Thursday, October 4, 2012

BofA $2.4B settlement re Merrill

On Sept. 28, 2012, the parties in the Bank of America consolidated securities class action reached an agreement to settle the action for $2.425 billion and Bank of America's agreement to institute certain corporate governance policies.  According to this source, individual defendants will pay nothing.

I am going to divide this entry into two parts A. The Litigation [lengthy for the reader to get a good feel of the situation] and B. My analysis.

A. The Litigation

The Bank of American Securites Litigation website gives this information:
The State Teachers Retirement System of Ohio, The Ohio Public Employees Retirement System, The Teacher Retirement System of Texas, Stichting Pensioenfonds Zorg en Welzijn, represented by PGGM Vermogensbeheer B.V., and Fjärde AP-Fonden are Court-appointed Co-Lead Plaintiffs and are represented by lead counsel Kessler Topaz, Bernstein Litowitz, and Kaplan Fox in this securities fraud class action arising out of the merger between Bank of America Corp. ("BoA") and Merrill Lynch & Co ("Merrill") announced on September 15, 2008 and that closed on January 1, 2009.  
On September 25, 2009, Co-Lead Plaintiffs filed their Consolidated Amended Class Action Complaint (the "CAC"). The gravamen of the CAC is that, throughout the Class Period, Defendants violated the federal securities laws by making a series of highly-material false statements and omissions concerning: (1) Defendants' secret agreement to allow Merrill to pay, on an accelerated basis and prior to the close of the Merger, up to $5.8 billion in bonuses to its executives and employees; (2) Merrill's undisclosed losses, which were in excess of $15 billion during October and November 2008 alone; (3) BoA's own unprecedented losses; (4) the internal debate prior to the shareholder vote on the Merger amongst senior BoA officers concerning invoking the material adverse change clause ("MAC") in the Merger agreement, as a result of Merrill's massive losses; (5) BoA senior management's decision to invoke the MAC within days of the shareholder vote; (6) BoA's agreement to proceed with the Merger only after the Secretary of the Treasury threatened to fire BoA's senior management and the Board if they invoked the MAC; and (7) the $138 billion taxpayer bailout BoA required to close the Merger.The truth about Merrill's financial condition and its materially adverse impact on BoA was not revealed until January 12, 2009, and investors did not learn of the massive taxpayer bailout until January 15. 
On January 21, 2009, investors finally learned that despite Merrill's staggering losses, BoA had allowed Merrill to pay $3.6 billion in bonuses before the merger closed. As these facts became known, the price of BoA common stock plummeted from $12.99 per share to a low of $5.10 per share, causing a market capitalization loss of approximately $50 billion.  
The plaintiffs' attorneys website says this:
The Class consists of all persons and entities who (i) held BoA common stock as of October 10, 2008, and were entitled to vote on the Acquisition, (ii) purchased or otherwise acquired BoA common stock from September 18, 2008 through January 21, 2009, inclusive, excluding any shares of BoA common stock acquired by exchanging Merrill stock for BoA stock through the Acquisition, (iii) purchased or otherwise acquired January 2011 call options on BoA common stock from September 18, 2008 through January 21, 2009, inclusive, or (iv) purchased BoA common stock issued under the Registration Statement and Prospectus and October 7, 2008 Prospectus Supplement of BoA, in the common stock offering that occurred on or about October 7, 2008, and were damaged thereby. 
* * *
Following the shareholder vote, but before the Acquisition closed on January 1, 2009, Defendants continued to conceal numerous additional highly material facts from shareholders, including that (i) almost immediately after the shareholder vote, BoA decided it had grounds to terminate the merger because of the magnitude of Merrill's losses; (ii) senior federal regulators had threatened to terminate Defendant Lewis and BoA's Board unless they agreed to proceed with the merger, thus placing these Defendants under an irreconcilable conflict of interest; and (iii) in order to consummate the merger, Defendant Lewis asked for and received a highly-dilutive $138 billion taxpayer bailout to prevent BoA's own collapse.

