Important Disclaimer Federal District Court Rejects Proposed Consent Judgment between Bank of America and the SEC September 22, 2009 On September 14, 2009, United States District Judge Jed S. Rakoff of the Southern District of New York issued an order sharply rejecting a proposed consent judgment between the U.S. Securities and Exchange Commission (SEC) and Bank of America.1 The proposed consent judgment was intended to settle a complaint filed by the SEC against Bank of America arising out of the bank's acquisition of Merrill Lynch in late 2008. In its complaint, the SEC had alleged that Bank of America had made false and misleading statements in its proxy statement seeking stockholder approval of the Merrill Lynch acquisition. Under the terms of the proposed consent judgment, Bank of America agreed to refrain from making false and misleading statements in future proxy solicitations and to pay a $33 million fine to the SEC. Background The SEC's complaint against Bank of America alleged "in stark terms" that the bank made false and misleading statements to its stockholders in its proxy statement seeking stockholder approval of the $50 billion acquisition of Merrill Lynch. Specifically, the SEC alleged that Bank of America's proxy claimed that "Merrill had agreed not to pay year-end performance bonuses or other discretionary incentive compensation to its executives prior to the closing of the merger without Bank of America's consent when in fact, contrary to the representation, Bank of America had agreed that Merrill could pay up to $5.8 billion—nearly 12 percent of the total consideration to be exchanged in the merger—in discretionary year-end and other bonuses to Merrill executives for 2008." Following a lengthy investigation by the SEC, and in a not uncommon procedure, on the same day the SEC filed its complaint against Bank of America, the company entered into a consent judgment with the SEC. Pursuant to the terms of this consent judgment, Bank of America (while not admitting the truth of the SEC's allegations) agreed to an injunction prohibiting it from making future false statements in proxy solicitations and to pay a $33 million fine to the SEC. In a number of earlier hearings and opinions, Judge Rakoff had expressed skepticism about the proposed consent judgment, and asked for additional information from both the SEC and Bank of America to support the judgment.2 In partial response to these requests, the SEC claimed that one of the reasons it had decided not to seek additional penalties was because it appeared that the decisions about what to disclose were made exclusively by outside counsel for both Bank of America and Merrill, and that the officers and directors deferred to counsel on these disclosure issues. In its earlier responses to the court's questions, Bank of America submitted substantial evidence, including a declaration from former SEC Commissioner Joseph Grundfest concluding that, based upon a review of Merrill's public disclosures and other public sources, the market recognized that "billions of dollars of bonuses were expected to be paid by Merrill." The Court's Conclusions In its most recent opinion, the court made a number of noteworthy findings. As an initial matter, the court recognized that a standard civil settlement is generally "close to unreviewable" and that even in the consent judgment context, the standard remains "highly deferential." The court found, however, that "even upon applying the most deferential standard of review," the proposed consent judgment was "neither fair, nor reasonable, nor adequate." Of particular note, the court blasted the parties' proposed settlement of a $33 million fine as "absurd," characterizing it as having "the victims of the violation pay an additional penalty for their own victimization." The court cited the failure of the SEC to pursue Bank of America executives or lawyers for the alleged false statements, as well as the willingness of Bank of America to pay $33 million of its stockholders' money as "a penalty for lying to them" while simultaneously protesting its innocence. Indeed, the court questioned "if the Bank is innocent of lying to its shareholders, why is it prepared to pay $33 million of its shareholders' money as a penalty for lying to them?" The court viewed this as evidence that the proposed consent judgment was merely "a contrivance" to provide the SEC a facade of enforcement while sparing Bank of America's management a potentially lengthy and damaging inquiry. The court also criticized the SEC's argument that it was unable to determine and pursue individual liability because Bank of America had claimed that its lawyers made all the relevant decisions while also refusing to waive attorney-client privilege. The court stated that this created an appearance that the SEC never "seriously pursued" whether the privilege was waived, or whether such conduct would fit within the crime/fraud exception to the privilege. The court further noted that Bank of America's testimony "would seem to invite investigating the lawyers." The court concluded by stating that the proposed consent judgment in general implied "a rather cynical relationship" between the SEC and