. Fraud Risk Alerts Relevant to Deloitte's Audit of Bear Stearns 533. The fraud risk factors described above at paragraphs 331 to 348 relating to Bear Stearns' financial statements were also relevant to Deloitte's considerations of the nature, timing, and extent of its audit procedures. 534. In addition, due to its role as the Company's independent auditor, there were supplemental fraud risk factors that should have been considered by Deloitte. These included: (a) The estimation of the fair value of investments (AU 316.39). As described above, Bear Stearns' use of leverage caused these estimations to have material implications on reported Principal Transactions Revenue; (b) The risk of transactions with related parties that do not have the substance or the financial strength to support a transaction without assistance from the entity under audit 136 EFTA00316864

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 152 of 347 (AU 316.67). Accordingly, transactions that Bear Steams may have entered into with its hedge funds, for example, warranted scrutiny by Deloitte; (c) The ever-present risk of management overriding internal controls (AU 316.08, 42, and 57-65). For purposes of its audits of Bear Steams, this risk should have caused Deloitte to perform specific procedures to address the internal controls related to the models used to determine the reported valuation of financial instruments; and (d) The risk that new regulatory requirements, such as the recently implemented CSE structure, may cause an incentive or pressure of fraudulent financial reporting (AU 316.85, A.2.a). In this regard, Deloitte should have been familiar with nature of Bear Steams' relationship with the TM and conducted certain procedures to understand the communications between those parties. 2. Audit Risk Alerts Relevant to Deloitte's Audit of Bear Stearns 535. The ARAs also addressed specific risk factors for Deloitte to consider in its audits of Bear Steams. The ARAs were released annually, typically in mid-summer, which enabled them to be considered for purposes of Deloitte's annual audits of Bear Steams. The SEC recognized the import of the ARAs and the need to consider the presented risks in the preparation and audits of financial statements. The risks in the ARAs that were incrementally relevant to Deloitte for purposes of its audits of Bear Stearns included the following: (a) 2005 ARA stated "...the auditor needs to be aware of any changes in the institution's loan profile (for example, prime vs. subprime, secured vs. unsecured, direct lending vs. indirect lending) and understand the institution's ability to identify, manage, and control the attendant risk for those credit profiles" (2005 AAM 8050.28). (b) The 2006 ARA warned auditors to "Examine specific collateral surrounding the client investment portfolio and evaluate potential impairment." (2006 AAM 137 EFTA00316865

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 153 of 347 8050.17) The potential for impairment was particularly relevant for "products [that] assume a continued rise in home prices that may not continue." (AAM 8050.35) As a result, Deloitte should have been aware of the risk factors related to the valuation of Bear Stearns' financial instruments such as CDOs. (c) The 2007 ARA cautioned auditors to "Consider the pressures financial institutions are facing when planning and performing the audit engagement." (2007 AAM 8050.16) In addition, it apprised auditors of the need to "Consider the current real estate climate when conducting an audit of a mortgage company." (2007 AAM 8050.30) Thus, Deloitte should have been attuned to the risks associated with home price depreciation and the pressures on management to avoid the negative adjustments to liquidity and capital caused by reductions in the reported value of financial instruments. 3. Deloitte's Experience Auditing the Hedge Funds 536. In addition to its audits of Bear Stearns, Deloitte was also responsible for the audits of the Hedge Funds. Based on knowledge gained during those audits, Deloitte knew that very large percentages of the hedge funds' holdings were valued by BSAM itself, with Bear Stearns' oversight. In fact, in 2006, Deloitte issued audit opinions on the hedge funds stating that it was relying upon BSAM's representations of the fair market value of the vast majority of the funds' assets. 537. Deloitte also knew that Bear Stearns was the source of the majority of the assets held by the hedge funds. The notes to the financial statements of the High Grade Fund for the year ended December 31, 2006 stated: "[t]he Master Fund may invest in securities issued by Bear, Stearns & Co., Inc. or an affiliate. At December 31, 2006, $751,840,048 (approximately 81.96% of net assets) is invested in such securities." 138 EFTA00316866

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 154 of 347 538. The notes to the financial statements of the High Grade Enhanced Fund for August 1, 2006 through December 31, 2006 similarly stated: "[t]he Master Fund may invest in securities issued by Bear, Steams & Co., Inc. or an affiliate. At December 31, 2006, $473,302,969 (approximately 71.54% of net assets) is invested in such securities." 539. Because Bear Steams retained large amounts of the CDOs it sold on its own books, the collapse of the Hedge Funds should have put Deloitte on notice that Bear Stearns' books were vulnerable to the same extraordinary declines. E. Red Flags Recklessly or Deliberately Disregarded by Deloitte 540. Deloitte was required to performed an integrated audit of Bear Steams in accordance with PCAOB Auditing Standards.9 Specifically, Deloitte was charged with evaluating the Company's fair value measurements, internal controls, internal audits, and financial disclosures. In each area Deloitte's accounting audit practices were so deficient that it was deliberately or recklessly ignored significant red flags. 1. Bear Stearns' Misleading Fair Value Measurements 541. The most significant dollar-value asset on Bear Stearns' balance sheet was "Financial Instruments Owned, at Fair Value." Accordingly, it was exceedingly important that the Company accurately determine the fair value of these assets. 542. For purposes of both its 2006 and 2007 audits, GAAS required Deloitte to apply auditing procedures to Bear Steams' financial instruments (GAAS including AU 328, "Auditing Fair Value Measurements and Disclosures" and AU 332, "Auditing Derivative Instruments, Hedging Activities, and Investments in Securities"). Among other things, GAAS required 9 Anintegrated audit is a reference to the fact that the independent auditor opines on both the effectiveness of internal control over financial reporting and the consistency of the financial statements with GAAP. 139 EFTA00316867

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 155 of 347 Deloitte to evaluate management assumptions used in determining fair value and controls over the consistency, timeliness, and reliability of the data used in valuation models. 543. GAAS also required Deloitte to test Bear Stearns' processes for preparing fair value measurements and the reasonableness, relevance, and timeliness of the information, assumptions, inputs and models (AU 328.23-.24). Deloitte's audit testing should have included an evaluation of whether the fair value measurements were consistent with market information, were determined using an appropriate model, and included relevant information that was reasonably available at the time (AU 328.26). 544. Deloitte's duties also included identification of those assumptions that had high sensitivities on valuation (AU 328.34).10 This duty should have focused Deloitte on Bear Stearns' stress testing or other sensitivity analysis as well as caused Deloitte to assess whether any sensitive assumptions had been excluded from the valuation process (AU 328.35). 545. In addition, to the extent that the inputs and assumptions employed in Bear Stearns' valuation models were dependent upon historical data, GAAS required Deloitte to test whether reliance on historical financial information in the development of assumptions was justified (AU 328.37).11 546. Standard audit procedure also required that Deloitte focus on testing the Company's pricing models to compute the reported fair value of Level 2 and Level 3 financial 1° AU 328.34, "The auditor considers the sensitivity of the valuation to changes in significant assumptions, including market conditions that may affect the value. Where applicable, the auditor encourages management to use techniques such as sensitivity analysis to help identify particularly sensitive assumptions. If management has not identified particularly sensitive assumptions, the auditor considers whether to employ techniques to identify those assumptions." " AU 328.37, "If management relies on historical financial information in the development of assumptions, the auditor considers the extent to which such reliance is justified. However, historical information might not be representative of future conditions or events, for example, if management intends to engage in new activities or circumstances change." 140 EFTA00316868

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 156 of 347 instruments, which included both mortgage-related securities and RIs. Deloitte also should have tested the Company's method of classification of financial instruments as either Level 2 and Level 3 since that information was material to users of the Company's financial statements. 547. For these assets, GAAS recognize that "an entity may use its own assumptions as long as there are no contrary data indicating that marketplace participants would use different assumptions." (AU 328.06) Accordingly, Deloitte was required to assess whether Bear Stearns' assumptions were reasonable and reflected market-based information. 548. Moreover, for purposes of Deloitte's 2007 audit of Bear Steams, it was no longer possible for the auditors to ignore the fact that the housing market downturn was in full force and that the market for mortgage-related securities was illiquid. At that time, it was widely understood that particular scrutiny should be applied by independent auditors to pricing models used to determine the valuation of financial instruments. For example, in October 2007, the Center for Audit Quality ("CAQ"), which is associated with the AICPA, published an audit alert entitled "Measurements of Fair Value in Illiquid (Or Less Liquid) Markets." 549. This alert observed in pertinent part, The level of defaults has, in many cases, exceeded the model-based projections originally used to structure and assign ratings to securities backed by subprime mortgage loans...and holders of existing loans and mortgage-backed securities have experienced sharp declines in their value. 550. Thus, in advance of Deloitte's 2007 audit, Deloitte should have been alert that (I) Bear Stearns' mortgage-related valuation models may not have anticipated the rising level of defaults associated with the housing market downturn, and (2) the resultant fair value of related financial instruments should reflect appropriately increased conservatism. 551. Indeed, during its audit of the Company's fair value measurements, Deloitte was confronted with significant red flags relating to measurement of fair value. According to the 141 EFTA00316869

