Corporate Counsel magazine has pored over hundreds of court documents, transcripts, e-mails and other documents pertaining to the various investigations of the merger between Bank of America Corp. and Merrill Lynch & Co. on Jan. 1. The full story will appear both in the November issue of the magazine, and here on CorpCounsel.com. In advance of that release, we're publishing one of our key findings:
Some members of Congress and others have accused federal regulators of pressuring Bank of America into going through with its merger with Merrill Lynch. But records suggest it was the bank, not regulators, doing the bullying.
In October and November, Merrill's losses were skyrocketing beyond anyone's expectations. A clause in the merger agreement allowed for one party to cancel if there had been a "material adverse change" -- a so-called MAC clause that is common in merger deals.
Exactly when and how the bank considered the MAC are revealed in transcripts of depositions taken by the office of New York Attorney General Andrew Cuomo. Chief Financial Officer Joseph Price testified that because of Merrill's spiraling losses, he and a bank vice chairman sought legal advice from general counsel Tim Mayopoulos about invoking the MAC on Dec. 1 -- four days before the shareholder vote to approve the merger. This conflicts with the bank's previous statements that it didn't know about the losses before the vote.
Mayopoulos testified about the Dec. 1 meeting:
Question: Did you give advice about whether there was a MAC clause or not?
Mayopoulos: Did I give advice about whether I thought there was a material adverse effect or not?
Mayopoulos was precluded from answering exactly what he advised because of attorney-client privilege. Jeffrey Litle, a partner at Jones Day in Columbus, Ohio, has been lead lawyer in dozens of national and international mergers and advises corporations on MAC clauses. Litle explains that a material adverse effect occurs when a change would cause a disproportionately adverse impact on the financial condition or operations of a business as compared to other companies in the same industry.
Because Bank of America is a Jones Day client, Litle can't comment on the specifics of the merger deal. But in general he adds, "If a transaction is large enough to be reported, then the fact that a buyer has shown real doubts about closing the deal, in most cases, that becomes a material fact that shareholders and investors will want to know about."
In fact, MAC clauses seldom get invoked or end up in court, Litle says. More often they are used as "leverage" to force the seller into renegotiating a lower price. But that renegotiation has to occur before a shareholder vote, he adds.
The record shows that Bank of America decided not to disclose to shareholders its consideration of a MAC before the Dec. 5 vote. It also apparently decided not to use the MAC as leverage against Merrill to lower its price before the vote, even though the bank had agreed to pay a premium -- $29 per share for Merrill stock that was selling at $17. It might have, but didn't, use the MAC to force Merrill to drop its multibillion-dollar bonus pool.
Instead, the bank waited until after the shareholders approved the merger -- but before the deal closed on Jan. 1 -- and used the MAC to muscle the federal government and U.S. taxpayers into ponying up more bailout funds. At the time, the bank did not disclose the role of federal regulators in not invoking the MAC, and in promising the bank another $20 billion of taxpayer money in 2009 to complete the deal. (The bank had already received $25 billion in bailout funds in 2008.)
Some observers and politicians have accused federal banking officials of forcing Bank of America CEO Kenneth Lewis into completing the merger. But the documents suggest it was Lewis doing the bullying, relying on a highly vulnerable marketplace to win his way.
According to testimony from both Lewis and then-Treasury Secretary Henry Paulson, Lewis called Paulson on the morning of Dec. 17 to say he had just learned about "surprising" Merrill losses for the fourth quarter. Lewis testified: "I told him that we were strongly considering the MAC and thought we actually had one."
Paulson was stunned. He would later say that "the magnitude of the losses was breathtaking ... so far above expectations." He testified, "I recognized the danger" that the MAC posed for both companies, as well as for the stability of the entire U.S. economy. He told Lewis it could lead to global "financial chaos."
Lewis flew to Washington that evening to meet with Paulson and Federal Reserve chief Ben Bernanke, and he promised to hold off on invoking the MAC until they could talk again. Pressed by Lewis, Paulson promised to pursue the possibility of more bailout funds for the bank to cover Merrill's losses.
E-mails and other documents from lawyers and advisers at the Federal Reserve and U.S. Treasury show that the feds thought Lewis certainly knew about the losses much earlier than he claimed. And they were skeptical of his threat to invoke the MAC.
The escape clause was written in vague terms, and the government's lawyers didn't think it could be successfully exercised. Still, if Lewis raised the claim publicly, "it would likely cause the demise of Merrill Lynch" and significantly damage Bank of America and the country's fragile financial system, they concluded.
On Dec. 21, Bernanke e-mailed colleagues at the Fed, saying he thought Lewis' "threat to use the MAC is a bargaining chip, and we do not see it as a very likely scenario at all." On the same day, Lewis called Paulson during his ski vacation in Colorado. Paulson bluntly told him that the dangers to the economy were too high, and the government would remove the board and management of the bank if Lewis tried to use the MAC.
To make sure Lewis stayed the course, the next day Bernanke -- despite his misgivings about being manipulated by the CEO -- cut a secret deal with him. According to an e-mail from Bernanke to Fed lawyers, Lewis agreed to drop the MAC threat, and Bernanke agreed to work with Lewis on "a support package" in time for the bank's January earnings statement.
On Jan. 16, the bank released its fourth quarter earnings statement. Its press release finally disclosed Merrill's 2008 fourth quarter loss reached $15.3 billion. On the news, bank shares plunged. The bank also revealed the Bernanke "support package" -- the government would invest another $20 billion in bailout funds and would provide further protection against losses on some $118 billion in toxic assets.