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Ken Lewis doesn't like lawyers. He especially doesn't seem to like Tim Mayopoulos, his former general counsel at Bank of America Corporation, according to insiders.

But not liking lawyers and not listening to them are two different things. And that raised some key questions for Lewis and the Charlotte-based bank. Such as: In the tumultuous weeks leading up to the bank's acquisition of Merrill Lynch & Co., Inc., a year ago, what did Mayopoulos and the bank's outside lawyers advise? And did Lewis listen?

Whether or not Lewis, who will step down December 31, took his lawyers' advice is now at the heart of hearings before Congress, and investigations by the Securities and Exchange Commission, the U.S.

Department of Justice, and the attorneys general of New York and North Carolina. For one thing, the investigators want to know why Lewis was acting on certain information behind the scenes, while not disclosing that information to shareholders. About two dozen shareholder suits are looking at the same thing.

For example, Lewis said that the bank didn't know about Merrill's $5.8 billion year-end bonus pool before the shareholder vote, but it did. Then he said that the bank didn't know about Merrill's accelerating losses before the shareholder vote, but it did. As one in-house lawyer close to the deal put it: "His public statements show that he needs a strong general counsel, because most of us would not let our executives say things that are demonstrably, provably false. This guy really needs to take some legal advice before he speaks."

But there's more. Corporate Counsel 's review of documents and e-mails in those hectic weeks before the merger closed shows not only that Lewis knew about the losses, but that he used this private knowledge to play a high-stakes game of chicken with the federal government. He told the feds that he was considering pulling out of the Merrill deal completely. Everyone knew that meant Merrill couldn't survive on its own—and its demise could have been catastrophic to the world's fragile financial system at that time.

In September 2008 the world's markets panicked after Lehman Brothers Inc. went into bankruptcy. So Lewis's suggestion in December that he'd walk away from the Merrill deal and let it fold amounted to a nuclear threat. Little wonder that the feds flinched. They secretly promised Lewis more bailout money and other support if he went through with the deal.

Apart from the drama, the Bank of America standoff shows how core concepts of corporate governance—disclosure and transparency—can be compromised in high-stakes situations. And it stands as a cautionary tale to all corporate counsel. During those critical days in December, Mayopoulos, now general counsel at Fannie Mae in Washington, D.C., was ousted from the bank, without notice and without explanation.

At the same time, the bank dismissed deputy general counsel David Onorato, chief of litigation and securities inquiries. (Onorato, now a partner with Freshfields Bruckhaus Deringer in New York, and Mayopoulos both declined to comment.) Even though Lewis had Merrill's veteran general counsel, Rosemary Berkery, in the wings, he ignored her, and she quickly left just before Christmas. Eventually, Lewis named deputy general counsel Edward O'Keefe [see "Does He Have the Toughest GC Job in America?" ] as the new general counsel for the country's largest bank, with $2.3 trillion in assets and 6,100 branches.

What transpired between Lewis and his in-house lawyers may never be fully revealed. Bank spokesman Scott Silvestri insists that the departures weren't related to the merger. Silvestri also says the terminations weren't performance-related. Then what were they? We may never know, because Lewis is clinging to attorney-client confidentiality. But a federal judge, New York attorney general Andrew Cuomo, and the head of at least one congressional panel are pressuring to pierce that privilege.

Legal experts say that it is nearly unheard-of for a Fortune 100 corporation to dismiss its general counsel in the middle of a huge merger. Charles Elson, director of the Weinberg Center for Corporate Governance in Delaware, calls it highly unusual. "It doesn't happen often, particularly without allegations of misconduct, and in the middle of such a situation," Elson says.

Elson agrees that the timing of the ouster raises questions about whether there were major internal disagreements over the disclosure decisions. "There's too much smoke to ignore," he concludes. "As a shareholder of Bank of America, I'd like to know why."

The answer is slowly beginning to emerge. By poring through hundreds of pages of documents, e-mails, and transcripts, we were able to get a better idea of what bank officials knew, when they knew it, and what they did—or didn't—do about it. The analysis by Corporate Counsel shows that there are three principal disclosure items under scrutiny. They are the multibillion-dollar bonus pool, the spiraling of Merrill's fourth-quarter losses, and the bank's quasi-threat to invoke an escape clause—called a MAC, short for "material adverse change"—to squirm out of the deal before it closed. Intertwined with all three, and hindering investigators, is the bank's attorney-client privilege.