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 157 of 347 2008 OIG Report, during the Class Period Bear Steams failed to include crucial factors in its valuation models including, for example, inadequate consideration of default risk and scenarios of home price depreciation. These missing assumptions would have been known to, and employed by, market participants, who were the focal audience for fair value measurements in accordance with GAAP. 552. Moreover, as set out at paragraphs 124 to 126 above, in November of 2005 and again in December of 2006, Bear Steams had been informed by the SEC that its models were critically deficient. In conducting its audit, Deloitte either deliberately or recklessly disregarded the fact that the SEC had already warned the Company of these problems. 2. Bear Stearns' Failures to Disclose Risks Inherent In Its Financial Statements 553. Deloitte also had a professional obligation to assess whether other disclosures in documents containing the financial statements were materially inconsistent with the financial statements (AU 550, Other Information in Documents Containing Audited Financial Statements I 4). 554. Bear Steams disclosed its VaR in the MD&A section of its regulatory filings with the SEC. 555. As set out above at paragraphs 123 to 124, the Company had been warned by the SEC as early as November of 2005 that its VaR models failed to take into account critical inputs reflecting risk in the housing market. 556. As set out in paragraphs 124 to 128 above, despite this warning, the Company did not complete any review of key inputs to its VaR models during the Class Period. 142 EFTA00316870

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 158 of 347 557. In light of the significant deficiencies in Bear Steams' VaR models that should have been identified during its testing of internal controls over financial reporting, Deloitte knew or should have known that the amounts reported as VaR were inaccurate and unreliable. 3. Bear Stearns' Misleading Accounting Treatment of the Hedge Fund Bailout 558. As a result of its bailout of the High Grade Fund that it managed, Bear Steams had effectively assumed onto its books more than $1.3 billion in the Fund's subprime-backed collateral. As set out above at paragraphs 214 to 216, less than a month later, the Company informed the Fund's investors that the Fund was virtually worthless. Deloitte deliberately or recklessly disregarded the fact that the Company carried this worthless collateral on its books for months without taking an appropriate write down. 559. Deloitte should have approached its testing of any related-party transactions with particular caution if they exhibited traits identified within GAAS to be of higher risk including (AU 334.06): (a) "An urgent desire for a continued favorable earnings record in the hope of supporting the price of the company's stock." (b) "Dependence on a single or relatively few products, customers, or transactions for the continuing success of the venture." (c) "A declining industry characterized by a large number of business failures." 560. For purposes of its 2007 audit, Deloitte knew or should have known that on June 22, 2007 Bear Steams had provided loans, in the form of a repo agreement, to the failing High Grade Hedge Fund. As a result, Deloitte was required to obtain an understanding of the business purpose of the transactions and obtain satisfaction concerning the value of any related collateral 143 EFTA00316871

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 159 of 347 (AU 334.09). Further, Deloitte was required to obtain information about the financial capability of the High Grade Hedge Fund (AU 334.10). 561. In this case, Deloitte knew or should have known that the collateral provided by the High Grade Funds was clearly insufficient to guarantee the value of the loans extended by Bear Stearns. The Company had informed the High Grade Fund investors in July of 2007 that the High Grade Fund "had very little value left." 562. Moreover, Deloitte knew or should have known that the hedge funds were otherwise incapable of repaying those loans. Indeed, as noted at paragraphs 211 to 213 above, the 2008 OIG Report noted that the hedge funds lacked the capability to repay the loans. 563. As a result, Deloitte also should have considered that both GAAP and GAAS recognize the "importance of reporting transactions and events in accordance with their substance" and "whether the substance of transactions or events differs materially from their form." (AU 411, "The Meaning of `Present Fairly in Conformity with GAAP" 16). Accordingly, the substance of these transactions was that Bear Steams had guaranteed the High Grade Fund by absorbing its worthless assets. Deloitte should also have ensured that the loan value and related implications on reported capital were appropriately incorporated into Bear Stearns' financial statements. Finally, Deloitte should have ensured that appropriate disclosure was provided to inform investors of the substance of Bear Steams' related party transactions with the hedge funds (AU 334.02). 4. Bear Stearns' Failure to Disclose Critical Information Relating to the Company's Valuation of Its Financial Instruments 564. GAAS requires the presentation of financial statements in accordance with GAAP includes adequate disclosure of material matters. (AU 431, Adequacy of Disclosure in Financial 144 EFTA00316872

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 160 of 347 Statements) This particular standard is specifically referenced in AU 328 because fair value information is significant to users of financial statements.'2 565. GAAS further state "If an item contains a high degree of measurement uncertainty, the auditor assesses whether the disclosures are sufficient to inform users of such uncertainty." (AU 328.45) 566. Nevertheless, in light of the SEC's repeated warnings to the Company, Deloitte knew or should have known that Bear Stearns, in violation of GAAP, failed to disclose in its financial statements that: (a) Its pricing models failed to consider inputs that were critical to the determination of the fair value of material holdings of mortgage-related financial instruments such as default rates and liquidity risk; (b) Programs to review mortgage pricing models were not put into place prior to the collapse of Bear Stearns in March 2008; (c) There were questions as to the independence of risk management personnel and that risk management personnel lacked experience in valuing mortgage-related assets, which represented the most significant component of Bear Stearns' financial instruments; and (d) The Company did not implement stress-testing scenarios that addressed negative house pricing appreciation (HPA) assumptions and shocked credit spreads for certain mortgage-back securities. 12 AU 328.43, "Disclosure of fair value information is an important aspect of financial statements. Often, fair value disclosure is required because of the relevance to users in the evaluation of an entity's performance and financial position." 145 EFTA00316873

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 161 of 347 567. A further red flag came in September of 2007, when the SEC informed Bear Steams that it was required to provide more information about its exposure to subprime investments." By virtue of its position as Bear Steams' auditors, Deloitte would have been knowledgeable about the receipt and contents of the SEC's comment letter. 568. While the resolution of the SEC Comment Letter pertained to the 2006 Form 10- K, Deloitte had been put on notice of the value of such disclosure in subsequent SEC filings. Accordingly, Deloitte's opinion that the 2007 financial statements were materially consistent with GAAP represented a significant shortcoming of due professional care because by then it was undeniable that at a minimum Bear Steams' fair value related disclosures were inadequate. 569. Indeed, Deloitte knew that Bear Steams not only failed to provide users of its financial statements with any of this meaningful information, it further failed to acknowledge even the existence of the Unresolved SEC Comments.'' 5. Bear Stearns' Inadequate Internal Controls 570. For purposes of its 2006 audit, Auditing Standard ("AS") No. 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of the Financial Statements was applicable to Deloitte. AS 214 states that "[m]aintaining effective internal control over financial reporting means that no material weaknesses exist; therefore, the objective of the audit of internal control over financial reporting is to obtain reasonable assurance that no material weaknesses exist as of the date specified in management's assessment." A 13 The 2008 OIG Report Stated that "[i]nvestors would have benefited from enhanced disclosures regarding [Bear Stearns] involvement in the subprime mortgage market and their potential exposures in this market.- 14 p art' Item 1B of the 2007 Form 10-K entitled "Unresolved Staff Comments" reported that there were "None." The 2007 Form 10-K was filed January 29, 2008 — two days prior to the Company's initial response to the SEC Comment Letter of September 2007. Bear Steams' response solely related to the (continued. .. ) 146 EFTA00316874

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 162 of 347 material weakness is a significant deficiency that "results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.s15 (AS 21 10) 571. For purposes of its 2007 audit of Bear Stearns, AS No. 5, An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements, was applicable to Deloitte. AS 5 12 reflected substantially similar provisions as AS 2 1 4. 572. AS 2, 1 27 (No. 5,17; No. 5, 162) describes components of internal controls and explains how an independent auditor should obtain a sufficient understanding of the internal controls for the purpose of assessing the risk of material misstatement and identifying deficiencies in internal control. AS 2127 (No. 5, 17; No. 5, 162) states as follows: In an audit of internal control over financial reporting, the auditor must obtain sufficient competent evidence about the design and operating effectiveness of controls over all relevant financial statement assertions related to all significant accounts and disclosures in the financial statements. The auditor must plan and perform the audit to obtain reasonable assurance that deficiencies that, individually or in the aggregate, would represent material weaknesses are identified. 573. AS 2152 required Deloitte to test "Company-level controls" (AS 5 1 22 refers to these controls as "Entity-level controls"). Company-level controls include management's risk assessment processes, controls to monitor the results of operations, controls to monitor other controls, including activities of the internal audit function, the audit committee, self-assessment ( continued) SEC's inquiry on subprime accounting issues extended over ten pages, which reflected the materiality of that information. Is AS 21 9 defines a significant deficiency as "is a control deficiency, or combination of control deficiencies, that adversely affects the company's ability to initiate, authorize, record, process, or report external financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of the company's annual or interim financial statements that is more than inconsequential will not be prevented or detected." 147 EFTA00316875

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 163 of 347 programs, the period-end financial reporting process, and Board-approved policies that address significant business control and risk management practices (AS 2 1 53, AS 5 1 23). Accordingly, Deloitte was required to include testing of Bear Stearns' risk management processes in its audit of internal controls over financial reporting. 574. Moreover, AS 21 108 precluded Deloitte from delegating the authority to perform procedures to assess the operating effectiveness of Bear Stearns' risk management personnel. While AS 51 19 modified this standard slightly for purposes of the 2007 audit, the significance of the control risk addressed by the risk management function at Bear Stearns called for Deloitte to continue to perform procedures to assess the effectiveness of the internal controls constituted by risk management. Deloitte was required to consider its understanding of Bear Stearns' internal controls gained in prior periods for purposes of its 2007 audit.I6 575. AS 2160 (AS 5 1 28) required Deloitte to perform targeted procedures to assess the internal controls over financial reporting related to the financial statement assertions of significant accounts. Bear Stearns' reported balance of financial instruments met the criteria of a significant account, which included the size and composition of the account, susceptibility of loss due to errors or fraud, accounting and reporting complexities associated with the account, and exposure to losses represented by the account (AS 2 1 65, AS 5 1 29). Accordingly, Deloitte was required to consider, among other factors, whether effective internal controls existed to 16 AU 319.26, "The nature, timing, and extent of procedures the auditor chooses to perform to obtain the understanding will vary depending on the size and complexity of the entity, previous experience with the entity, the nature of the specific controls used by the entity including the entity's use of IT, the nature and extent of changes in systems and operations, and the nature of the entity's documentation of specific controls." (emphasis added) 148 EFTA00316876

