LEHMAN BROTHERS HOLDINGS INC - 10-Q Quarterly Report

Back to GetFilings.com

================================================================================

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MAY 31, 2002

OR

|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM ____________ TO ____________

COMMISSION FILE NUMBER 1-9466

LEHMAN BROTHERS HOLDINGS INC.
(Exact name of registrant as specified in its charter)

DELAWARE 13-3216325
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)

745 SEVENTH AVENUE
NEW YORK, NEW YORK 10019
(Address of principal (Zip Code)
executive offices)

(212) 526-7000
(Registrant's telephone number, including area code)

INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. Yes |X| No |_|

AS OF JUNE 30, 2002, 243,521,524 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR
VALUE $0.10 PER SHARE, WERE OUTSTANDING.

================================================================================

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES

FORM 10-Q

FOR THE QUARTER ENDED MAY 31, 2002

INDEX

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION

ITEM 1 FINANCIAL STATEMENTS

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE DATA)

See notes to consolidated financial statements.

2

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE DATA)

See notes to consolidated financial statements.

3

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
(UNAUDITED)
(IN MILLIONS)

See notes to consolidated financial statements.

4

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION - (CONTINUED)
(UNAUDITED)
(IN MILLIONS, EXCEPT SHARE DATA)

See notes to consolidated financial statements.

5

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS)

Interest paid totaled $5,367 and $9,210 for the six months ended May 31, 2002
and May 31, 2001, respectively. Income taxes paid totaled $199 and $422 for the
six months ended May 31, 2002 and May 31, 2001, respectively.

See notes to consolidated financial statements.

6

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION:

The consolidated financial statements include the accounts of Lehman Brothers
Holdings Inc. ("Holdings") and subsidiaries (collectively, the "Company" or
"Lehman Brothers"). Lehman Brothers is one of the leading global investment
banks serving institutional, corporate, government and high-net-worth individual
clients and customers. The Company's worldwide headquarters in New York and
regional headquarters in London and Tokyo are complemented by offices in
additional locations in North America, Europe, the Middle East, Latin America
and the Asia Pacific Region. The Company is engaged primarily in providing
financial services. The principal U.S. subsidiary of Holdings is Lehman Brothers
Inc. ("LBI"), a registered broker-dealer. All material intercompany accounts and
transactions have been eliminated in consolidation. The Company's financial
statements have been prepared in accordance with the rules and regulations of
the Securities and Exchange Commission (the "SEC") with respect to Form 10-Q and
reflect all normal recurring adjustments which are, in the opinion of
management, necessary for a fair presentation of the results for the interim
periods presented. Pursuant to such rules and regulations, certain footnote
disclosures which are normally required under generally accepted accounting
principles have been omitted. It is recommended that these consolidated
financial statements be read in conjunction with the audited consolidated
financial statements incorporated by reference in Holdings' Annual Report on
Form 10-K for the twelve months ended November 30, 2001 (the "Form 10-K"). The
Consolidated Statement of Financial Condition at November 30, 2001 was derived
from the audited financial statements.

The nature of the Company's business is such that the results of any interim
period may vary significantly from quarter to quarter and may not be indicative
of the results to be expected for the fiscal year. Certain prior period amounts
reflect reclassifications to conform to the current period's presentation.

CONSOLIDATION ACCOUNTING POLICIES

OPERATING COMPANIES

The Company follows Statement of Financial Accounting Standards ("SFAS") No. 94
"Consolidation of All Majority-Owned Subsidiaries" and consolidates operating
entities when the Company has a controlling financial interest over the business
activities of such entities. Non-controlled operating entities are accounted for
under the equity method when the Company is able to exercise significant
influence over the business activities of such entities. The cost method is
applied when the ability to exercise significant influence is not present.

SPECIAL PURPOSE ENTITIES

For those entities which do not meet the definition of conducting a business,
often referred to as special purpose entities ("SPE's"), the Company follows the
accounting guidance under SFAS 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities--a replacement of FASB No.
125," and Emerging Issues Task Force ("EITF") Topic D-14, "Transactions
Involving Special-Purpose Entities," to determine whether or not such SPE's are
required to be consolidated. The majority of the Company's involvement with
SPE's relates to securitization transactions meeting the SFAS 140 definition of
a qualifying special purpose entity ("QSPE"). A QSPE can generally be described
as an entity with significantly limited powers which are intended to limit it to
passively holding financial assets and distributing cash flows based upon
predetermined criteria. Based upon the guidance in SFAS 140, the Company does
not consolidate such QSPE's. Rather, the Company accounts for its involvement
with such QSPE's under a financial components approach in which the Company
recognizes only its retained involvement with the QSPE. The Company accounts for
such retained interests at fair value.

7

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Certain special purpose entities do not meet the QSPE criteria due to their
permitted activities not being sufficiently limited, or because the assets are
not deemed qualifying financial instruments (e.g., real estate). In the limited
instances in which the Company is either the sponsor of or transferor of assets
to a non-qualifying SPE, the Company follows the accounting guidance provided by
EITF Topic D-14 to determine whether consolidation is required. Under this
guidance, the Company would not consolidate such SPE if a third party investor
made a substantial equity investment in the SPE (minimum of 3%), was subject to
first dollar risk of loss of such SPE, and had a controlling financial interest.

TRANSFERS OF FINANCIAL ASSETS

The Company accounts for transfers of financial assets in accordance with SFAS
140. In accordance with this guidance the Company recognizes the transfer of
financial assets as sales provided that control has been relinquished. Control
is deemed to be relinquished only when all of the following conditions have been
met: i) the assets have been isolated from the transferor even in bankruptcy or
other receivership (true sale opinions are required), ii) the transferee has the
right to pledge or exchange the assets received and iii) the transferor has not
maintained effective control over the transferred assets (e.g., a unilateral
ability to repurchase a unique or specific asset).

REVENUE RECOGNITION POLICIES

PRINCIPAL TRANSACTIONS

Securities and other financial instruments owned and securities and other
financial instruments sold but not yet purchased (both of which are recorded on
a trade date basis) are valued at market or fair value, as appropriate, with
unrealized gains and losses reflected in Principal Transactions in the
Consolidated Statement of Income. Market value is generally based on listed
market prices. If listed market prices are not available, or if liquidating the
Company's position is reasonably expected to affect market prices, fair value is
determined based on broker quotes, internal valuation pricing models which take
into account time value and volatility factors underlying the financial
instruments, or management's estimate of the amounts that could be realized
under current market conditions, assuming an orderly liquidation over a
reasonable period of time.

INVESTMENT BANKING

Underwriting revenues and fees for merger and acquisition advisory services are
recognized when services for the transactions are determined to be completed.
Underwriting expenses are deferred and recognized at the time the related
revenues are recorded.

COMMISSIONS

Commissions primarily include fees from executing and clearing client
transactions on stock, options and futures markets worldwide. These fees are
recognized on a trade date basis.

INTEREST REVENUE/EXPENSE

The Company recognizes contractual interest on securities and other financial
instruments owned and securities and other financial instruments sold but not
yet purchased on an accrual basis as a component of Interest and Dividends
revenues and Interest Expense, respectively. Interest flows on the Company's
derivative transactions are included as part of the Company's mark-to-market
valuation of these contracts within Principal Transactions and are not
recognized as a component of interest revenue/expense.

The Company accounts for its secured financing activities, and short and
long-term borrowings on an accrual basis with related interest recorded as
interest revenue or interest expense, as applicable.

8

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. EVENTS OF SEPTEMBER 11, 2001:

As a result of the September 11, 2001 terrorist attack, the Company's leased
facilities in the World Trade Center were destroyed and its leased and owned
facilities in the World Financial Center complex (including the 3 World
Financial Center building owned jointly with American Express) were
significantly damaged.

During the fourth quarter of 2001, the Company recognized a pretax special
charge of $127 million ($71 million after-tax) associated with the net losses
stemming from the events of September 11, 2001. This charge was comprised of
charges and costs of $487 million, less estimated insurance recoveries of $360
million.

During the first six months of 2002, the Company incurred additional costs
resulting from the September 11, 2001 terrorist attack of approximately $43
million, primarily related to technology restoration, repair costs to the
Company's 3 World Financial Center facility and other costs associated with
temporary facilities, which were fully offset by estimated insurance recoveries.
Included within these amounts were costs of $21 million and $22 million recorded
in the first and second quarters of 2002, respectively.

In addition, the Company's repair of its facilities at 3 World Financial Center
is ongoing and estimated to cost approximately $30 million. Such costs are
anticipated to be fully recoverable under the Company's insurance policy.

To date, the Company has collected $300 million of interim advances on its
insurance recoveries and is actively pursuing additional amounts including
amounts related to business interruption losses.

For further information regarding the special charge associated with the events
of September 11, 2001 recognized during 2001, refer to Note 2 to the
Consolidated Financial Statements incorporated by reference in the Form 10-K.

3. LONG-TERM DEBT:

During the six months ended May 31, 2002, the Company issued $3,133 million of
long-term debt (all of which were senior notes). Of the total issuances during
the period, $1,054 million were U.S. dollar fixed rate, $1,502 million were U.S.
dollar floating rate, $229 million were foreign currency denominated fixed rate,
and $348 million were foreign currency denominated floating rate. These
issuances were primarily utilized to refinance current maturities of long-term
debt in 2002.

The Company's floating rate new issuances contain contractual interest rates
based primarily on London Interbank Offered Rates ("LIBOR"). All of the
Company's fixed rate new issuances were effectively converted to floating rate
obligations through the use of interest rate swaps. Of the foreign denominated
new issuances totaling $577 million, $137 million were effectively swapped to
U.S. Dollars, with the remainder used to fund foreign currency denominated
capital needs.

The Company had $4,973 million of long-term debt ($4,706 million of senior notes
and $267 million of subordinated notes) mature during the six months ended May
31, 2002. Long-term debt at May 31, 2002 scheduled to mature within one year
totaled $7,787 million ($7,055 of senior notes and $732 of subordinated notes).

9

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. CAPITAL REQUIREMENTS:

The Company operates globally through a network of subsidiaries, with several
subject to regulatory requirements. In the United States, LBI, as a registered
broker-dealer, is subject to SEC Rule 15c3-1, the Net Capital Rule, which
requires LBI to maintain net capital of not less than the greater of 2% of
aggregate debit items arising from customer transactions, as defined, or 4% of
funds required to be segregated for customers' regulated commodity accounts, as
defined. At May 31, 2002, LBI's regulatory net capital, as defined, of $1,964
million exceeded the minimum requirement by $1,862 million.

Lehman Brothers International (Europe) ("LBIE"), a United Kingdom registered
broker-dealer and subsidiary of Holdings, is subject to the capital requirements
of the Financial Services Authority ("FSA") of the United Kingdom. Financial
resources, as defined, must exceed the total financial resources requirement of
the FSA. At May 31, 2002, LBIE's financial resources of approximately $2,465
million exceeded the minimum requirement by approximately $666 million. Lehman
Brothers Japan Inc.'s Tokyo branch, a regulated broker-dealer, is subject to the
capital requirements of the Japanese Financial Services Agency and at May 31,
2002, had net capital of approximately $337 million which was approximately $138
million in excess of the specified levels required. Lehman Brothers Bank, FSB
(the "Bank"), the Company's thrift subsidiary, is regulated by the Office of
Thrift Supervision ("OTS"). The Bank exceeds all regulatory capital requirements
and is considered well capitalized by the OTS. Certain other non-U.S.
subsidiaries are subject to various securities, commodities and banking
regulations and capital adequacy requirements promulgated by the regulatory and
exchange authorities of the countries in which they operate. At May 31, 2002,
these other subsidiaries were in compliance with their applicable local capital
adequacy requirements. In addition, the Company's "AAA" rated derivatives
subsidiaries, Lehman Brothers Financial Products Inc. ("LBFP") and Lehman
Brothers Derivative Products Inc. ("LBDP"), have established certain capital and
operating restrictions which are reviewed by various rating agencies. At May 31,
2002, LBFP and LBDP each had capital which exceeded the requirement of the most
stringent rating agency by approximately $67 million and $28 million,
respectively.