The bonus pool scandal broke in the Financial Times in January. Lewis at first denied knowing about Merrill's paying out $3.6 billion in bonuses from the pool the day before the merger closed. But the bank later admitted that it had agreed to the bonuses when it signed the merger deal three months earlier. Shareholders demanded to know why they weren't told before the merger vote.

The SEC investigated, and in August it filed a securities fraud complaint against the bank, saying that it misled investors in its proxy statements. Instead of saying there was a bonus pool, and details were in a separate and confidential schedule, the bank's lawyers played word games with the proxy statement. It said Merrill would grant no bonuses unless Bank of America signed off on them. It omitted to say that the bank had already signed off on the bonus fund. And the bank never told shareholders the size of the pool—several times larger than other corporate bonuses that had set off an outcry across the country in 2008.

The bank has denied that it failed to disclose any material fact.

The SEC's case turns on the word "material." The agency considers a fact material if there is a likelihood that a reasonable investor would want to know about it before making a decision. John Coffee, Jr., corporate law professor at Columbia Law School, says the bank will dispute the materiality of the bonus pool. "But it was a huge number at a time when the public and Congress were demanding lower bonuses for executives," Coffee says. "My belief is that there would have been shareholders not willing to vote for this merger if they saw that number."

The SEC and the bank reached a settlement that required the bank to pay a $33 million penalty. But federal district court judge Jed Rakoff in Manhattan said the investigation and charges didn't go far enough. In mid-September he scathingly rejected the proposed settlement with the bank as "neither fair, nor reasonable, nor adequate." He criticized making the shareholders, not individual bank officials, pay the fine.

Rakoff urged the SEC, in keeping with the agency's own policy, to hold individuals accountable and not penalize the shareholders, who were actually the victims of the alleged fraud. The SEC claimed it couldn't go after individuals, because "lawyers for Bank of America and Merrill drafted the documents at issue and made the relevant decisions concerning disclosure of the bonuses."

But if that is the case, Rakoff countered in his opinion, then "why are the penalties not then sought from the lawyers?" Rakoff said the agency "never seriously considered" whether the executives' reliance on advice of counsel constituted a waiver of the attorney-client privilege.

Then the judge dropped a bombshell in a footnote. He indicated that the SEC should pursue "whether [the legal advice] fit within the crime/fraud exception to the privilege." And then he added: "On its face, such testimony would seem to invite investigating the lawyers." The bank's lead outside counsel, Lewis Liman of Cleary Gottlieb Steen & Hamilton in New York, has simply said there was no actionable omission of a material fact from the proxy materials. Liman did not return messages seeking comment for this story.

But one former SEC commissioner, who asked to remain anonymous, strongly agreed with Judge Rakoff. This official was incredulous that the agency even offered to settle its disclosure complaint with the bank without evaluating the lawyers' advice. "I have thrown the [SEC] staff out of the room for raising reliance on attorney advice without first checking out if that were true," he says.

Will the bank waive the privilege? Will the SEC go after bank executives or the lawyers? Will the lawyers take a bullet for their client? A bank spokesman says only that it is prepared to litigate. SEC spokesman John Nester says only that the agency will go forward in court.

Unless circumstances change, and they've been changing daily, we'll find out the answers next year. Rakoff set the case for trial February 1, and the SEC and the bank have filed their joint case management plan to proceed to trial.

The second disclosure item in controversy concerns the enormity of Merrill's fourth-quarter losses. New York attorney general Andrew Cuomo, for one, is investigating when Bank of America knew about the cascading losses and why it didn't share that knowledge with shareholders before the December 5, 2008, vote approving the merger. And U.S. representative Dennis Kucinich (D-Ohio), of the House Committee on Oversight and Government Reform, has asked the SEC to investigate if the bank withheld material information about the losses from shareholders.

Cuomo has released transcripts showing that Mayopoulos and another in-house lawyer were consulted about the growing losses a few days before the shareholder vote. But it's impossible to say what they advised.

SEC financial reports show that Merrill had averaged just over $1 billion a month in losses through the first nine months of the year. CEO Lewis has said that he expected those losses to continue at roughly the same rate through the end of the year. But they didn't. Records show that the losses accelerated in October and November—$9 billion in just two months. By the end of the year, Merrill lost $15.3 billion in the fourth quarter alone.

Lewis has testified that he learned about Merrill's burgeoning losses on December 14, nine days after the shareholder vote. But the evidence is overwhelming that the bank knew much earlier. Merrill was sharing its financial data with Bank of America on a weekly and sometimes daily basis, sources say.