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 164 of 347 ensure that the reported valuation of Bear Steams' financial instruments was appropriate (AS 2 1 68, AS 5 1 28)." 576. GAAS recognized audit risk stems in part from the "business risk that the institution does not properly understand the terms and economic substance of a significant complex investment. Such misunderstandings could result in the incorrect pricing of a transaction and improper accounting for the investment or related income." (D&L AAG 7.107) As implementation guidance, the D&L AAG notes that relevant control activities include: (a) Procedures exist to identify and monitor credit risk, prepayment risk, and impairment. (b) basis. Current fair value of securities are obtained and reviewed on a timely (c) Securities are monitored on an ongoing basis and factors affecting income recognition and the carrying amount of the securities are analyzed periodically to determine whether adjustments are necessary. 577. The D&L AAG also provides guidance for independent accountants when testing internal controls. It states (Ch. 7 Investments in Debt & Equity Securities ¶ Ill): Control activities that would contribute to internal controls over financial reporting in this area include the maintenance of management policies, adopted by the board of directors or its investment committee, that establish authority and responsibility for investments in securities. 578. When reviewing such management policies, GAAS observes "...the independent accountant should be alert to potential abuses and override of policies and procedures when such circumstances exist." (D&L AAG 7.113) 11 AU326.07, Valuation or allocation assertions address whether balances and transactions presented (continued. .. ) 149 EFTA00316877

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 165 of 347 579. Deloitte's internal controls testing should have addressed Bear Steams' mortgage- underwriting and securitization practices.I8 In doing so, Deloitte was on notice that it should take special care, as Bear Stearns was increasingly relying on non-conforming loans (i.e., the 2/28 Hybrid ARMs) (D&L AAG Ch. 8, Loans).19 This pattern was reflected in the growth of Bear Stearns' assets that were subject to management's subjective estimates. These were the very types of investments explicitly identified in the ARAs as possessing higher degrees of inherent risk (2006 AAM 8050.35). Moreover, Deloitte should have been attuned to material industry and Bear Steams specific risks such as:20 (a) The June 2006 meltdown of the Bear Steams U.K. subsidiary that specialized in subprime originations; (b) The observations of the housing market downturn by the National Association of Realtors beginning in May 2006 described above; and (.. .continued) within the financial statements have been reflected using the appropriate amount. IS AU 319.49, "The auditor should obtain sufficient knowledge of the information system relevant to financial reporting to understand — The procedures, both automated and manual, by which transactions are initiated, recorded, processed, and reported from their occurrence to their inclusion in the financial statements." 19 2006 D&L AAG 8.06, "Internal factors—such as an institution's underwriting practices, credit practices, training, risk management techniques, familiarity and experience with its loan products and customers, the relative mix and geographic concentration of its loan portfolio and the strength of its internal control—also have a significant effect on an institution's ability to control and monitor its credit exposure." (emphasis added) See also 8.07, which notes that concentrations of particular type of product increases credit risk. Ch.8 in conjunction with AU 319 requires that the auditor gain an understanding of an entity's internal controls. 20 AU 319.49, "The auditor should obtain sufficient knowledge of the information system relevant to financial reporting to understand — How the information system captures other events and conditions that are significant to the financial statements." 150 EFTA00316878

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 166 of 347 (c) The FDIC reiteration that "Bankers and bank regulators need to remember that rapid expansion in loan volumes often leads, over time, to declining credit quality.s21 580. A close scrutiny of the Company's internal controls relating to its securitization business should have placed Deloitte on notice that Bear Steams was engaged in wrongdoing to the detriment of its investors. The GIG identified a: Lack of expertise by risk managers in mortgage-backed securities at various times; lack of timely formal review of mortgage models; persistent understaffing; a proximity of risk managers to traders suggesting lack of independence; turnover of key personnel during times of crisis; and an inability or unwillingness to update models quickly enough to keep up with changing circumstances. 581. In addition, the 2008 OIG Report found "Bear Stearns' concentration of mortgage securities was increasing for several years and was beyond its internal limits, and that a portion of Bear Steams' mortgage securities (i.e., adjustable rate mortgages) represented a significant concentration of market risk...". Accordingly, Deloitte should have been aware of the red flag associated with the fact that Bear Stearns' holdings of MBS-related securities were in excess of its internal policy limits. 582. In addition to the above, Deloitte should have taken notice of the varying risk management and pricing approaches taken by Bear Stearns' trading desks described at paragraphs 130 to 131 above. The B&D AAG observed that this practice constitutes a fraud risk factor, which for purposes of Deloitte's audits of Bear Steams should have become a red-flag.22 21 http://www.fdic.gov/news/news/press/2006/pr06072.html 22 Ch. 5, Auditing Considerations, Fraud Risk Factors, Appendix A,1 5.195, Part 1 Fraudulent Financial Reporting, B.2.i, "Use of different valuations of same product in two related companies?' 151 EFTA00316879

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 167 of 347 6. Bear Stearns' Deficient Internal Audit Function 583. GAAS recognize that the internal audit function serves an important role in monitoring the performance of an entity's controls (AU 322, The Auditor's Consideration of the Internal Audit Function in an Audit of Financial Statements, 1 4). Accordingly, GAAS states "the auditor should obtain an understanding of the internal audit function sufficient to identify those internal audit activities that are relevant to planning the audit." (AU 322.04) 584. Deloitte was subject to professional standards to evaluate the work performed by Bear Stearns' internal auditors. Specifically, when the work of internal auditors is used, the independent auditor is required to evaluate: (a) The competence of those internal auditors (AU 322.09); (b) The procedures performed by internal audit to develop an understanding of relevant internal controls (AU 322.13). 585. GAAS further specify that when there is a high risk of misstatement, such as with the valuation of assets, the external auditor is required to conduct its own testing.23 The auditor is similarly responsible for critical judgments such as inherent and control risks, and the materiality of misstatements.24 586. In addition to the material weaknesses it observed with respect to Bear Stearns' risk management function, the SEC concluded that there were significant deficiencies of the 23 AU 322.21, "However, for such assertions, the consideration of internal auditors' work cannot alone reduce audit risk to an acceptable level to eliminate the necessity to perform tests of those assertions directly by the auditor. Assertions about the valuation of assets and liabilities involving significant accounting estimates, and about the existence and disclosure of related-party transactions, contingencies, uncertainties, and subsequent events, are examples of assertions that might have a high risk of material misstatement or involve a high degree of subjectivity in the evaluation of audit evidence." 24 AU 322.19, "Because the auditor has the ultimate responsibility to express an opinion on the financial statements, judgments about assessments of inherent and control risks, the materiality of (continued . ) 152 EFTA00316880

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 168 of 347 Company's internal audit function. These deficiencies were observed relative to Bear Steams' Internal Audit's assessment of risk management controls. Importantly, this conclusion was reached on a contemporaneous basis as set forth in the 2008 OIG Report: TM's own memorandum dated November 2006 noted significant deficiencies in Bear Steams internal auditors' work as follows: The audits for Market Risk Management, Credit Risk Management and Funding/Liquidity Risk Management are completed and the reports are in draft form. At this point it can be noted the (sicJ there appears to be significant deficiencies in the coverage for the review of liquidity and funding risk management which will be a focal point of our discussions of scope expansion in the 2007 CSE audits. (emphasis added) 587. Given applicable professional standards, Deloitte should have similarly identified and addressed the red-flags constituted by the deficiencies in Bear Stearns' Internal Audit function. Deloitte should have been particularly sensitive to its review of the internal audit reports regarding Bear Steams' risk management because Sarbanes-Oxley as originally drafted required the external auditor rather than internal auditors to perform this work. In other words, applicable standards anticipated that greater levels of independence and expertise were likely to be necessary in the assessment of risk management than could be provided by internal audit personnel. 588. Risk control at Bear Steams was inextricably linked to the effectiveness of risk management and internal audit personnel as well as the procedures those functions carried out. In consideration of the significant deficiencies identified by the SEC, Deloitte should have known that Bear Steams' internal audit function did not mitigate any of the shortcomings of the Company's risk management function. Critically, the ineffectiveness of Bear Steams' oversight (... continued) misstatements, the sufficiency of tests performed, the evaluation of significant accounting estimates, and other matters affecting the auditor's report should always be those of the auditor." 153 EFTA00316881