The regulatory rules referred to above, and certain covenants contained in
various debt agreements, may restrict Holdings' ability to withdraw capital from
its regulated subsidiaries, which in turn could limit its ability to pay
dividends to shareholders.

5. DERIVATIVE FINANCIAL INSTRUMENTS:

In the normal course of business, the Company enters into derivative
transactions both in a trading capacity and as an end-user. The Company's
derivative activities (both trading and end-user) are recorded at fair value on
the Company's Consolidated Statement of Financial Condition. As an end user, the
Company utilizes derivatives to modify the market risk exposures of certain
assets and liabilities. In this regard, the Company primarily enters into fair
value hedges utilizing interest rate swaps to convert a substantial portion of
the Company's fixed rate long-term debt and certain term fixed rate secured
financing activities to a floating interest rate. The ineffective portion of the
fair value hedges were included in "Interest Expense" on the Consolidated
Statement of Income and were immaterial for the three and six months ended May
31, 2002 and 2001.

10

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Market or fair value for derivative instruments is generally determined by
either quoted market prices (for exchange-traded futures and options) or pricing
models (for over-the-counter swaps, forwards and options). Pricing models
utilize a series of market inputs to determine the present value of future cash
flows, with adjustments, as required for credit risk and liquidity risk. Further
valuation adjustments may be recorded, as deemed appropriate for new or complex
products or for positions with significant concentrations. These adjustments are
integral components of the mark-to-market process. Credit-related valuation
adjustments represent estimates of expected losses which incorporate business
and economic conditions, historical experience, concentrations, and the
character, quality and performance of credit sensitive financial instruments.

Unrealized gains and losses on derivative contracts are recorded on a net basis
in the Consolidated Statement of Financial Condition for those transactions with
counterparties executed under a legally enforceable master netting agreements
and are netted across products when such provisions are stated in the master
netting agreement. Listed in the following table is the fair value of the
Company's derivative activities. Assets and liabilities represent net unrealized
gains (amounts receivable from counterparties) and net unrealized losses
(amounts payable to counterparties), respectively.

* Amounts represent carrying value (exclusive of collateral). Amounts do
not include receivables or payables related to exchange-traded futures
contracts.

Assets included in the table above represent the Company's net
receivable/payable for derivative financial instruments before consideration of
collateral held by the Company. Included within the $12,511 million fair value
of assets at May 31, 2002 was $11,242 million related to swaps and other
over-the-counter ("OTC") contracts and $1,269 million related to exchange-traded
option and warrant contracts. Included within the $11,555 million fair value of
assets at November 30, 2001 was $10,555 million related to swaps and other OTC
contracts and $1,000 million related to exchange-traded option and warrant
contracts.

With respect to OTC contracts, the Company views its net credit exposure to be
$7,194 million at May 31, 2002, representing the fair value of the Company's OTC
contracts in an unrealized gain position, after consideration of collateral.
Presented below is an analysis of the Company's net credit exposure at May 31,
2002 for OTC contracts based upon actual ratings made by external rating
agencies or by equivalent ratings established and utilized by the Company's
Credit Risk Management Department.

11

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

COUNTERPARTY S&P/MOODY'S NET CREDIT
RISK RATING EQUIVALENT EXPOSURE
----------- ---------- --------
1 AAA/Aaa 15%
2 AA-/Aa3 or higher 29%
3 A-/A3 or higher 34%
4 BBB-/Baa3 or higher 18%
5 BB-/Ba3 or higher 3%
6 B+/B1 or lower 1%

The Company's OTC contracts credit exposure by weighted-average maturity is set
forth below:

The Company is also subject to credit risk related to its exchange-traded
derivative contracts. Exchange-traded contracts, including futures and certain
options, are transacted directly on the exchange. To protect against the
potential for a default, all exchange clearinghouses impose net capital
requirements on their members. Additionally, exchange clearinghouses require
counterparties to futures contracts to post margin upon the origination of the
contracts and for any changes in the market value of the contracts on a daily
basis (certain foreign exchanges provide for settlement within three days).
Therefore, the potential for losses from exchange-traded products is limited.

For a further discussion of the Company's derivative related activities, refer
to "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Off-Balance Sheet Financial Instruments and Derivatives" and the
Notes to the Consolidated Financial Statements, incorporated by reference in the
Form 10-K.

12

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. SECURITIZATIONS:

The Company is a market leader in mortgage- and asset-backed securitizations and
other structured financing arrangements. In connection with these activities,
the Company utilizes special purpose entities principally for (but not limited
to) the securitization of commercial and residential mortgages, home equity
loans, government and corporate bonds, and lease and trade receivables. The
Company derecognizes financial assets transferred in securitizations provided
that the Company has relinquished control over such assets. For further
information regarding the accounting for securitization transactions, refer to
Note 1, BASIS OF PRESENTATION - CONSOLIDATION ACCOUNTING POLICIES -- TRANSFERS
OF FINANCIAL ASSETS. The Company may retain an interest in the financial assets
it securitizes ("Retained Interests") which may include assets in the form of
residual interests in the special purpose entities established to facilitate the
securitization. Any Retained Interests are included in Securities and Other
Financial Instruments Owned (principally Mortgages and Mortgage-Backed) within
the Company's Consolidated Statement of Financial Condition. The Company records
its Securities and Other Financial Instruments Owned, including Retained
Interests, at fair value with changes in fair value reported in earnings. Fair
value is determined based upon listed market prices, if available. When listed
market prices are not available, fair value is determined based on other
relevant factors, including broker or dealer price quotations and valuation
pricing models which take into account time value and volatility factors
underlying the financial instruments among other factors. During the first six
months of 2002, the Company securitized approximately $60 billion of financial
assets, including: $43.4 billion of residential mortgages, $4.4 billion of
commercial mortgages, and $12.2 billion of other asset backed assets.

As of May 31, 2002 and November 30, 2001, the Company had approximately $1.1
billion and $1.6 billion, respectively, of non-investment grade Retained
Interests from its securitization activities (principally a junior security
interest in the securitization) including $0.4 billion and $0.3 billion of
residential mortgages, $0.5 billion and $1.0 billion of commercial mortgages,
and $0.2 billion and $0.3 billion of other asset backed assets, respectively.
The Company records its trading assets on a mark-to-market basis, including
those assets held prior to securitization, as well as any retained interests
post securitization. Mark-to-market gains or losses are recorded in "Principal
Transactions" in the Consolidated Statement of Income.

13

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7. FINANCIAL INSTRUMENTS:

Securities and other financial instruments owned and securities and other
financial instruments sold, but not yet purchased are recorded at fair value and
were comprised of the following:

8. SECURITIES PLEDGED AS COLLATERAL:

The Company enters into secured borrowing and lending transactions to finance
trading inventory positions, obtain securities for settlement, and meet
customers' needs. The Company primarily receives collateral in connection with
resale agreements, securities borrowed transactions, customer margin loans and
other loans. The Company is generally permitted to sell or repledge these
securities held as collateral and use the securities to secure repurchase
agreements, enter into securities lending transactions or deliver to
counterparties to cover short positions. The Company carries secured financing
agreements for financial reporting purposes on a net basis when permitted under
the provision of Financial Accounting Standards Board Interpretations No. 41
("FIN 41").

At May 31, 2002 and November 30, 2001, the fair value of securities received as
collateral and securities owned that have not been sold, repledged or otherwise
encumbered totaled approximately $44 billion and $38 billion, respectively. At
May 31, 2002 and November 30, 2001, the gross fair value of securities received
as collateral where the Company was permitted to sell or repledge the securities
was approximately $283 billion and $245 billion, respectively. Of this
collateral, approximately $271 billion and $234 billion at May 31, 2002 and
November 30, 2001, respectively, has been sold or repledged, generally as
collateral under repurchase agreements or to cover securities and other
financial instruments sold but not yet purchased.

The Company also pledges its own assets, principally to collateralize certain
financing arrangements. These pledged securities, where the counterparty has the
right, by contract or custom, to rehypothcate the financial instruments are
classified as securities and other financial instruments owned, pledged as
collateral, on the Company's Consolidated Statement of Financial Condition as
required by SFAS 140.

14

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In addition, the carrying value of securities and other financial instruments
owned that have been pledged to counterparties where those counterparties do not
have the right to sell or repledge were approximately $44 billion and $52
billion at May 31, 2002 and November 30, 2001, respectively.

9. OTHER COMMITMENTS AND CONTINGENCIES:

As of May 31, 2002 and November 30, 2001, the Company was contingently liable
for $0.7 billion and $1.1 billion, respectively, of letters of credit, primarily
used to provide collateral for securities and commodities borrowed and to
satisfy margin deposits at option and commodity exchanges, and other guarantees.

In connection with its financing activities, the Company had outstanding
commitments under certain lending arrangements of approximately $1.8 billion and
$2.1 billion at May 31, 2002 and November 30, 2001, respectively. These
commitments require borrowers to provide acceptable collateral, as defined in
the agreements, when amounts are drawn under the lending facilities. Advances
made under the above lending arrangements are typically at variable interest
rates and generally provide for over-collateralization based upon the borrowers'
creditworthiness. At May 31, 2002 the Company had commitments to enter into
forward starting secured financing transactions including reverse repurchase
agreements and repurchase agreements of approximately $64.5 billion and $39.1
billion, respectively, as compared to $52.3 billion and $26.5 billion,
respectively, at November 30, 2001. In addition, the Company had other
guarantees of approximately $4.0 billion and $2.0 billion at May 31, 2002 and
November 30, 2001, respectively. These other guarantees, which are principally
overcollateralized with investment grade collateral, consist of liquidity
facilities and default protection to investors.

In addition, the Company, through its high grade and high yield sales, trading
and underwriting activities, makes commitments to extend credit in loan
syndication transactions. The Company utilizes various hedging and funding
strategies to actively manage its market, credit and liquidity exposures on
these commitments. In addition, total commitments are not indicative of actual
risk or funding requirements, as the commitments may not be drawn or fully
utilized. These commitments and any related draw downs of these facilities
typically have fixed maturity dates and are contingent upon certain
representations, warranties and contractual conditions applicable to the
borrower.

At May 31, 2002 and November 30, 2001, the Company had lending commitments to
investment grade borrowers of $6.7 billion and $5.9 billion, respectively.
However, the company views its credit risk associated with these commitments
after consideration of hedges to be $3.5 billion and $4.1 billion at May 31,
2002 and November 30, 2001, respectively. Lending commitments to non-investment
grade borrowers totaled $1.6 billion and $1.4 billion at May 31, 2002 and
November 30, 2001, respectively. The Company had available undrawn borrowing
facilities with third parties of approximately $4.8 billion and $4.9 billion,
respectively at those dates, which can be drawn upon to provide funding for
these commitments. These funding facilities contain limits for certain
concentrations of counterparty, industry or credit ratings of the underlying
loans.

At May 31, 2002 and November 30, 2001, the Company had commitments to invest up
to $792 million and $555 million, respectively, directly and through
partnerships in private equity related investments. These commitments will be
funded as required through the end of the respective investment periods,
principally expiring in 2004.

In the normal course of its business, the Company has been named a defendant in
a number of lawsuits and other legal proceedings. After considering all relevant
facts, available insurance coverage, established reserves and the advice of
counsel, in the opinion of the Company such litigation will not, in the
aggregate,

15

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

have a material adverse effect on the Company's consolidated financial position
or cash flows, but may be material to the Company's operating results for any
particular period, depending on the level of income for such period.

As a leading global investment bank, risk is an inherent part of all of the
Company's businesses and activities. The extent to which the Company properly
and effectively identifies, assesses, monitors and manages each of the various
types of risks involved in its trading (including derivatives), brokerage, and
investment banking activities is critical to the success and profitability of
the Company. The principal types of risks involved in the Company's activities
are market, credit or counterparty, liquidity, legal and operational risks.
Management has developed a control infrastructure throughout the Company to
monitor and manage these risks on a global basis. For further discussion of
these matters, refer to the Risk Management section of Management's Discussion
and Analysis of Financial Condition and Results of Operations incorporated by
reference in the Form 10-K and the Risk Management section of Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in this Report.

