Securities: Court Reluctantly Accepts Settlement in SEC Suit against Bank of America

Judge Jed Rakoff of the U.S. District Court for the Southern District of New York has reluctantly accepted a proposed global settlement of two Securities and Exchange Commission cases against the Bank of America. The settlement requires BofA to pay $150 million in penalties. The two matters revolved around BofA's acquisition of Merrill Lynch & Co. in late 2008. The first matter addressed the failure of BofA to disclose to shareholders the Bank's agreement to allow Merrill to pay $5.8 million in bonuses at a time when the brokerage house was suffering huge losses. The second case involved the failure of the bank to disclose to shareholders the fact that Merrill suffered a fourth quarter 2008 loss of $15.3 billion and had accelerated bonus payments of $3.6 billion to certain executives. The court had previously rejected a proposed settlement of the undisclosed bonus case as "neither fair, reasonable, adequate nor in the public interest. . . ."

There are two aspects to the current settlement. The first and less controversial is the requirement of remedial action by BofA to ensure that the same disclosure failures do not reoccur. The second aspect, and much more controversial one, is the payment of the penalty by the bank.

The remedial measures included the following: 1) an independent auditor to access BofA's accounting controls and procedures for the next three years, 2) an independent disclosure counsel to report to BofA's audit committee on the adequacy of public disclosures for the next three years, 3) an outside compensation expert to advise an independent board of directors compensation committee as to the terms of executive compensation for the next three years, and 4) the submission of executive compensation recommendations to shareholders for a nonbinding approval vote. The $150 million in penalties is to be paid by BofA to an SEC "fair funds" account for disbursement to BofA shareholders at the time of the Merrill acquisition.

As a threshold matter the court had to decide whether the proposed settlement had a reasonable basis in fact for concluding that the nondisclosures of the bank and its officers were the result of negligence rather than being intentional or reckless. The court reviewed a 35 page statement of facts and a supplemental 13 page statement of facts. Additionally, Judge Rakoff obtained from the New York State Attorney General deposition testimony that office used in bringing a fraud action under New York state law against the bank and two top officials. Without opining about whether the evidence gave greater support to the SEC's negligence theory or the AG's fraud theory, the court ruled that the SEC's negligence conclusion had evidentiary support and was not therefore irrational.

After determining that the factual basis was not irrational, the court had to decide whether the proposed settlement is "fair, reasonable, adequate, and in the public interest." Referring to the remedial measures, Judge Rakoff called them "helpful, as far as they go." Moreover, he pointed out that the BofA decision makers and lawyers employed a working assumption of not disclosing information "if a rationale could be found for not doing so." The remedial measures should help produce disclosure in the future when there is a question about whether or not to disclose information.

Judge Rakoff had the greatest difficulty with the penalty provision of the settlement. While the $150 million penalty is significantly greater than the $33 million proposed settlement that the court rejected earlier for the undisclosed bonuses case, Judge Rakoff considered the $150 million amount to still be modest since it included both cases. More importantly, the court said that assessing the fine against BofA rather than those responsible for the nondisclosures penalizes the shareholders who were the actual victims of the failures to disclose. While the decision that the monies will go to a "fair fund" account for payment to the victims of the nondisclosures is helpful, the court points out that it will only amount to pennies per share. Moreover, by not accessing fines against the persons responsible, a significant deterrent effect of the penalties is lost.

The court calls the proposed settlement "far from ideal." "While better than nothing, it is half-baked at best." Judge Rakoff writes that, if he were deciding the case "de novo," he would "reject the settlement as inadequate and misguided." However, the parties apparently pressed upon the court the fact that the law requires courts to give substantial deference to regulatory bodies, such as the SEC, in the areas of their primary responsibility. This factor coupled with the much more important consideration of the court's exercise of judicial restraint led Judge Rakoff grant the SEC's motion to approve the settlement, albeit with certain revised provisions.

The ultimate settlement of the case and the court's obvious concerns with the parties' settlement agreement raises a valid question of whether the SEC acted in the best interest of the BofA shareholders, the investing public in general, and the markets. It will be interesting to monitor the success of the New York Attorney General's fraud suit against the bank and two of its officers. If the AG is successful, that fact should raise question about the SEC's lack of aggressive law enforcement action against those responsible for BofA's disclosure failures.