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 169 of 347 functions raised red-flags about the Company's internal controls and commitment to the effective risk management operations it was reporting to users of its financial statements. VIII. DEFENDANTS' MATERIALLY FALSE AND MISLEADING STATEMENTS A. Statements Relating to Fiscal Year 2006 and Fourth Ouarter 2006 589. The Company's deception of its investors began on December 14, 2006, with a series of false statements regarding its 2006 results made in a press release and press conference. It continued to misrepresent its results in the Form 10-K it filed with the SEC covering fiscal year 2006. 1. December 14, 2006 Press Release 590. On December 14, 2006, Bear Steams issued a press release regarding its fourth quarter and fiscal year end results for 2006. The Company stated: The Bear Stearns Companies Inc. (NYSE:BSC) today reported earnings per share (diluted) of $4.00 for the fourth quarter ended November 30, 2006, up 38% from $2.90 per share for the fourth quarter of 2005. Net income for the fourth quarter of 2006 was $563 million, up 38% from $407 million for the fourth quarter of 2005. Net revenues for the 2006 fourth quarter were $2.4 billion, up 28% from $1.9 billion for the 2005 fourth quarter. The annualized return on common stockholders' equity for the fourth quarter of 2006 was 20.5%. For the fiscal year ended November 30, 2006, earnings per share (diluted) were a record $14.27, up 38% from $10.31 for fiscal 2005. Net income for the fiscal year 2006 was $2.1 billion, up 40% from the $1.5 billion earned in the twelve-month period ended November 30, 2005. Net revenues for fiscal year 2006 were $9.2 billion, an increase of 25% from $7.4 billion in the prior fiscal year. The after-tax return on common stockholders' equity was 19.1% for fiscal 2006. *** Net revenues in Capital Markets, which includes Institutional Equities, Fixed Income and Investment Banking, were $1.8 billion for the fourth quarter of 2006. 154 EFTA00316882

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 170 of 347 *** Fixed income net revenues were $1.1 billion, up 25% from $839 million in the fourth quarter of 2005. 591. As a result, on December 14, 2006, Bear Steams' stock closed at $159.96 per share, up from a close of $155.89 per share the day before. The following day, December 15, 2006, Bear Steams' shares closed at $163.68. a. December 14, 2006 Press Release Statements Regarding the Company's Fourth Quarter 2006 Results 592. In the press release, Bear Steams misstated its earnings per share, net income, and net revenues. Revenues from Capital Markets, specifically within the Fixed Income area, were also falsely inflated. 593. These statements were false and misleading because Bear Stearns achieved these results by using misleading mortgage valuation models to value significant portions of its Level 3 assets, as described above at paragraphs 100 to 111. 594. At the time of the statements, the Company's Level 3 assets represented 11% of the Company's total assets held at market value, or a total of about $12.1 billion. Because these assets were highly leveraged, even a small decline in value would be vastly magnified, as set out in paragraphs 77 to 80 above. 595. The Company had been warned by the SEC that the models it used to value mortgage-backed securities, the lion's share of these assets, did not reflect key factors relating to the downturn in the housing industry, such as rising default rates. As set out above at paragraphs 139 to 148, default rates and other signs of market declines had risen dramatically in the second half of 2006. 155 EFTA00316883

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 171 of 347 596. Accordingly, the values the Company assigned to this large group of assets was significantly higher than they should have been, violating GAAP as set out at paragraphs 324 to 423 above. b. Press Release Regarding Fiscal 2006 Results 597. Bear Stearns also announced its fiscal year 2006 results in the December 14, 2006 press release. For the 2006 fiscal year, Bear Steams reported that it earnings per share (diluted) were a record $14.27, its net income was $2.1 billion and its net revenues for fiscal year 2006 were $9.2 billion. These figures were false and misleading for the same reasons set out in paragraphs 593 to 596 above. 2. Fourth Oulu-ter 2006 Earnines Conference Call 598. On December 14, 2006, Bear Steams held its fourth quarter 2006 earnings conference call, conducted by defendant Molinaro, the Company's CFO. During the call, Molinaro repeated the financial results set out in paragraphs 590 above. These statements were false and misleading for the reasons set out above at paragraphs 593 to 596. 599. During the call, an analyst asked Molinaro: There's obviously been a lot of worry in the investment community about slowing originations, the sub prime scare we've seen. What's your overall take on that? And if there's any way you can in some way scale the origination platform vis-à-vis the trading component and the other asset classes within MBS would be helpful. 600. Molinaro responded that: (T]he sub prime sector does represent a relatively small piece of the overall mortgage market and the composition of the sub prime class representing an even smaller component of the overall market. While there's clearly been some issues in sub prime, as we have seen, the issue has really been more of a vintage issue as we've got some of the production that was originated maybe of what now looks like the top of the cycle with underwriting standards diminishing, experiencing some difficulties. But I 156 EFTA00316884

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 172 of 347 think that is and has been relatively well contained and not really spilling over into the broader market. In fact, I would say the broader market continues to be quite healthy and investor demand for the product continues to be quite robust. I think a lot of the attention does appear to be somewhat overblown, certainly there are some issues in the sub prime segment, but I would say the broader market is — maybe we've seen the worst of it and I think it feels pretty good right now. 601. The statements above were materially false and misleading when made because the Company understood that the unusually risky loans it was continuing to purchase through its EMC subsidiary were not limited to any particular "vintage". As noted above in paragraph 59, CW 3 reported that during the latter part of 2006 and the beginning of 2007 EMC would "buying everything" without regard for the known riskiness of the loan. Moreover, the Company understood that its own loan origination practices had resulted in "cutting corners" on standard underwriting practices, as set out above at paragraphs 53 to 63. 602. An analyst at Sandler O'Neill, Jeff Harte, asked Molinaro about the Company's exposure to increased defaults on subprime mortgages: As we see some default rises in subprime land, and as we also see you originating more of the mortgages that you're actually securitizing and sending out, does the risk of defaulting mortgages coming back to you rise, or how do you look at that? 603. Molinaro responded by vastly understating Bear Steams' exposure to increasing defaults in the subprime market: Well, I don't — no, it doesn't. Because essentially we're originating and securitizing. But I think the point we should make about what's happening in the subprime sector — in other words, the vintage class that seems to be experiencing the most difficulty certainly coming at the end at what appears to be the heights of the cycle when the lending standards were the most lenient. What's going on now in the market with a lot of the weaker hands getting forced out of the business, the business is really moving into stronger hands, who have improved underwriting standards and are not going to be stretching as much for businesses, maybe some of the other shops were who really, 157 EFTA00316885

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 173 of 347 their livelihood was focused on volume. So what we saw in 2006, our activity in the subprime sector declined dramatically, largely because our standards was higher and our pricing was not at the Level that would generate a lot of business. I think the good news in the subprime sector, as the business is moving into the hands of much stronger players in an environment where the underwriting standards are being tightened and the business should improve. 604. The statements above in paragraph 603 were materially false and misleading when made because Bear Stearns did far more than originate and securitize subprime loans—it retained on its books large amounts of the riskiest tranches of RMBS and CDOs it produced. Indeed, as set out at paragraph 65 above, by November of 2006, the Company held $5.6 billion of the riskiest tranches of subprime-backed RMBS on its books. 605. Moreover, Bear Steams' own underwriting standards were not higher in 2006 than in previous years, and the Company understood that the loans it was continuing to purchase through its EMC subsidiary during the latter part of 2006 and the beginning of 2007 that were unusually risky, and in fact EMC was not tightening its underwriting standards. 3. Form 10-K for Fiscal Year 2006 606. On February 13, 2007, Bear Steams filed its Form 10-K for the annual and quarterly period ended November 30, 2006. The 10-K was signed by, among others, defendants Greenberg, Cayne, Schwartz, Spector and Farber. The Form 10-K made misrepresentations regarding the Company's financial results, risk management practices, exposure to market risk, compliance with banking capital requirements, and internal controls. Finally, the 2006 Form 10- K contained false and misleading statements by the Company's auditor, Deloitte, relating to its review and certification of the Company's reported financial results. 158 EFTA00316886

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 174 of 347 607. As a result, on February 13, 2007, Bear Steams' stock closed at $160.10 per share, up from a close of $157.30 per share the day before. The following day, February 14, 2007, Bear Steams' shares closed at $165.81. a. The Company's Financial Results and Assets 608. The financial results, including revenues, earnings, and earnings per share reported by the Company in the Form 10-K for 2006 were misleading for the same reasons set out in paragraphs 593 to 596 above, relating to the Company's announced results for fiscal year 2006. 609. Moreover, in the 2006 Form 10-K the Company was materially false and misleading in its assertions about the value of assets corresponding to Level 3. The Company stated that: at November 30, 2006 and 2005, the total value of all financial instruments whose fair value is estimated based on internally developed models or methodologies utilizing significant assumptions or other data that are generally less readily observable from objective sources (primarily fixed income cash positions) aggregated approximately $12.1 billion and $7.1 billion, respectively, in "Financial Instruments Owned[.] 610. As set out in paragraphs 100 to III above, by the date of this statement, the Company's Principal Accountant and Controller had already been informed that the models the Company used to value the mortgage-backed securities in this asset category failed to reflect dramatic declines in the housing market. b. The Company's Risk Management Practices 611. Bear Steams' 2006 Form 10-K misled investors with respect to the Company's use of its VaR models and the accuracy and of its valuation models for assets linked to subprime mortgages. The 2006 Form 10-K stated that: 159 EFTA00316887