The truth about Merrill's financial condition and its materially adverse impact on BoA was not revealed until mid-January 2009, when BoA announced that Merrill had suffered a loss of more than $21 billion during the fourth quarter of 2008 and, as a result, BoA had sought and accepted a $138 billion taxpayer bailout. On January 21, 2009, it was further reported that, despite Merrill's staggering losses, BoA had allowed Merrill to pay $3.6 billion in bonuses before the merger closed, ahead of Merrill's normal schedule, thus ensuring that Merrill's value and financial condition were depleted even further.

As these facts became known, the price of BoA common stock plummeted from $12.99 per share to a low of $5.10 per share, causing a market capitalization loss of approximately $50 billion.
 The class action notice says:
On September 15, 2008, BoA agreed to acquire Merrill in a stock-for-stock transaction in which shares of Merrill common stock would be exchanged for 0.8595 shares of BoA common stock (the "Merger"). BoA and Merrill issued a Definitive Joint Proxy Statement to shareholders on November 3, 2008, and on December 5, 2008, BoA and Merrill shareholders voted in favor of the Merger. The Merger was consummated on January 1, 2009.
[Below are captions from the complaint and the entirety of Q]
A. BoA Hastily Seizes The Opportunity To Acquire Merrill, And Agrees To Pay A
Significant Premium For The Company

B. BoAAnd Merrill Secretly Agree To Pay Up To $5.8 Billion Of Bonuses To Merrill
Executives And Employees Before The Year-End

C. Lewis Presents The Merger To InvestorsWhile Concealing The BonusAgreement

D. During October And November 2008, Merrill’s Losses Grow To At Least $15.5
Billion Before The Shareholder Vote

E. BoA’s Senior Officers Were Fully Aware Of Merrill’s Staggering Losses Before The
Shareholder Vote

F. Internal BoA Documents And Sworn Testimony Establish That Defendants
Recognized That Merrill’s Losses Should Be Disclosed In Advance Of The
Shareholder Vote

G. As Merrill’s Losses Mount, Defendants Acknowledge That Disclosure Of Merrill’s
Losses Would Cause Shareholders To Vote Against The Merger – And Abruptly
Reverse Their Decision To Disclose The Losses

H. As The Vote Approaches, Senior Management Is Informed That Merrill’s Quarterly
Losses Will Exceed $16 Billion, And Ignores Repeated Entreaties To Disclose The

I. While Merrill Deteriorates, The Billions In Merrill Bonuses Are Finalized

J. BoAAnd Merrill Issue The Materially False And Misleading Proxy

K. Almost Immediately After Shareholders Approve The Merger, Mayopoulos Learns
That Merrill’s Pre-Vote Losses Are Materially Higher Than What He Has Been
Told, Seeks To Confront Price About That Discrepancy, And Is Immediately Fired

L. Lewis Secretly Decides To Invoke The MAC And Terminate The Deal, But Agrees To
Consummate The Transaction After Federal Regulators Threaten To Fire Him

M. With BoA Unable To Absorb Merrill’s Losses, Lewis Secretly Seeks And Receives
An Enormous Taxpayer Bailout

N. Internal BoA Emails Establish That, At The Same Time BoA’s Senior Officers
Decided Not To Disclose The Bailout Prior To The Merger’s Close, They Internally
Acknowledged That The Market Was Being Misled As To Merrill’s True Financial

O. The Merger Is Consummated While Defendants Lewis And Price Continue To
Conceal Merrill’s $21 Billion Of Losses, The $3.6 Billion In Bonuses Paid To Merrill
Executives And Employees, And The Taxpayer Bailout

