New York AG Andrew Cuomo Brings Civil Fraud Charges Against Bank Of America Executives

Yesterday, New York Attorney General Andrew Cuomo filed civil charges against former Bank of America CEO Ken Lewis, and a current Bank of America executive, Joe Price, who served as Chief Financial Officer under Ken Lewis. The civil charges relate to the controversial role that both men played in Bank of America’s merger with Merrill Lynch & Co.

In the Complaint, Cuomo alleges that Bank of America’s management team, namely Lewis and Price, understated losses at Merrill Lynch to get shareholders to approve of the transaction. Further, the Complaint alleges that the pair, Lewis and Price, overstated Bank of America’s desire to terminate the merger to federal regulators weeks later in order to force the federal government to offer Bank of America $20 billion in additional TARP aid. The Complaint makes the following specific allegations:

• Shortly before the shareholder vote, Price ignored a warning from the bank’s Corporate Treasurer, Jeffrey Brown, who told Price that, “I didn’t want to be talking [about Merrill’s losses] through a glass wall over a telephone.”
  
  
• The bank’s management failed to tell shareholders that it was allowing Merrill to pay $3.57 billion in bonuses. The amount, criteria, and timing of the bonus payments were omitted from the proxy. The bonuses were distributed in a manner that was completely inconsistent with Merrill’s prior practice, and in the worst year in Merrill’s history.
  
  
• The bank’s management did not tell the bank’s lawyers about the full extent of Merrill’s losses before the shareholder vote. For example, the bank’s former General Counsel, Timothy Mayopoulos, was intentionally mislead about the size and nature of Merrill’s losses. After the shareholder vote, when Mayopoulos learned of the actual losses, he attempted to confront Price but was summarily terminated.
  
  
• In the course of the Attorney General’s investigation, Lewis and other executives misled investigators about their conduct during and after the shareholder vote.

Despite the allegations of fraud leveled at Lewis and Price, the pair is sure to argue in their defense that they are blameless and the victims of a deteriorating economy and overall forces outside of their control. Recall, that in the only other fraud case against perceived initiators of the financial crisis, in a case involving Bear Stearns executives Mark Tannin and Ralph Cioffi, which I posted on earlier, that defense worked successfully. Under principles of indemnification, Bank of America is technically saddled with the financial burden of paying for the legal defense of Ken Lewis and Joe Price. Already, Lewis has hired Mary Jo White of the prominent firm Debevoise & Plimpton to represent him. White has gone on the record to indicate that Lewis has been “unfairly vilified” in a search for culprits in connection with the financial crisis.

This will be an interesting and intriguing case to watch. I’ll keep you posted.

SEC v. Bank of America Round Two: Bank Of America Seeks To Pay $150 Million To Make The SEC Go Away

In September I posted a piece on the blog discussing Judge Jed Rakoff’s unusual rejection of a proposed settlement between the Securities Exchange Commission ("SEC") and Bank of America surrounding the solicitation of shareholder proxies to purchase Merrill Lynch & Co. The SEC alleged in its original Complaint that Bank of America failed to adequately disclose information relating to Merrill Lynch bonuses to shareholders as part of the acquisition. Well, as promised, my post today is an update designed to bring you up to speed on the SEC v. Bank of America litigation. At the outset, it should be noted that just about one month ago, in January, the SEC amended its Complaint to allege that Bank of America failed to disclose Merrill Lynch & Co.’s expected losses to shareholders.

On Thursday, February 2, 2010, Bank of America agreed to pay a settlement of $150 million to the SEC to dispose of claims that Bank of America misled shareholders in relation to bonuses and losses at Merrill Lynch. Again, this settlement is subject to the approval of United States District Court Judge Jed Rakoff. Recall, that in September 2009 Judge Rakoff rejected a proposed $33 million settlement between Bank of America and the SEC as unfair and unreasonable.

As part of the settlement, Bank of America would have to take a number of steps over the course of the next three (3) years to reinforce corporate governance and internal control measures. In a court filing on Thursday, in seeking Judge Rakoff’s support the SEC noted: “The relief contemplated by the proposed order is fair, reasonable, adequate and in the public interest…” Certainly, Judge Rakoff will have the final word. It will be interesting to see if Judge Rakoff decides to approve this current settlement proposal.