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 175 of 347 members of the Controllers and Risk Management Departments perform analysis of internal valuations, typically on a monthly basis but often on an intra-month basis as well. These departments are independent of the trading areas responsible for valuing the positions. Results of the monthly validation process are reported to the MTM Committee, which is composed of senior management from the Risk Management and Controllers Departments. The MTM Committee is responsible for ensuring that the approaches used to independently validate the Company's valuations are robust, comprehensive and effective. Typical approaches include valuation comparisons with external sources, comparisons with observed trading, independent comparisons of key model valuation inputs, independent trade modeling and a variety of other techniques. 612. In addition, the Company specifically asserted that: The Company regularly evaluates and enhances such VaR models in an effort to more accurately measure risk of loss. 613. These statements were false and misleading when made because, as set out at paragraphs 123 to 127 above, by the time of this statement the SEC had repeatedly warned the Company that the models it used to assess risk, including its VaR and mortgage valuation models, failed to reflect key indicators of market declines. According to the 2008 DIG Report, Bear Stearns' VaR models failed to include critical variables such as "housing price appreciation, consumer credit scores, patters of delinquency rates, and potential other data." It was precisely these indicators that would have reflected the rapidly declining housing market. 614. Moreover, according to the 2008 (DIG Report, reviews of the Company's risk management models which should have taken place before the subprime market cratered were never completed at any time before the Company's collapse. 615. Bear Stearns' 2006 Annual Report to Stockholders, attached as an Exhibit to the Form 10-K, misled investors with respect to Bear Stearns' risk control philosophy when it stated that "the Company's Risk Management Department and senior trading managers monitor 160 EFTA00316888

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 176 of 347 exposure to market and credit risk for high yield positions and establish limits and concentrations of risk by individual issuer." 616. In fact, Bear Stearns lacked risk management personnel and was unable to appropriately model for risk. Even when Bear Steams had the correct personnel in place, the 2008 OIG Report indicates that its risk managers were unable to effectively communicate with the traders who were responsible for taking on additional risk. Bear Stearns did not have risk managers that had experience or were capable of valuing the MBS which were central to Bear Stearns' business models. 617. Bear Steams' 2006 Form 10-K also misled investors with respect to Bear Steams' risk management procedures when it stated that "comprehensive risk management procedures have been established to identify, monitor and control [its] major risks." 618. In fact, this statement was false and misleading when made because, according the 2008 DIG Report and verified independently by confidential witnesses, Bear Steams did not have risk management personnel at the time capable of accurately valuing MBS. 619. Bear Steams' 2006 Form 10-K also stated that "The Treasurer's Department is independent of trading units and is responsible for the Company's funding and liquidity risk management. . . [m]any of the independent units are actively involved in ensuring the integrity and clarity of the daily profit and loss statements," and that: The Risk Management Department is independent of all trading areas and reports to the chief risk officer... [t]he department supplements the communication between trading managers and senior management by providing its independent perspective on the Company's market risk profile." 620. In fact, as set out at paragraphs 129 to 136 above, in this period Bear Steams' risk managers had little independence from its trading desk, and no ability to reign in the Company's accumulation of risk. 161 EFTA00316889

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 177 of 347 c. The Company's Exposure to Market Risk 621. As reflected in the exchange of letters between the SEC and the Company described above at paragraphs 312 to 323, the Company's 2006 Form 10-K was also false and misleading in that it failed to disclose the Company's true exposure to the subprime market. The SEC concluded in the 2008 OIG Report that, as a result, investors were deprived of "material information" that they could have used "to make well-informed investment decisions." 622. Bear Steams' 2006 Form 10-K also misled investors with respect to its exposure to "market risk." In its 2006 Form 10-K the Company stated that it: mitigates its exposure to market risk by entering into hedging transactions, which may include over-the-counter derivative contracts or the purchase or sale of interest-bearing securities, equity securities, financial futures and forward contracts. In this regard, the utilization of derivative instruments is designed to reduce or mitigate market risks associated with holding dealer inventories or in connection with arbitrage-related trading activities. 623. These statements were false when made because Bear Stearns managers were aware that it was impossible to effectively hedge against declines in assets in light of deficiencies in its VaR and mortgage valuation models, as discussed above at paragraphs 100 to 111 and 123 to 128. 624. Furthermore, because of the deficiencies in its VaR models, the Company's representation in its 2006 Form 10-K that it had an aggregate VaR of just $28.8 million, which was far lower than its peers, was materially false and misleading. In fact, the Company knew that its VaR numbers failed to reflect its exposure to declining housing prices. d. The Company's Compliance With Banking Regulations 625. In its 2006 Form 10-K Bear Stearns stated that "the Company is in compliance with CSE regulatory capital requirements." This statement was materially false and misleading 162 EFTA00316890

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 178 of 347 when made because, as set forth at paragraphs 427 to 452 above, the Company had misled regulators into believing that it was meeting capital requirements only by repeatedly violating banking regulations relating to the appropriate calculation of net capital. As set forth in the 2008 OIG Report, the Company violated CSE rules by (i) inflating its profit and its capital by using inflated marks on assets subject to mark disputes; and (ii) falsely inflating its net capital by using misleading methods to calculate VaR. The Company's Internal Controls 626. Defendants Cayne and Molinaro each made false and misleading statements when they executed Sarbanes-Oxley Act certifications, annexed as an exhibit to the Form 10-K filing. This certification stated that the 10-K report "does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report" and "the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition." 627. Cayne and Molinaro also certified that the Company had: [d]esigned such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles." 628. These statements were false and misleading, in that, despite repeated warnings from the SEC, the Company had made no effort to address deficiencies that went to the heart of the Company's ability to assess the value of its assets and its exposure to risk. Moreover, the encouraging revenue growth and earnings per share Bear Stearns reported in its certified statements were only made possible as a result of Bear Stearns' ability to avoid taking losses by 163 EFTA00316891

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 179 of 347 relying on misleading valuation models that failed to reflect the declining value of its highly illiquid Level 3 assets. f. Deloitte's Certification 629. As the Company's auditor Deloitte certified Bear Steams' 2006 Form 10-K, as required by Sarbanes-Oxley, and, in so doing, knowingly and recklessly offered a materially misleading opinion as to the financial statements' accuracy. As set out in detail at paragraphs 523 to 588 above, Deloitte knew or recklessly disregarded that these statements and certifications were materially false and misleading when made, perpetrating a fraud on the Company's investors. B. Statements Relating to Fiscal Year 2007 Results 630. In press releases, conference calls and SEC filings, Bear Steams deceived investors with respect to its 2007 financial results. 1. First Quarter 2007 Results a. First Quarter 2007 Press Release 631. On March 15, 2007, Bear Steams issued a press release regarding its first quarter 2007 results. NEW YORK, NY — March 15, 2007 — The Bear Steams Companies Inc. (NYSE:BSC) today reported earnings per share (diluted) of $3.82 for the first quarter ended February 28, 2007, up 8% from $3.54 per share for the first quarter of 2006. Net income for the first quarter of 2007 was $554 million, up 8% from $514 million for the first quarter of 2006. Net revenues were $2.5 billion for the 2007 first quarter, up 14% from $2.2 billion in the 2006 first quarter. The annualized return on common stockholders' equity was 18.3%. "We are pleased with this excellent performance, revenues for the first quarter were up for every business segment," said James E. Cayne, chairman and chief executive officer of The Bear Steams Companies Inc. "Growing the company remains a core focus as we 164 EFTA00316892

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 180 of 347 continue to invest in the clearing, mortgage, international and asset management franchises with successful results." *** Capital Markets net revenues for the first quarter of 2007 were $2.0 billion, up 15% from $1.7 billion *** Fixed Income net revenues were $1.1 billion, up 27% from $907 million in the year-ago quarter. 632. As a result, on March 15, 2007, Bear Stearns' stock closed at $148.50 per share, up from a close of $145.29 per share the day before. The following day, March 16, 2007, Bear Steams' shares closed at $145.48. 633. In the press release, Bear Steams misstated its earnings per share, net income, and net revenues. Bear Stearns' financial results for Capital Markets, specifically Fixed Income, were also falsely inflated. 634. These statements were false and misleading because Bear Stearns achieved these results by using misleading mortgage valuation models to value its Level 3 assets, as described above at paragraphs 100 to 111. 635. At the time of the statements, the Company's Level 3 assets represented 11.64% of the Company's total assets held at market value, or a total of about $15 billion. Because these assets were highly leveraged, even a small decline in value would be vastly magnified, as set out in paragraphs 77 to 80 above. 636. The Company had been warned by the SEC that the models it used to value mortgage-backed securities, a large share of these assets, did not reflect key factors relating to the downturn in the housing industry, such as rising default rates. As set out above at paragraphs 165 EFTA00316893

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 181 of 347 139 to 148, default rates and other signs of market declines had risen dramatically in the second half of 2006 and into the first quarter of 2007. 637. Accordingly, the values the Company assigned to this group of assets was significantly higher than they should have been, violating relevant GAAP as set out at paragraphs 324 to 423 above. Because the Company was not reflecting these losses on its books, its revenues, earnings, and earnings per share were overstated. b. First Quarter 2007 Conference Call 638. On March 15, 2007 Bear Stearns held its first quarter 2007 earnings conference call, conducted by defendant Molinaro, the Company's CFO. During the call, Molinaro repeated the financial results described in paragraph 631. For the reasons set out in 633 to 637 above, these statements were false and misleading. 639. In the same call, Molinaro stated that Bear Stearns' internal origination platform: allows us to control the performance of the loans and it puts the servicing at very strong stable hands and historically in periods of dislocation like this, the opportunities to buy pools of defaulted loans or semi- performing loans, have been there and that servicing capacity has been a key asset in our ability to generate return from those assets." 640. These statements were false and misleading because the Company understood that the loans it was continuing to purchase through its EMC subsidiary were being bought with little due diligence. As noted above in paragraph 59, CW 3 reported that during the latter part of 2006 and the beginning of 2007 EMC was "buying everything" without regard for the risk of the loan. Moreover, as noted above at paragraphs 54 and 58 to 60, additional confidential witnesses have testified that Bear Stearns' own origination platforms were seriously flawed and were not accurately measuring the risk of the loans issued. Additional Confidential Witnesses have 166 EFTA00316894