Liman, the bank's outside counsel, so far has not contested the timing allegations. Instead, he said in response to Cuomo's investigation, the bank had made general disclosures about the volatility of the marketplace in late 2008, and any other financial disclosures weren't necessary for shareholders to assess the risk. CEO Lewis testified in June before the House, "I don't decide on disclosures; we have [in-house] securities lawyers, and many times they talk to external counsel."

But other legal experts say the bank's failure to disclose the growing losses looms as a serious legal problem. "As far as I'm concerned," says the former SEC commissioner who spoke to Corporate Counsel , "this is the more serious disclosure allegation [than the bonuses]."

At least one lawyer seemed to see this coming. Scott Alvarez, general counsel to the Federal Reserve Board, exchanged a series of merger-related e-mails with his boss, Ben Bernanke, the Fed's chairman, in mid-December. In one message, Alvarez wrote, "Some of our analysis suggests that Lewis should have been aware of the problems at [Merrill] earlier (perhaps as early as mid-November) and not caught by surprise. That could cause other problems for him around the disclosures BA [BofA]made for the shareholder vote." (Alvarez did not return calls for comment.) Then Bernanke forwarded one of Lewis's worries about possible litigation, and Alvarez responded that Lewis was worrying about the wrong thing. "A different question that doesn't seem to be the one Lewis is focused on is related to disclosure," Alvarez wrote. "His potential liability here will be whether he knew (or reasonably should have known) the magnitude of the losses when BA made its disclosures" to shareholders before the vote.

Depositions by Cuomo's office shed a little more light on when and how the bank decided not to disclose. Under questioning, chief financial officer Joseph Price admitted that bank officials discussed in mid-November whether or not to disclose the losses, well before the shareholder vote. Price testified that the bank decided not to disclose them "after receiving legal advice from then–general counsel Timothy Mayopoulos, as well as from outside counsel" on November 20, 2008.

In another deposition, bank controller Gary Carlin testified that part of the losses included Merrill's $2 billion goodwill write-off in November related to subprime mortgage loans. Bank officials considered immediately disclosing this loss in an 8-K filing, he said, but didn't do it, on advice from in-house counsel. From the deposition:

Question: And who at in-house counsel did you contact?

Counsel for Carlin: I just want to caution the witness, we're definitely getting into a privileged conversation, so we should take it one question at a time.

Carlin: Richard Alsop [then an in-house attorney].

Question: Why were you satisfied [with not making a disclosure and instead relying on prior disclosures]?

Counsel for Carlin: Without revealing the contents of a privileged conversation.

Carlin: Based on several things, but the conversation with Richard Alsop.

In a September letter to Liman, Cuomo's office complained about the bank not allowing Alsop or any of the lawyers to talk with investigators about what advice they actually gave. "This is particularly troubling," the letter states, "because . . . we have evidence that Mr. Alsop did not have key information when he rendered his advice." Alsop could not be reached for comment for this story.

In answer to another deposition question, CFO Price testified that he, a bank vice chairman, and Mayopoulos discussed the rising losses again on December 1, and yet again on December 3 when the loss estimate rose to $11 billion. This was still two days before the shareholder vote, and refutes any claim that the bank learned of the losses only after the vote.

Price testified that the decision not to disclose the losses was made after his conversations with Mayopoulos. The general counsel, in turn, sought outside counsel advice:

Question: So I'm clear, with regard to the conversation you had with Tim Mayopoulos on December 3 after the second forecast was provided to him, were you speaking with him for the purpose of getting legal advice?

Price: On that subject of disclosure, he's our general counsel, yes.

Question: Was there a disclosure made on the financial losses after this conversation with Mr. Mayopoulos?

Price: No.

Question: Did you and Bank of America rely on Mr. Mayopoulos's advice?

Counsel for Price: If you can answer that without revealing any substance, describe it.

Price: Yes.

Cuomo's September letter to Liman and the bank also complains about not being able to explore these conversations with Mayopoulos. "Despite the purported defense that the decision not to disclose Merrill's deteriorating financial condition was fully vetted by informed legal counsel, you have instructed Mr. Price and Mr. Mayopoulos not to answer questions regarding the discussions with counsel," it states. "We cannot even establish whether these law firms were asked any of the questions vital to deciding whether to disclose. . . ."

