SEC v. BANK OF AMERICA: HOW THE DISCLOSURE DECISIONS WERE MADE
The latest SEC – Bank of America proposed settlement is pending before the court. The settlement would cover the two suits the Commission has pending against the Bank arising out of its acquisition of Merrill Lynch. The first suit alleged that shareholders were not told the truth in the proxy materials they were furnished for use on December 5, 2008 when the deal was approved by shareholders. Those materials misled shareholders, according to the SEC, about billions of dollars worth of bonuses which had been approved for Merrill employees. That suit, rejected in a scathing opinion by the court as discussed here, resulted in discovery that led to the second complaint.
There, the SEC claimed shareholders should have been provided updated financial information on Merrill in view of the billion dollar losses the broker was experiencing in the fourth quarter of 2008. The proposed settlement, discussed here, would resolve both cases. As the SEC filed papers seeking court approval of its settlement, the New York AG filed an action based on essentially the same facts which named two senior bank officers as defendants in addition to the bank as also discussed here.
A critical question raised by the Court in rejecting the initial SEC settlement focused on the reason that no individuals were named as defendants. Although the SEC filed an amended complaint in its first case and then a second complaint, it has steadfastly refused to name any individuals. The New York AG however named former bank CEO Ken Lewis and CFO Joseph Prices as defendants. Differentiating the actions based on the court papers is difficult at best. The Commission’s proposed settlement is supported by an unusual “Statement of Facts” which the bank acknowledges has a basis in the discovery record. It provides an overview of the BAC – ML deal. The New York complaint also contains a significant amount of detail, recording the history of the transaction.
While many of the events recorded by the SEC and the New York complaint are identical, and at times one set of papers fills gaps in the other, certain differences persist. First, the SEC maintains that it lacks evidence of scienter. In contrast, the New York complaint repeatedly notes that an individual “knew or was reckless or negligent in not knowing . . .” of a particular fact or event. Clearly there is a difference in standards.
Second, in some senses there is a difference of approach. Both the SEC Statement of Facts and the New York complaint contain a virtual blizzard of numbers regarding Merrill’s fourth quarter performance. All would agree Merrill was deteriorating and suffering billion dollar losses. At the same time, the SEC’s numbers tend to focus on net results, while the New York complaint frequently relies on pre-tax calculations, although it also contains after tax numbers.
Third, the Commission’s Statement of Facts tends to talk about estimates when referring to Merrill’s fourth quarter financial condition, although this is not always the case. The New York complaint stresses that the broker was making actual calculations of its financial position throughout the time period, although it also uses estimates. In some key instances, certain bank officials apparently did not realize the Merrill numbers were actual. This may have impacted their view.
Despite these differences, the basic chronology of the deal which emerges from the two sets of papers details a story of a bank acquiring a brokerage which was under substantial financial stress and incurring multi-billion dollar fourth quarter losses which were not disclosed to shareholder as they voted. Nor were those shareholders told of the commitment to pay billions of dollars of bonuses to the brokerage employees based on a new formula. The essential chronology, drawn form both sets of papers is as follows (the SEC papers are cited by reference to a paragraph while the New York complaint is cited “NY” followed by a paragraph number):
10/08 . A Form S-4 registration statement is filed. It incorporates the Bank of America and Merrill proxy statements. This becomes effective October 30, 2008. The materials state in part that there will be updates for any fundamental chance (7 – 10).
11/3/08. The proxy for the deal with a notice of special meeting for 12/5/08 is filed with the SEC. Incorporated are Merrill’s latest quarterly results which show a net loss for the quarter of $5.1 billion (11 – 12).
11/5. Neil Cotty, the bank’s chief accounting officer, forwards an e-mail to Mr. Price which attaches an estimate of the Merrill October results at $3.8 billion (15). According to the New York complaint, Merrill furnished numbers indicating a loss of $6.113 billion (NY). The difference appears to be pre- and post tax. Both documents agree the e-mail says “Read and weep.”
11/13. The bank’s then general counsel confers with outside counsel. In the discussions, the estimated after tax losses are in the $4 to $5 billion range. Both agree that the proper course is disclosure (NY 79 – 82). Following this, the bank’s GC did additional research on the issue to establish the range of Merrill’s prior losses (NY 85 – 86). This advice was not followed and the outside lawyers would later play a limited role on the issue (NY 92).
Mid-Nov. There were a range of opinions on disclosure, according to the SEC Statement of Facts. Messrs. Thain (CEO of Merrill) and Chai (Merrill CFO) believed that no disclosure was required because Merrill ordinarily did not disclose interim results. Merrill’s outside auditors apparently thought disclosure would be appropriate, although the broker’s in-house attorneys did not (17).
11/20. The bank’s GC met with Mr. Price and had outside counsel on the phone. As a result of this meeting, they concluded that no disclosure was required. The losses discussed in the meeting were only the after tax losses for October (NY 94 – 95). Outside counsel thought the numbers were for the quarter (NY 96).
End Nov. The Bank of America GC, Mr. Price and others consulted with outside counsel in view of a forecast $5 billion quarterly loss. After analyzing Merrill’s loses over prior quarters, the lawyers concluded that no additional disclosure was required. Mr. Price informed Mr. Lewis of this conclusion (18).
12/3. Messrs. Price and Lewis are aware that actual pretax losses at Merrill are about $11.043 billion without adding another $2.3 billion for a goodwill write-off. At the bank, they are estimating that the quarterly loss would be about $16.3 billion pretax or $10.4 billion after tax. Mr. Price met with the bank GC and told him that the losses were increasing, but were about $7 billion. The GC did not change his advice. He was not told that the losses were about $10.4 billion after tax, which is outside the range in which he believed the number had to be if it was not going to be disclosed. He was also not told that the numbers he was furnished were not estimates (NY 122 – 127). The SEC Statement of Facts records essentially the same facts (22 – 24). However, footnote 6 notes that the bank GC recalls the total number he was given was about $7 billion after tax while Mr. Price claimed it was $9 billion. Both numbers included certain “plug” assumptions made by the bank for other unaccounted for items.
12/4. The day before the vote Merrill losses were updated. The Merrill October and November losses were at $7.5 billion after tax. There was no consideration of disclosure (25).
12/5. Early on the morning of the shareholder vote the Merrill pretax losses based on actual numbers were $15.322 billion (136).
The New York complaint does not record how the decision was made not to disclose the approval of the bonuses. The SEC Statement of Facts however notes that an attorney working on the deal thought the bonuses did not have to be disclosed because they were not special transactional bonuses and were consistent with the prior year. Outside counsel did not actually discuss the issue with the bank (40).
Two days later an internal e-mail from Merrill’s then controller forwarded updated results to the bank. It showed a monthly loss of $5.8 billion pre-tax and noted “What a disaster!” (26). By then, the shareholders had approved the deal.