P. The Prices Of BoA Securities Plummet As The Truth Emerges

Q. Post-Class Period Events
198. The fallout from the revelations described above has been immense, resulting in
additional civil and criminal investigations at both the federal and state levels. In addition to the
New York Attorney General’s investigation, which resulted in a complaint being filed on
February 4, 2010 against BoA, Lewis, and Price charging them with securities fraud, a similar
investigation was initiated by the Attorney General of North Carolina to determine whether,
among other things, Merrill and BoA had violated that state’s laws against fraudulent transfers
and civil racketeering. Neil Barofsky, the TARP Inspector General, also opened a probe.
199. Additionally, in January 2009, although it would not be disclosed to shareholders
until mid-July 2009, the Federal Reserve and the Office of the Comptroller of the Currency
downgraded the overall rating of BoA from “fair” to “satisfactory.” A letter sent by Federal
Reserve officials explaining the action criticized BoA’s management and directors for being
“overly optimistic” about risk and capital. As the letter explained, “Management has taken on
significant risk, perhaps more than anticipated at the time the acquisition was proposed,” and, as
a result, “more than normal supervisory attention will be required for the foreseeable future.” As
a result of these conclusions, in early May 2009, federal regulators imposed a “memorandum of
understanding” on BoA that, among other things, required it to address its problems with
liquidity and risk management.
200. On February 10, 2009, the New York Attorney General wrote a letter to Congress
providing details on Merrill’s accelerated bonus payments. The letter detailed how Merrill’s
accelerated bonus schedule had allowed it to disproportionately reward its top executives despite
its massive losses – actions which the New York Attorney General described as “nothing short of
staggering.” In particular, the New York Attorney General stated that:
While more than 39 thousand Merrill employees received bonuses from the pool,
the vast majority of these funds were disproportionately distributed to a small
number of individuals. Indeed, Merrill chose to make millionaires out of a select
group of 700 employees. Furthermore, as the statistics below make clear, Merrill
Lynch awarded an even smaller group of top executives what can only be
described as gigantic bonuses.
201. Among the statistics that the New York Attorney General set forth were that
(i) “[t]he top four bonus recipients received a combined $121 million”; (ii) “[t]he next four bonus
recipients received a combined $62 million”; (iii) “[f]ourteen individuals received bonuses of
$10 million or more and combined they received more than $250 million”; and (iv) “[o]verall,
the top 149 bonus recipients received a combined $858 million.”
202. On April 29, 2009, at the Company’s annual meeting, BoA shareholders voted to
strip Lewis of his position as Chairman of the BoA Board in a vote that analysts deemed a rebuke
to Lewis’s conduct in connection with the merger. BusinessWeek reported that the “vote marked
the first time that a company in the Standard & Poor’s 500-stock index had been forced by
shareholders to strip a CEO of chairman duties.” At the shareholder meeting, Lewis conceded
that BoA’s shareholders “have carried a heavy burden” as a result of the Merrill acquisition.
203. On May 7, 2009, the U.S. Government revealed results of certain “stress tests” of
large banks conducted by the Federal Reserve. BoA was deemed to need an additional $33.9
billion of Tier 1 common capital – far more than any other of the 19 banks tested.
204. Beginning in May 2009, several members of BoA’s Board of Directors resigned,
including its lead independent director, O. Temple Sloan Jr., and Jackie Ward, chairman of the
Board’s asset quality committee. Other departures included Chief Risk Officer Amy Woods
Brinkley, and J. Chandler Martin, an enterprise credit and market risk executive.
205. In June and July 2009, the Domestic Policy Subcommittee of the Oversight and
Government Reform Committee of the House of Representatives held a series of hearings on the
merger, with a particular focus on Lewis’s failure to disclose either Merrill’s mounting losses or
his arrangement to receive a Government bailout. During Lewis’s testimony on June 11, 2009,
Representative Dennis Kucinich told Lewis that, “Our investigation, Mr. Lewis, also finds that
Fed officials believe that you are potentially liable for violating securities laws by withholding
material information in your possession from shareholders before the vote to approve the merger
with Merrill Lynch on December 5th, 2008.” Representatives Peter Welch and Elijah Cummins
both repeatedly pressed Lewis on the lack of disclosure to shareholders. As Representative
