What The Judge's Crushing Denial Of SEC/BofA Agreement Really Means

In a crushing memorandum order issued yesterday, a federal judge in Manhattan (the increasingly beloved-by-the-masses Jed S. Rakoff) denied the $33 million handshake agreement the SEC made with Bank of America to end the agency’s lawsuit related to the bank’s alleged failure to properly disclose bonus payments made to Merrill Lynch employees. 

As we wrote, Rakoff said the parties’ proposed settlement would allow the SEC to look like it was pursuing enforcement and the bank to make it all go away with a relatively puny fine (the BofA/Merrill merger was valued at $50 billion and the approved bonuses at issue totaled approximately $5.8 billion). 

Trial is scheduled for February 1, but it’s of course never that simple. 

The order left open many questions, including:

  • Would any proposed settlement agreement satisfy the judge?
  • Will Rakoff’s concern that BofA shareholders would foot the bill be alleviated by judgment at trial?
  • What does the denial mean for the SEC in prosecuting future corporate misbehavior?

A very low percentage of civil trials ever reach the jury — and it’s no different with suits brought by the SEC — so it’s difficult to picture either party allowing a case under this much scrutiny to go to public trial.  That’s why they wanted to settle in the first place.  But the judge appears unwilling to accept a settlement agreement where BofA does not admit fault (not admitting anything is a boilerplate part of practically all settlement agreements) or where payment comes, even indirectly, from shareholders. 

In order to avoid trial — assuming the charges remain as they are — either the SEC must drop its complaint altogether (this is universally considered unlikely) or Bank of America would have to admit some degree of fault and pay a fine large enough to satisfy Rakoff.  Because the SEC has not brought charges against individuals, only the company would be responsible for payment, a circle that leads right back to the shareholders and an apparently unacceptable outcome to Rakoff. 

Unfortunately, the shareholder footing the bill issue would still exist if it makes it to trial.  Assuming a win by the SEC (a big assumption — Bank of America continually asserts its innocence and what must be directly included in proxy statements isn’t always so black and white), the shareholders will still wind up footing the bill — and potentially a much larger one than $33 million. 

This logic obviously did not escape Rakoff, and clearly he knows that every SEC fine levied against a company and not individuals hits shareholders. This isn’t a new concept.  But forcing this litigation to continue furthers his goal of requiring Bank of America to admit which individuals made the decisions and which may then force the SEC to go after them.  The SEC so far claims that it does not have the evidence to pursue individual executives and that it appears company lawyers made the call.  But, as the case moves through discovery — additional document review and depositions of major players — the SEC could gather enough evidence to include individuals in the suit. 

But the judge’s crackdown on the settlement also raises broader questions of how the SEC should, or will have to, prosecute cases in the future.  24/7 Wall Street suggests the order will force the SEC to spend less time pursuing quick settlements across the board and push Congress to either accept “shoddy” SEC investigative work or provide the SEC more funding for litigation.  (A larger litigation budget is one of the reasons Mary Shapiro and others are pushing for the SEC to become a self-funded agency through member fees, like the FDIC.) 

It’s a little idealistic to think one order could have so broad an impact, but in the overall climate of near-weekly Ponzi scheme discoveries and financial-collapse-related shareholder disputes, few people deny that the SEC doesn’t need to step up its game.  So, in line with the rest of financial regulation reform, it could be the start of a slow movement.  No matter what, in the case of the BofA suit, Rakoff has thrown down the gauntlet.

Pardaoxically, as the New York Times points out, some analysts believe the case is more or less irrelevant, “given that Bank of America’s takeover of Merrill has increased the bank’s profits, resulting in a surge in its stock price.”

Regardless, this saga has definitely become the securities lawsuit-of-the-moment.  Unfortunately, that February 1 trial date is but a pipe dream.  The BofA/Merrill merger may have been made over a very long weekend (a lack of time for true due diligence being a huge part of the problem in this whole debacle), but it’ll take much longer than five months to make it to opening arguments.

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