10. SEGMENTS:

The Company operates in three segments: Investment Banking, Capital Markets and
Client Services.

The Investment Banking Division provides advice to corporate, institutional and
government clients throughout the world on mergers, acquisitions and other
financial matters. The division also raises capital for clients by underwriting
public and private offerings of debt and equity securities.

The Capital Markets Division includes the Company's institutional sales,
trading, research and financing activities in equity and fixed income cash and
derivatives products. Through the division, the Company is a global market-maker
in numerous equity and fixed income products, including U.S., European and Asian
equities, government and agency securities, money market products, corporate
high grade, high yield and emerging market securities, mortgage- and
asset-backed securities, municipal securities, bank loans, foreign exchange and
derivatives products. The division also includes the Company's risk arbitrage
and secured financing businesses, as well as realized and unrealized gains and
losses related to the Company's direct private equity investments. The financing
business manages the Company's equity and fixed income matched book activities,
supplies secured financing to institutional clients and customers, and provides
secured funding for the Company's inventory of equity and fixed income products.

Client Services revenues reflect earnings from the Company's private client and
private equity businesses. Private Client revenues reflect the Company's
high-net-worth retail customer flow activities as well as asset management fees
earned from these clients. Private Equity revenues include the management and
incentive fees earned in the Company's role as general partner for thirty-three
private equity partnerships.

16

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company's segment information for the three and six months ended May 31,
2002 and May 31, 2001 is prepared utilizing the following methodologies:

o Revenues and expenses directly associated with each segment are included
in determining pre-tax earnings.

o Expenses not directly associated with specific segments are allocated
based upon the most relevant measures applicable, including each
segment's revenues, headcount and other factors.

o Net revenues include allocations of interest income and interest expense
to securities and other positions in relation to the cash generated by,
or funding requirements of, the underlying positions.

o Segment assets include an allocation of indirect corporate assets which
have been fully allocated to the Company's business segments, generally
based on each segment's respective headcount figures.

SEGMENTS (THREE MONTHS ENDED):

(1) Before dividends on preferred securities.

17

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEGMENTS (SIX MONTHS ENDED):

(1) Before dividends on preferred securities.

(1) Before dividends on preferred securities.

The following are net revenues by geographic region:

18

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11. EARNINGS PER COMMON SHARE:

Earnings per share was calculated as follows (in millions, except for per share
data):

12. CONVERTIBLE DEBT:

In March 2002, the Company issued $575 million of floating rate convertible
notes. These notes bear an interest rate equivalent to LIBOR minus 90 basis
points per annum (subject to adjustment in certain events) and mature on April
1, 2022. The notes are convertible at $96.10 per share, in certain
circumstances. These circumstances include Holdings' common stock trading at or
above $120.125 for a specified number of trading days, as well as the trading
price of the notes declining to certain levels, a downgrade in the ratings of
the notes and other events. Holdings has the option to repurchase these notes on
or after April 1, 2004. The holders of the notes may cause Holdings to
repurchase the notes at par on April 1, 2004, 2007, 2012, or 2017, or upon a
change of control of Holdings.

19

ITEM 2. LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

BUSINESS ENVIRONMENT

The principal business activities of Lehman Brothers Holdings Inc. ("Holdings")
and subsidiaries (collectively, the "Company" or "Lehman Brothers") are
investment banking and capital markets facilitation, which by their nature are
subject to volatility, primarily due to changes in interest and foreign exchange
rates and security valuations, global economic and political trends and industry
competition. Through the Company's investment banking, research, trading,
structuring and distribution capabilities in equity and fixed income products,
the Company continues to build on its client/customer business model. This model
focuses on "customer flow" activities. The "customer flow" model is based upon
the Company's principal focus of facilitating customer transactions in all major
global capital markets products and services. The Company generates customer
flow revenues from institutional and high-net-worth customers through its
abilities to (i) advise on and structure transactions specifically suited to
meet client needs, (ii) act as a market maker and/or intermediary in the global
marketplace including having securities and other financial instrument products
available to allow clients to rebalance their portfolios and diversify risks
across different market cycles and (iii) act as underwriter to clients.

Marketplace uncertainties experienced throughout 2001 continued into the second
quarter of 2002. Geo-political risks continued to weigh on the economy and
markets, along with events in the Middle East and the continued threats of
terrorism. U.S. labor markets remained sluggish as the unemployment rate grew to
5.8% at May 31, 2002 from 5.5% as of the end of the first fiscal quarter of
2002. The Federal Reserve has left the Federal Funds rate unchanged at 1.75%
since December of 2001 in an attempt to stimulate growth.

These economic conditions, combined with a number of high-profile defaults and
continued concerns over accounting and corporate governance issues, produced
lower returns in all major U.S. equity markets during the fiscal second quarter
of 2002, when compared to the same period a year ago. As of May 31, 2002, the
Standard & Poor's 500 Index had declined by 15% from the end of the fiscal
second quarter of 2001 and 6% during fiscal 2002. The NASDAQ experienced even
greater deterioration, closing the fiscal second quarter of 2002 with decreases
of 23% from May 31, 2001 and 16% during the six months ended May 31, 2002.

- --------------------------------------------------------------------------------
SOME OF THE STATEMENTS CONTAINED IN THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, INCLUDING THOSE RELATING TO THE
COMPANY'S STRATEGY AND OTHER STATEMENTS THAT ARE PREDICTIVE IN NATURE, THAT
DEPEND UPON OR REFER TO FUTURE EVENTS OR CONDITIONS OR THAT INCLUDE WORDS SUCH
AS "EXPECTS," "ANTICIPATES," "INTENDS," "PLANS," "BELIEVES," "ESTIMATES" AND
SIMILAR EXPRESSIONS, ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. THESE STATEMENTS ARE NOT
HISTORICAL FACTS BUT INSTEAD REPRESENT ONLY THE COMPANY'S EXPECTATIONS,
ESTIMATES AND PROJECTIONS REGARDING FUTURE EVENTS. THESE STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE CERTAIN RISKS AND UNCERTAINTIES
THAT ARE DIFFICULT TO PREDICT, WHICH MAY INCLUDE MARKET, CREDIT OR COUNTERPARTY,
LIQUIDITY, LEGAL AND OPERATIONAL RISKS. MARKET AND LIQUIDITY RISKS INCLUDE
CHANGES IN INTEREST AND FOREIGN EXCHANGE RATES AND SECURITIES AND COMMODITIES
VALUATIONS, THE AVAILABILITY AND COST OF CAPITAL AND CREDIT, CHANGES IN INVESTOR
SENTIMENT, GLOBAL ECONOMIC AND POLITICAL TRENDS, CONCERNS ABOUT POSSIBLE
TERRORIST ACTIVITY AND INDUSTRY COMPETITION. LEGAL RISKS INCLUDE LEGISLATIVE AND
REGULATORY DEVELOPMENTS IN THE U.S. AND THROUGHOUT THE WORLD. THE COMPANY'S
ACTUAL RESULTS AND FINANCIAL CONDITION MAY DIFFER, PERHAPS MATERIALLY, FROM THE
ANTICIPATED RESULTS AND FINANCIAL CONDITION IN ANY SUCH FORWARD-LOOKING
STATEMENTS AND, ACCORDINGLY, READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE
ON SUCH STATEMENTS. THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE ANY
FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE
EVENTS OR OTHERWISE.

20

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Global equity origination activity remained sluggish and continued to be
hampered by a decline in market valuations and wavering investor confidence as
geopolitical risks and accounting scandals continue to weigh on the market.
However, fixed income markets continued to benefit in the fiscal second quarter
of 2002 from low interest rates, a steepened Treasury yield curve and tightening
credit spreads. The volume of global debt origination was up approximately 27%
and 8% when compared to the fiscal first quarter of 2002 and the fiscal second
quarter of 2001, respectively, according to Thomson Financial Securities Data
Corp. ("TFSD").

Mergers and acquisitions ("M&A") advisory activity, which slowed considerably in
2001, continued to be weak during the fiscal second quarter of 2002, but
somewhat improved from first quarter 2002 levels. M&A advisory volume continued
to remain near its lowest level since 1997, as the combination of accounting
concerns and weak global equity markets continued to hamper activity. Worldwide
completed mergers and acquisitions were down by 42% in the fiscal second quarter
of 2002 as compared to the fiscal second quarter of 2001 and down 61% year to
date, as compared to the first half of fiscal 2001, according to TFSD; however,
M&A volumes increased 6% in the fiscal second quarter of 2002 from first quarter
2002 levels. Announced transaction volumes industry-wide were down by 33% in the
fiscal second quarter of 2002 compared to the fiscal second quarter of 2001 and
down 37% year to date, as compared to the first half of fiscal 2001.

RESULTS OF OPERATIONS

FOR THE THREE MONTHS ENDED MAY 31, 2002 AND MAY 31, 2001

The Company reported net income of $296 million for the quarter ended May 31,
2002, a decrease of 31% from the second quarter of 2001. Earnings per common
share (diluted) for the second quarter of 2002 were $1.08 as compared to $1.38
for the second quarter of 2001. Earnings per share in the second quarter of 2001
were reduced by approximately $0.19 as a result of a $50 million special
preferred dividend on Holdings' redeemable voting preferred stock. The Company's
pre-tax operating margin for the second quarter of 2002 was 26.2%, and its
return on equity was 14.1% as compared to a pre-tax operating margin of 30.9%
and return on equity of 20.6% in the second quarter of 2001. Return on equity
for the second quarter of 2001 was reduced by approximately 2.8% as a result of
the special preferred dividend. Although the 2002 amounts are down versus 2001
comparable amounts, the Company believes that these numbers demonstrate the
ability of the Company's franchise to deliver a reasonable level of
profitability and returns even in an exceedingly difficult market environment.

REVENUES

Net revenues were $1,663 million for the second quarter of 2002 as compared to
$2,022 million for the second quarter of 2001. Revenues have declined 18% as
compared to the prior year's levels, reflecting the negative trends in global
equity markets and reduced investment banking activities. However, these results
are the highest level of net revenues reported over the past four quarters as
the Company recaptured market share and trading volumes temporarily lost after
the events of September 11th and continued to benefit from strong fixed income
underwriting.

21

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

PRINCIPAL TRANSACTIONS, COMMISSIONS AND NET INTEREST REVENUES

The Company measures the profitability of its capital markets and client
services activities in the aggregate, including Principal Transactions,
Commissions and Net Interest. Decisions relating to these activities are based
on an overall review of aggregate revenues, which includes an assessment of the
potential gain or loss associated with a transaction, including any associated
commissions, and the interest income or expense associated with financing or
hedging the Company's positions. Therefore, the Company views net revenues from
principal transactions, commissions and interest, offset by related interest
expense, in the aggregate, because the revenue classifications, when analyzed
individually, are not always indicative of the profitability of the Company's
overall capital markets and client services activities.

Principal Transactions, Commissions and Net Interest revenues were $1,185
million for the second quarter of 2002 as compared to $1,450 for the second
quarter of 2001. Principal Transactions, Commissions and Net Interest revenues
decreased 18% from the second quarter 2001 as a result of strong fixed income
results being more than offset by weakness in the global equity markets. Fixed
income results were fueled by historically low interest rate levels and
increased trading volumes, particularly in investment grade debt and mortgage
related products, as investors rebalanced portfolios into fixed income products
amid geopolitical and accounting uncertainties. The weakness in equity results
was driven by continued depressed levels of market volatility and declining
equity indexes, which negatively impacted derivatives revenues.