Welch put it: “Did you tell your shareholders that you had come upon this information, that the
deal they voted on is not the deal that was going through, because they had a $12 billion hole that
was accelerating?”
206. On August 3, 2009, the SEC filed a complaint against BoA in the United States
District Court for the Southern District of New York, alleging that BoA had violated Section
14(a) of the Exchange Act by misleading shareholders about the Merrill bonus agreement. That
same day, the SEC announced that BoA had agreed to settle the action and pay a $33 million
207. As the SEC charged in its complaint, although the Proxy had stated that Merrill
would not pay year-end bonuses without BoA’s consent, in fact, BoA had already consented to
the payments as part of 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.
208. During the SEC’s investigation, Merrill’s most senior human resources executive,
Peter Stingi (“Stingi”), whose responsibilities included monitoring the annual bonus pay of
Merrill’s competitors, acknowledged that the compensation expense set forth in Merrill’s
financial statements did not disclose Merrill’s bonus plans. Specifically, Stingi testified under
oath that:
We would not be able to see what our competitors’ quarterly [bonus] accruals
were because they like us would report their compensation and benefits expense
[as an aggregate] . . . . [Y]ou really couldn’t make a very exact guess about what
the impact on the annual bonus funding was because there are so many other line
items that go into the aggregate expense.
209. The day after the SEC filed its complaint, Representative Kucinich wrote to Mary
Schapiro, Chair of the SEC, to “request that the SEC expand its investigation into possible
securities law violations committed by Bank of America in connection with its merger with
Merrill Lynch.” Representative Kucinich explained that the House of Representatives’ Domestic
Policy Subcommittee of the Oversight and Government Reform Committee had “reviewed over
10,000 pages of confidential documents obtained from the Federal Reserve” and that “our
investigation has revealed . . . [t]op staff at the Federal Reserve had concluded that Bank of
America knew, as early as mid-November, about a sudden acceleration in the losses at Merrill
Lynch, and [Federal Reserve] General Counsel Scott Alvarez believed that Bank of America
could potentially be liable for securities laws violations for its failure to update its proxy
solicitation and public statements it had made about the merger in light of information Bank of
America possessed about Merrill’s deterioration before the shareholder vote.”
210. On September 8, 2009, the New York Attorney General sent a letter to BoA’s
outside counsel, which summarized the results of the New York Attorney General’s investigation
and stated that it was in the process of “making charging decisions with respect to Bank of
America and its executives.” The letter provided that, “The facts of [Merrill’s] cascading losses
and bonus payments – and the facts of Bank of America’s senior executives’ knowledge of these
events – are straightforward.” The letter further provided that, “Our investigation has found at
least four instances in the fourth quarter of 2008 where Bank of America and its senior officers
failed to disclose material non-public information to its shareholders,” and did so knowingly,
including their failure to disclose (i) at least “$14 billion” of Merrill’s “losses prior to
shareholder approval of the merger,” about which “Bank of America knew”; (ii) “a goodwill
charge of more than $2 billion associated with sub-prime related losses,” which “was known of
by November” 2008 but nevertheless lumped into Merrill’s “purportedly ‘surprising’” losses
after the shareholder vote; (iii) Bank of America’s determination, “eight business days after the
merger was approved, that it had a legal basis to terminate the merger because of Merrill’s
losses,” which it reversed only “when the jobs of its officers and directors were threatened by
senior federal regulators”; and (iv) Merrill’s “accelerated bonus payments,” which “were not
disclosed in the proxy materials even though they clearly should have been under the
211. On September 14, 2009, the Honorable Jed S. Rakoff, United States District
Judge for the Southern District of New York, rejected the proposed $33 million settlement of the
suit filed by the SEC against BoA. The Court held that the proposed settlement was “neither fair,
nor reasonable, nor adequate” because no senior BoA executives were sued or contributed to the
settlement. The Court found that the settlement violated the SEC’s “normal policy in such
situations [] to go after the company executives who were responsible for the lie,” and rejected
the SEC’s contention that it did not have grounds for bringing claims against senior BoA
officials, remarking, “How can such knowledge [of the falsity of the statements in the Proxy] be