Bank of America, characterizing that relationship as one in which the SEC would benefit by being able to claim it was exposing wrongdoing in a high-profile merger on the one hand, while Bank of America simultaneously would be able to claim it was coerced "into an onerous settlement by overzealous regulators" on the other—all at the expense of stockholders. The court then rejected the settlement in total, and instead ordered the parties to prepare to litigate the action and set a trial date of February 1, 2010. The rejection of the consent judgment and continuing litigation in the Southern District of New York is not the full extent of the legal issues facing Bank of America. On September 16, 2009, New York Attorney General Andrew Cuomo subpoenaed five members of the Bank of America board to testify under oath regarding the acquisition. The acquisition also faces scrutiny from the House Oversight and Government Reform Committee, which has announced plans to question representatives of both the FDIC and current and former SEC officers in what may be an attempt to ascertain what, if any, role the government had in pressuring Bank of America to complete the acquisition. Judge Rakoff noted that "lurking in the background" are suggestions that Bank of America was pressured by the government to complete the acquisition when it might otherwise have walked away after learning that Merrill Lynch's losses were far greater than what was represented during negotiations. Key Takeaways Although this case stems from the unique and high-profile fact pattern arising out of Bank of America's acquisition of Merrill Lynch during the height of the financial meltdown of 2008 (with the considerable involvement of, among others, the Federal Reserve), it holds several lessons for companies and their outside counsel generally in their M&A deals. Among the key takeaways are the following: - Full and accurate disclosure of all material items and financial arrangements with a target remains crucial (including information contained in schedules to a transaction document). In addition, consideration of what is required to be disclosed is very fact specific and can become a highly political issue. In this instance, Judge Rakoff noted as particularly relevant the size of the undisclosed bonuses, which represented approximately 12 percent of the total deal consideration. Of course, the size of bonuses as a percentage of the deal consideration was influenced by the fact that Merrill's equity value had declined substantially in light of the market decline in the fall of 2008—at the time the deal closed, Merrill was trading at about $11 per share, but a year earlier (when the company began reserving for its year-end bonuses) the company's stock price was more than $50 per share, and Merrill had traded as high as $93 per share in 2006. Thus disclosure must be considered in a holistic and timely fashion, so that current issues are addressed. This is particularly true when the issue in question involves executive compensation or other hot-button issues in today's governance and political environments.
- In a rare circumstance, the fact that information is publicly available may not be enough to satisfy a court. Although generally courts have looked at the total mix of information in the marketplace to determine whether disclosure is accurate, Judge Rakoff held that public information about underlying facts—even if accurate—was not sufficient to correct what he found to be (at least according to the SEC's allegations) the false statements by Bank of America in its proxy statement.
- When considering disclosure issues, one should keep in mind the new financial and regulatory environment. Judge Rakoff's scathing opinion and unusual rejection of a consent judgment reflects that potential settlements with the SEC may garner more scrutiny than has previously been commonplace. Some of the reasons given by the court in rejecting the settlement (for example, why would the bank settle when it believes it is not guilty?) ignore the fundamental realities that all parties consider when threatened with litigation, particularly when the potential adversary is the SEC or another governmental agency. Judge Rakoff's opinion in this case has potentially significant implications for all parties involved in a merger, including outside directors and even counsel who are not typically targets of regulatory actions. In this case, for example, Judge Rakoff repeatedly has suggested that the SEC should consider seeking additional information from Bank of America's outside counsel. More broadly, New York State Attorney General Cuomo is seeking the testimony of several of the bank's former outside directors, intending to question them about the disclosures made by Bank of America. The potential impact of this type of environment remains to be seen.
Please contact the authors, your regular WSGR contact, or any member of our mergers and acquisitions or securities litigation practices with any questions you may have about this important decision and the potential implications it could have on your business or transactions in which you are involved.
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