SEC V. BANK OF AMERICA: JUDGE RAKOFF HAS NO RUBBER STAMP

On September 14, 2009, a phenomenal and extraordinary thing happened: A judge took a courageous stand in the face of enormous pressure, deciding to reject a proposed settlement, and looked out for and vindicated the rights of shareholders and taxpayers alike. Generally, where parties to a civil lawsuit agree to a mutual settlement, in most cases, judges merely rubber stamp those settlement agreements and dismiss the case and move on to the next cases on their overwhelming dockets.

On August 3, 2009, the Securities and Exchange Commission (“SEC”) filed a civil complaint against Bank of America in the United States District Court for the Southern District of New York. The Complaint alleged that Bank of America materially lied to its shareholders in a November 3, 2008 proxy statement that solicited the shareholders’ approval of the $50 billion acquisition of Merrill Lynch & Co. (“Merrill”). In essence, the Complaint alleges that Bank of America lied to shareholders by representing that Merrill had agreed not to pay year-end performance bonuses and other discretionary incentive compensation to executives prior to closing the agreed upon merger between Bank of America and Merrill without Bank of America’s consent. Indeed, bonuses and other discretionary compensation payments were made that amounted to $5.8 billion, or nearly 12% of the total consideration exchanged in the merger.

Interestingly, however, on the very same day that the SEC’s Complaint was filed, the SEC and Bank of America sought the Court’s approval of a proposed final Consent Judgment. Under the Consent Judgment, Bank of America would not admit or deny the allegations in the Complaint, would be enjoined from making future false statements in proxy solicitations, and would pay the SEC a fine of $33 million. Again, when parties reach an amicable solution to their problems courts defer to the parties’ judgment in most cases. NOT THIS TIME!!! Judge Jed Rakoff said no way. In his September 14, 2009 Memorandum Order he rejected the proposed SEC and Bank of America settlement as neither fair, reasonable, nor adequate. Judge Rakoff’s well-reasoned and considerate Order speaks volumes. Judge Rakoff observed: “In other words, the parties were proposing that the management of Bank of America – having allegedly hidden from the Bank’s shareholders that as much as $5.8 billion of their money would be given as bonuses to the executives of Merrill who had run that company nearly into bankruptcy – would now settle the legal consequences of their lying by paying the S.E.C. $33 million more of their shareholders’ money...This proposal to have the victims of the violation pay an additional penalty for their own victimization was enough to give the Court pause.”

What about vigorous enforcement? Judge Rakoff pointed out that “…the parties’ submission, when carefully read, leave the distinct impression that the proposed Consent Judgment was a contrivance designed to provide the S.E.C. with the façade of enforcement and the management of the Bank with a quick resolution of an embarrassing inquiry – all at the expense of the sole alleged victims, the shareholders.” Judge Rakoff’s clear displeasure with the SEC’s role as regulatory enforcer did not stop here. Later in his Order, Judge Rakoff observes:

“Oscar Wilde once famously said that a cynic is someone “who knows the price of everything and the value of nothing.” Oscar Wilde, Lady Windermere’s Fan (1892). The proposed
Consent Judgment in this case suggests a rather cynical relationship between the parties: the
S.E.C. gets to claim that it is exposing wrongdoing on the part of the Bank of America in a
high-profile merger; the Bank’s management gets to claim that they have been coerced into
an onerous settlement by overzealous regulators. And all this is done at the expense, not only
of the shareholders, but also of the truth.”

Did the SEC really pursue the most culpable parties and players in the Bank of America case? No. Interestingly, the SEC chose not to pursue the lawyers and executives at Bank of America responsible for the misrepresentations about Merrill it found offensive in the Bank of America proxy statement. Judge Rakoff’s Order assesses the “advice of counsel” defense and the issue of waiver. It is troubling that the SEC decided to take a pass at pursuing the parties most responsible (i.e. Bank of America’s lawyers and executives).

Judge Rakoff was particularly troubled by Bank of America’s acceptance of TARP funds. Judge Rakoff noted: “Undoubtedly, the decision to spend this money was made even easier by the fact that the U.S. Government provided the Bank of America with a $40 billion or so “bail out,” of which $20 billion came after the merger…To say, as the Bank now does, that the $33 million does not come directly from U.S. funds is simply to ignore the overall economics of the Bank’s situation.” In Judge Rakoff’s mind Bank of America’s initial agreement and willingness to enter into a $33 million settlement constitutes corporate waste.

