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When Paulson called later that week to encourage Fuld to consider raising capital, he was

gratified to learn that Lehman was already working on it, and by April 1 the bank had

raised $4 billion in convertible preferred shares. On April 12, at a G7 dinner in

Washington, D.C., Paulson took Fuld aside. "I congratulated him on his capital raise,"

Paulson says. "I encouraged him to do more." Paulson was trying to use positive

reinforcement to get Fuld to be even more cautious and even consider selling the firm,

but that's not what Fuld heard. Later that night, he e-mailed Tom Russo the following

memo:

Just finished the Paulson dinner.

A few takeaways//

1. we have huge brand with treasury

2. loved our capital raise

3. really appreciate u +Rieders work on ideas

4. they want to kill the bad HFnds + heavily regulate the rest

5. they want all the G7 countries to embrace

Mtm stnds

Cap stnds

Lev + liquidty stnds

6-HP has a worried ed view of ML [Merrill Lynch]

All in all worthwhile.

Dick

No doubt emboldened by her home-run earnings call, Callan began appearing more often

on television--particularly on the business channel CNBC--to brag about Lehman's huge

brand and its many successes. There was a personal benefit to this as well: She told

colleagues that a former high school friend, now a fireman, had contacted her after seeing

her on the network, and they were dating.

On April 1, as Fuld dealt with Paulson, Callan was talking to longtime CNBC anchor

Maria Bartiromo about the capital raise. She hedged expectations ("pretty solid results,

[but] not on an absolute basis") and kept with her line about transparency: "We' re happy

to open the kimono and let everyone see the story." It was another articulate, confident

performance.

"As you know, Maria, we' re in a market where perception trumps reality," she said.

That would not be the case for much longer, thanks to the 40-year-old hedge fund

manager David Einhorn.

Einhorn hadn't applauded when he'd heard Callan's earnings announcement. He

increasingly suspected the firm had been resorting to accounting fraud to juice its

earnings, and he said as much in various investor conferences. He even said he believed

that the Securities and Exchange Commission (SEC) was letting it slide to avert a bigger

crisis. (Einhorn had been badly burned by the foreclosure crisis as a major shareholder

and director of the subprime mortgage behemoth New Century Financial, which had gone

bankrupt almost overnight in 2007.)

Einhorn figured the only way Lehman could be reporting profits was if it was vastly--and

illegally--overvaluing those assets. And he had some convincing evidence: a $1.1 billion

discrepancy between the results posted in Callan's March earnings call--in which she said

the bank had written down the value of its Level 3 assets to the tune of $875 million--and

those in the quarterly report filed with the SEC a few weeks later, which claimed the

bank's Level 3 assets had actually risen in value.

He asked Callan to call him--via e-mail. And, against the advice of the executive

committee, who felt Einhorn was best ignored, she did. On the call, Einhorn challenged

Callan to explain how the firm had come to write up its assets during a period when

everything, from equities to fixed income to real estate and private equity, had lost value.

He reportedly asked Callan about the rejiggering of the Level 3 assets, and how the firm

could justify its minuscule $200 million write-down on a $6.5 billion pool of

collateralized debt obligations (CDOs), when the value had plainly collapsed in the past

few months.

Einhorn claimed not to have gotten a single straight answer from Callan, but the phone

call gave him plenty of material for his next public anti-Lehman diatribe--at the Ira W.

Sohn Investment Research Conference on May 21st.

Among other things, he said: "Now, given my experience with . . . the SEC, I have no

expectation that Lehman will be sanctioned in any