Within these amounts, Principal Transactions revenues were $627 million for the
second quarter of 2002 as compared to $984 million for the second quarter of
2001, a decrease of 36%. The decrease represents strong fixed income results,
driven by historically low interest rate levels and resulting increased trading
volumes, that were more than offset by weakness in the global equity markets
from the continued depressed levels of market volatility and declining equity
indexes. In addition, Principal Transactions revenues in 2002 decreased as a
result of the transition to a commission-based revenue structure on certain
Nasdaq trades. In the prior year, the Company's Nasdaq trades for substantially
all of its institutional customers were transacted on a spread basis (with
related revenues classified within Principal Transactions).

Interest and Dividends revenues were $2,910 million for the second quarter of
2002 as compared to $4,433 million for the second quarter of 2001. Interest
expense was $2,684 million for the second quarter of 2002 as compared to $4,262
million for the second quarter 2001. Interest and dividend revenues and interest
expense are a function of the level and mix of total assets and liabilities,
principally financial instruments owned and secured financing activities, the
prevailing level of interest rates, as well as the term structure of the
Company's financings. Interest and dividends revenues and interest expense are
integral components of trading activities. The decline in interest revenue by
34% and interest expense by 37% from the previous year is principally due to a
substantial decline in interest rates over the period. The increase in net
interest income was due to increased spreads resulting from declining interest
rates as well as higher interest and dividend earning asset levels in the second
quarter of 2002 as compared to the second quarter of 2001.

Commissions revenues were $332 million for the second quarter of 2002 as
compared to $295 million for the second quarter of 2001. Commissions revenues
increased 13% as compared to the prior year's level due, in part, to the record
levels of institutional and high-net-worth customer flow, driven by the Firm's
increased secondary market share in both the listed and Nasdaq markets. In
addition, commissions

22

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

revenues in 2002 were bolstered by the increase in the share of revenue derived
from institutional commission-based pricing in the Nasdaq market, whereas in the
prior year, the Company's Nasdaq trades for institutional customers were
primarily transacted on a spread basis with related revenues classified within
Principal Transactions.

INVESTMENT BANKING

Investment Banking revenues were $465 million for the second quarter of 2002 as
compared to $565 million for the second quarter of 2001. Investment Banking
revenues result mainly from fees earned by the Company for underwriting public
and private offerings of fixed income and equity securities, and advising
clients on M&A activities and other services. Investment Banking revenues
decreased 18% from the second quarter of 2001 as a result of the lower volumes
of equity originations and M&A activity in the overall market place. This was
partially offset by record results in fixed income originations, where markets
were characterized by low interest rates, tighter credit spreads and corporate
preference for long-term financing.

SEGMENTS

The Company is segregated into three business segments (each of which is
described below): Investment Banking, Capital Markets and Client Services. Each
segment represents a group of activities and products with similar
characteristics. These business activities result in revenues from both
institutional and high-net-worth retail clients, which are recognized across all
revenue categories contained in the Company's Consolidated Statement of Income.
(Net revenues also contain certain internal allocations, including funding
costs, which are centrally managed.)

SEGMENT RESULTS - THREE MONTHS ENDED MAY 31, 2002 AND MAY 31, 2001

(1) Before dividends on preferred securities

The following discussion provides an analysis of the Company's net revenues
results by segment for the periods above.

23

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

In assessing the profitability of Capital Markets and Client Services, the
Company measures principal transactions, commissions and net interest revenues
in the aggregate. Decisions relating to capital markets and client services
activities are based on an overall review of aggregate revenues, which includes
an assessment of the potential gain or loss associated with a transaction
including any associated commissions, and the interest income or expense
associated with financing or hedging the Company's positions. Therefore, the
Company views net revenues from principal transactions, commissions and
interest, offset by related interest expense, in the aggregate, because the
revenue classifications, when analyzed individually, are not always indicative
of the profitability of the Company's capital markets and client services
activities.

INVESTMENT BANKING This segment's earnings result from fees earned by the
Company for underwriting public and private offerings of fixed income and equity
securities, and advising clients on M&A activities and other services.

Investment Banking pre-tax earnings of $107 million decreased 9% in the second
quarter of 2002 compared to second quarter of 2001 pre-tax earnings of $118
million, as an 18% decrease in net revenues was partially offset by a 20%
decrease in non-interest expenses. The decrease in non-interest expenses
primarily reflected reduced compensation and benefits associated with lower
revenue levels as well as reduced discretionary spending on business development
and professional fees as the Company continued to focus on minimizing expenses
in a down market.

Debt underwriting revenues totaled $266 million for the second quarter of 2002,
slightly better than the $265 million recorded in the second quarter of 2001.
Fixed income origination benefited for the three months ended May 31, 2002, as
issuers continued to take advantage of lower interest rates to raise long-term
debt and replace short-term financing and investors displayed an appetite for
less risky assets. Global debt origination market volume in the US, Europe and
Asian markets increased from the previous year's second quarter by approximately
8%, with the most significant increases in the US.

Equity underwriting revenues decreased 31% to $109 million in the second quarter
of 2002 from the second quarter of 2001. The decrease in equity origination was
due to unfavorable secondary markets and industry issuance volumes remaining
lower than historical levels, resulting from declining equity indices and
generally cautious investor sentiment. Industry-wide global equity origination
volumes increased 19% during the second quarter of 2002 as compared to the
second quarter of 2001. However, much of this increase was attributable to a
small number of large deals. The Company's global equity volumes decreased
approximately 27% as compared to the second quarter of 2001, mainly as a result
of a decrease in the US, which was somewhat offset by increases in Europe and
Asia.

24

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

M&A advisory fees for the second quarter of 2002 were $79 million, down 38% from
the second quarter of 2001 reflecting the extremely difficult climate for
strategic transactions globally.

CAPITAL MARKETS This segment's earnings reflect institutional customer flow
activities and secondary trading and financing activities related to fixed
income and equity products. These products include a wide range of cash,
derivative, secured financing and structured instruments.

Capital Markets pre-tax earnings of $280 million decreased 40% from the second
quarter of 2001 pre-tax earnings of $465 million, driven by a 22% decrease in
net revenues. Capital Markets non-interest expenses decreased 11% during the
quarter to $720 million from $809 million in the second quarter of 2001,
primarily due to a decrease in compensation and benefits associated with lower
revenues, which was slightly offset by an increase in nonpersonnel expenses,
particularly occupancy costs associated with increased headcount levels.

Capital Markets' net revenues were $1,000 million for the second quarter of
2002, down 22% from the second quarter of 2001, as strong fixed income results
were more than offset by lower revenues from equity products. Overall, the
Company continued to experience strong institutional customer flow activity with
particular interest in fixed income products as equity investors remained
cautious given geopolitical uncertainties resulting from terrorist activities
and continued concerns over accounting and corporate governance issues. Interest
and dividend income and interest expense decreased by 34% and 37%, respectively,
from the second quarter of the previous year, mainly as a result of the
substantial decline in interest rates over the period. However, net interest
income benefited due to increased spreads resulting from declining interest
rates as well as higher interest earning asset levels in the second quarter of
2002 as compared to the second quarter of 2001.

Net revenues from the fixed income component of Capital Markets in the second
quarter of 2002 increased by 2% from the second quarter of 2001 driven by record
levels of mortgage securitizations. During the second quarter of 2002, the
increase in the Company's transaction volume in US mortgage securitizations from
the second quarter of 2001 was proportionally greater than that of the industry
overall in both the residential and commercial markets. The Company's volume in
the residential market more than tripled while the industry increased 117%, and
the Company's volume in the commercial market increased 95% while the market
decreased 35%. Partially offsetting this increase were lower revenues from high
grade and high yield activities.

Net revenues from the equities component of Capital Markets were $324 million in
the second quarter of 2002, down 47% from second quarter of 2001. The decrease
resulted from continued difficult conditions in the secondary markets resulting
from declining indices and low volatility, including declining global market
valuations and lack of corporate demand for derivative products and
convertibles. An increase in commissions revenues was a result of the increase
in the portion of revenue derived from institutional commission-based pricing in
the Nasdaq market, with related revenues classified within commissions,

25

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

whereas in the prior year, the Company's Nasdaq trades for institutional
customers were primarily transacted on a spread basis with related revenues
classified within principal transactions.

CLIENT SERVICES Client Services earnings reflect earnings from the Company's
Private Client and Private Equity businesses. Private Client net revenues
reflect the Company's high-net-worth retail customer flow activities as well as
asset management fees. Private equity net revenues include the management and
incentive fees earned in the Company's role as general partner for thirty-three
private equity banking partnerships.

Client Services pre-tax earnings of $49 million increased 17% in the second
quarter of 2002 compared to the second quarter of 2001. Non-interest expenses
increased 3% to $160 million in the second quarter of 2002 compared to $155
million second quarter of 2001.

Private equity net revenues declined by $2 million to $12 million in the second
quarter of 2002 from the second quarter of 2001 primarily as a result of lower
incentive fees earned on general partnership interests (which are carried on a
mark-to-market basis).

NON-INTEREST EXPENSES Non-interest expenses were $1,227 million for the second
quarter of 2002 compared to $1,397 million for the second quarter of 2001. The
decrease in non-interest expenses highlights the Company's continued disciplined
approach to expense management. This ongoing focus is a key element of the
Company's strategic objectives. Compensation and benefits expense of $848
million decreased 18% from $1,032 million in the second quarter of 2001.
Compensation and benefit expense, as a percentage of net revenues, remained at
51% for the quarter, consistent with the Company's fiscal 2001 level. Lower
levels of revenues in 2002 resulted in lower variable compensation expenses,
which decreased by 32% from the second quarter of 2001. Fixed compensation,
consisting primarily of salaries and benefits, increased 6% in the second
quarter of 2002 from the second quarter of 2001 as a result of the growth in the
Company's headcount over the prior period.

Nonpersonnel expenses were $379 million for the second quarter of 2002, up 4%
compared to the second quarter of 2001. The increase is mainly attributable to a
higher level of technology and communications and occupancy expenses. Technology
and communication expenses were $142 million for the second quarter of 2002
compared to $134 million for the second quarter of 2001. The increase is
attributable to spending in order to continue to enhance the Company's capital
markets trading platforms and technology infrastructure. Occupancy expenses
increased to $71 million during the second quarter of 2002 from $44 million
during the second quarter of 2001. The increase is principally attributable to
the increase in space required for the increase in headcount the Company has
experienced over recent periods. Business development and professional fees
decreased by 26% and 17%, respectively from the second quarter of 2001, due to
lower discretionary spending in response to the current market

26

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

environment. Brokerage and clearance expenses are relatively consistent with the
second quarter of 2001.

INCOME TAXES The Company's income tax provision was $126 million for the second
quarter of 2002 versus $181 million for the second quarter of 2001. The
effective tax rate was 29% for the second quarter of both 2002 and 2001. The
effective tax rate for both 2002 and 2001 is lower than the Company's statutory
tax rate of 35% primarily due to the impact of tax benefits attributable to
income subject to preferential tax treatment.

RESULTS OF OPERATIONS
FOR THE SIX MONTHS ENDED MAY 31, 2002 AND MAY 31, 2001

The Company reported net income of $594 million for the six months ended May 31,
2002, a decrease of 27% from the six months ended May 31, 2001. Earnings per
common share (diluted) were $2.07 for the first six months of 2002 compared to
$2.77 for the comparable period in 2001. Earnings per share computations include
the recognition of a special dividend on the Company's Redeemable Voting
Preferred Stock of $25 million in the first quarter of 2002 and $50 million in
the second quarter of 2001. These special preferred dividends had the impact of
reducing earnings per share by $0.09 and $0.22 for the six months ended May 31,
2002 and May 31, 2001, respectively.

These results reflect the difficult market conditions experienced in 2002, led
by a decline in equity capital markets and reduced investment banking and M&A
activities. However, during this six month period, the Company was generally
able to continue to execute its strategy of building market share while
maintaining a strict discipline with regard to its expenses, capital and
liquidity. Pre-tax operating margin and return on equity were 26.8% and 14.3%
(excluding the impact of the $25 million in dividends on the Company's
Redeemable Voting Preferred Stock), respectively, in the first half of 2002, as
compared to a pre-tax operating margin and return on equity of 30.7% and 22.3%
(excluding the impact of the $50 million in dividends on the Company's
Redeemable Voting Preferred Stock), respectively, in the first half of 2001. The
Company believes that the discipline in the management of Firm resources and
focus on expense management have served to diminish the impact of an unfavorable
market cycle.

