When CNBC interrupted the banter of its morning hosts on Aug. 3 with "breaking news" that the Securities & Exchange Commission had filed charges against Bank of America (BAC), the first reaction was that an imminent showdown between the SEC and the bank would push its embattled CEO, Ken Lewis, a step closer to the exit. Already shareholders had voted to strip Lewis of his chairmanship and federal regulators had imposed tough sanctions that required BofA to overhaul its board, tighten up its risk management and lending practices, and give the government a clear succession plan—a move that by itself suggested the government was losing patience with Lewis. The prospect of a battle with the SEC—which was alleging that the bank had failed to inform investors about nearly $6 billion in bonuses that Merrill Lynch was paying top executives on the eve of its takeover by BofA—would seem to be the last straw for Lewis.
By day's end, many analysts and securities lawyers were asking a different question: Is that all the SEC has?
For one thing, the spectacle of an SEC vs. Bank of America legal drama was immediately dashed when the SEC filed its suit and revealed that the Charlotte-based bank had already agreed to settle the charges, largely by paying a $33 million penalty. A number of securities lawyers who looked into the lawsuit's details were underwhelmed, concluding that the case was brought more to satisfy populist outrage about executives at bailed-out banks who have pocketed large bonuses than to punish egregious behavior.
"Kid Gloves Instead of Boxing Gloves" That's because some of the information that the SEC said Bank of America failed to disclose in the proxy statements mailed to shareholders isn't usually disclosed—and probably wouldn't have changed shareholders' minds about the deal. "If 'executive compensation at bailout recipients' wasn't such a hot issue, I don't think this case would have been brought," says Jay Brown, a corporate governance expert at the University of Denver's Sturm College of Law. "When you read this case, it feels like [SEC officials] were trying to meet a public need."
Jacob Frenkel, a former senior counsel in the SEC's enforcement division, agrees that "politically, the SEC had to bring this case…With the attention to the excessive bonuses paid to executives of financial firms, this was an 'in your face' material omission." But Frenkel, now a private attorney in Rockville, Md., also admits that critics will be underwhelmed by the SEC's modest actions against BofA. "There's a perception that the SEC enforcement staff uses kid gloves instead of boxing gloves when it investigates major corporations—and this case does nothing to change that perception."
At the heart of the issue is whether BofA executives knew after they agreed to acquire Merrill Lynch last September that Merrill's board was planning to pay out $5.8 billion in yearend bonuses to top executives, even as the Wall Street firm was on the brink of reporting $27 billion in losses for the fourth quarter—far more than BofA executives and Wall Street analysts were expecting. In the proxy statement that was mailed to shareholders, Bank of America said that Merrill wouldn't pay executive bonuses before the deal closed, except as set out in a schedule—which, the SEC contends, BofA had already drawn up weeks earlier. When the bonuses came to light last January, Bank of America at first said it was powerless to stop the payouts since it didn't yet own Merrill Lynch, then said it was blindsided by the magnitude of Merrill's problems.
Merrill Bonuses: Standard Procedure? But in its lawsuit, SEC attorneys contend that BofA officials were intimately aware of the bonuses—and even recommended the amount that Merrill officials paid out in the bonus pool, as well as the bonus portions that would be paid in stock rather than cash. More to the point, SEC attorneys argued that Lewis and his team had an obligation to apprise investors of the payouts in the proxy materials mailed out ahead of the shareholder vote in early December, since the bonus totals constituted 12% of the effective $50 billion purchase price. "Shareholders need to have all the material information when they're voting on a merger," David Rosenfeld, associate director of the SEC's New York regional office, told BusinessWeek. "The fact that Bank of America had agreed for Merrill to pay billions in bonuses is something investors would have needed to know."
According to the SEC suit, Bank of America's formal merger contract restricted Merrill Lynch from paying bonuses without BofA's approval—which BofA provided in a separate, undisclosed contract that outlined the acceptable size of the bonus pool. But Brown, the governance expert, argued that shareholders should have expected that Merrill Lynch would pay out yearend bonuses because it's been standard practice on Wall Street for decades. He further notes that the annual bonuses Merrill paid out last December were roughly 40% less than the size of the 2007 bonus pool and thus were not out of line with prior practice. "I think investors would have reasonably expected that Merrill would have paid bonuses before the deal closed," he said.
Some industry watchers believe that the question of whether BofA was complicit in the bonuses pales against the bigger question surrounding the BofA-Merrill merger: Should Bank of America executives have disclosed to shareholders ahead of the vote the growing problems at Merrill—as well as their increasing qualms about the deal? More important, did Treasury Dept. officials browbeat Lewis into going through with the deal—and not disclosing the extent of Merrill's problems? "That's the issue that was more important for shareholders—what did Bank of America know about Merrill's problems and when did they know it? And were they coerced by the government not to talk about it?" notes Bert Ely, a veteran banking industry consultant in Alexandria, Va.
Lewis Is Hardly Off the Hook While most analysts believe Bank of America struck the settlement just to move forward, the matter isn't likely to go away. Rosenfeld said the government's investigation is continuing—which suggests that the SEC could be looking into whether individual charges should be brought against any executives from BofA or Merrill. While Rosenfeld wouldn't comment on the ongoing probe, analysts speculate that the government could be looking into whether Merrill Lynch executives hid the scope of the firm's problems until after the deal was too far advanced for BofA to abandon it.
Questions will continue to swirl around Lewis' fate. While some Wall Street analysts argue that he will survive the latest controversy—Rochdale Securities analyst Richard X. Bove assured clients in a memo that Lewis still enjoys the support of his board and Wall Street and "is clearly the best person to run Bank of America"—the CEO's power is no longer absolute. On July 31, BofA disclosed that three more directors were stepping down, bringing the number of board departures this year to 10. And the SEC's confirmation that BofA was dictating the size of the Merrill bonus pool—despite Lewis' claims to the contrary—will give ammunition to the CEO's congressional critics, who feel the BofA chief has dissembled on several key issues and lacks credibility.
Less than two hours after the SEC settlement was disclosed, Lewis announced a further shakeup of the bank's management team—which, the CEO said, puts "all the pieces of the puzzle in place to be the leading financial-services firm in the world." The moves include the exit of consumer banking chief Liam McGee, who until recently had been considered among the candidates to succeed Lewis. Coming aboard: former Citigroup (C) executive Sallie Krawcheck, who joins as head of BofA's global wealth and investment management group. Krawcheck—described by one money manager as "the most honest person on Wall Street"—replaces Brian Moynihan, who moves over to run consumer banking. The new assignment means that Moynihan will now have experience running all of BofA's major product groups, and some analysts think he appears to be the executive most likely to succeed Lewis. How soon that day comes remains to be seen.
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