People of the State of New York v. Bank of America Corp, Kenneth Lewis, & Joseph Price – Examining the Martin Act & Securities Enforcement in New York State (Part III)

This is the final of three posts that addresses New York State Attorney General Andrew Cuomo’s suit against Bank of America, CEO Kenneth Lewis, and former CFO, and now president of Consumer, Small Business and Card Banking, Joseph Price.  Post I discussed the history of the settled SEC action against Bank of America, and it also presented a synopsis of New York’s Martin Act.  Post II summarized how past Attorneys General utilized the Martin Act in notorious cases of the past decade.  This post discusses the cause of action that the SEC had at its disposal, and then summarizes the Attorney General’s claims against BofA, Lewis, and Price.

A.        The Rule 14a-9 Cause of Action

In its complaints against BofA, the SEC alleged that the Company violated Section 14(a) of the ’34 Act and SEC Rule 14a-9.  15 U.S.C. § 78n(a); 17 C.F.R. § 240.14a-9.  Section 14(a) prohibits any person from “solicit[ing] any proxy or consent or authorization in respect of any security” in “contravention of rules and regulations the Commission may prescribe.”  15 U.S.C. § 78n(a).  Rule 14a-9 prohibits “any statement which . . . is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading . . . with respect to the solicitation of a proxy.”  17 C.F.R. § 240.14a-9. 

The Supreme Court has recognized an implied private right of action to sue under Rule 14a-9. See, e.g., TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438 (1976).  In addition to alleging a material misrepresentation or omission, a private plaintiff suing under Rule 14a-9 must prove materiality, loss causation, and transaction causation.  In 2009, Judge Posner of the Seventh Circuit affirmed that scienter is not an element in a private Rule 14a-9 suit.  Beck v. Dombrowski, 559 F.3d 680, 682-83 (7th Cir. 2009) (internal citations omitted).  A private plaintiff must establish injury and a causal connection to sustain an action for a Rule 14a-9 proxy violation.  See generally Stahl v. Gibraltar Fin. Corp., 967 F.2d 335 (9th Cir. 1992). 

B.        SEC v. Bank of America Corp.

The crux of the SEC’s second Complaint was that BofA failed to disclose “extraordinary financial losses at [Merrill] prior to the shareholder vote to approve a merger between the two companies.”  BofA filed its proxy statement the SEC and a registration statement, incorporating the proxy by reference, before the December 5, 2008 shareholder vote.  The proxy detailed Merrill’s losses at the end of September 2008.  “By the time of the December 5 shareholder meeting, however, [BofA] had become aware of $4.5 billion in net losses that Merrill had sustained in October and estimated that Merrill had experienced billions of additional losses in November . . . .”  Thus, by allegedly failing to disclose fully the issues with Merrill, BofA “kept shareholders in the dark.”

The SEC alleged that BofA violated Section 14(a) and Rule 14a-9 by omitting the fundamental and material changes that Merrill’s deteriorating financial condition represented.  BofA settled with the SEC by paying a $150 million fine and agreeing to  injunctive relief, including stronger corporate governance practices.

In his February 22, 2010 Opinion and Order approving BofA’s settlement with the SEC, Judge Rakoff compared the SEC’s view of BofA’s alleged non-disclosures with the New York State Attorney General’s view: “A parallel investigation by the Attorney General of the State New York (conducted, perhaps ironically, by a former high-ranking official of the S.E.C.) reached a more sinister interpretation of what happened.”  Judge Rakoff approved the settlement while noting that Attorney General Cuomo’s suit may lead to different results.  “It is important to emphasize . . . with respect to all the events that the Attorney General interprets so very differently from the S.E.C., that the Court is not here making a determination as to which of the two competing versions of the events is the correct one (an issue not before the Court).” 

C.        Cuomo’s Suit Against BofA, Lewis, & Price

Judge Rakoff reviewed significant evidence in both of the matters and “conclude[d] that none of the evidence [from Attorney General Cuomo’s office] directly contradicts the Bank’s assertion” as to why it fired abruptly its General Counsel in December 2008.  “This is not to say that plausible contrary inference might not be drawn.”  Attorney General Cuomo viewed the abrupt termination of General Counsel Timothy Mayopoulos as proof that BofA believed Mayopouls “knew too much” about BofA intentionally concealing Merill’s losses.  The Attorney General’s Complaint alleges essentially the same facts as those alleged by the SEC, but Cuomo expands upon those facts and alleges that Lewis and Price, who were not named by the SEC, are responsible for the non-disclosure of Merrill’s losses. 

He further alleges that BofA and its executives knew—before the December 5, 2008 shareholder vote—about the issues at Merrill and relied on day-to-day reports on Merrill and met with top Merrill executives.  Merrill, allegedly, was transparent with BofA.  Attorney General Cuomo alleges that Lewis and Price, “knew or were reckless or negligent in not knowing of losses” at Merrill.  While this form of pleading would likely not survive the federal pleading standard required in private Rule 10b-5 actions, given the Martin Act’s broad ascription to the meaning of securities fraud, Attorney General Cuomo has greater powers than the SEC had at its disposal.