While he telegraphed his displeasure with the settlement both at the hearing held on August 10, 2009 on the settlement and in his order requesting clarification of the parties’ initial submissions on August 25, Judge Rakoff’s rejection of the settlement by his order of yesterday was nevertheless surprising. As he himself admits, settlements of this nature, by an agency that is as generally respected by the courts as the SEC, are rarely set aside. This one has been, to the general acclaim of the populace, if the reactions in the press, ranging from The New York Times to The Wall Street Journal, are any indication. The comments on The Times’ website to its report of the settlement yesterday were overwhelmingly favorable. Here’s a sample, from some of the 385 readers’ comments (as of September 15) from The Times’ website:
“Thank you your Honor!”
“Such fundamental reasoning was sorely missing from all the prior bailout efforts.”
“Well, what do you know? A judge does the right thing.”
“Yes, there is justice in this world.”
“Good to see the light of Justice exposing and rejecting the ‘insider’ deal between the SEC and BOA!”
“I like this judge! Nominate him for Stevens’ seat on SCOTUS!”
“A judge with some intelligence and integrity. Faith renewed, at least temporarily….”
A. Judge Rakoff, Populist
The Judge’s September 14th order rejecting the settlement is a refreshing read. He disdains the technical language of securities lawyers, and says it plain and simple. Where the Commission refers to BofA’s proxy statement as containing a “proxy violation” and “false” and “misleading” statements, the Judge refers to BofA’s conduct as allegedly “lying” to its shareholders. Thus Judge Rakoff begins his order:
“In the Complaint in this case, … the Securities and Exchange Commission … alleges, in stark terms, that defendant Bank of America Corporation materially lied to its shareholders….”
What particularly frosts the Judge is that the effect of the settlement is to impose upon the victims of the Bank’s alleged lies — BofA’s shareholders — the burden of paying the settlement’s fine of $33 million:
“In other words, the parties were proposing [by the settlement] 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 the shareholders’ money.”
September 14th Order at 2.
The Judge blasts the settlement as none of “fair, nor reasonable, nor adequate.” Not content to rely solely on law and notions of justice, the Judge finds that the proposed settlement violates fundamental norms of morality:
“It is not fair, first and foremost, because it does not comport with the most elementary notions of justice and morality, in that it proposes that the shareholders who were the victims of the Bank’s alleged misconduct now pay the penalty for that misconduct.”
September 14th Order at 4.
Not the prose one typically reads in legal opinions!
In response to the SEC’s argument that the penalty against the corporate entity — the Bank — is justified because it would send “a strong signal to shareholders that unsatisfactory corporate conduct has occurred [and would allow] shareholders to better assess the quality and performance of management,” the Judge is aghast:
“This hypothesis, however, 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.”
September 14th Order at 4.
And in response to the Bank’s claims that its investigation indicated that it was the Bank’s lawyers who drafted the proxy statement, the Judge offers the obvious rejoinder: “But if that is the case, why are penalties not then sought from the lawyers?” Id. at 5.
The Judge blasts BofA for, on the one hand, claiming its innocence of the charges of distributing a misleading proxy statement while at the same time agreeing to fork over $33 million of its shareholders’ money. Not only does the Judge question the decision as a business matter, but he points to the obvious, namely, that management of the Bank may not be disinterested parties:
“It is one thing for management to exercise its business judgment to determine how much of its shareholders money should be used to settle a case brought by former shareholders or third parties. It is quite something else for the very management that is accused of having lied to its shareholders to determine how much of those victims’ money should be used to make the case against the management go away.”
September 14th Order at 7 (footnote omitted).
In what must particularly sting the Commission, particularly under its new head Mary Schapiro, the Judge characterizes the settlement at a “contrivance” designed to provide cover to the SEC:
“Overall, indeed, the parties’ submissions, when carefully read, leave the distinct impression that the proposed Consent Judgment was a contrivance designed to provide the S.E.C. with the façade of enforcement and the management of the Bank with a quick resolution of an embarrassing inquiry — all at the expense of the sole alleged victims, the shareholders.”