REVENUES

Net revenues were $3,269 million for the first six months of 2002 compared to
$3,905 million for the first six months of 2001. Revenues declined 16% as
compared to the prior year's levels, as strong fixed income results were more
than offset by the negative conditions in equity markets (e.g. declining indices
and low volatility) and historically low levels of M&A activity.

PRINCIPAL TRANSACTIONS, COMMISSIONS AND NET INTEREST REVENUES

The Company measures the profitability of its capital markets and client
services activities in the aggregate including Principal Transactions,
Commissions and Net Interest. Decisions relating to these activities are based
on an overall review of aggregate revenues, which includes an assessment of the
potential gain or loss associated with a transaction, including associated
commissions, and the interest income or expense associated with financing or
hedging the Company's positions. The Company views these revenues in the
aggregate, because the revenue classifications, when analyzed individually, are
not always indicative of the profitability of the Company's capital markets and
client services activities.

27

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Principal Transactions, Commissions and Net Interest revenues were $2,309
million for the first six months of 2002 as compared to $2,838 million for the
first six months of 2001. Principal Transactions, Commissions and Net Interest
revenues decreased 19% from the first six months of 2001 as a result of strong
fixed income results being more than offset by weakness in the global equity
markets. Fixed income results were fueled by historically low interest rate
levels and increased trading volumes, particularly investment grade debt and
mortgage related products, as investors rebalanced portfolios into fixed income
products amid geopolitical and accounting uncertainties. The weakness in equity
results were driven by continued depressed levels of market volatility and
declining equity indexes, which negatively impacted derivatives revenues.

Within these amounts, Principal Transactions revenues were $1,196 million for
the first six months of 2002 as compared to $1,981 for the first six months of
2001, a decrease of 40%. This decrease represents the weakness in the global
equity markets from the continued depressed levels of market volatility and
declining equity indexes partially offset by strong fixed income results, driven
by historically low interest rate levels and resulting increased trading
volumes. In addition, Principal Transaction revenues in 2002 decreased as a
result of the transition to a commission-based revenue structure on certain
Nasdaq trades. In the prior year, the Company's Nasdaq trades for substantially
all of its institutional customers were transacted on a spread basis (with
related revenues classified within Principal Transactions).

Interest and Dividends revenues were $5,796 million for the first six months of
2002 as compared to $9,414 million for the first six months of 2001. Interest
Expense was $5,304 million for the first six months of 2002 as compared to
$9,131 million for the first six months of 2001. Interest and Dividends revenues
and Interest Expense are a function of the level and mix of total assets and
liabilities, including financial instruments owned and secured financing
activities, the prevailing level of interest rates, as well as the term
structure and volatility of the Company's financings. Interest and Dividends
revenues and Interest Expense are integral components of trading activities. The
decline in interest income by 38% and interest expense by 42% from the previous
year is principally due to a substantial decline in interest rates over the
period. The increase in net interest income was due to higher interest and
dividend earning asset levels in the first six months of 2002 as compared to the
first six months of 2001.

Commissions revenues were $621 million for the first six months of 2002 as
compared to $574 million for the first six months of 2001. Commissions revenues
increased 8% as compared to the prior year's level driven by increased secondary
market share in both listed and Nasdaq markets as well as the migration to
institutional commission-based pricing in the Nasdaq market.

INVESTMENT BANKING

Investment Banking revenues were $935 million for the first six months of 2002
as compared to $1,048 million for the first six months of 2001. Investment
Banking revenues result mainly from fees earned by the Company for underwriting
public and private offerings of fixed income and equity securities, and advising
clients on M&A activities and other services. Investment Banking revenues
decreased 11% from the first half of 2001 as a result of the decline in equity
origination and M&A activity in the overall market place, partially offset by
record performance in fixed income origination.

28

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

SEGMENTS

The Company is segregated into three business segments (each of which is
described below): Investment Banking, Capital Markets and Client Services. Each
segment represents a group of activities and products with similar
characteristics. These business activities result in revenues from both
institutional and high-net-worth retail clients, which are recognized across all
revenue categories contained in the Company's Consolidated Statement of Income.
(Net revenues also contain certain internal allocations, including funding
costs, which are centrally managed.)

SEGMENT RESULTS - SIX MONTHS ENDED MAY 31, 2002 AND MAY 31, 2001

(1) Before dividends on preferred securities

The following discussion provides an analysis of the Company's net revenues
results by segment for the periods above.

In assessing the profitability of Capital Markets and Client Services, the
Company measures principal transactions, commissions and net interest revenues
in the aggregate. Decisions relating to capital markets and client services
activities are based on an overall review of aggregate revenues, which includes
an assessment of the potential gain or loss associated with a transaction
including any associated commissions, and the interest income or expense
associated with financing or hedging the Company's positions. The Company views
these revenues in the aggregate, because the revenue classifications, when
analyzed individually, are not always indicative of the profitability of the
Company's capital markets and client services activities.

INVESTMENT BANKING This segment's earnings result from fees earned by the
Company for underwriting public and private offerings of fixed income and equity
securities and advising clients on M&A activities and other services.

Investment Banking pre-tax earnings of $225 million increased 17% during the
first half of 2002 compared to first half 2001 pre-tax earnings of $193 million,
as an 11% decrease in net revenues was

29

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

more than offset by lower expenses. The decrease in non-interest expenses
reflected reduced compensation expenses associated with lower revenue levels and
reduced benefits and non-compensation related expenses (business development and
professional fees) as the Company focused on minimizing discretionary spending
in light of reduced revenue levels.

Investment Banking's net revenues of $913 million -----------------------------------------------------------
decreased 11% in the first six months of 2002 when INVESTMENT BANKING NET REVENUES
compared to $1,022 million for the first six months of -----------------------------------------------------------
2001. The decrease in Investment Banking net (IN MILLIONS) Six Months Ended
revenues was a result of the decline in M&A advisory May 31 May 31
revenues partially offset by increases in debt and equity 2002 2001
underwriting revenues. -----------------------------------------------------------
Debt Underwriting $471 $ 448
Equity Underwriting 272 263
Merger and Acquisition Advisory 170 311
-----------------------------------------------------------
$913 $1,022
-----------------------------------------------------------

Debt underwriting revenues increased 5% to $471 million in the first six months
of 2002 from $448 million in the first six months of 2001. The increase is
mainly attributable to strong performance in a very favorable investment grade
market. The Company continued to improve its competitive position as its league
table rank for worldwide investment grade issuances advanced to #4 from #6 and
its market share improved to 7% from 6.4% in 2002 and 2001, respectively; in
addition, the Company improved ranking and market share in the leveraged finance
business to #6 from #9 and 9.4% from 6.3% in 2002 and 2001, respectively
(according to TFSD for the first five months of calendar years 2002 and 2001,
respectively).

Global debt origination volume in the US, European and Asian markets increased
from the first six months of the previous fiscal year by approximately 10%, with
the most significant increases in the US. The Company's debt origination
increased in the first half of fiscal 2002 versus the first half of fiscal 2001
by approximately 28%, with the most significant portion attributable to
continued strength in investment grade issuances from US operations.

Equity underwriting revenues increased slightly to $272 million in the first
half of 2002 compared to $263 million in the first half of 2001 as global market
volume picked up slightly, although, syndicate activity overall remained slow
and issuers and investors continue to be cautious. Market-wide global equity
origination volumes increased 22% during the first six months of 2002 as
compared to the first six months of 2001. However, much of this increase was
attributable to a small number of large deals during the second quarter of 2002.
The Company's equity volumes decreased approximately 15% in the first half of
2002 as compared to the first half of 2001, mainly as a result of a decrease in
lower margin US activity, which was somewhat offset by increases in Europe and
Asia.

M&A advisory revenues decreased by 45% to $170 million for the first six months
of 2002 from $311 million for the first six months of 2001. The decrease
reflected the extremely difficult global market conditions, partially attributed
to weak equity share valuations and corporate scandals, as the market volume was
the lowest it has been in the last five years. Despite the low volume of
activity in the advisory markets, the Company was able to improve its market
share to 10.5% in 2002 from 7.8% in 2001 (according to TFSD for the first five
months of calendar years 2002 and 2001, respectively).

30

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

CAPITAL MARKETS This segment's earnings reflect institutional flow activities
and secondary trading and financing activities related to fixed income and
equity products. These products include a wide range of cash, derivative,
secured financing and structured instruments.

Capital Markets pre-tax earnings of $556 million decreased 39% from the first
half of 2001 pre-tax earnings of $916 million, driven by a 22% decrease in net
revenues. Capital Markets non-interest expenses decreased 11% during the first
half of 2002 to $1,389 million from $1,566 million in the first half of 2001, as
a decrease in compensation and benefits was partially offset by an increase in
non-personnel expenses (occupancy and technology).

Capital Markets' net revenues were $1,945 million for the first six months of
2002, down 22% from the first six months of 2001, as an extremely weak equities
market was partially offset by increased customer flow in fixed income products.
Interest and dividend income and interest expense decreased from the first six
months of the previous year by 38% and 42%, respectively, mainly as a result of
the substantial decline in interest rates over the period. However, net interest
income benefited in part due to a steepening yield curve environment and higher
interest earning asset levels in the first six months of 2002 as compared to the
first six months of 2001.

Net revenues from the fixed income component of Capital Markets increased 14% to
$1,357 million in the first six months of 2002 from $1,186 million in the first
six months of 2001. These record results were driven by strong institutional
customer flow activity in credit and mortgage related products.

Net revenues from the equities component of Capital Markets decreased 55% to
$588 million in the first half of 2002 from $1,296 million in the comparable
2001 period. The decrease was a result of reduced customer flow from record
levels set in the first half of 2001, as investors remained wary of
geo-political risks and accounting and corporate earnings uncertainties. The
difficult market conditions were evidenced by the decline in the global equity
indices since November 2001 and the historical lows in volatility levels. These
conditions also resulted in declines in revenues from both private equity
investments and risk arbitrage activity from levels experienced a year ago. An
increase in commissions revenues was a result of the increase in the portion of
revenue derived from institutional commission-based pricing in the Nasdaq market
with related revenues classified within commissions, whereas in the prior year,
the Company's Nasdaq trades for institutional customers were primarily
transacted on a spread basis with related revenues classified within principal
transactions.

CLIENT SERVICES Client Services' earnings reflect earnings from the Company's
private client and private equity businesses. Private client net revenues
reflect the Company's high-net-worth retail customer flow activities as well as
asset management fees. Private equity net revenues include the management and
incentive fees earned in the Company's role as general partner for thirty-three
private equity partnerships.

31

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Client Services pre-tax earnings of $95 million increased 7% in the first six
months of 2002 compared to the first six months of 2001 pre-tax earnings of $89
million. Non-interest expenses increased slightly to $316 million in the first
six months of 2002 compared to $312 million during the first six months of 2001.

Private equity net revenues decreased by $3 million to $23 million during the
first six months of 2002 from the first six months of 2001 primarily as a result
of reduced lower incentive fees earned on general partnership interests (which
are carried on a mark-to-market basis).

NON-INTEREST EXPENSES Non-interest expenses were $2,393 million for the first
six months of 2002 and $2,707 million for the comparable period of 2001. The
decrease in non-interest expense highlights the Company's continued disciplined
approach to expense management. This ongoing focus is a key element of the
Company's strategic objectives. Compensation and benefits expenses of $1,667
million in the first half of 2002 decreased 16% from $1,992 million in the first
half of 2001. Compensation and benefit expense, as a percentage of net revenues,
remained at 51% for the first six months of 2002, consistent with the Company's
fiscal 2001 level. The lower levels of revenues in 2002 resulted in lower
variable compensation expenses, which decreased by 20% from the first six months
of 2001. Fixed compensation, consisting primarily of salaries and benefits,
increased 6% in the first six months of 2002 from the first six months of 2001
as a result of the growth in the Company's headcount over the previous year.