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 182 of 347 confirmed that Bear Stearns' internal origination platforms were not using prudent lending standards (paragraphs 54 and 58 to 60 above). 641. In the same call, Molinaro also made false and misleading statements regarding the Company's exposure to risk connected with the Hedge Funds. An unidentified analyst on the call asked, "Can you give any insight about whether you've seen or had issues with margin calls or any kind of difficulties in hedge fundland given how volatile the Markets have been the last few weeks?" 642. Molinaro responded that "[w]e haven't seen any difficulties. I would say it's been, obviously there's a lot of market volatility but we've had no difficulties there." Barely two weeks earlier, Cioffi, a Senior Managing Director of BSAM and a member of Bear Stearns' Board of Directors, had written of the Funds' February results that "I can't believe anything has been this bad." 643. In fact, as described at paragraphs 193 to 196 above, the Hedge Funds were in the midst of a disastrous collapse in the value of their assets. The managers of these Hedge Funds reported directly to defendant Spector, the Co-President of the Company at the time. 644. When asked to give details regarding Bear Stearns' exposure to subprime CDOs, Molinaro refused, saying "I think that we feel like we've got the situation in hand. We think it's well hedged." 645. This statement was false and misleading, in that Molinaro was aware that the VaR and valuation models, essential to meaningful hedging of risk, failed to reflect key data about housing declines. 167 EFTA00316895

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 183 of 347 c. First Quarter 2007 Form 10-0 646. In its report for the first quarter of 2007, signed by defendant Farber, the Company materially misrepresented its financial results, its exposure to risk, its internal controls, and its compliance with regulatory capital requirements. (i) Financial Results 647. In the Form 10-Q it filed on April 9, 2008, the Company stated that: Net revenues for Capital Markets increased 15.4% to $1.97 billion for the 2007 quarter compared with $1.70 billion for the 2006 quarter. Pre-tax income for Capital Markets increased 12.9% to $736.3 million for the 2007 quarter from $652.3 million for the comparable prior year quarter. Pre-tax profit margin was 37.5% for the 2007 quarter compared with 38.3% for the 2006 quarter. * * * Fixed income net revenues increased 26.7% to $1.15 billion for the 2007 quarter from $907.1 million for the comparable prior year quarter. 648. These statements were false and misleading because, as explained in paragraphs 100 to 111 above, Bear Steams was able to achieve these results only by avoiding taking losses on its Level 3 assets. It did this by using misleading valuation models that did not accurately reflect declines in the housing market. This avoidance of loss permitted the Company to increase its revenues and asset values, inflating the value of its stock. 649. Because the Level 3 assets the Company reported for the period stood at $15.64 billion, the Company's knowing use of materially deficient models to value those assets had grave repercussions for accuracy of the Company's financial reporting. These effects were magnified by the Company's leveraging practices. 168 EFTA00316896

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 184 of 347 650. Moreover, the Company's assertion that its Level 3 assets stood at $15.64 billion was materially false and misleading, given that it was a product of a valuation model that did not reflect key declines in the market. (ii) Exposure to Risk 651. Bear Steams' first quarter 2007 Form 10-Q also misled investors with respect to its assessment of risk exposure. In the filing, Bear Stearns asserted that "The Company regularly evaluates and enhances such VaR models in an effort to more accurately measure risk of loss." 652. In fact, the Company had undertaken no such review, and its Controller and Principal Accountant, Farber, had been repeatedly warned by government regulators that the Company's VaR models were inaccurate and out of date. According to the 2008 OIG Report, at no time before the Company collapsed in 2008 did Bear Steams complete a review of its risk management models. 653. As a result, according to the 2008 OIG Report, in this period Bear Stearns' VaR models failed to include critical variables such as "housing price appreciation, consumer credit scores, patters of delinquency rates, and potential other data." Because these indicators would have reflected the ongoing collapse of the housing market, the Company's decision to omit them from its VaR calculations was materially misleading. 654. In the Form 10-Q Bear Steams reported the reassuringly low VaR numbers it had calculated for the first quarter of 2007, including an aggregate risk of just $27.9 million — far lower than its peers. This statement was wildly misleading, in that the Company knew that its VaR modeling failed to reflect its exposure to declining housing prices. 655. The first quarter 2007 Form 10-Q also misled investors with respect to Bear Steams' risk control philosophy when it stated that "the Company's Risk Management 169 EFTA00316897

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 185 of 347 Department and senior trading managers monitor exposure to market and credit risk for high yield positions and establish limits and concentrations of risk by individual issuer." 656. In fact, Bear Steams lacked risk management personnel and was unable to appropriately model for risk. Even when Bear Steams had the correct personnel in place, the 2008 OIG Report indicates that its risk managers were unable to effectively communicate with the traders who were responsible for taking on additional risk. Bear Stearns did not have risk managers that had experience or were capable of valuing MBS which were central to Bear Stearns' business models. (iii) Compliance With Banking Regulations 657. In its first quarter 2007 Form 10-Q Bear Stearns stated that "the Company is in compliance with CSE regulatory capital requirements." This statement was materially false and misleading when made because Bear Stearns was only able to meet the CSE program's minimum capital requirements by repeatedly violating CSE rules relating to the appropriate calculation of net capital. As set out in the 2008 OIG Report, the Company violated CSE rules by (i) inflating its profit and its capital by using inflated marks on assets subject to mark disputes; and (ii) falsely inflating its net capital by using misleading methods to calculate VaR. (iv) Sarbanes-Oxley Certifications 658. Defendants Cayne and Molinaro each made false and misleading statements when they executed Sarbanes-Oxley Act certifications, annexed as an exhibit to the Form I0-Q filing for the first quarter of 2007. This certification stated that stated that the 10-Q report "does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report" and "the financial statements, and 170 EFTA00316898

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 186 of 347 other financial information included in this report, fairly present in all material respects the financial condition." 659. Cayne and Molinaro also certified that the Company had: (d]esigned such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles." 660. These statements were false and misleading, in that, despite repeated warnings from the SEC, the Company had made no effort to address deficiencies that went to the heart of the Company's ability to assess the value of its assets and its exposure to risk. Moreover, the encouraging revenue growth and earnings per share Bear Steams reported in its certified statements reported were only made possible by the fact that Bear Stearns was avoiding taking losses only by relying on misleading valuation models that failed to reflect the declining value of its highly illiquid Level 3 assets. (v) Deloitte's Certification 661. As the Company's auditor Deloitte certified Bear Stearns' first quarter 2007 Form I0-Q, as required by Sarbanes-Oxley, and, in so doing, knowingly and recklessly falsely offered an opinion as to the financial statement's accuracy. As set out in detail at paragraphs 523 to 588 above, Deloitte knew or recklessly disregarded that these statements and certifications were materially false and misleading when made, and perpetrated a fraud on Bear Stearns investors as a result. 171 EFTA00316899

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 187 of 347 2. Second Quarter 2007 Results a. Second Quarter 2007 Press Release 662. On June 14, 2007, Bear Steams issued a press release regarding its second quarter 2007 results. NEW YORK — June 14, 2007 — The Bear Steams Companies Inc. (NYSE:BSC) today reported earnings per share (diluted), after a non-cash charge, of $2.52 for the second quarter ended May 31, 2007, down 32% from $3.72 per share for the second quarter of 2006 ... Net income for the second quarter of 2007, after the non- cash charge, was $362 million. Net income excluding the non- cash charge would have been $486 million, down 10% from $539 million for the second quarter of 2006. Net revenues for the 2007 second quarter were a record $2.512 billion, up from the previous record of $2.499 billion reported for the 2006 second quarter. The annualized return on common stockholders' equity for the second quarter of 2007 was 11.6%, and 16.4% for the trailing 12-month period ended May 31, 2007. *** Capital Markets net revenues for the second quarter of 2007 were $1.9 billion. *** Fixed Income net revenues were $962 million for the 2007 second quarter. 663. As a result, on June 14, 2007, Bear Steams' stock closed at $149.60 per share, up from a close of $149.49 per share the day before. The following day, June 15, 2007, Bear Steams' shares closed at $150.09. 664. In the press release, Bear Steams misrepresented its earnings per share, net income, and net revenues - specifically its financial results for Capital Markets. 665. These statements were false and misleading because Bear Stearns achieved these results by using misleading mortgage valuation models to value its Level 3 assets, as described above at paragraphs 100 to 111. 172 EFTA00316900

