SETTLING BANK OF AMERICA: THE SEC HAS THE RIGHT FORMULA
The Wall Street Journal, in a Saturday editorial, claims SEC Chairman Mary Schapiro is some how inconsistent or perhaps disingenuous because of certain corporate governance procedures in the Commission’s proposed settlements with Bank of America. Somehow, the Journal cobbles those together with the Commission’s rule making agenda and a claimed lack of similar procedures at FINRA while Ms. Schapiro was there. Whatever the validity of this far fetched syllogism – and that is far from clear – it is readily apparent that the WSJ has totally missed the mark. Not only does the editorial neglect to discuss the underlying securities law violations and their impact on the shareholders, but perhaps more importantly, it fails to link those issues to the corporate governance which is, after all, the whole point.
The two SEC enforcement actions against Bank of America are about what shareholders were told and what they should have been told when they voted on whether to approve the acquisition of financially troubled Merrill Lynch by the bank. Two points in those cases are beyond dispute: First, the shareholders were not told that the bank and Merrill had agreed executives of the broker could be paid billions of dollars in bonuses. Thus shareholders did not know that in voting for the deal they were also approving huge bonuses for executives who steered the firm historic losses and near collapse. The fact that at the time of the shareholder vote there was wide spread concern and discontent about huge Wall Street bonuses might suggest that shareholder would have wanted to know those facts.
Second, shareholders were not given updated financial information about the brokerage firm’s fourth quarter performance. That information would have told shareholders that Merrill was piling up losses of historic proportions, running into the billions of dollars. Thus, shareholders did not know that in voting for the deal the value of the investment they were approving was plummeting precipitously compared to the financial information in the materials they were furnished. Again, investors may have found this information important when spending their money.
The SEC suits claim that shareholders should have been given the information about the bonuses and the financial condition of Merrill. Judge Rakoff’s inquires have sought to unravel who may have been responsible for these disclosure decisions and the basis for the different conclusions on individual liability reached by the SEC and the New York Attorney General in his suit. Regardless of the outcome of the court’s inquiries, any settlement of the two SEC enforcement actions should address the specific disclosure issues in the case and make sure that the wrongful conduct is not repeated.
For the SEC, charged by Congress with bringing a new ethics to the marketplace, the question should be how to make sure that the shareholders it claims were lied to in the Merrill acquisition get the information they need in the future. The huge fine proposed is supposed to address this question based on the notion that monetary sanctions equal deterrence in the future. This theory is dubious at best. The $30 million penalty in the initial settlement rejected by the court did nothing to halt the bank from insisting that its conduct was absolutely correct, a position which virtually ensured a replication of the claimed wrongful conduct in the future. There is little reason to believe that multiplying the size of the penalty for a huge financial institution like Bank of America will change its stance. The deterrence through big money payments theory, while perhaps appropriate in some cases, is best left to the criminal prosecutors who more typically invoke it.
What can protect shareholders in the future is the installation of procedures which focus on the key problems in the cases. Here, that is what shareholders were told when voting. While there are many ways to fashion appropriate remedial procedures to address this point, those contained in the proposed SEC settlement are keyed to these issues. They include:
• The retention of an independent auditor to review the Bank’s internal disclosure controls;
• New CEO and CFO certifications regarding the annual and merger proxy statement;
• Retention of disclosure counsel who will report to the Audit Committee;
• Adoption of a super-independence standard for all members of the Board’s compensation committee;
• Retaining a consultant to the compensation committee;
• Providing shareholders with a “say on pay;” and
• Implementing incentive compensation principles that will be disclosed on the bank’s web site.
To be sure there no set of procedures designed after the fact which can undo the harm caused. No set of procedures can take the shareholders back in time and tell them about the huge bonuses or the rapidly deteriorating financial condition of Merrill before the December 2008 meeting. At the same time, the procedures in the proposed consent decree do focus on the key issues disclosure and compensation issues in the case to make sure that in the future shareholders are given the proper information when they are required to vote. This is how the securities laws envision bringing a new ethics to the marketplace. Unfortunately the Journal, in an apparent spat of free market anti-regulatory zeal which seems to overlook what happened in these cases and the origins of the current market crisis, missed this critical point. Fortunately for shareholders, Ms. Shapiro and the SEC did not.