This is a case that might set a new regulatory tone for the SEC. Further, corporations might now take pulse when trying to quickly settle a matter and make it go away by dangling money in the face of regulatory enforcers. At any rate, I applaud Judge Rakoff for having the courage to call out the questionable regulatory and litigation tactics employed by the SEC, and the actions of Bank of America in connection with the Merrill merger. Finally, shareholders have found a defender and champion in the form of Judge Rakoff. Judge Rakoff shows us courageously that there are no rubber stamps in his courtroom. I think that years from now we will look back at this as a watershed moment when the balance of power began to shift back in the direction of shareholders. Additionally, the earnestness and enforcement vigor of the SEC will be under intense scrutiny moving forward. Only time will tell what impact this case has on the legal landscape.

Remembering Lehman on the First Anniversary of Its Collapse: Part II

Lehman Brothers’ collapse exactly one year ago, on Sept. 15, 2008, ignited a massive contraction in the $3.6 trillion money market industry, which provides short-term loans often referred to as commercial paper, used by businesses worldwide to cover everyday expenses, including payroll and utilities. The panic left companies such as Goodyear Tire & Rubber Co., whose operations are a long way from Wall Street stranded with insufficient cash and ravaged the investment accounts of millions of unsuspecting average Americans.

Everyone knew that Lehman was too big to fail without dire consequences. Tim Geithner, Treasury Secretary, recently said in an interview with Fortune that regulators expected bad things from Lehman’s collapse, but things proved even worse than they expected. When Lehman filed for bankruptcy its commercial paper was transferred to the Reserve Primary Fund. As result, Reserve Primary Fund became the first big money-market mutual fund to have its net asset value fall below $1 per share. It was the first time in history that a money market mutual fund opened with less than $1 per share net asset value. The event scared millions of average investors and prompted the U.S. government to guarantee money fund accounts to avoid a deposit run that could have destroyed short-term financial markets. The U.S. government has been keeping the American financial system functioning every since because companies that were too big to fail, did fail.

Wall Street was aware that the unregulated subprime mortgage lending business and the securitization of such inferior loans into investment vehicles such as collateralized debt obligations (CDOs) had pushed the financial system to the breaking point. What the Wall Street bankers failed to calculate was that short term borrowing would be literally frozen and would throw the global economy into a tailspin. The failure of Wall Street bankers and regulators to understand the importance of commercial paper and how that market would be negatively affected by Lehman’s collapse was critical because its aftershocks came closest to destroying the world economy. The run on money market funds, considered the safest investments after bank deposits, and also the principal buyers of commercial paper, sent shockwaves through the global economy. World stock markets lost $2.85 trillion, or more than 6 percent of their value, within three days of Lehman’s bankruptcy filing. Worldwide the cost of banks borrowing overnight funds from other banks, as measured by the London Interbank Offered Rate, or LIBOR, jumped 4.29 percentage points between Friday, Sept. 12, 2008 and Tuesday, Sept. 16, 2008. “We did not expect how the Lehman Brothers' bankruptcy would transmit through the commercial paper market and cause all the stress in the money funds,” said David Nason, a former assistant Treasury secretary for financial institutions under Treasury Secretary Paulson.

The financial chieftains inclusive of Goldman Sachs and JP Morgan Chase tried desperately to unwind their derivatives trades and keep bank-to-bank loans flowing, but they ignored the commercial paper market, the lifeblood of the economy. It was an oversight that would flat-line the American economy. Within a week of Lehman’s bankruptcy filing, the U.S. government stepped in to halt withdrawals from money market funds and provided a $1.6 trillion backstop for the commercial paper market. With these first defensive measures, the U.S. government became committed to strengthening the American financial industry regardless of the cost. “They put the entire financial system at risk, and they didn’t have to,” said Harvey R. Miller, a partner at Weil Gotshal & Manges LLP in New York who represented Lehman in the bankruptcy. Miller stated that “[government officials] were warned. I told them, ‘Armageddon is coming. You don’t know what the consequences will be.’ Their response was, ‘We have it covered.’” Lehman’s problems stemmed from borrowing too much to finance too many hard-to-sell investments, such as mortgage-backed securities, that were rapidly declining in value as a result of the deteriorating real estate market. Lehman was different because the U.S. government let it declare bankruptcy rather than bail Lehman out, as it had bailed out Bear Stearns, Merrill Lynch and Long-Term Capital Management because no one, not even the U.S. government, wanted to be responsible for Lehman’s undeterminable losses, which could tally into the millions or even billions. As a result, Lehman’s creditors were wiped out as well as its stockholders and the aftershocks are still reverberating in the world economy.