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 188 of 347 666. At the time of the statements, the Company's Level 3 assets represented 10.55% of the Company's total assets held at market value, or a total of about $14.39 billion. Because these assets were highly leveraged, even a small decline in value would be vastly magnified, as set out in paragraphs 77 to 80 above. 667. The Company had been warned by the SEC that the models it used to value mortgage-backed securities, the lion's share of these assets, did not reflect key factors relating to the downturn in the housing industry, such as rising default rates. As set out above at paragraphs 139 to 148, default rates and other signs of market declines had risen dramatically in the second half of 2006 and into the second quarter of 2007. 668. Accordingly, the values the Company assigned to this large group of assets was significantly higher than they should have been, violating relevant GAAP provisions as set out at paragraphs 324 to 423 above. Because the Company was not reflecting these losses on its books, its revenues, earnings, and earnings per share were overstated. b. Second Quarter 2007 Conference Call 669. On June 14, 2007, Bear Stearns held its second quarter 2007 earnings conference call, conducted by defendant Molinaro, the Company's CFO. During the call, Molinaro repeated the financial results described at paragraph 662 above. These statements were false and misleading for the reasons set out at paragraphs 664 to 668 above. 670. During the June 14, 2007 conference call, Molinaro also stated that the: During the quarter we adopted tighter underwriting standards in the origination of sub prime and Alt-A mortgages which served to dramatically reduce the volume of 100% CLTV lending as well as stated income lending above 90% LTV, both important segments of the sub prime and Alt-A market. 671. These statements were false and misleading because the Company understood that the loans it was continuing to purchase through its EMC subsidiary were unusually risky. As 173 EFTA00316901

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 189 of 347 noted above in paragraph 59, CW 3 reported that during the latter part of 2006 and the beginning of 2007 EMC was "buying everything" without regard for the risk of the loan. Moreover, as noted above, additional Confidential Witnesses have testified that Bear Steams' own origination platforms were seriously flawed and were not accurately measuring the risk of the loans issued. Additional Confidential Witnesses have confirmed that Bear Steams' internal origination platforms were not using prudent lending standards. c. June 22, 2007 Press Release 672. According to a June 22, 2007 press release announcing the Company's bailout of the High Grade Fund, Bear Steams had provided the High Grade Hedge fund with a $1.6 billion credit line, secured by collateral worth more than $1.6 billion. Bear Steams reported that asset sales had reduced the loan balance to $1.345 billion. This statement was false and misleading. 673. As set out at paragraphs 212 to 213 above, according to the 2008 OIG Report, by the time of this statement the estimated value of the collateral securing the loan had deteriorated by nearly $350 million—that is, to approximately the value of the loan Bear Steams had given the High Grade Fund. Moreover, the High Grade Hedge fund had no assets other than the collateral Bear Steams already held. 674. Bear Stearns further misled investors during a June 22, 2007 conference call held to discuss the liquidity difficulties experienced by BSAM's in-house hedge funds. During this conference call, Molinaro was asked "[t] what extent has this event caused you to relook at some of your practices overall for Bear Steams since you are such a big player in the mortgage market? I mean you have had the sub-prime problem for more than three months now. Are there other trigger events we should pay attention to over the next year?" Molinaro responded with the following: 174 EFTA00316902

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 190 of 347 Well [] I don't know that it's causing us to have any different point of view on the activities in our mortgage business. Our mortgage business has basically been not affected by this and has not really been a part of this situation. So our mortgage business continues to operate in a very effective way. Albeit in a more in a lower volume environment and a more difficult operating environment given the macro picture in the marketplace. As it relates to our Asset Management division, we feel that we have adequate controls in place. Obviously if you have a problem like this, you are going to reassess those controls and look to strengthen them. But I think the simple point in this Fund is that or these two Funds, they are invested in an asset class that went through a period of severe distress. 675. In fact, as set out above at paragraphs 139 to 148, by June of 2007 capital was ebbing from the subprime securitization market, reducing demand for the origination of subprime loans. d. Second Quarter 2007 Form 10-O 676. In its report for the second quarter of 2007, signed by defendant Farber, the Company materially misrepresented its financial results, its exposure to risk, its compliance with regulatory capital requirements, its internal controls, and the effects of its bailout of the High Grade Fund. Deloitte also filed a materially false and misleading certification in connection with the Form 10-Q. 677. As a result, on July 10, 2007, Bear Stearns' stock closed at $137.96 per share, down from a close of $143.89 per share the day before. The following day, July 11, 2007, Bear Stearns' shares closed at $138.03. (i) Financial Results 678. In the Form 10-Q it filed on July 10, 2007, the Company stated that: Net revenues for Capital Markets decreased 9.7% to $1.86 billion for the 200 quarter compared with $2.06 billion for the 2006 quarter. 175 EFTA00316903

Case 1:08-cv-02793-RWS Document 102 Filed 0227/09 Page 191 of 347 * * * Fixed income net revenues decreased 21.3% to $962.3 million for the 2007 quarter from $1.22 billion for the comparable prior year quarter primarily due to a decrease in mortgage-related revenues. Secondary trading revenues decreased in the 2007 quarter compared with the 2006 quarter, particularly non-agency fixed rate whole loans and Adjustable-Rate Mortgages ("ARMs"), reflecting the challenges associated with the subprime mortgage sector. Partially offsetting these decreases were increases in primary revenues from commercial mortgage-backed securities and non- agency fixed rate whole loans. 679. These statements were false and misleading because, as explained in paragraphs 100 to 111 above, in this period Bear Stearns avoided taking losses on its Level 3 assets by using misleading mortgage valuation models, which did not accurately value its Level 3 assets. This avoidance of loss permitted the Company to increase its revenues and asset values, inflating the value of its stock. 680. At the time, the Level 3 assets the Company reported for the period stood at $14.38 billion. Moreover, just four months later, the residential mortgage component of the Company's Level 3 assets stood at $5.8 billion. 681. The Company's knowing use of materially deficient models to value its mortgage-backed assets had grave repercussions for accuracy of the Company's financial reporting. These effects were magnified by the Company's leveraging practices. 682. Moreover, the Company's assertion that its Level 3 assets stood at $14.38 billion was itself materially false and misleading, given that it was a product of a valuation model that did not reflect key declines in the market. 176 EFTA00316904

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 192 of 347 (ii) Exposure to Risk 683. Bear Stearns' second quarter 2007 Form 10-Q misled investors with respect to its assessment of risk exposure. In the filing, Bear Stearns asserted that "The Company regularly evaluates and enhances [its] VaR models in an effort to more accurately measure risk of loss." 684. In fact, the Company had undertaken no such review, and its Controller and Principal Accountant, Farber, had been repeatedly warned by government regulators that the Company's VaR models were inaccurate and out of date. According to the 2008 OIG Report, at no time before the Company collapsed in 2008 did Bear Steams complete a review of critical inputs into its risk management models. 685. As a result, according to the 2008 OIG Report, in this period Bear Stearns' VaR models failed to include critical variables such as "housing price appreciation, consumer credit scores, patters of delinquency rates, and potential other data." Because these indicators would have reflected the ongoing collapse of the housing market described at paragraphs 139 to 148 above, the Company's decision to omit these key variables from its VaR calculations was materially misleading. 686. In the Form 10-Q Bear Steams reported the reassuringly low VaR numbers it had calculated for the second quarter of 2007, including an aggregate risk of just $28.7 million — far lower than its peers. This statement was materially misleading, in that the Company knew that its VaR modeling failed to reflect its exposure to declining housing prices. 687. The second quarter 2007 Form 10-Q also misled investors with respect to Bear Steams' risk control philosophy when it stated that "the Company's Risk Management Department and senior trading managers monitor exposure to market and credit risk for high yield positions and establish limits and concentrations of risk by individual issuer." 177 EFTA00316905

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 193 of 347 688. In fact, Bear Steams lacked risk management personnel and was unable to appropriately model for risk. Even when Bear Steams had the correct personnel in place, the 2008 OIG Report indicates that its risk managers were unable to effectively communicate with the traders who were responsible for taking on additional risk. Bear Steams did not have risk managers that had experience or were capable of valuing MBS which were central to Bear Steams' business models. (iii) Compliance With Banking Regulations 689. In its second quarter 2007 Form 10-Q Bear Steams stated that "the Company is in compliance with CSE regulatory capital requirements." This statement was materially false and misleading when made because Bear Steams met the CSE program's minimum capital requirements only by repeatedly violating CSE requirements relating to the appropriate calculation of net capital. As set out in the 2008 OIG Report and at paragraphs 427 to 452 above, the Company violated CSE rules by failing to take appropriate capital charges related to its collapsed hedge funds; by inflating its profit and its capital by using inflated marks on assets subject to mark disputes; and, by falsely inflating its net capital by using misleading methods to calculate VaR. (iv) The Company's Internal Controls 690. Defendants Cayne and Molinaro each made false and misleading statements when they executed Sarbanes-Oxley Act certifications, annexed as an exhibit to the Form 10-Q filing for the second quarter of 2007. This certification stated that stated that the Form 10-Q report "does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report" and "the 178 EFTA00316906

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 194 of 347 financial statements, and other financial information included in this report, fairly present in all material respects the financial condition." 691. Cayne and Molinaro also certified that the Company had: [d]esigned such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles." 692. These statements were false and misleading, in that, despite repeated warnings from the SEC, the Company had made no effort to address deficiencies that went to the heart of the Company's ability to assess the value of its assets and its exposure to risk. Moreover, the encouraging revenue growth and earnings per share Bear Steams reported in its certified statements reported were only made possible by the fact that Bear Stearns was avoiding taking losses only by relying on misleading valuation models that failed to reflect the declining value of its highly illiquid Level 3 assets. (v) The High Grade Fund Bailout 693. The second quarter 2007 Form 10-Q also contained false and misleading information about the financial impact of Bear Steams' support of the High Grade Hedge Fund. The second quarter 2007 10-Q advised investors that Bear Steams had entered into a $1.6 billion secured financing agreement with the High Grade Hedge Fund "in the form of collateralized repurchase agreements, enabled the High Grade Fund to replace existing secured financing, thereby improving the High Grade Fund's liquidity and allowing an orderly de-leveraging of the High Grade Fund in the marketplace. Currently, we believe the High Grade Fund has sufficient assets available to fully collateralize the Facility." 179 EFTA00316907

