Train wreck or savior? (Photo credit: Wikipedia)
The New York Times today reports that former Bank of America Chief Executive Kenneth Lewis has admitted in a deposition that bank officers knew before it completed the 2008 acquisition of Merrill Lynch that Merrill's losses would be devastating for both companies.
Lewis's admission isn't exactly news, since the Securities and Exchange Commission sued over similar allegations and settled that case for $150 million in February 2010. Included in the judge's approval of the SEC settlement were references to testimony in yet another lawsuit against Bank of America over the Merrill merger -- this one by the state of New York -- that executives approved $5.8 billion in bonuses at the same time as they were aware that Merrill would report billions of dollars in losses.
A couple of things are certain following Lewis's belated admissions: BoA shareholders will probably pay a lot more over the Merrill merger, since Lewis's admissions under oath just about seal any shareholder complaint alleging misstatements in shareholder communications. (BoA said "there is nothing new here, because the allegations were "scrutinized and explored in numerous venues nearly three years ago.")
And in an ironic follow-on, Merrill's rebounding operations will contribute a lot of the cash that lawyers wrest away from the bank. BoA's global investment advisory business earned $1.7 billion last year while the total bank's earnings after various charges were only $1.45 billion. Global banking and markets, which also includes some of the legacy Merrill businesses, earned another $3 billion.
The details of Lewis's deposition were filed yesterday as plaintiff lawyers and BoA filed motions to dismiss the lawsuit. This case is an unusual sort of action, in which lawyers are seeking damages for shareholders who owned stock when BoA shares plunged in January 2009 following a flurry of news articles about the executive bonuses and fevered negotiations with John Paulson at Treasury over a bailout for the faltering BoA/Merrill combo.
The lawsuit is a bit unusual because it seeks money for all shareholders, not just the ones who bought supposedly inflated shares and then sold them at a loss. As BoA notes in its motion to dismiss, the lawyers are seeking money for shareholders who only lost money to the extent they didn't sell their stock for an inflated price to some other sucker who was left holding it when the price fell. BoA argues the law doesn't allow shareholders to collect damages in that situation.
The idea of current BoA shareholders paying for the sins of past managers also bothered U.S. District Judge Jed Rakoff when he mulled the SEC's first attempt to settle its lawsuit against the bank. The SEC alleged, like lawyers in the current case, that executives hid Merrill's deteriorating condition as well as plans to pay out billions of dollars in bonuses.
Rakoff rejected the first, $33 million settlement as inadequate and unfair to BoA shareholders, since they were supposedly the victims of the fraud and they were also being forced to pay for it.
The parties were proposing that the management of Bank of America – having allegedly hidden from the Bank’s shareholders that as much as $5.8 billion of their money would be given as bonuses to the executives of Merrill who had run that company nearly into bankruptcy – would now settle the legal consequences of their lying by paying the S.E.C. $33 million more of their shareholders’ money.
Rakoff wanted some human being involved in the case to be ordered to pay something. Frauds, after all, are perpetrated by people, not businesses. But BoA countered that its executives made their decisions after consulting their lawyers at Wachtell Lipton, who advised against the disclosure. That undercuts the legal argument that they engaged in knowing fraud and makes it a case, at best, about negligence.
Lawyers for the government and BoA both protested that time, as the lawyers in the current shareholder case no doubt will when their own settlement is up for approval, that it doesn't matter who pays. Any settlement has an important "disciplinary effect" on management and helps shareholders assess the quality of managers.
But Rakoff wasn't buying that argument.
This hypothesis ...makes no sense when applied to the facts here: for the 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.
Rakoff ultimately approved a $150 million settlement after reviewing evidence from the New York State case that convinced him some shenanigans might have gone on, but evidence meeting the legal standard of fraud was lacking. The settlement also ordered BoA to hire outside consultants to monitor its disclosure practices for the next three years. But Rakoff wasn't done castigating everybody involved.
The judge noted that an additional condition imposed on the settlement was that no money flow to shareholders who got BoA stock by tendering their own Merrill shares. That meant the payout was really a $75 million retroactive dividend paid by current shareholders to former BoA shareholders.
“Put another way, it serves to renegotiate the price that shareholders would have paid for purchasing Merrill shares if the disclosures had been made,” the judge concluded, calling it “half-baked justice at best.”
Given how Merrill's operations are now providing the cash that will flow to former shareholders in this next round of litigation, BoA's owners should probably be glad they bought the company back in 2008, warts and all.
Bank of America supplied this statement about Lewis's statements in the shareholder suit:
“The issues around disclosure of Merrill Lynch’s financial condition were scrutinized and explored in numerous venues nearly three years ago and made the subject of numerous suits. There is nothing new here. It was clear that Merrill Lynch’s deteriorating financial condition was widely appreciated by shareholders before voting for approval. Most importantly, Merrill has performed extremely well on behalf of Bank of America shareholders, providing billions in earnings in the quarters immediately post-closing.”
