The Settlement in SEC v. Bank of America Corp. Under Attack: Bank of America's Defense of the Settlement

In my post of September 3, 2009, I addressed the settlement entered into on August 3, 2009 between the SEC and Bank of America in which the Bank, settling the SEC’s complaint of the same day alleging material misstatements and omissions in the Bank’s October 31, 2008 proxy statement, agreed to a permanent injunction against future violations of the proxy rules and agreed to pay a $33 million fine. I reviewed the SEC’s support of the settlement and Judge Raikoff’s concerns over the settlement. In this post I discuss the Bank’s defense of the settlement, set forth in its memorandum filed August 24, and the submissions of its two experts, Morton Pierce, chairman of Dewey & LeBoeuf’s mergers and acquisitions group, and Joe Grundfest, professor of law at Stanford.

A. The Best Defense is a Powerful Offense

It is clear that what bothers Judge Raikoff about the settlement is the SEC’s failure to name, and include in the settlement, any of the Bank’s officers. In its defense of the settlement, the Bank chooses not to defend this specific omission, but to assert that the SEC’s complaint itself is subject to powerful defenses and that, if the case were tried, the Bank would likely prevail. The thrust of the Bank’s position, therefore, is that the settlement should be approved because the SEC is fortunate to have secured the terms that it did — never mind that one or more individual officers of the Bank was not named as a defendant in the SEC’s complaint.

In support of its position, the Bank makes two arguments: first, that its proxy statement contained no false or misleading statement and no material omission, and second, that even if the proxy statement can be faulted for not specifically flagging Merrill’s and the Bank’s agreement that Merrill could pay year-end incentive bonuses of up to $5.8 billion, the omission was immaterial, given that Merrill’s intent to pay year-end bonuses in approximately this amount was well known to the market prior to the stockholder vote on the merger, via Merrill’s SEC filings and in extensive press reports concerning Merrill.

B. No Misstatement or Omission

The crux of the SEC’s complaint against BofA is that the Bank failed to disclose in the proxy statement distributed to the Bank’s stockholders in connection with the Merrill merger its agreement with Merrill that Merrill could pay up to $5.8 billion in discretionary year-end performance bonuses to Merrill’s officers and employees. In the merger agreement, summarized in the joint proxy statement, the Bank and Merrill agreed that Merrill would not pay discretionary bonuses to its directors, officers, and employees between the date of the merger agreement (September 15, 2008) and the close of the merger, except as set forth in Merrill’s disclosure schedule, without the prior written consent of the Bank. The disclosure schedule, which was not filed with the merger agreement or otherwise made publicly available, reflected the parties’ understanding and agreement that Merrill could pay discretionary year-end bonuses in an amount not to exceed $5.8 billion in the aggregate (and $4.5 billion in the aggregate as an accounting expense).

In defending the proxy statement disclosure, the Bank distorts what the SEC alleges in its complaint, asserting that the Commission alleges that Merrill “was prohibited from making [year-end] bonus payments.” Bank’s Memorandum of August 24, 2009 (“BofA Memo”), at 1. The charge is picked up by Professor Grundfest in his affidavit in support of the Bank’s submission: “The Complaint alleges that Bank of America made ‘representations that Merrill was prohibited from making [year-end bonus] payments.’” Grundfest Affidavit, dated August 21, 2009, ¶ 34. But it wasn’t Merrill’s negative covenant not to pay year-end discretionary bonuses that the Commission attacked, but the proxy statement’s failure to disclose the deal that the Bank and Merrill had already struck by the time they signed the merger agreement:

“The omission of Bank of America’s agreement authorizing Merrill to pay discretionary year-end bonuses made the statements to the contrary in the joint proxy statement and its several subsequent amendments materially false and misleading. Bank of America’s representations that Merrill was prohibited from making such payments were materially false and misleading because the contractual prohibition on such payments was nullified by the undisclosed contractual provision expressly permitting them.”

SEC Complaint, dated August 3, 2009, ¶ 3.

Morton Pierce, one of the Bank’s experts, testifies in his affidavit that the inclusion of compensation-related information in disclosure statements and the non-disclosure of the contents of disclosure statements is customary practice in M&A transactions. That may very well be true, but it does not respond to the question of whether non-disclosure of BofA’s and Merrill’s agreement on the payment of year-end bonuses in this disclosure statement made the Bank’s statement in its proxy statement that no such bonuses would be paid without the Bank’s written consent misleading. (And, on that point, Mr. Pierce is careful to “express no view.”). And, while maintaining the confidentiality of disclosure statement disclosures is customary, neither the Bank nor its experts respond to the point, made by the SEC in its August 24th memorandum, that the very Reg. S-K instructions that permit the nondisclosure of disclosure statements requires disclosure of their contents if “such schedules contain information which is material to an investment decision and which is not otherwise disclosed in the agreement or the disclosure document [transmitted to the shareholders and/or investors].” Reg. S-K, Item 601(b)(2).

