Out of the frying pan and into the fire seems an apt description of SEC enforcement and the efforts to revive the program. While the agency is moving past the Madoff failures it may have jumped into another fire. This fire is called SEC v. Bank of America. There, the Commission claimed proxy fraud in connection with the acquisition by the bank of Merrill Lynch. To date, the court has refused to sign-off on the settlement as well as the initial explanations for the deal offered by the parties. More explanations are due.

Before the new explanations can be offered however, more questions have been raised. These come from the inquiry being conducted by New York AG Andrew Cuomo from a September 8, 2009 letter about the deal at the center of the SEC’s case to outside counsel for the bank. The letter reveals that Mr. Cuomo’s office has also been investigating the merger and what was told to shareholders. The inquiry has reached the point of making a charging decision. Investigators however, have in part been thwarted by what the letter calls the “indiscriminate invocation of the attorney-client privilege.” The assertions are blocking factual development on four key issues:

1) Pre-merger losses which were not disclosed. By November, the bank knew that Merrill anticipated pre-tax fourth quarter losses of nearly $9 billion which were expected to increase to over $14 billion before the shareholder vote on December 5, 2008. The losses were so significant that the bank sought guidance about the applicability of the material adverse change clause in the merger agreement. Yet, the losses were not disclosed, apparently based on advice from the bank’s general counsel. Privilege has been asserted.

2) Goodwill write downs prior to the merger vote that were not disclosed. By November it was known that Merrill would have to take a good will charge of more than $2 billion from sub-prime related losses. The write-off, however, was not taken until after the December shareholder vote. The charge was not disclosed based on legal advice give by in-house counsel. Privilege has been asserted.

3) The acceleration of the Merrill bonus payments based on changed standards was not disclosed. In November, Merrill decided to accelerate the payment of the bonuses at the center of the SEC’s case. In prior years, the broker had paid bonuses after year end based on results and performance. Here, Merrill changed the practice to pay the undisclosed bonuses prior to year end and based on a determination by an outside consultant who measured what more successful competitors were paying. The bank permitted Merrill to pay $3.6 billion in undisclosed bonuses. The payment was approved on December 8, 2008. The bank’s justification for this is that the proxy materials were prepared by outside law firms. Privilege has been asserted.

4) Post vote losses which were not disclosed. Shortly after the shareholder vote, the bank furnished its regulators with updated financials showing that Merrill expected losses would be $21 billion. Those losses would impact the bank’s shareholders for two or three years, according to Bank of America officials. The decision not to disclose these facts was made by counsel. Privilege has been asserted.

The New York AG appears to be struggling with the same difficulty the SEC encountered in its investigation: the facts can not be determined because of privilege assertions. At the same time the bank’s defense is advice of counsel. The Commission stopped and tried to settle the case, apparently content to take what it could get.

Mr. Cuomo’s office has not stopped. The letter to Bank of America’s counsel challenges the privilege assertions, noting that “[w]e cannot simply accept Bank of America’s officer’ naked assertions that they sought and relied on advice of counsel in good faith, and that, therefore, they should not be charged.” The letter goes on to state that it is inappropriate for the bank to claim it is relying on advice of counsel and then assert privilege. This is the same position penned by Judge Rakoff in his August 25, 2009 order in the SEC’s case, discussed here.

The critical question here is why the SEC chose to fold its tent and not challenge the bank as Mr. Cuomo’s office has done? To be sure, the New York AG has the advantage of Judge Rakoff’s order. That, however, is not the point. The fact that one cannot rely on advice of counsel and assert privilege is well established as the citations in the letter reflect and Judge Rakoff noted. If the SEC had questions about the privilege assertions, it could have sought a ruling from a court. It did not. This left critical questions concerning what the SEC claims is lies to the shareholders unanswered, why it happened and who may be responsible.

Perhaps the SEC has good answers to these questions. Perhaps those answers will come in the next round of briefs that will be submitted to Judge Rakoff. For now, however, the SEC seems to have jumped from the Madoff frying pan with its late Friday evening release of the Inspector General’s report, only to land in the fire of Bank of America with new questions about SEC Enforcement. These questions are not about the past, however. Rather, they are about the present and the future.

FCPA Seminar

On September 10, 2009 from 12:00 to 1:30 p.m. the ABA will sponsor the Second Annual seminar on the FCPA. The program features a discussion of current enforcement trends by senior DOJ and SEC officials and provides guidance on compliance by expert in-house counsel. For more information please click on the link below.