ANOTHER BLACK EYE FOR SEC ENFORCEMENT

The court rejected the proposed settlement in SEC v. Bank of America in part because the truth about what happened had not emerged. The SEC essentially said it could not find the truth, claiming the bank asserted privilege. The bank claimed it told the truth to its shareholders in the proxy materials used to secure approval of the Merrill Lynch acquisition, but it was not telling who made the decision or how it was made to omit the schedule the SEC claimed should have been included which listed the bonuses.

Now it appears that the truth is about to emerge, or at least some of it. Bank of America has reached an agreement regarding the production of privileged material with the New York Attorney General’s office in its investigation which parallels that of the SEC. Under the agreement, the bank will waive privilege and produce documents on five topics: 1) disclosures to be made in or omitted from the proxy statement; 2) the bank’s consideration of whether to invoke the material adverse change clause in the acquisition agreement; 3) the disclosure or non-disclosure of any matter relating to any potential impairment of goodwill of Merrill Lynch in the fourth quarter of fiscal year 2008; 4) the public disclosure or non-disclosure prior to the merger of the financial performance, forecasts, and/or preliminary and interim results of Merrill Lynch for the fourth quarter; and 5) the bank’s communications with federal regulators regarding the terms of federal assistance in connection with the merger.

While this agreement is with the New York AG, it will inure to the benefit of the SEC. The letter specifically states that “[b]ecause Bank of America has decided to reconsider its position with respect to your investigation, it will also produce privileged information to federal regulators . . .” If indeed the truth now emerges, perhaps it will set the stage for a settlement of SEC v. Bank of America.

Even if the case settles, a key question will remain: Why was the New York AG is able to secure an agreement to obtain the critical information when the SEC could not? The SEC has all the tools to obtain evidence necessary to its investigations. The Commission cannot of course obtain privileged material. In rejecting the settlement in the SEC’s case however, the court virtually dismissed out of hand the Commission’s suggestions that privilege blocked its investigation. Now Mr. Cuomo has obtained by agreement what the SEC claims it could not obtain.

What is befuddling about the SEC’s position is not that it failed where Mr. Cuomo succeeded. Clearly the New York AG had the benefit of the opinions in the SEC’s case. The troubling aspect of the SEC’s investigation is that the agency appears not to have even tried to obtain the material. Its papers do not suggest that it confronted the bank on the question of producing materials about the decision to omit the critical schedule from the proxy materials. No subpoena enforcement action was filed. In sum, it appears that the agency simply rolled over when the bank said it could not have the documents or the testimony.

Now it appears that the New York AG can do what the SEC will not even attempt. This is yet another black eye for the SEC and its enforcement program. How many more will it take before enforcement is rejuvenated or the agency is dismantled?

IS IT TIME TO SETTLE SEC v. BANK OF AMERICA?

The SEC and Bank of America are preparing for a trial on the proxy fraud case, discussed here. Pretrial orders are being filed. The SEC has demanded a jury. The Commission and the Bank are both undoubtedly deep in trial preparation. Neither wanted a trial. There seems to be no way out.

Previously the court rejected a proposed settlement as discussed here. In an order critical of both SEC enforcement and the bank, the court directed the case to trial. The critical question remains: Is it time to settle SEC v. Bank of America?

The stakes are high. Too high for either side. The SEC it appears to have taken a quick settlement with a nice size fine after caving into dubious defense tactics from a big market player. The settlement brings back the often repeated claim that the Commission only picks on the little guy while essentially giving big players a pass. To be sure the SEC can argue that a $33 million fine is not chump change. At the same time, it is not even a down payment on the bonuses its complaint claims the bank lied about.

Equally clear is the fact that the fine had zero deterrent effect. If there was any doubt about it, Bank of America made this clear. The bank not only did no wrong, it is right, according to its papers. The $33 million is a convenience fee paid to make the nuisance (sorry, is that SEC enforcement?) go away. The SEC tried to go away. Not pretty. The bank wanted them to go away. Unrepentant. The judge said no.

