SEC v. Bank of America Corp.: Recent Developments

This case is headed for trial on March 1, 2010 before Judge Rakoff. Two recent decisions by the Judge have sharpened the issues for trial. Whether the case actually is tried is problematic, given BofA’s obvious attempts, under new CEO Brian Moynihan, to settle all litigation arising out of BofA’s acquisition of Merrill Lynch.

A. Judge Rakoff’s Evidentiary Ruling of January 4

I have commented extensively on this case in prior posts. As I have observed, BofA’s primary defense was to be that the fact that Merrill would pay substantial 2008 year-end bonuses to its officers and employees was so well known by the market that any failure to disclose BofA’s agreement that Merrill could pay such bonuses (of up to $5.8 billion) was immaterial.

By his January 4, 2010 Opinion and Order (“Order”) Judge Rakoff dealt with the SEC’s motion to exclude from evidence all media reports concerning Merrill’s payment of year-end bonuses. The Judge granted the motion. The ground for the decision was BofA’s own October 31, 2008 proxy statement, used to solicit the consent of its stockholders for the merger. BofA was hoisted on its own petard, as it cautioned its stockholders to rely only on the information set forth in the proxy statement and information specifically incorporated by reference into the proxy statement:

“You should rely only on the information contained or incorporated by reference into this document. No one has been authorized to provide you with information that is different from that contained in, or incorporated by reference into, this document.”

Order at 1-2.

To emphasize the point, BofA repeated this admonition, in even stronger language, in bold face type, at the end of its proxy statement:

“You should rely only on the information contained or incorporated by reference in this document. Neither Bank of America nor Merrill Lynch has authorized anyone to give any information or make any representation about the merger or our companies that is different from, or in addition to, that contained in this document. Therefore, if anyone does give information of this sort, you should not rely on it.”

Order at 2.

These disclosures provided the Judge with all he needed to grant the SEC’s motion to exclude all media reports from evidence, including any reliance on such reports by both the SEC’s and BofA’s experts.

“Furthermore, even if the media reports of Merrill’s likelihood of paying bonuses could otherwise somehow be said to bear indirectly on the question of how material was the Bank’s alleged failure to disclose that it had in fact already approved the payment of such bonuses when it purported to represent that it had not given such approval, the warnings in the proxy statement totally changed the relevant mix of information for assessing materiality. Since the test of materiality is whether the undisclosed information, if disclosed, “would have been viewed by a reasonable investor as having significantly altered the ‘total mix’ of information made available,” TSC Indus., 426 U.S. at 438, one must ask what a reasonable investor would reasonably consider the total mix of information in this case. The answer is that since the Bank itself warned investors not to rely on the media, it would be unreasonable for a shareholder to consider the media pronouncements to be a part of the relevant mix of information.”

Order at 5.

As is his want, Judge Rakoff could not resist putting in a final dig at BofA for its position:

In effect, the Bank is arguing that, even though it expressly warned its shareholders to disregard the media, it can now defend itself by asserting that a reasonable shareholder would have disregarded these warnings and, by consulting the media, perceived that the Bank’s alleged lies were immaterial. Even a zealous advocate might perceive that such an argument hints at hypocrisy.”

Order at 6.

B. The Judge Rejects the SEC’s Request to Amend Its Complaint

By his order of January 11, the Judge rejected the SEC’s attempt to amend its Complaint to add an additional alleged omission by the Bank, namely its purported failure to disclose Merrill’s sizeable losses incurred in the fourth quarter of 2008. Apparently the Judge was convinced this new claim was brought too late and would prejudice BofA. For our purposes it is a sideshow; its exclusion from the case doesn’t detract from the drama that is unfolding in Judge Rakoff’s court.

On January 13, the SEC filed a new complaint, also in the Southern District, against BofA repeating its allegations of proxy violations for BofA’s failure to disclose Merrill’s sizeable fourth quarter 2008 losses. While I am not familiar with the Southern District’s assignment procedures, this action could very well be deemed a “related” case to that pending before Judge Rakoff and therefore assigned to him. If so, the SEC’s filing of this second action against BofA may have strategic implications: one or both parties may request a delay in the March 1 trial date of the current action before Judge Rakoff so that both actions, clearly involving similar facts, documents, evidence, and witnesses, be tried at the same time. The SEC may also believe that the second action gives it additional leverage over BofA.

C. Prognosis

I discussed in some detail my prognosis for any trial in this case in my post of September 25, 2009 and concluded, “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 would not be as stringent as those set out in the settlement to which BofA was prepared to accept.” The settlement Judge Rakoff rejected called for payment of a civil fine by BofA of $33 million and entry of a permanent injunction against future violations of the proxy rules.

We now know, after extensive discovery, including of BofA’s lawyers (BofA waived the attorney-client privilege - see my post of October 15, 2009), that the SEC’s initial conclusions based upon the discovery it conducted prior to entering into the settlement, that the record did not establish scienter on the part of any officer of BofA or its counsel, sufficient to allow the SEC to name any such persons, have been confirmed, at least in the SEC’s mind. So the Judge’s outrage at the settlement for its failure to name any individual culprits will not be vindicated at trial. Assuming, as appears likely to this observer, that the Bank will be found liable for a proxy violation for failing to disclose its agreement with Merrill to pay year-end bonuses of up to $5.8 billion, what remedies will Judge Rakoff impose?

Given the sensitivities of the Judge to imposing upon the “victim,” here BofA’s shareholders, any damages for BofA’s proxy violations, it is entirely reasonable to conclude that the most probable remedy Judge Rakoff would impose is an injunction. As I discussed in my post of September 25, even on that remedy the Bank will mount a vigorous defense, namely on the ground that the odds of its repeating a proxy violation are nil.

The Judge is of course very bright, and probably appreciates that this case is headed in that direction so he may be more amenable to accepting the next settlement BofA and the SEC agree to. This leaves open the possibility that BofA will enter into a global settlement with the SEC and New York’s Attorney General Andrew Cuomo that includes the payment of a fine (to the extent demanded by Cuomo) and a consent to injunctive relief against future violations of the proxy rules. Given there’s a new captain of the BofA ship, CEO Moynihan, I am reasonably confident that is a settlement he would gladly accept to get the Merrill litigation behind him.