Non-personnel expenses were $726 million for the first six months of 2002,
relatively flat to the $715 million recorded in the first six months of 2001.
Technology and communication expenses were $264 million for the first six months
of 2002 as compared to $245 million for the first six months of 2001. The
increase is attributable to spending in order to continue to enhance the
Company's capital markets trading platforms and technology infrastructure.
Occupancy expenses increased to $140 million in the first half of 2002 from $85
million in the first half of 2001. The increase is principally attributable to
the increase in space required for the increased headcount experienced over the
recent periods. Business development and professional fees decreased by 29% and
39%, respectively, from the first six months of 2001, due to lower discretionary
spending in response to the current market environment. Brokerage and clearance
expenses are relatively consistent with the first half of 2001.

INCOME TAXES The Company's income tax provision was $254 million for the first
six months of 2002 compared to $353 million for the six months of 2001. The
effective tax rate was 29.0% for the first half of 2002, comparable to the
Company's tax rate of 29.5% for the first half of 2001. The effective tax rate
for both 2002 and 2001 is lower than the Company's statutory tax rate of 35%
primarily due to the impact of tax benefits attributable to income subject to
preferential tax treatment.

32

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

LIQUIDITY, FUNDING AND CAPITAL RESOURCES

LIQUIDITY RISK MANAGEMENT Liquidity risk management is of critical importance to
the Company, providing a framework which seeks to ensure that the Company
maintains sufficient liquid financial resources to continually fund its balance
sheet and meet all of its funding obligations in all market environments. The
Company's liquidity framework has been structured so that even in a severe
liquidity event the balance sheet does not have to be reduced purely for
liquidity reasons (although we may choose to do so for risk reasons). This
should allow the Company to continue to maintain its customer franchise and debt
ratings during a liquidity event.

The Company's liquidity management philosophy incorporates the following
principles:

o Liquidity providers are credit and market sensitive. Consequently, firms
must be in a state of constant liquidity readiness.

o Firms should not rely on asset sales to generate cash or believe that
they can increase unsecured borrowings or funding efficiencies in a
liquidity crisis.

o During a liquidity event, certain secured lenders may require higher
quality collateral. Firms must therefore not over-estimate the
availability of secured financing, and must fully integrate their secured
and unsecured funding strategies.

o A firm's legal entity structure may constrain liquidity. Regulatory
requirements can restrict the flow of funds between regulated and
unregulated group entities, and this must be accounted for in liquidity
planning.

The Company's Funding Framework incorporates these principles and mitigates
liquidity risk whenever possible. This Framework is comprised of four major
components:

(1) The Cash Capital Model - which evaluates the amount of long-term
liabilities - with remaining maturities of over one year - that are
required to fund the Company.

(2) The Reliable Secured Funding Model - which forecasts the reliable sources
of overnight secured funding available to the Company.

(3) The Maximum Cumulative Outflow - which estimates the size of the added
liquidity requirement necessary to fund contingent cash outflows expected
from a stress environment.

(4) The Contingency Funding Plan - which represents a detailed action plan to
manage a stress liquidity event within the Company.

For further discussion of these principles refer to the Liquidity, Funding and
Capital Resources section of Management's Discussion and Analysis of Financial
Condition and Results of Operations incorporated by reference in the Form 10-K.

As a consequence of implementing its Funding Framework, the Company has
generally shifted to longer-term funding over the past several years. As a
result, the Company has continued to reduce its reliance on

33

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

short-term unsecured debt, which now represents only 1% of adjusted total assets
and less than 7% of total debt.

TOTAL CAPITAL The Company's Total Capital (defined as long-term debt, preferred
securities subject to mandatory redemption and stockholders' equity) was $46.3
billion at May 31, 2002 compared to $47.5 billion at November 30, 2001. The
decrease in Total Capital resulted from a net decrease in long-term debt,
partially offset by an increase in total equity, principally due to net income.

During the first six months of 2002, the Company issued $3,133 million in
long-term debt securities (all of which were senior notes) which was $1,840
million less than maturing debt securities. The Company had $4,706 million of
senior notes and $267 of subordinated notes mature during the six months ended
May 31, 2002. Long-term debt decreased to $36.6 billion at May 31, 2002 from
$38.3 billion at November 30, 2001, with a weighted-average maturity of 3.9
years at May 31, 2002 and 3.8 years at November 30, 2001.

CREDIT FACILITIES Holdings maintains a Revolving Credit Agreement (the "Credit
Agreement") with a syndicate of banks. In April 2002, the Company renegotiated
the Credit Agreement; under the new terms, the banks have committed to provide
up to $1 billion for three years with a final maturity in April 2005 (Under the
terms of the previous agreement, the banks committed to provide up to $1 billion
for up to 364 days). The Credit Agreement contains covenants that require, among
other things, that the Company maintain a specified level of tangible net worth.
Prior to April 2002 the Company had not actively used the Credit Agreement; it
now has begun to do so and intends to use the proceeds for general corporate
purposes.

The Company also maintains a $1 billion Committed Securities Repurchase Facility
(the "Facility") for LBIE, the Company's major operating entity in Europe. The
Facility provides secured multi-currency financing for a broad range of
collateral types. Under the terms of the Facility, the bank group has agreed to
provide funding for up to one year on a secured basis. Any loans outstanding on
the commitment termination date may be extended for up to an additional year at
the option of LBIE. The Facility contains covenants which require, among other
things, that LBIE maintain specified levels of

34

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

tangible net worth. This commitment expires in October 2002, but the Company
anticipates obtaining a new $1 billion commitment on substantially similar
terms.

There were no borrowings outstanding under either the Credit Agreement or the
Facility at May 31, 2002. The Company has maintained compliance with the
applicable covenants for both the Credit Agreement and the Facility at all
times.

BALANCE SHEET The Company's total assets increased to $267.8 billion at May 31,
2002 from $247.8 billion at November 30, 2001. The Company's adjusted total
assets, defined as total assets less the lower of securities purchased under
agreements to resell or securities sold under agreements to repurchase, were
$173.7 billion at May 31, 2002 compared to $164.5 billion at November 30, 2001.
The Company believes adjusted total assets is a more effective measure of
evaluating balance sheet usage when comparing companies in the securities
industry. The increase in adjusted total assets, as well as total assets,
reflects higher levels of investing and secured financing associated with
increased customer flow activities within the Company's Capital Markets
business.

The Company's Balance Sheet consists primarily of cash and cash equivalents,
securities and other financial instruments owned, and collateralized short-term
financing agreements. The liquid nature of these assets provides the Company
with flexibility in financing and managing its business. The majority of these
assets are funded on a secured basis through collateralized short-term financing
agreements.

FINANCIAL LEVERAGE Balance sheet leverage ratios are one measure used to
evaluate the capital adequacy of a company. Leverage ratios are commonly
calculated using either total assets or adjusted total assets divided by total
stockholders' equity and preferred securities subject to mandatory redemption.
The Company believes that the adjusted leverage ratio is a more effective
measure of financial risk when comparing companies in the securities industry.
The Company's net leverage ratios based on adjusted total assets were 18.1x and
17.9x as of May 31, 2002 and November 30, 2001, respectively. Consistent with
maintaining a single A credit rating, the Company targets an adjusted leverage
ratio of under 20x. The Company continues to operate below this level. Due to
the nature of the Company's sales and trading activities, the overall size of
the Company's balance sheet fluctuates from time to time and, at specific points
in time, may be higher than the fiscal quarter ends.

CREDIT RATINGS

The Company, like other companies in the securities industry, relies on external
sources to finance a significant portion of its day-to-day operations. The cost
and availability of unsecured financing generally are dependent on the Company's
short-term and long-term credit ratings. Factors that may be significant to the
determination of the Company's credit ratings or otherwise affect the ability of
the Company to raise short-term and long-term financing include its profit
margin, its earnings trend and volatility, its cash liquidity and liquidity
management, its capital structure, its risk level and risk management, its
geographic and business diversification, and its relative positions in the
markets in which it operates. A deterioration in any of the previously mentioned
factors or combination of these factors may lead rating agencies to downgrade
the credit ratings of the Company, thereby increasing the cost to the Company
of, or possibly limiting the access of the Company to, certain types of
unsecured financings. In addition, the Company's debt ratings can impact certain
capital markets revenues, particularly in those businesses where longer-term
counterparty performance is critical, such as over-the-counter derivative
transactions, including credit derivatives and interest rate swaps. As of May
31, 2002 the short- and long-term debt ratings of Holdings and LBI were as
follows:

35

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

* Provisional ratings on shelf registration
** Senior/subordinated

HIGH YIELD

The Company underwrites, trades, invests and makes markets in high yield
corporate debt securities. The Company also syndicates, trades and invests in
loans to below investment grade-rated companies. For purposes of this
discussion, high yield debt instruments are defined as securities or loans to
companies rated BB+ or lower, or equivalent ratings by recognized credit rating
agencies, as well as non-rated securities or loans which, in the opinion of
management, are non-investment grade. Non-investment grade securities generally
involve greater risks than investment grade securities, due to the issuer's
creditworthiness and the liquidity of the market for such securities. In
addition, these issuers have relatively higher levels of indebtedness, resulting
in an increased sensitivity to adverse economic conditions. The Company
recognizes these risks and aims to reduce market and credit risk through the
diversification of its products and counterparties. High yield debt instruments
are carried at fair value, and unrealized gains or losses for these securities
are recognized in the Company's Consolidated Statement of Income. Such
instruments at May 31, 2002 and November 30, 2001 included long positions with
an aggregate market value of approximately $3.9 billion and $3.5 billion,
respectively, and short positions with an aggregate market value of
approximately $1.1 billion and $1.0 billion, respectively. The Company mitigates
its aggregate and single-issuer net exposure through the use of derivatives,
non-recourse securitization financing and other financial instruments.

PRIVATE EQUITY

The Company has investments in thirty-three private equity partnerships, for
which the Company acts as general partner, as well as related direct
investments. At May 31, 2002, the Company's private equity related investments
were $843 million. The Company's policy is to carry its investments, including
the appreciation of its general partnership interests, at fair value based upon
the Company's assessment of the underlying investments. Additional information
about the Company's private equity activities, including related commitments,
can be found in Note 8 to the Consolidated Financial Statements (Other
Commitments and Contingencies).

SUMMARY OF CONTRACTUAL OBLIGATIONS

As of May 31, 2002 and November 30, 2001, the Company was contingently liable
for $0.7 billion and $1.1 billion, respectively, of letters of credit, primarily
used to provide collateral for securities and commodities borrowed and to
satisfy margin deposits at option and commodity exchanges, and other guarantees.

In connection with its financing activities, the Company had outstanding
commitments under certain lending arrangements of approximately $1.8 billion and
$2.1 billion at May 31, 2002 and November 30,

36

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

2001, respectively. These commitments require borrowers to provide acceptable
collateral, as defined in the agreements, when amounts are drawn under the
lending facilities. Advances made under the above lending arrangements are
typically at variable interest rates and generally provide for
over-collateralization based upon the borrowers' creditworthiness. At May 31,
2002, the Company had commitments to enter into forward starting secured
financing transactions including reverse repurchase agreements and repurchase
agreements of $64.5 billion and $39.1 billion, respectively, as compared to
$52.3 billion and $26.5 billion, respectively, at November 30, 2001. In
addition, the Company had other guarantees of approximately $4.0 billion and
$2.0 billion at May 31, 2002 and November 30, 2001, respectively. These other
guarantees, which are principally overcollateralized with investment grade
collateral, consist of liquidity facilities and default protection to investors.

In addition, the Company, through its high grade and high yield sales, trading
and underwriting activities, makes commitments to extend credit in loan
syndication transactions. The Company utilizes various hedging and funding
strategies to actively manage its market, credit and liquidity conditions
exposures on these commitments. In addition, total commitments are not
indicative of actual risk or funding requirements, as the commitments may not be
drawn or fully utilized. These commitments and any related draw downs of these
facilities typically have fixed maturity dates and are contingent upon certain
representations, warranties and contractual conditions applicable to the
borrower.