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 195 of 347 694. The statements in the above paragraph were materially false and misleading because Bear Steams' management knew that the High Grade Fund did not have sufficient assets available to fully collateralize the facility. The fact that the High Grade Fund did not have sufficient assets to collateralize the Facility was known to Bear Stearns management because the collateral that Bear Steams took in the repurchase agreement were the same CDOs that had lost so much value, causing other lenders to make the margin calls that severally threatened the hedge fund's liquidity. (vi) Deloitte's Certification 695. As the Company's auditor Deloitte certified Bear Steams' second quarter 2006 10-Q, and, in so doing, knowingly and recklessly falsely offered an opinion as to the financial statement's accuracy. As set out in detail at paragraphs 523 to 588 above, Deloitte knew or recklessly disregarded that these statements and certifications were materially false and misleading when made. 3. August 3, 2007 Press Release and Conference Call 696. On August 3, 2007, Standard & Poor's cut Bear Steams' credit rating outlook to negative. In an effort to limit damage to its share price, Bear Steams issued a press release which contained misleading statements with regard to Bear Steams' liquidity and its risk controls. The Company also hosted a conference call with analysts making similar misstatements. 697. In the press release, the Company stated: The Bear Stearns Companies Inc. (NYSE: BSC) said today that it is disappointed with S&P's decision to change its outlook on Bear Stearns. Most of the themes highlighted in its report are common to the industry and are not likely to have a disproportional impact on Bear Stearns. S&P's specific concerns over issues relating to certain hedge funds managed by BSAM are unwarranted as these 180 EFTA00316908

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 196 of 347 were isolated incidences and are by no means an indication of broader issues at Bear Stearns. * * * our balance sheet is strong and liquid. . .With respect to operating performance and financial condition, the Company has been solidly profitable in the first two months of the quarter, while the balance sheet, capital base and liquidity profile have never been stronger. Bear Steams' risk exposures to high profile sectors are moderate and well-controlled. The risk management infrastructure and processes remain conservative and consistent with past practices. 698. These statements were false and misleading when made for at least two reasons. First, because the Company knowingly used VaR models that would vastly underrepresent the risk the Company faced as a result of the declining housing market, it was reckless to assert that its liquidity and capital were sufficient to cover potential losses. 699. Moreover, the Company's "solid" profits in fact resulted from the Company's use of misleading valuation models to avoid taking losses, resulting in an overstatement of earnings, as set out at paragraphs 100 to III above. 700. On the conference call held on the same day, Company executives responded to analysts' concerns regarding the downgrade. During the conference call, Defendant Alix, Bear Stearns' Chief Risk Officer, stated "we have long focused on the origination, transformation and redistribution of risk. We've always managed the risk in this process by adjusting the intake, the origination of risk, to the demand for the end products." 701. These statements were false and misleading because, as the head of the Company's Global Risk Management division, Alix knew that the VaR models the company employed to assess risk and hedge purchases did not reflect the reality of the collapsing real estate market. Moreover, Alix knew that the Company had made no attempt to revise or update these defective models in years. 181 EFTA00316909

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 197 of 347 702. During the same conference call, Molinaro made false and misleading statements regarding the collateral that Bear Steams took in the repurchase agreement with the High Grade Fund, stating that "the market value of the inventory approximately reflects what the repo balance was." 703. However, as noted above, Bear Steams did not have accurate valuation models to value the Hedge Funds' subprime-backed collateral, and therefore, was at least reckless in offering any opinion on the market value of the highly illiquid collateral it had received from the Fund. Moreover, given that barely two weeks earlier the Company had informed the High Grade Fund investors that the fund was worth almost nothing, the hedge fund collateral that the Company held on its books was worth closer to zero. 4. Third Quarter 2007 Results a. Third Quarter 2007 Press Release 704. On September 20, 2007, Bear Steams issued a press release regarding its third quarter 2007 results. NEW YORK, NY — September 20, 2007 — The Bear Steams Companies Inc. (NYSE:BSC) today reported earnings per share (diluted) of $1.16 for the third quarter ended August 31, 2007, down 62% from $3.02 per share for the third quarter of 2006. Net income for the third quarter of 2007 was $171.3 million, down 61% from $438 million for the third quarter of 2006. Net revenues were $1.3 billion for the third quarter, down 38% from $2.1 billion for the third quarter of 2006. The annualized return on common stockholders' equity for the third quarter of 2007 was 5.3%, and 13.7% for the 12-month period ended August 31, 2007. Third quarter results include approximately $200 million in losses and expenses related to the BSAM High Grade hedge... * * * Net revenues for the Capital Markets segment were $1.0 billion for the quarter ended August 31, 2007. * * * 182 EFTA00316910

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 198 of 347 Fixed Income net revenues were $118 million for the 2007 third quarter. 705. In light of statements made in connection with these disappointing results, Bear Steams' stock closed at $115.46 per share, down just eighteen cents from its close of $115.64 per share the day before. Indeed, the following day, September 21, 2007, Bear Stearns' shares closed up, at $117.32. 706. In the press release, Bear Steams falsely stated that, for the first quarter, its earnings per share were $1.16, net income was $171.3 million, and net revenues were $1.3 billion. Financial results for Capital Markets, specifically Fixed Income, were also false and misleading. 707. These statements were false and misleading because Bear Stearns achieved these results by using misleading mortgage valuation models to value its Level 3 assets, as described above at paragraphs 100 to 111. 708. At the time of the statements, the Company's Level 3 assets represented 13% percent of the Company's total assets held at market value, or a total of about $16.6 billion. According to a February 8, 2008 presentation by defendant Molinaro to Credit Suisse analysts, $5.8 billion of that figure was residential mortgage-backed securities. Because these assets were highly leveraged, even a small decline in value would be vastly magnified, as set out in paragraphs 77 to 80 above. 709. The Company had been warned by the SEC that the models it used to value mortgage-backed securities, more than a quarter of these assets, did not reflect key factors relating to the downturn in the housing industry, such as rising default rates. As set out above at paragraphs 139 to 148, default rates and other signs of market declines had risen dramatically in the second half of 2006 and into the third quarter of 2007. 183 EFTA00316911

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 199 of 347 710. Accordingly, the values the Company assigned to this large group of assets was significantly higher than they should have been, violating relevant GAAP as set out at paragraphs 324 to 423 above. Because the Company was not reflecting these losses on its books, its revenues, earnings, and earnings per share were overstated as well. b. Third Quarter 2007 Conference Call 711. On September 20, 2007 Bear Steams also held its third quarter 2007 earnings conference call, conducted by Sam Molinaro, the Company's CFO. During the call, Molinaro repeated the financial results set out in paragraph 704 above. These results were false and misleading for the reasons set out in paragraphs 706 to 710 above. 712. Also during the call, Molinaro made false and misleading statements regarding Bear Stearns' valuation methodology when he stated: At Bear Stearns we mark our inventory to market Levels that we can observe in the marketplace. We've taken the view that the stress markets are the markets and that inventory should be marked at Levels that transactions are occurring. Of course we do have inventory that does not actively trade in the market. In those cases, we rely on valuation models that utilized observable market inputs in determining fair value. These valuations can typically be benchmarked against transactions in similar products or assets taking place in the market." 713. This statement was false and misleading because it disregarded the material fact, as noted in the 2008 OIG Report that Bear Stearns' valuation methodology did not take into account key market inputs and were more than ten years out of date. 714. In the same call, Molinaro stated that Bear Stearns would take "$200 million of losses associated with the failure of the high-grade funds, representing the write-off of our investment and fees receivable, losses from the liquidation of the $1.6 billion repo facility." 715. An analyst asked "and — and then on the — on the $200 million write down of the high-grade funds. That effectively a write down what was last reported a $1.3 billion balance?" 184 EFTA00316912

Case 1:08-cv-02793-RWS Document 102 Filed 02/27/09 Page 200 of 347 716. Molinaro responded that "about $100 million of that is the write-off of our investment in the fund and the write-off of receivables that we had from the funds related to predominantly related to management and performance fees that related to 2006." 717. As set out above at paragraphs 212 to 216, this $100 million figure was $1.2 billion short of the Company's true losses due to the Hedge Fund collapse. The Company did not disclose the full amount of its losses on the collateral for fear that its lenders and counterparties would realize that it had been consistently overvaluing its assets. 718. In fact, even by the Company's own estimations regarding the write downs associated with the Hedge Fund, the numbers revealed to investors in September 2007 were misleading. The 2008 OIG Report states that the Company's internal documents reflect that it ultimately took a $500 million write down in connection with the bailout in the fall of 2007. However, the Company never disclosed this additional write down to investors. c. Third Quarter 2007 Form 10-0 719. In its report for the third quarter of 2007, signed by defendant Farber, the Company materially misrepresented its financial results, its exposure to risk, its internal controls, and its compliance with regulatory capital requirements. In addition, Deloitte made materially false statements to investors in certifying the Company's results for the quarter. (i) Financial Results 720. In the Form 10-Q it filed on October 10, 2007, the Company stated that: Net revenues for Capital Markets decreased 36.4% to $1.05 billion for the 2007 quarter compared with $1.65 billion for the 2006 quarter. * * * Fixed income net revenues decreased 87.6% to $117.6 million for the 2007 quarter from $945.0 million for the comparable prior year quarter. The Company recognized approximately $700 million in 185 EFTA00316913