On the one year anniversary of Lehman’s collapse, "policymakers haven’t learned the key lesson of Lehman’s collapse," said Richard Bernstein, CEO of Richard Bernstein Capital Management LLC in New York and former chief investment strategist for Merrill Lynch. Bernstein added “[by] designating certain institutions as too big to fail, and not having a thorough regulatory process to match, practically invites another catastrophe.” Perhaps the U.S. government should consider breaking up financial behemoths such as Bank of America Corp. and Citigroup Inc., or limit their expansion, instead the U.S. government has given them billions of dollars in tax incentives and loan guarantees that enabled them to grow even bigger and have created a factual predicate were it could all fall apart, again.

Lydie Nadia Cabrera Pierre-Louis
St. Thomas University

Remembering Lehman on the Eve of the First Anniversary of Its Collapse: Part I

As we approach the first anniversary of Lehman Brothers’ collapse, a failure that many believe triggered the current global economic crisis, we should perhaps pause and reflect on the topsy-turvy financial year that Americans have survived. This is not an anniversary that Richard S. Fuld, Lehman’s former chairman and chief executive officer is looking forward to celebrating. Fuld has been vilified and humiliated before a congressional panel last October and named in nearly 40 different legal actions. “I’ve been pummeled, I’ve been dumped on, and it’s all going to happen again. I can handle it. You know what, let them line up,” Fuld stated recently. To be fair to Fuld, he took control of Lehman in 1994 at one of Lehman’s darkest hours and rebuilt it into the fourth-largest U.S. investment bank, a Wall Street powerhouse whose massively profitable mortgage banking machine inspired rivals’ envy. The question remains, however, how did it all go wrong? Is Fuld really to blame for Lehman’s demise or was Lehman the first victim of a massive systemic failure in the American financial services industry? Perhaps, more importantly, why didn’t the federal government save Lehman like it saved, Long-Term Capital Management, a hedge fund in the late 1990s, Bear Stearns a mere six months before Lehman’s collapse, Merrill Lynch at the same time that it allowed Lehman to collapse, Bank of America, Goldman Sachs, AIG and countless other financial institutions after it allowed Lehman to collapse, that were deemed too big to fail?

On Friday, September 12, 2008, U.S. Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke assembled thirty of the most powerful figures in the American banking industry to the headquarters of the U.S. Federal Reserve in New York. The group of thirty was told Merrill Lynch and Lehman Brothers were on the brink of collapse. The U.S. government would not bail them out because it was only a week since the U.S. government had agreed to rescue Fannie Mae and Freddie Mac. It was up to the thirty banking executives in the room to save Merrill and Lehman. The future of the entire global banking system was now under threat because the collapse of these two Wall Street giants would deal a huge blow to the world’s confidence in the U.S. financial industry. In particular it would raise questions as to whether American financial service companies could make good on their debts, if Lehman and Merrill were to collapse.

Ken Lewis, chief executive officer of Bank of America, was interested in buying Merrill, but Lehman was out of the question, primarily because no one was really sure of the Lehman’s true financial condition, that is--the true state of the Lehman’s finances, the true worth of thousands of “esoteric contracts” to which Lehman was a counterparty. There could be billions of dollars in liability for the company that eventually purchased Lehman. Lehman’s potential liability for its outstanding loans was not clear and no one wanted to take on such a tremendous risk. Except perhaps Barclays, a 300 year-old British bank, who wanted flagship operations in the United States. The Financial Services Authority and Bank of England were adamant in their belief that the U.S. Federal Reserve would not allow Lehman to fail. They had grave reservations about the idea of a Barclays-Lehman deal. They wanted reassurances from the U.S. government, in particular they wanted guarantees as a condition precedent to the deal. If Barclays were to purchase Lehman blind, unsure of the liabilities Barclays would inherit from the “esoteric contracts,” the U.S. government would have to provide some insurance for Lehman’s and eventually Barclays’ potential losses. The U.S. government refused not because it did not want to save Lehman but because the U.S. government itself did not know what the ceiling of the potential Lehman losses would be. Lehman was too big for the U.S. government to rescue. The Barclays deal was dead and so was Lehman.