lacking when, as the Complaint in effect alleges, executives at the Bank expressly approved
making year-end bonuses before they issued the proxy statement denying such approval?”
212. Following the Court’s rejection of the settlement, the SEC filed a second action on
January 12, 2010, which asserted claims against Bank of America for violating Section 14(a) by
failing to disclose Merrill’s “extraordinary” fourth quarter 2008 financial losses. On February 4,
2010, BoA and the SEC jointly moved for approval of a Final Consent Judgment to resolve both
of the SEC actions, submitting a Statement of Facts establishing that BoA’s senior officers were
aware of the bonus agreement and Merrill’s losses. Significantly, BoA admitted that the SEC
Statement of Facts has an evidentiary basis and agreed to pay a civil penalty of $150 million and
to implement certain corporate governance reforms.
213. On February 22, 2010, Judge Rakoff approved the proposed settlement of the
SEC actions. In his Order approving the proposed settlement, Judge Rakoff noted that “it is clear
to the Court” that:
(1) the Proxy Statement that the Bank sent to its shareholders on November 3,
2008 soliciting their approval of the merger with Merrill Lynch & Co., Inc.
(“Merrill”) failed adequately to disclose the Bank’s agreement to let Merrill pay
its executives and certain other employees $5.8 billion in bonuses at a time when
Merrill was suffering huge losses; and
(2) the Bank failed adequately to disclose to its shareholders either prior to the
shareholder approval of the merger on December 5, 2008 or prior to the merger’s
effective date of January 1, 2009 the Bank’s ever-increasing knowledge that
Merrill was suffering historically great losses during the fourth quarter of 2008
(ultimately amounting to a net loss of $15.3 billion, the largest quarterly loss in
the firm’s history) and that Merrill had nonetheless accelerated the payment to
certain executives and other employees of more than $3.6 billion in bonuses.
S.E.C. v. Bank of America Corp., 2010 WL 624581, at *1 (S.D.N.Y. Feb. 22, 2010).
214. The Court further determined that these omissions were material, holding that, “it
seems obvious that a prudent Bank shareholder, if informed of the aforementioned facts, would
have thought twice about approving the merger or might have sought its renegotiation.” Id. The
Court further found that, “based on careful review of voluminous materials,” including an
extensive ex parte review of confidential deposition testimony provided by the New York
Attorney General’s office, BoA and its officers acted at least negligently in making these
omissions, and specifically declined to make “any determination” of whether BoA and its
officers acted intentionally because that issue was neither before the Court nor necessary to its
decision. Id. at *3. While the Court noted that “a reasonable regulator” could conclude that BoA
and its officers acted negligently, the Court also found that the facts supported “plausible
contrary inferences” of intentional misconduct. Id.
215. On September 18, 2009, the Charlotte Observer reported that, for the prior six
months, the F.B.I. and the U.S. Department of Justice had been conducting an extensive
“criminal investigation” of BoA in connection with the merger. As part of this wide-ranging
investigation, BoA “provided hundreds of thousands of documents and dozens of hours of
executive time” to answer questions.
216. That same day, Bloomberg reported that, on September 17, 2009, Defendant
Thain gave a speech at the Wharton School of the University of Pennsylvania, during which he
made clear that BoA’s claim that it lacked control over the bonuses paid to Merrill executives and
employees was not true:
[W]hen [BoA] said, “John Thain secretly accelerated these bonuses,” they were
lying and that has now trapped them into a lot of trouble because there is a piece
of paper, there’s a document that says, yes, in fact they agreed to this in
September. So one take away for all of you is it’s really always better to just tell
the truth.
217. Then, on February 4, 2010, the New York Attorney General formally charged
BoA, Lewis, and Price with four counts of securities fraud under New York’s Martin Act,
General Business Law §§ 352 and 353. Specifically, the New York Attorney General alleged that
BoA, Lewis, and Price made a series of false and misleading statements and omissions
concerning, among other things, Merrill’s massive fourth quarter losses; BoA’s agreement to
allow Merrill to pay billions in bonuses on an accelerated basis before the merger closed, despite
Merrill’s financial performance; and the undisclosed $138 billion taxpayer bailout that BoA
required in order to complete the merger. Defendants did not move to dismiss the New York
Attorney General’s complaint and, instead, answered the allegations on August 18, 2010.