Id. at 8.
In a final call to arms, the Judge throws down the gauntlet:
“Yet the truth may still emerge. The Bank of America states unequivocally that if the Court disapproves the Consent Judgment, it is prepared to litigate the charges. … The S.E.C., having brought the charges, presumably is not about to drop them. Accordingly, the Court, having hereby disapproved the Consent Judgment, directs the parties to file with the Court, no later than one week from today, a jointly proposed Case Management Plan that will have this case ready to be tried on February 1, 2010.”
Id. at 12 (footnote omitted).
B. Now What?
The first question for the parties is whether to appeal Judge Rakoff’s rejection of their settlement. (Not being a litigator, I assume each can do so.) While the Judge’s comments undoubtedly rub both parties raw, I assume cooler heads will prevail and one or both of the SEC and the Bank will appeal. From the SEC’s standpoint, none of the arguments it advanced to Judge Rakoff for approving the settlement go away. The Judge’s comments about the burden of the $33 million fine being borne by the innocent shareholders of BofA will hurt, because they are true, but I doubt the SEC is ready to forego its policy of imposing corporate fines altogether. Plus the Commission has its institutional prerogatives to protect, namely, its discretion in investigating, prosecuting, and settling cases. Plus Judge Rakoff is known as a maverick, so the Commission will undoubtedly assume it would receive a more receptive audience at the Second Circuit.
From the Bank’s standpoint, before pursuing any appeal it will have to swallow the bravado of its briefs that if the case were tried, the Bank would undoubtedly prevail. The Bank would be foolish to submit to Judge Rakoff and/or to a jury a case involving, at its core, the payment of billions of dollars in bonuses to Wall Street executives. Testifying in court and before a jury of your average New Yorkers is not something Ken Lewis and the other executives of the Bank will relish. So I would expect the Bank to conclude that a deal is a deal and that this deal should be approved.
If, surprise of surprises, the case does head to trial, then one of the first issues the parties will have to address is the Bank’s invocation of the attorney-client privilege. Fundamental to the Commission’s defense of the settlement and its failure to include any individual officers of BofA is the fact that the Bank invoked the privilege, thereby preventing the Commission from investigating communications between the Bank and counsel regarding the proxy statement’s disclosures concerning the payment of discretionary year-end bonuses to Merrill’s executives and employees. Somewhat surprisingly, the Bank, in its reply memorandum of September 9, 2009, appears to take the position that it did not invoke the attorney-client privilege: “It [the Bank] did not prevent any witnesses from testifying or ever invoke the attorney-client privilege in testimony regarding the subject of whether or how to disclose Merrill Lynch’s incentive compensation.” Reply Memo at 1. While this statement is hedged, undoubtedly the first question the Commission would put to the Bank, if the parties proceed to trial, is whether the Bank will now waive the privilege as to all communications between the Bank and counsel regarding the disclosures in the proxy statement concerning bonus compensation to Merrill’s officers and employees. While the Bank may squirm at that question, I would anticipate the response would be a firm “No.”
If the case proceeds to trial, would the Commission add as party defendants any officers of the Bank? Any lawyers of its counsel, the Wachtell firm? It would seem, given a trial date of February 1, 2010, that it is a bit late to add party defendants. Moreover, the Commission has made plain in its briefs filed with the Court that it was not able to develop any evidence establishing scienter on behalf of the Bank’s officers or counsel, and so, how could it name any such individuals as party defendants now?
And, if the case proceeds to trial, and the Commission does not add to the case any individual party defendants, what is the point of proceeding? It would appear that hell will freeze over before Judge Rakoff would impose a penalty on the Bank when no individuals stand before him as defendants, so what would the Commission seek in any trial against the Bank only?
So, upon reflection, the odds of the parties taking up Judge Rakoff’s command to proceed to trial appear nil. Next up: the Second Circuit.
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