At May 31, 2002 and November 30, 2001, the Company had lending commitments to
investment grade borrowers of $6.7 billion and $5.9 billion, respectively.
However, the company views its credit risk associated with these commitments
after consideration of hedges to be $3.5 billion and $4.1 billion at May 31,
2002 and November 30, 2001, respectively. Lending commitments to non-investment
grade borrowers totaled $1.6 billion and $1.4 billion at May 31, 2002 and
November 30, 2001, respectively. The Company had available undrawn borrowing
facilities with third parties of approximately $4.8 billion and $4.9 billion,
respectively at those dates, which can be drawn upon to provide funding for
these commitments. These funding facilities contain limits for certain
concentrations of counterparty, industry or credit ratings of the underlying
loans.

As of May 31, 2002 and November 30, 2001, the Company had commitments to invest
up to $792 million and $555 million, respectively, directly and through
partnerships in private equity related investments. These commitments will be
funded as required through the end of the respective investment periods,
principally expiring in 2004.

37

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

For additional information on contractual obligations see the Summary of
Contractual Obligations section of Management's Discussion and Analysis of
Financial Condition and Results of Operations incorporated by reference in the
Form 10-K.

OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES

For a discussion of the Company's use of derivative instruments and the risks
related thereto, see Note 14 to the Consolidated Financial Statements
(Derivative Financial Instruments) and the Off-Balance Sheet Financial
Instruments and Derivatives section of Management's Discussion and Analysis of
Financial Condition and Results of Operations incorporated by reference in the
Form 10-K.

RISK MANAGEMENT

As a leading global investment banking company, risk is an inherent part of the
Company's businesses. Global markets, by their nature, are prone to uncertainty
and subject participants to a variety of risks. The Company has developed
policies and procedures to identify, measure and monitor each of the risks
involved in its trading, brokerage and investment banking activities on a global
basis. The principal risks of Lehman Brothers are market, credit, liquidity,
legal and operational risks. Risk Management is considered to be of paramount
importance in the Company's day-to-day operations. Consequently, the Company
devotes significant resources (including investment in personnel and technology)
across all of its worldwide trading operations to the measurement, management
and analysis of risk.

The Company seeks to reduce risk through the diversification of its businesses,
counterparties and activities in geographic regions. The Company accomplishes
this objective by allocating the usage of capital to each of its businesses,
establishing trading limits for individual products and traders, and setting
credit limits for individual counterparties, including regional concentrations.
The Company seeks to achieve adequate returns from each of its businesses
commensurate with the risks that they assume. Nonetheless, the effectiveness of
the Company's policies and procedures for managing risk exposure can never be
completely or accurately predicted or fully assured. For example, unexpectedly
large or rapid movements or disruptions in one or more markets or other
unforeseen developments can have an adverse effect on the Company's results of
operations and financial condition. The consequences of these developments can
include losses due to adverse changes in inventory values, decreases in the
liquidity of trading positions, higher volatility in the Company's earnings,
increases in the Company's credit exposure to customers and counterparties and
increase in general systemic risk.

Overall risk management policy is established at the Office of the Chairman
level. The Capital Markets Committee is chaired by the CEO and consists of the
members of the Company's Executive Committee (including the Co-Chief Operating
Officers, the Global Head of Risk, the CFO, the CEO of Europe and Asia and the
heads of the Company's business units) as well as certain members of the
Company's research team. It serves to frame the Company's risk opinion in the
context of the global market environment.

The Capital Markets Risk Committee is chaired by the Global Head of Risk, who is
a member of the Office of the Chairman, and consists of the Heads of the Fixed
Income and Equity Divisions, the Global Head of Credit Risk, the Global Head of
Market Risk and the Controller. The committee meets twice a week and reviews all
risk exposures, position concentrations and risk taking activities.

38

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

The Global Risk Management Group (the "Group") remains independent of the
trading areas and reports directly into the Office of the Chairman to the Global
Head of Risk. The Group combines two departments, credit risk management and
market risk management, into one unit. This combination facilitates the analysis
of counterparty credit and market risk exposures, while leveraging personnel and
information technology resources in a cost-efficient manner. The Group maintains
staff in each of the Company's regional trading centers and has daily contact
with trading staff at all levels within the Company. These discussions include a
review of trading positions and risk exposures.

CREDIT RISK Credit risk represents the possibility that a counterparty will be
unable to honor its contractual obligations to the Company. Credit risk
management is therefore an integral component of the Company's overall risk
management framework. The Credit Risk Management Department ("CRM Department")
has global responsibility for implementing the Company's overall credit risk
management framework.

The CRM Department manages the credit exposure related to trading activities by
giving initial credit approval for counterparties, establishing credit limits by
counterparty, country and industry group, and by requiring collateral in
appropriate circumstances. In addition, the CRM Department strives to ensure
that master netting agreements are obtained whenever possible. The CRM
Department also considers the duration of transactions in making its credit
decisions, along with the potential credit exposure for complex derivative
transactions. The CRM Department is responsible for the continuous monitoring
and review of counterparty credit exposure and creditworthiness and recommending
valuation adjustments, where appropriate. Credit limits are reviewed
periodically to ensure that they remain appropriate in light of market events or
the counterparty's financial condition.

MARKET RISK Market risk represents the potential change in value of a portfolio
of financial instruments due to changes in market rates, prices and
volatilities. Market risk management also is an essential component of the
Company's overall risk management framework. The Market Risk Management
Department ("MRM Department") has global responsibility for implementing the
Company's overall market risk management framework. It is responsible for the
preparation and dissemination of risk reports, developing and implementing the
firmwide Risk Management Guidelines, and evaluating adherence to these
guidelines. These guidelines provide a clear framework for risk management
decision-making. To that end, the MRM Department identifies and quantifies risk
exposures, develops limits, and reports and monitors these risks with respect to
the approved limits. The identification of material market risks inherent in
positions includes, but is not limited to, interest rate, equity and foreign
exchange risk exposures. In addition to these risks, the MRM Department also
evaluates liquidity risks, credit and sovereign concentrations.

The MRM Department utilizes qualitative as well as quantitative information in
managing trading risk, believing that a combination of the two approaches
results in a more robust and complete approach to the management of trading
risk. Quantitative information is developed from a variety of risk methodologies
based upon established statistical principles. To ensure high standards of
qualitative analysis, the MRM Department has retained seasoned risk managers
with the requisite experience and academic and professional credentials.

Market risk is present in cash products, derivatives, and contingent claim
structures that exhibit linear as well as non-linear profit and loss
sensitivity. The Company's exposure to market risk varies in accordance with the
volume of client-driven market-making transactions, the size of the Company's
proprietary and arbitrage positions, and the volatility of financial instruments
traded. The Company seeks

39

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

to mitigate, whenever possible, excess market risk exposures through the use of
futures and option contracts and offsetting cash market instruments.

The Company participates globally in interest rate, equity and foreign exchange
markets. The Company's Fixed Income division has a broadly diversified market
presence in U.S. and foreign government bond trading, emerging market
securities, corporate debt (investment and non-investment grade), money market
instruments, mortgages and mortgage-backed securities, asset-backed securities,
municipal bonds, and interest rate derivatives. The Company's Equities division
facilitates domestic and foreign trading in equity instruments, indices and
related derivatives. The Company's foreign exchange businesses are involved in
trading currencies on a spot and forward basis as well as through derivative
products and contracts.

The Company incurs short-term interest rate risk when facilitating the orderly
flow of customer transactions through the maintenance of government and
high-grade corporate bond inventories. Market-making in high yield instruments
exposes the Company to additional risk due to potential variations in credit
spreads. Trading in international markets exposes the Company to spread risk
between the term structure of interest rates in differing countries. Mortgages
and mortgage-related securities are subject to prepayment risk and changes in
the level of interest rates. Trading in derivatives and structured products
exposes the Company to changes in the level and volatility of interest rates.
The Company actively manages interest rate risk through the use of interest rate
futures, options, swaps, forwards and offsetting cash market instruments.
Inventory holdings, concentrations and agings are monitored closely and used by
management to selectively hedge or liquidate undesirable exposures.

The Company is a significant intermediary in the global equity markets through
its market-making in U.S. and non-U.S. equity securities, including common
stock, convertible debt, exchange-traded and OTC equity options, equity swaps
and warrants. These activities expose the Company to market risk as a result of
price and volatility changes in its equity inventory. Inventory holdings are
also subject to market risk resulting from concentrations and liquidity that may
adversely impact market valuation. Equity market risk is actively managed
through the use of index futures, exchange-traded and OTC options, swaps and
cash instruments.

The Company enters into foreign exchange transactions in order to facilitate the
purchase and sale of non-dollar instruments, including equity and interest rate
securities. The Company is exposed to foreign exchange risk on its holdings of
non-dollar assets and liabilities. The Company is active in many foreign
exchange markets and has exposure to the euro, Japanese yen, British pound,
Swiss franc, and Canadian dollar, as well as a variety of developed and emerging
market currencies. The Company hedges its risk exposures primarily through the
use of currency forwards, swaps, futures and options.

If any of the strategies utilized to hedge or otherwise mitigate exposures to
the various types of risks described above are not effective, the Company could
incur losses.

VALUE-AT-RISK For purposes of Securities and Exchange Commission ("SEC") risk
disclosure requirements, the Company discloses an entity-wide value-at-risk for
virtually all of its trading activities. In general, value-at-risk measures the
potential loss of revenues at a given confidence level over a specified time
horizon. Value-at-risk over a one-day holding period measured at a 95%
confidence level implies that potential loss of daily trading revenue will be at
least as large as the value-at-risk amount on one out of every 20 trading days.

40

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

The Company's methodology estimates a reporting day value-at-risk using actual
daily trading revenues over the previous 250 trading days. This estimate is
measured as the loss, relative to the median daily trading revenue. The
following table sets forth the daily value-at-risk for each component of market
risk as well as total value-at-risk:

Value-at-risk is one measurement of potential loss in trading revenues that may
result from adverse market movements over a specified period of time with a
selected likelihood of occurrence. As with all measures of value-at-risk, the
Company's estimate has substantial limitations due to its reliance on historical
performance, which is not necessarily a predictor of the future. Consequently,
this value-at-risk estimate is only one of a number of tools the Company
utilizes in its daily risk management activities.

TRADING NET REVENUES DISTRIBUTION Substantially all of the Company's inventory
positions are marked-to-market on a daily basis and changes are recorded in net
revenues. The following chart sets forth the frequency distribution for
substantially all of the Company's trading net revenues on a weekly basis for
the three months ended May 31, 2002:

[Graphic omitted--bar graph showing: ]

Weekly trading net revenues:

Less than $0 0 weeks
$ 0-50 million 2 weeks
$ 50-100 million 2 weeks
$100-150 million 7 weeks
$150-200 million 2 weeks
$200+ million 0 weeks

As discussed throughout Management's Discussion and Analysis, the Company seeks
to reduce risk through the diversification of its businesses and a focus on
customer flow activities. This diversification and focus, combined with the
Company's risk management controls and processes, helps mitigate the net revenue
volatility inherent in the Company's trading activities. Although historical
performance is not necessarily indicative of future performance, the Company
believes its focus on business diversification and customer flow activities
should continue to help mitigate the volatility of future net trading revenues.

41

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

SIGNIFICANT ACCOUNTING POLICIES

The Company's financial statements are prepared in conformity with generally
accepted accounting principles, many of which require the use of management
estimates and assumptions. Management believes that the estimates utilized in
preparing its financial statements are reasonable and prudent. Actual results
could differ from these estimates.