For the SEC there is no way to win. At best, it cannot lose. If the Commission prevails at trial, it will only happen because the court made it. The critics will remain. They will claim, with much justification, that this is not the rejuvenated enforcement promised by Chairman Schapiro and her new enforcement director. A loss could seriously compromise the program and undermine the previous Section 21(a) report the SEC claims warned registrants against the kind of conduct here.

For Bank of America the stakes are equally high. The bank has thumbed its nose at the SEC. From the first, it has boldly asserted did nothing wrong. Not including the schedule listing the bonuses is not fraud the bank says, but standard corporate practice despite the SEC’s earlier guidance to the contrary. Indeed, that guidance is entitled to virtually no weight the bank asserted. Throughout this case, the bank has refused to take any intermediate position or in any manner acknowledging that the SEC may have a point, but it has defenses. The fine was paid simply to buy peace and for no other reason, the bank has flatly stated. The harsh position puts the SEC in a corner. It also puts the bank in a corner.

At the same time, a loss for the bank is unthinkable. That would mean a finding that the bank defrauded its shareholders. That finding would say the bank lied to those whose money and interest it manages and has an obligation to protect. For a banking institution which operates on trust it is hard to imagine a worse finding.

The liability for the bank will not stop with the SEC, however. There are parallel class actions just waiting with plaintiffs’ lawyers cheering for the SEC to prevail. If the agency wins, the summary judgment motions will be filed the next day as those plaintiffs’ lawyers will start calculating damages.

If the SEC cannot afford to lose and the bank cannot afford to lose, how does it end? Settlement. A meaningful settlement. That starts with the conduct. A critical component of SEC enforcement is not just to identify and halt violations, but to ensure that they do not happened again. Here, according to the SEC, the shareholders were defrauded, lied to when they went to vote on a huge merger that will impact the value of their holdings for years.

Beyond the standard injunction, which of course it the starting point, perhaps the SEC should demand that the proxy process at the bank is reformed. Perhaps the SEC should consider requiring that the bank implement its prior Section 21(a) report on this point and take steps to ensure that shareholders are told all the salient facts in the future by the bank. Perhaps the SEC should make sure that shareholder democracy does not mean hunting across the internet to find the key facts as the bank claims they could have done here to find out about the bonuses. If this is standard practice as the bank claims, and this spells fraud for the shareholders as the SEC claims, then the Commission should demand remedial that provide a meaningful remedy for the shareholders.

As part of this process, the bank will have to identify the officers that made the critical decisions, or at least delegated it to the outside lawyers and let the proxy process go forward in a manner the SEC has described as wrong. Since the bank has relied on a defense which asserts that a key corporate decision was delegated to the lawyers who then made it in a privilege setting, it is clear the institution had relied on counsel. Regardless of the merits of the bank’s argument on this point during the investigation, in litigation that choice results in a waiver of privilege. In view of that waiver, the facts about the who, what and when of the decision should emerge. Whether this ultimately means that there will be liability for any individual is a function of those facts.

Another key component of any settlement is the adherence by the bank to the SEC’s regulations regarding comments by a defendant about a settlement. Under those regulations the defendant is not permitted to deny the facts in the complaint. The bank should adopt this position not just because the SEC requires it, but in its own interest.

Finally, forget the fine. It is meaningless here. If the SEC is right, the shareholders here have paid enough. In any event, the bank’s conduct clearly demonstrates that no fine will be meaningful.

The court’s prior orders suggest it will accept this settlement. The court’s concern has been that the truth did not emerge in the investigation and that the settlement was meaningless or worse, a waste of shareholder and taxpayer money. The type of settlement proposed here should meet those concerns. It will also extricate the SEC and the bank from a no win position for both. Then, the reform of SEC enforcement can begin in earnest.

Seminars

Webcast on FCPA trends at noon on October 13, 2009
http://westlegaledcenter.com/program_guide/course_detail.jsf?courseId=21854662

ABA National Institute: Securities Fraud

October 15 & 16, Washington, D.C.