SEC v. Bank of America Corp.: The Parties Head for Trial

The parties’ decision to proceed to trial rather than appeal Judge Rakoff’s rejection of their settlement on September 14 surprised this observer. I had speculated in my post of September 15 that the parties would appeal. That they have not may be due to technical issues involving the rejection (it did not constitute a final decision) or it may be that the parties’ submissions and Judge Rakoff’s comments so stirred them up that they have concluded it’s time to strap on their holsters and enter the ring. Whatever is the explanation, the case is now headed for trial, scheduled to commence March 1, 2010. Each party will have many interesting decisions to make over the next few months, including:

A. Will the SEC Sue Additional Parties?

Judge Rakoff has set October 19, 2009 as the date by which the SEC, without leave of court, may amend its pleadings or add additional parties. Given Judge Rakoff’s severe criticism of the Commission for failing to pursue any individual officers of BofA or its counsel for the alleged misstatements and omissions in BofA’s October 31, 2008 proxy statement, will the Commission add as parties defendant any of BofA’s executive officers, BofA’s in-house counsel who worked on the proxy statement, or the Wachtell firm, which acted as BofA’s outside counsel?

I would be surprised if the Commission did so. The Commission has made clear in its filings in support of the settlement that it had developed no evidence establishing the requisite “scienter” or knowledge of wrongdoing by any of the executive officers of BofA or its counsel so as to justify adding any of them to the complaint. The Commission cannot simply run away from these assertions and now do what it said only weeks ago that it could not do:

“… the Commission investigated the relevant roles played by various senior officials and other individuals in the events surrounding Merrill’s payment of year-end bonuses and the related proxy disclosures. The Commission duly considered whether to allege additional charges against Bank of America and charges against individuals but determined that such charges were not sufficiently supported by the investigative record.”

SEC’s Memo of August 24, 2009 at 23.

“… there is an insufficient evidentiary basis to establish a prima facie case of the requisite scienter with respect to the lawyers for purposes of alleging secondary liability under the securities laws.”

SEC Reply Memorandum of September 9, 2009, at 14 (footnote omitted).

B. Will the Parties Request a Jury Trial?

Each of the SEC and BofA may request that the trial be held before a jury. Will they do so?

My guess is that the Commission would be satisfied with Judge Rakoff as trier of fact, whereas the Bank may be more inclined to present its case to a jury. The Bank’s strategy will clearly be to parade expert witness after expert witness (to the extent Judge Rakoff will allow them) and possibly fact witnesses to establish that all the world knew that Merrill intended to pay year-end bonuses in a substantial amount and at least equal to what it in fact did pay — $3.6 billion, a pittance by Wall Street standards (the SEC’s charge is that BofA did not disclose its prior agreement with Merrill that Merrill could pay up to $5.8 billion in fourth-quarter bonuses). The challenge is whether the Bank really wants a group of New Yorkers to dwell over the course of a trial upon the payment of billions in bonuses to Wall Street suits.

C. Will the Parties “Re-Settle” the Case Before Trial?

There is nothing to prevent the Commission and BofA to revise their settlement and present the revised settlement to Judge Rakoff for approval. What would that revision consist of?

The Commission could agree to eliminate the civil fine of $33 million, leaving only the permanent injunction against BofA’s commission of future proxy violations. Presumably BofA would not object to this, and on what grounds could Judge Rakoff object to it, given his outrage over the fact that the civil fine in the original settlement was to be borne by the victims of the alleged “lies” (Judge Rakoff’s words) — BofA’s shareholders?

On the other hand, as an astute colleague of mine has observed, how would the SEC look if it agreed to a settlement eliminating the fine agreed to by BofA? Better to try the case and let the judge decide upon the appropriate monetary remedy (and take whatever heat comes from doing so).