On Monday, September 15, 2008, 158 years after it was founded, Lehman filed for bankruptcy. It was a catastrophic event. Shockwaves were felt throughout the global banking industry. Within days, Halifax Bank of Scotland had been rescued by Lloyds of London. Within two weeks, Bradford & Bingley was nationalized. Within a month, the British government had given financial bailouts to Lloyds of London and Royal Bank of Scotland with an unprecedented £37bn. Banks were in crisis everywhere. Not to be outdone, the United States developed a $700bn Troubled Asset Relief Program (TARP) to bailout American banks. On September 21, 2008, Goldman Sachs and Morgan Stanley were given permission from the U.S. government to convert their status from investment banks to regulated commercial banks, marking the end of the last two major independent Wall Street investment banks. It was the end of an era.

A year later, as we remember Lehman, the American banking system is still fragile, recovery is slow, and many questions and lessons exist regarding the near-death experience of the American banking system. "You had an old 19th century-style panic," said Cary Leahey, senior economist at Decision Economics. "There was no single catalyst" for the upheaval. Economists believe that big investment banks and other influential financial market players had taken on massive risks, borrowing heavily to bet on securities tied to subprime real estate loans which were outside the scope of regulators’ authority. As a result, when the U.S. housing market collapsed, this sent the walls crashing down, freezing credit markets and economic activity in the worst crisis since the Great Depression. Hugh Johnson, chairman and chief investment officer at Johnson Illington Advisors stated that "there was a belief that the financial crisis could not be solved and would lead to a second Great Depression.” The U.S. government took aggressive action. The new regulatory focus may curb the excesses that led to the boom and bust of Lehman. However, the current focus on regulation and risk mitigation "have enormous implications for the availability of risk capital in the U.S. and the primacy of the U.S. financial system," said Joel Naroff of Naroff Economic Advisors.

What shall be remembered about the Lehman collapse?

First, although some historic names have vanished forever and others are mere shadows of their former selves, Wall Street hasn't changed all that much. It still operates on the principle of an insider club where disclosure is minimal even to regulators. The best interest of the public is not the primary concern. Business is good and likely to get better. Simply look at the second quarter earnings report for the major financial service firms. Previously on July 22, 2009, I commented on the amazing second quarter earnings of the large banks that had received TARP funds and queried whether they really needed the TARP funds, in the first place? Currently, the burgeoning need for Wall Street’s capital raising services will be a welcomed relief in a world that's suffered trillions of dollars in losses over the past two years.

Second, regulators and central bankers could not save Lehman because Lehman was too big to save. The huge uncertainty of Lehman’s potential losses illustrated that the world's capital markets have become too powerful relative to the central banks. "The U.S. government didn't let Lehman fail; it didn't have the authority to save it," Treasury Secretary Tim Geithner said in an interview with Fortune.
"The fundamental constraint was that the Treasury at that point had no authority" to put capital into Lehman, and "the central bank did not have the ability to fill a capital hole." There was no buyer willing to assume most of Lehman's obligations, as Morgan Stanley did for Bear Stearns. The U.S. government would have been risking unlimited losses because Lehman didn't have enough collateral to back hundreds of billions or trillions of dollars of outstanding loans.

Third, the American financial markets can overwhelm the U.S. government’s resources. Lehman shall remain an unfortunate footnote in U.S. financial history. However, Lehman's collapse underscores for all of us that financial regulation is not only fashionable, it is instrumental for the survival of the American financial system and global economic stability. Despite everything that has transpired, hope is not lost. In the words of Mr. Fuld, “I’m not a defeatist. I do believe at the end of the day that good guys do win.”

Lydie Nadia Cabrera Pierre-Louis
Assistant Professor of Law
St. Thomas University