[End of extracts from complaint]

B. My analysis

1. Compensating losses

In this corporate mayhem, BofA did a stock offering at $22 a share and got $10 billion in its coffers.  In addition, during the period September 18, 2008 through January 21, 2009, there were untold billions of dollars of BofA stock, options and other securities that were bought and sold on the open market at inflated prices (i.e., prices that were higher than if the information about the Merrill losses and bonuses were publicly known).  The inflated prices that were paid went into the pockets of the sellers of the stock, and the buyers were in for the losses that would happen to them when the information became public and the BofA stock price went down.  Further, the BofA shareholders approved a merger in which the number of BofA shares received by Merrill shareholders for their Merrill shares was too high.  The Merrill shareholders got the benefit of this and the BofA shareholders were damaged to a corresponding extent from the merger.  After the merger the Merrill shareholders became BofA shareholders, and as BofA shareholders they held more BofA shares than they should have.  Further, the billions of dollars that were paid out as Merrill bonuses went into the pockets of the Merrill employees and were dollars that were drained from all the Merrill and BofA shareholders.

The $2.4 billion payment that BofA will make in the settlement is effectively coming from all the current BofA shareholders on an equal per share basis, including from current BofA shareholders who are members of the plaintiff class.  That payment will be allocated to members of the plaintiff class on the basis of some proportionality of the losses they experienced.  Former Merrill shareholders who received BofA shares in exchange for their Merrill shares in the merger are not members of the plaintiff class and will not have any portion of the payment allocated to them.  While those former Merrill shareholders will not receive any portion of the payment, they will be allowed to hold onto all the BofA shares they received in the merger.  This extra value the Merrill shareholders got will greatly exceed their share of the $2.4 billion payment and so they will have a net gain from the corporate wrongdoing.  .

BofA current shareholders who get allocated a share of the settelement payment have in part been a source of funds for that payment (i.e., to that extent they areeffectively making a payment to themselves).  Also there is deducted their share of the attorneys fees that the plaintiffs' lawyers will receive.  Some current BofA shareholders (who did not receive their shares in exchange for exchanging Merrill shares in the merger) will effectively contribute to the Settlement Payment but receive no allocated part of the Settlement Payment.

There is rough correspondence between the total losses in question and the sum of (i) the windfall gains received by all selling shareholders who sold their BofA shares during the period from September 18, 2008 through January 21, 2009 and (ii) the excess BofA shares received in the merger by Merrill shareholders.  There is effectively no recovery from the selling BofA shareholders and the former Merrill shareholders, and the total losses, increased by attorneys fees, will be arbitrarily shifted around..

2. Deterring future misconduct
Ohio Attorney General Mike DeWine is reported as saying. “Not only did we accomplish an excellent financial recovery, but other companies will look at the result here and think twice about not fully disclosing all necessary information to their shareholders.”

Another reported quote is “We believe the Settlement represents a landmark recovery for BAC shareholders who voted on the acquisition without complete and accurate information,” said Eloy Lindeijer, Chief Investment Management of PGGM Investments in the Netherlands. “The settlement sends a strong message to all companies concerning the paramount importance of conducting a fully‐informed shareholder vote on corporate acquisitions and mergers.”
In my view, reviewing the corporate mayhem that took place, I don't think this class action settlement will be any deterrent to officers and directors in other companies and other situations, and only criminal and civil liabilities imposed on the individual defendants will send any meaningful message to other officers and directors deciding to engage in corporate wrongdoing.

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