D. Will BofA Waive the Attorney-Client Privilege?

In my post of September 15, 2009, I speculated on this question, concluding that it is unlikely that the Bank would respond affirmatively to any Commission request that it waive the privilege so as to allow everyone to come clean on what was discussed between the Bank and its lawyers concerning the proxy statement’s disclosure of Merrill’s year-end bonuses.

In my initial post on this case of September 3, 2009, I speculated on the possible explanations for the proxy statement’s omission of the Bank’s agreement with Merrill that Merrill could pay up to $5.8 billion in year-end bonuses, ranging from a deliberate omission to the explanation that it was simply an inadvertent omission, due to the incredible time pressures under which this deal and the proxy statement were cobbled together. If I am correct, why not waive the privilege and frankly admit that yes, the agreement set forth in the disclosure schedule was not included in the proxy statement, the explanation being that the team responsible for preparing the disclosure schedule did not adequately communicate with the team drafting the proxy statement — the failure was therefore simply a boot?

The problem with waiving the privilege, however, is that it can have other consequences, including in related litigation. And if BofA waived the privilege here, how could it avoid doing so in any future litigation or dispute? Moreover, the SEC has made clear that the record to date does not provide any evidence of the requisite scienter to enable the SEC to name as party defendants any officer of BofA or its counsel, so why not let a sleeping dog lie?

E. And Now for Judge Rakoff

What remedies would he impose upon BofA if it is found liable for having violated the proxy rules?

Judge Rakoff as judge has to be a neutral arbiter. He cannot force the SEC to name defendants, develop theories of liability, or examine witnesses (as a litigant). So let’s assume the Commission tries the case solely against the Bank, and Judge Rakoff (or a jury) finds the Bank liable for a proxy violation in failing to disclose its agreement with Merrill to allow Merrill to pay billions in-year 2008 bonuses. What sanctions does Judge Rakoff then impose upon the Bank?

The Commission in its complaint seeks monetary damages against the Bank pursuant to the provisions of Section 21(d)(3) of the Exchange Act. The “money penalties” available to the Commission under this provision are a function of the “tier” in which a violation falls. Assuming the BofA finder of fact does not conclude that BofA committed an act of fraud, deceit, manipulation, or a deliberate or reckless disregard of the proxy rules, which appears to be the state of the record based upon what the SEC asserts in its briefs filed in support of the settlement, then the relevant tier to which any probable violation found against the Bank would fall is the “first” tier. For corporations, the amount of a first tier penalty is, for “each violation,” $50,000 or, if the defendant has realized “pecuniary gain,” then the gross amount of such gain.

How does one get to a penalty in the millions of dollars under such provision? One way is to find numerous violations, e.g., 50 different misleading statements in a proxy statement. The law in this area is unclear. One mechanism of truly expanding the penalty would be to find a separate violation based upon the number of shareholders to whom the BofA proxy statement was sent — which numbered 283,000. 283,000 times $50,000 is real money. But the point is that even if the Court finds the Bank to have violated the proxy rules, getting to a fine in the range of $33 million (the fine BofA agreed to pay in the settlement) takes some work. Given Judge Rakoff’s express concerns about the burden of any civil fine, it would be surprising if he imposed one of any material significance against the Bank.

How about an injunction, identical to the one secured by the SEC in its settlement? Here, the Bank will inevitably argue that the odds of its repeating a proxy violation are nil, and therefore even the imposition of an injunction is inappropriate. So, while the imposition of an injunction as a remedy for any finding of a proxy violation by the Bank would not surprising, there could be a real fight over even its appropriateness given relevant case law about the standards governing the entry of injunctions.

So it’s entirely possible that even if the Bank is found liable for proxy violations as alleged by the SEC, the remedies Judge Rakoff would enter will not be as stringent as those set out in the settlement to which BofA was prepared to accept. How will that look? And who would suffer if that were the case? If the answer is Judge Rakoff, then perhaps there are grounds for one or both of the parties to ask him to recuse himself from the case.

The twists and turns this case has taken are not yet over.