SEC Brief Defends Bank of America Consent Settlement before Federal Judge

The SEC has filed a reply memorandum in federal court defending its consent settlement in the Bank of America enforcement action. The Commission believes that the proposed disposition is reasonable and in the public interest. The charges comport with the evidence as applied against the applicable legal standard and the proposed relief, including the penalty amount, takes full account of the seriousness of the violation and the need for deterrence, while giving serious consideration to all other relevant factors.

Despite acknowledging the public importance of the SEC enforcement action, a federal judge (SD NY) initially withheld approval of the proposed consent judgment. SEC v. Bank of America, SD NY, Litigation Release No. 21164.The SEC charged the bank with making materially false statements in a joint proxy statement that it filed with Merrill Lynch & Co., Inc. in connection with the bank’s $50 billion acquisition of Merrill Lynch. Among other things, the SEC said that the bank falsely represented to both its own shareholders and to the Merrill Lynch shareholders that Merrill had agreed not to pay year-end bonuses to the firm’s executives when, in fact, the bank had agreed that Merrill could pay such bonuses up to as much as $5.8 billion. As a result, according to the SEC’s complaint, Merrill paid $3.6 billion in bonuses in the face of a record loss of $27.8 billion in 2008.

The SEC alleged that the merger agreement was included as an appendix and summarized in the joint proxy statement that was distributed to all 283,000 shareholders of both companies. But Bank of America's agreement to allow Merrill to pay these discretionary bonuses was in a separate document that was omitted from the proxy statement and whose contents were never disclosed before the shareholders' vote on the merger.In tandem with the complaint, the parties filed a proposed consent judgment by which, among other things, the bank, without admitting or denying the allegations, agreed to pay a civil penalty in the amount of $33 million and agreed the entry of a judgment that permanently enjoins it from violating the proxy solicitation rules.

In its reply brief, the SEC said that the complaint alleged a clear and well-supported proxy violation claim against BofA; and it is undisputed that the joint proxy statement represented to shareholders that Merrill was prohibited from paying discretionary bonuses before the merger closed without BoA’s consent while failing to disclose that BofA had already agreed that Merrill could pay up to $5.8 billion in bonuses., That agreement, which existed at the time the proxy was filed, was never disclosed prior to the shareholder vote.

Among other things, BofA argued that the shareholders could have strung together relevant information from an assortment of other sources; and that the proxy presentation was consistent with common practice in merger disclosures. These arguments however, said the SEC, run counter to the fundamental principle that it is the duty of the issuer company to provide shareholders with an accurate proxy statement so that shareholders can cast an informed. Shareholders are entitled to rely on the proxy itself, emphasized the SEC, and are not required to puzzle out material information from external sources.

Moreover, BofA’s defense that the proxy presentation followed standard transactional practices is not persuasive in light of the SEC’s 2005 warning to issuers against non-public schedules in merger agreements where the schedules contradict or qualify express representations in proxy materials. Later case law has upheld the same principle. In omitting the disclosure schedule and its contents from the proxy, said the SEC, BofA ignored those warnings at its peril.

The SEC also asserted that the proposed disposition properly balances relevant considerations, including the need for corporate deterrence and avoiding undue burdens on innocent shareholders. When a company issuer has not met its statutory obligations, said the SEC, the need for corporate deterrence is especially strong.

The absence of individual changes does not diminish the appropriateness of the disposition. In the SEC’s view, the record does not provide a factual predicate to charge individuals. The SEC has often sought penalties from companies in the absence of individual charges. Key executives said that they delegated to counsel, noted the SEC, and there was no evidence that company executives separately discussed concealing compensation.

While the SEC assigns no weight to reliance on counsel assertions in assessing executives’ state of mind, there was a lack of evidence to establish the factual predicate needed to allege scienter-based fraud charges against the company executives. Similarly, there was insufficient evidence to establish a prima facie case of the requisite scienter with respect to the lawyers for purposes of alleging secondary liability under the securities laws. Further, BofA’s counsel could not be charged with primary violations of the federal proxy provisions because they did not solicit the proxies in their name.

The SEC respectfully asked the court to enter the proposed final consent judgment.

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