Southern District of New York Judge Jed S. Rakoff on Monday rejected the proposed $33 million settlement between the Securities and Exchange Commission and Bank of America stemming from the bank's takeover of Merrill Lynch & Co.
The SEC had gone after Bank of America for an allegedly false proxy statement because it failed to disclose that the bank had agreed to allow Merrill to pay up to $5.8 billion in employee bonuses in advance of Bank of America's $50 billion December 2008 takeover of Merrill Lynch.
The SEC filed suit and announced a settlement on the same day, Aug. 3, 2009, but Judge Rakoff refused to accept the pre-packaged consent order and held an Aug. 10 hearing on the matter. He then asked the parties additional questions about the settlement that troubled him and received subsequent submissions on Aug. 24 and Sept. 9.
In rejecting the settlement Monday in a 12-page order in Securities and Exchange Commission v. Bank of America Corp., 09 Civ. 6829, the judge said, "Overall, indeed, the parties' submissions, when carefully read, leave the distinct impression that the proposed Consent Judgment was a contrivance designed to provide the SEC with the façade of enforcement and the management of the Bank with a quick resolution of an embarrassing inquiry -- all at the expense of the sole alleged victims, the shareholders."
Rakoff examined closely the settlement, which turned on Bank of America's Nov. 3, 2008, proxy statement to shareholders urging their approval of the bank's $50 billion acquisition of Merrill Lynch.
Bank of America, the SEC alleged in its complaint, "represented that Merrill had agreed not to pay year-end performance bonuses or other discretionary incentive compensation to its executives prior to the closing of the merger without the Bank of America's consent" when, in fact, the bank had agreed to the bonus payments.
In his opinion, the judge noted he was obligated to give "considerable deference" to the parties' settlement proposal.
But, he said, when a "federal agency such as the SEC seeks to prospectively invoke the Court's own contempt power by having the court impose injunctive prohibitions against the defendant, the resolution has aspects of a judicial decree and the Court is therefore obligated to review the proposal a little more closely, to ascertain whether it is within the bounds of fairness, reasonableness, and adequacy -- and, in some certain circumstances, whether it serves the public interest."
Rakoff said the consent judgment "is neither fair, nor reasonable, nor adequate."
In his opinion, the judge took the SEC to task for admitting the $33 million would be indirectly borne by the shareholders, while nonetheless arguing that the payment would increase shareholder scrutiny and management accountability.
"[T]he notion that Bank of America shareholders, having been lied to blatantly in connection with the multi-billion-dollar purchase of a huge, nearly bankrupt company, need to lose another $33 million of their money in order to 'better assess the quality and performance of management' is absurd," he said.
QUESTION OF ACCOUNTABILITY
The SEC's next argument -- that it normally goes after individual executives but it could not in this case because those executives relied on lawyers who drafted the documents at issue -- also failed to convince the judge.
"But if that is the case, why are the penalties not then sought from the lawyers?" the judge asked. "And why, in any event, does that justify imposing penalties on the victims of the lie, the shareholders?"
Wachtell Lipton Rosen & Katz represented the Bank of America in the merger; Shearman & Sterling was counsel for Merrill.
Bank of America claimed the proxy statement was not misleading, but the judge clearly rejected its defense that shareholders were exposed to several press reports about the bonuses in the weeks leading up to the vote.
The judge said he never got the answers he wanted on just how, exactly, the proxy statement was prepared and "who made the relevant decisions as to what to include and not include as far as the Merrill bonuses were concerned."
Rakoff said, "If the Bank is innocent of lying to its shareholders, why is it prepared to pay $33 million of its shareholders' money as a penalty for lying to them?"
He said accepting the judgment "would effectively close the case without the S.E.C. adequately accounting for why, in contravention of its own policy ... it did not pursue charges against either bank management or the lawyers who allegedly were responsible for the false and misleading proxy statements."
The SEC claimed it was limited by the fact that Bank of America refused to waive the attorney-client privilege. But the bank said it did not rely on the defense of advice of counsel and so there had been no waiver.
However, Judge Rakoff said it "appears that the S.E.C. never seriously pursued" whether there was a waiver "let alone whether it fit within the crime/fraud exception to the privilege."
It also bothered the judge that the government said culpable intent was lacking because the executives were acting on advice of counsel.
"But, if so, then how can the lawyers be said to lack intent?" he said.
In the end, the judge said the proposed consent judgment "suggests a rather cynical relationship between the parties: the S.E.C. gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger; the Bank's management gets to claim that they have been coerced into an onerous settlement by overzealous regulators.
"And all this is done at the expense, not only of the shareholders, but of the truth," he said.
The judge added, "Yet, the truth shall still emerge," and he set a trial date for Feb. 1, 2010.
Lewis J. Liman of Cleary Gottlieb Steen & Hamilton represented Bank of America. The SEC was led by Associate Regional Director David Rosenfeld.
John C. Coffee Jr., a securities expert and professor at Columbia Law School, said Rakoff "has really taken the SEC to task for a kind of fraudulent deterrence."
"More broadly this is a fairly blistering, devastating portrait of attempts by the SEC to buy deterrence on the cheap that I think lets corporate executives purchase immunity with their shareholders' money while letting the SEC proclaim itself the noble victor in a glorious contest," said Coffee, a New York Law Journal columnist.
Now, he said, the agency can either go to trial, suffer the embarrassment of dropping the charges, or appeal, which "would only further embarrassment" to the SEC.
ATTORNEY GENERAL PROBE
The fight over the SEC's civil enforcement action is running parallel to an attempt by Attorney General Andrew Cuomo to investigate the circumstances surrounding the acquisition of Merrill Lynch. Last week, Liman responded to a letter from David Markowitz, chief of the attorney general's Investor Protection Unit, in which Markowitz said Bank of America was stonewalling the probe.
Markowitz had said in his letter, "We cannot simply accept Bank of America's officers' naked assertions that they sought and relied on advice of counsel in good faith, and that, therefore, they should not be charged."
Liman wrote back to reject Markowitz's "spurious and false allegations." He also insisted that the bank's legal team has "repeatedly" sought to meet with the attorney general but had been denied, saying, "Because Bank of America did not violate the law, it has not offered reliance on legal advice as a defense."