The third questionable disclosure decision concerns the bank's consideration of using an escape clause, or a MAC, to cancel the merger before the deal closed January 1. At that time the bank also did not disclose the role of federal regulators in pressuring the bank not to invoke the MAC, and in promising the bank another $20 billion of taxpayer money in 2009 if it would complete the deal. The bank had already received $25 billion in bailout funds in 2008.

Again, transcripts of depositions by Cuomo's lawyers show when and how the bank considered invoking the MAC. CFO Price testified that because of Merrill's spiraling losses, he and a bank vice-chairman sought legal advice from Mayopoulos about invoking the MAC on December 1—four days before the shareholder vote.

Mayopoulos testified about that 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?

Question: Yes.

Mayopoulos: Yes.

Again, the bank's lawyer stopped Mayopoulos from answering any substantive questions about his advice because of attorney-client privilege.

Jeffrey Litle, a partner at Jones Day in Columbus, 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 December 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 bonus pool.

Instead, the bank waited until after the shareholders approved the merger—but before the deal closed on January 1—and used the MAC to muscle the federal government and U.S. taxpayers into ponying up more bailout funds.

According to testimony from both CEO Lewis and then–Treasury secretary Henry Paulson, Jr., Lewis called Paulson on the morning of December 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 astonished. 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 and met with Paulson and the Fed's Bernanke, and promised not to invoke the MAC until they could talk again. Paulson promised to pursue the possibility of more bailout funds for the bank.

E-mails and other documents from lawyers and advisers at the Fed and the U.S. Department of the Treasury show that they thought Lewis certainly knew of the losses much earlier. 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, they concluded.

On December 21 Bernanke e-mailed colleagues at the Fed, saying he thought Lewis's "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.

The next day Bernanke made sure that Lewis stayed the course. Despite his misgivings about being manipulated by the CEO, Bernanke 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 January 16 the bank released its fourth-quarter earnings statement. Its press release finally disclosed Merrill's 2008 fourth-quarter loss of $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.

Ten months later, the merger looks like it will be a sound financial deal for the bank in the long term. Lewis is pushing to repay at least part of its bailout funds right away. In its second-quarter earnings (the latest available at press time) the bank reported net income of $3.2 billion, and its stock price is inching back up. But the legal and internal fallout hasn't been as kind.

On the regulatory side, in the spring shareholders forced CEO Lewis to give up his other title, chairman of the board. The government has also imposed corporate governance measures and pressured the institution to shed nine of the 14 directors who took part in the Merrill deal. It is forcing the bank to bring on directors with more financial institution experience.

The government housecleaning swept out any number of other executives, including the chief risk officer who fired Mayopoulos. Consider that the bank has gone through four CFOs, four general counsel, and two chief risk officers in the last five years. That is the worst churn of any U.S. banking institution, according to the trade publication American Banker .

On the legal side, the bank still has to face the SEC and Judge Rakoff, as well as numerous civil suits. The bank's state and federal criminal investigations are ongoing. And so is the battle over attorney-client privilege. At this writing, Edolphus Towns (D–New York), the chairman of the House Oversight panel, has demanded that the bank let the committee question the lawyers involved in the merger decisions. The bank is negotiating what it might allow.

Cuomo's office wants to talk to the lawyers too. Hinting at criminal charges, the September letter from Cuomo concluded: "We cannot simply accept Bank of America's officers' bald assertions that their decisions to keep each of these material events from Bank of America's shareholders were based on a full review of all the relevant information by their inside and outside counsel."

Cuomo's threats do not sit well with Susan Hackett, general counsel of the Association of Corporate Counsel in Washington, D.C. Her organization has helped fight the government's creeping demands that corporations waive attorney-client privilege, winning some concessions from both the Department of Justice and the SEC last year. Hackett says that Cuomo's approach won't win in court, and is just bad public policy.

Cuomo's quest to question attorneys, if allowed, "will reverberate through every corporate boardroom," Hackett argues. "It will have a chilling effect on clients' willingness to engage in crucial conversations with lawyers on the most sensitive and complex matters they face. Yet those are precisely the circumstances in which the public interest most favors candid consultations with counsel."

Not everyone agrees. Even Elson, the corporate governance expert who considers the privilege "sacrosanct," thinks that this case should be an exception: "Here the damaged party—the investor—is not being protected by its fiduciaries. Forcing investors to pay [any SEC penalty] is appalling. In this situation, everyone needs to be transparent. The truth needs to come out." 

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