The SEC, Public Pressure and a Case of Bad Timing for Bank of America

Last week, the SEC brought an action against Bank of America in connection with the bonuses paid to Merrill Lynch officials shortly before completion of the merger.  It was, however, a case of bad timing for Bank of America rather than real evidence of improper behavior.

So what did BofA do wrong?  Well, according to the Litigation Release, the case seemed to be a relatively straightforward case of misleading disclosure.

• The SEC alleges that in proxy materials soliciting the votes of shareholders on the proposed acquisition of Merrill, Bank of America stated that Merrill had agreed that it would not pay year-end performance bonuses or other discretionary compensation to its executives prior to the closing of the merger without Bank of America's consent. In fact, Bank of America had already contractually authorized Merrill to pay up to $5.8 billion in discretionary bonuses to Merrill executives for 2008. According to the SEC's complaint, the disclosures in the proxy statement were rendered materially false and misleading by the existence of the prior undisclosed agreement allowing Merrill to pay billions of dollars in bonuses for 2008.

The complaint, however, tells a more elaborate and slightly different story.  It turns out that the merger agreement contained a section on "Company Forbearances" that listed 18 actions that Merrill could not take "except as set forth" in the Exhibit to the Section unless first receiving permission from BofA.  In other words, the provision did not say bonuses would not be paid.  It said that they would not be paid without prior approval unless listed in the Schedule.  The Schedule was apparently not filed publicly. 

Thus, the market was made aware of at least the possibility of bonuses (in the undisclosed Schedule).  Moreover, the market knew that even if there was no present agreement, bonuses could be paid anytime Merrill and BofA agreed.  Add in that bonuses in the financial industry (large bonsues) were routine.  

What about the amount?  The agreement was to pay as much as $5.8 billion in discretionary bonuses.  Yet this was apparently a substantial reduction from prior years.  John Thain, the former CEO of Merrill, indicated that the pool was 41% less than in 2007.   In other words, the non-disclosure was that there was a possibility of bonuses that were dramatically lower than in the prior year. 

The routine (except for their low amount) and relatively unimportant nature of the payments can be seen from a number of facts in the case.  First, $4.5 billion had been expensed for 2008.  In other words, the financial statements already reflected the payments.  Second, BofA agreed to pay a premium of 70% for the shares of Merrill.  If the compensation was in effect draining Merrill of a substantial and unusual amount of cash, BofA would have factored that into the price.  The fact that BofA could offer a 70% premium illustrates that the bonus payments were routine and expected.

In short, the information about the bonuses wasn't material, at least with respect to the disclosure in the proxy statement.   

So why did Bank of America cave?  It gets an albatross off its back at a relatively insignificant price (a $33 million penalty).  This was not the time to fight the charges.  Moreover, the Commission did not bring a charge for fraud but alleged violations of the proxy rules which are negligence based.  Finally, while the release indicated that the investigation is continuing, it is significant that no individuals were charged.  In short, the continued investigation is likely against officials from Merrill Lynch. 

Of course, the decision by Judge Rakoff to hold a hearing today may alter the deal.  More likely he will approve the settlement, but only after delving further into the facts surrounding the payment of the bonuses.