So I don’t find persuasive the Bank’s claim that its proxy statement disclosure concerning its agreement with Merrill over the payment of discretionary year-end bonuses is not misleading.

C. The Omission of the Agreement on Payment of Year-End Bonuses Was Immaterial

The Bank has a stronger argument on this point. The Bank does not claim that the amount of the permitted year-end bonuses — up to $5.8 billion — is not material, but that the fact and probable amount of Merrill’s intent to pay such bonuses was widely known, both through Merrill’s 10-Q filings with the SEC and in press reports. The Bank cites Merrill’s first two 2008 quarterly reports for the proposition that Merrill had made known to the market its intent to pay compensation and bonuses in an amount comparable to those paid in 2007, and continued with that disclosure in its 10-Q filed after announcement of the merger agreement on September 15, 2008 (for the third calendar quarter ended September 30, 2008). And the Bank, primarily through Professor Grundfest, cites, ad nauseum, media reports that detailed Merrill’s claims to pay compensation and bonuses, including reports from The New York Times, Bloomberg News, and The Today Show, to the effect that Merrill was setting aside some $6.7 billion for officer and employee bonuses.

Both the Bank and Merrill, in their joint proxy statement, as is typical, incorporated by reference their recent SEC filings, including their 2008 10-Qs, and the SEC filings they would make prior to the stockholder meeting of December 5, 2008. So the Bank could clearly raise as a defense that the very information the Commission alleges it omitted from its proxy statement could be found in the Bank’s SEC filings. While media reports are not incorporated by reference in SEC filings, the Bank could argue that the information on Merrill’s expected bonuses was so widely available that the “market” and therefore BofA’s stockholders must be considered to have been aware of it.

The SEC, in its initial August 24 filing, anticipated these claims, and responded by pointing out that Merrill’s SEC filings do not break out bonuses from compensation accruals generally, and that BofA’s stockholders should not be expected to conduct a treasure hunt to ascertain information material to their vote on whether to approve the Bank’s merger with Merrill:

“Although tidbits of information relevant to the issue of year-end compensation at Merrill were available to the public at the time that the proxy materials were disseminated, none of that information disclosed Merrill’s plan to pay billions of dollars in discretionary bonuses and, more importantly, Bank of America’s consent to that plan in connection with the proposed merger. Merrill’s quarterly filings disclosing accruals for “compensation and benefits” did not provide any breakdown for the components of that aggregate accrual. An investor could not have known what portion was being accrued for year-end bonuses as opposed to salaries, benefits, or other expenses. In any event, investors are entitled to full disclosure of material facts within the four corners of the proxy statement and are not required to puzzle through reams of other data from which they may or may not be able to infer those material facts. ….

"While Merrill’s plan to pay bonuses was discussed to some extent in the media before the December 5, 2008 shareholders’ meetings, these reports do not negate Bank of America’s liability for its misleading proxy statement. As an initial matter, the media reports consisted of speculation and some of the reports were based on anonymous sources. Moreover, none of the reports stated that Bank of America had contractually consented to the payment of the Merrill bonuses before the merger closed. In any event, investors were not required to ignore Bank of America’s express representations in its proxy materials and rely instead on sporadic media speculation that was inconsistent with those representations.”

SEC August 24 Memo at 22-23 (emphasis in original).

The Bank’s reliance upon the claim that Merrill’s intent to pay year-end bonuses in the range of $5.8 billion (the actual bonuses paid were some $3.6 billion) was so widely known as to make the failure to expressly refer to that intent in the proxy statement immaterial raises an obvious question: if so widely known, why not include the Bank’s agreement with Merrill that it could pay bonuses of up to $5.8 billion in the proxy statement? Why the need to maintain in confidence information that was known, among others, by the viewers of The Today Show?

The Bank’s claim that the omission of its agreement with Merrill over the payment of year-end bonuses from the text of the proxy statement was immaterial should give Judge Raikoff pause, and could very well establish the bona fides of the settlement to his satisfaction. But if not, and the tone of his August 25 Order reflects considerable skepticism about the merits of the settlement, then the Bank will be forced to emphasize that while it may have exposure for the omission, none of its officers should have as there is no evidence that any of them had the slightest awareness of the omission and therefore no evidence to establish the necessary scienter that would have justified the SEC’s naming any of the Bank’s officers as defendants in the complaint.

The parties have today filed their replies, including to the issues raised in Judge Rakoff's August 25th order. I will address any points I find of interest in their briefs in a subsequent post.