FAIR VALUE The Company records its inventory positions, including Securities and
Other Financial Instruments Owned and Securities Sold but not yet Purchased, at
fair value, with unrealized gains and losses reflected in Principal Transactions
in the Consolidated Statement of Income. Market value is generally based on
listed prices. If listed market prices are not available, or if liquidating the
Company's position is reasonably expected to affect market prices, fair value is
determined based on either internal valuation pricing models, which take into
account time value and volatility factors underlying the financial instruments,
or management's estimate of the amounts that could be realized under current
market conditions, assuming an orderly liquidation over a reasonable period of
time. The determination of fair value is fundamental to the Company's financial
condition and results of operations and, in certain circumstances, it requires
the use of complex judgments. The use of different pricing models or assumptions
could produce different estimates of fair value.

TRANSFERS OF FINANCIAL ASSETS The Company accounts for transfers of financial
assets in accordance with Statement of Financial Accounting Standards No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities--a replacement of FASB No. 125". In accordance with this guidance
the Company recognizes transfers of financial assets as sales provided that
control has been relinquished. Control is deemed to be relinquished only when
all of the following conditions have been met: (i) the assets have been isolated
from the transferor, even in bankruptcy or other receivership (true sale
opinions are required), (ii) the transferee has the right to pledge or exchange
the assets received and (iii) the transferor has not maintained effective
control over the transferred assets (e.g. a unilateral ability to repurchase a
unique or specific asset). The Company is a market leader in mortgage- and
asset-backed securitizations and other structured financing arrangements. In
connection with these activities, the Company utilizes special purposes entities
principally for (but not limited to) the securitization of commercial and
residential mortgages, home equity loans, government and corporate bonds, and
lease and trade receivables. The Company derecognizes financial assets
transferred in securitizations provided that the Company has relinquished
control over such assets.

The Company may retain an interest in the financial assets it securitizes
("Retained Interests"), which may include assets in the form of residual
interests in the special purpose entities established to facilitate the
securitization. Any Retained Interests are included in Securities and Other
Financial Instruments Owned (principally Mortgages and mortgage-backed) within
the Company's Consolidated Statement of Financial Condition. The Company records
its Securities and Other Financial Instruments Owned, including Retained
Interests, at fair value, with changes in fair value reported in earnings.

For additional information on the Company's significant accounting policies see
Note 1 to the Consolidated Financial Statements (Summary of Significant
Accounting Policies) incorporated by reference in the Form 10-K.

42

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information under the caption "Item 2, Management's Discussion and Analysis
of Financial Condition and Results of Operations--Risk Management" above in this
Report is incorporated herein by reference.

43

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is involved in a number of judicial, regulatory and arbitration
proceedings concerning matters arising in connection with the conduct of its
business. Such proceedings include actions brought against the Company and
others with respect to transactions in which the Company acted as an underwriter
or financial advisor, actions arising out of the Company's activities as a
broker or dealer in securities and commodities and actions brought on behalf of
various classes of claimants against many securities and commodities firms,
including the Company.

Although there can be no assurance as to the ultimate outcome, the Company
generally has denied, or believes it has a meritorious defense and will deny,
liability in all significant cases pending against it including the matters
described below, and it intends to defend vigorously each such case. Based on
information currently available, advice of counsel, available insurance coverage
and established reserves, the Company believes that the eventual outcome of the
actions against it, including the matters described below, will not, in the
aggregate, have a material adverse effect on the consolidated financial position
or cash flows of the Company but may be material to the Company's operating
results for any particular period, depending on the level of the Company's
income for such period.

LEHMAN BROTHERS COMMERCIAL CORPORATION AND LEHMAN BROTHERS SPECIAL
FINANCING INC. V. MINMETALS INTERNATIONAL NON-FERROUS METALS TRADING
COMPANY (reported in Holdings' 2001 Annual Report on Form 10-K)

In June 2002, the parties entered into an agreement to settle all claims.

ACTIONS REGARDING FRANK GRUTTADAURIA (reported in Holdings' 2001 Annual Report
on Form 10-K and Quarterly Report on Form 10-Q for the quarter ended
February 28, 2002)

To date, the following cases have been filed against Lehman Brothers and SG
Cowen Securities Corporation: seven cases in the United States District Court
for the Northern District of Ohio, four cases in the United States District
Court for the Northern District of Illinois, one case in the United States
District Court for the Southern District of California and one case in Wisconsin
Circuit Court, Milwaukee County. Two arbitrations have been filed before the New
York Stock Exchange ("NYSE"). Generally speaking, the complaints, amended
complaints and statements of claim allege violations of federal securities laws,
violations of state and Blue Sky laws, civil conspiracy, and common law claims
for fraud, promissory estoppel, negligent and reckless failure to supervise and
breach of fiduciary duty. On the whole, plaintiffs seek compensatory and
punitive damages, pre- and post-judgment interest, attorneys fees and costs, an
accounting, and in some instances, treble damages. With the exception of one
case, each case pending in federal court is or will be subject to a motion to
compel arbitration based on plaintiffs' contractual agreement to arbitrate their
claims against defendants. One of the NYSE arbitrations has been set for a
December 2002 hearing.

LBI has received, and is responding to, requests for information, documents
and/or testimony from the NYSE, the SEC, the Division of Securities of the
Department of Commerce of the State of Ohio and the House of Representatives
Committee on Financial Services, Subcommittee on Oversight and Investigations,
in connection with the Gruttadauria matter.

44

FIRST ALLIANCE MORTGAGE COMPANY MATTERS

During 1999 and the first quarter of 2000, Lehman Commercial Paper, Inc.
("LCPI") provided a warehouse line of credit to First Alliance Mortgage Company
("FAMCO"), and LBI underwrote securitizations of mortgages originated by FAMCO.
In March 2000, FAMCO filed for protection from its creditors under Chapter 11 of
the United States Bankruptcy Code. In August 2001, a purported adversary class
action was filed in the United States Bankruptcy Court for the Central District
of California (the "Bankruptcy Court"), allegedly on behalf of a class of FAMCO
borrowers seeking equitable subordination of LPCI's (among other creditors')
liens and claims in the Bankruptcy Court. In October, 2001, the complaint was
amended by adding LBI as a defendant and adding claims for aiding and abetting
alleged fraudulent lending activities by FAMCO and for unfair competition under
the California Business and Professions Code. In addition to equitable
subordination, the complaint seeks actual damages, the imposition of a
constructive trust on all proceeds paid or being paid by FAMCO to LCPI and LBI,
disgorgement of profits, and attorneys' fees and costs.

In November, 2001, the Official Joint Borrowers Committee (the "Committee")
initiated an adversary proceeding, allegedly on behalf of the FAMCO-related
debtors, in the Bankruptcy Court by filing a complaint against LCPI, LBI,
Holdings and several individual officers and directors of FAMCO and its
affiliates. As to the Lehman Brothers defendants, the Committee asserted
bankruptcy claims for avoidance of lien, recovery of property, equitable
subordination, and disallowance of claim and also asserted claims for
declaratory relief and aiding and abetting breach of fiduciary duty. In
December, 2001, the Committee amended its complaint, dropping Holdings as a
defendant and adding claims for equitable indemnification and contribution. In
addition to relief under the Bankruptcy Code, the Committee seeks unspecified
compensatory and punitive damages as well as attorneys' fees and costs.

These two actions have been transferred to the United States District Court for
the Central District of California and have been consolidated. A January 2003
trial date has been set.

Separately, LBI is in discussions with the Attorney General's office in Florida
about that office's investigation of LBI regarding LBI's role in connection with
First Alliance.

45

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES

PART II - OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the annual meeting of stockholders of Holdings held on April 9, 2002, the
following matters were submitted to a vote of security holders:

A) A proposal was submitted for the election of all Class I Directors. The
results for the nominees were: Michael L. Ainslie - 210,513,222 votes
for, 2,417,243 votes withheld; John F. Akers -210,668,315 votes for,
2,262,150 votes withheld; and Richard S. Fuld, Jr. - 210,860,357 votes
for, 2,070,108 votes withheld. Messrs. Ainslie, Akers and Fuld were
elected to serve until the Annual Meeting in 2005 and until a successor
is elected and qualified.

B) A proposal was submitted for the ratification of the Company's selection
of Ernst & Young LLP as the Company's independent auditors for the 2002
fiscal year. The results were 206,921,246 votes for 4,950,277 against and
1,058,942 abstaining, and the proposal was adopted.

46

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES

PART II - OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS:

The following exhibits are filed as part of this Quarterly Report or, where
indicated, were heretofore filed and are hereby incorporated by reference:

3.01 Restated Certificate of Incorporation of the Registrant dated May
27, 1994 (INCORPORATED BY REFERENCE TO EXHIBIT 3.1 TO THE
REGISTRANT'S TRANSITION REPORT ON FORM 10-K FOR THE ELEVEN MONTHS
ENDED NOVEMBER 30, 1994)

3.02 Certificate of Designations with respect to the Registrant's 5.94%
Cumulative Preferred Stock, Series C (INCORPORATED BY REFERENCE TO
EXHIBIT 4.1 TO THE REGISTRANT'S CURRENT REPORT ON FORM 8-K FILED
WITH THE COMMISSION ON MAY 13, 1998)

3.03 Certificate of Designations with respect to the Registrant's 5.67%
Cumulative Preferred Stock, Series D (INCORPORATED BY REFERENCE TO
EXHIBIT 4.2 TO THE REGISTRANT'S CURRENT REPORT ON FORM 8-K FILED
WITH THE COMMISSION ON JULY 23, 1998)

3.04 Certificate of Designations with respect to the Registrant's
Fixed/Adjustable Rate Cumulative Preferred Stock, Series E
(INCORPORATED BY REFERENCE TO EXHIBIT 4.2 TO THE REGISTRANT'S
CURRENT REPORT ON FORM 8-K FILED WITH THE COMMISSION ON MARCH 30,
2000)

3.05 Certificate of Amendment of the Restated Certificate of
Incorporation of the Registrant, dated April 9, 2001 (INCORPORATED
BY REFERENCE TO EXHIBIT 3.5 TO THE REGISTRANT'S QUARTERLY REPORT
ON FORM 10-Q FOR THE QUARTER ENDED MAY 31, 2001)

3.06 By-Laws of the Registrant, amended as of March 26, 1997
(INCORPORATED BY REFERENCE TO EXHIBIT 3 TO THE REGISTRANT'S
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED FEBRUARY 28,
1997)

11.01 Computation of Per Share Earnings (OMITTED IN ACCORDANCE WITH
SECTION (B)(11) OF ITEM 601 OF REGULATION S-K; THE CALCULATION OF
PER SHARE EARNINGS IS SET FORTH IN PART I, ITEM 1, IN NOTE 11 TO
THE CONSOLIDATED FINANCIAL STATEMENTS (EARNINGS PER COMMON SHARE))

12.01 Computation of Ratios of Earnings to Fixed Charges and to Combined
Fixed Charges and Preferred Stock Dividends (FILED HEREWITH)

47

LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES

PART II - OTHER INFORMATION

(B) REPORTS ON FORM 8-K:

The following reports on Form 8-K were filed during the quarter for which
this Quarterly Report is filed:

1. Form 8-K dated May 9, 2002, Items 5 and 7.

2. Form 8-K dated April 30, 2002, Item 7.

3. Form 8-K dated March 26, 2002, Item 7.

4. Form 8-K dated March 20, 2002, Items 5 and 7.

Financial Statements:

Exhibit 99.2 Selected Statistical Information
(Preliminary and Unaudited)

Exhibit 99.3 Consolidated Statement of Income

(Three Months Ended February 28, 2002 and 2001)
(Preliminary and Unaudited)

Exhibit 99.4 Segment Net Revenue Information
(Three Months Ended February 28, 2002 and 2001)
(Preliminary and Unaudited)

48

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.

LEHMAN BROTHERS HOLDINGS INC.
(Registrant)

Date: July 15, 2002 By: /s/ DAVID GOLDFARB
-------------------------------------------
Chief Financial Officer
(principal financial and accounting officer)

49

EXHIBIT INDEX

EXHIBIT NO. EXHIBIT

Exhibit 12.01 Computation of Ratios of Earnings to Fixed Charges and to
Combined Fixed Charges and Preferred Stock Dividends

50