Judge’s Rejection of SEC and Bank of America’s Settlement Raises Interesting Questions
September 15th, 2009 | 
Author: Jed Rakoff, a U.S. District Judge in New York, has rejected the proposed $33 million settlement between the SEC and Bank of America that was supposed to resolve the SEC’s claim that the bank deceived shareholders in a proxy statement concerning bonuses to be paid to Merrill Lynch executives. The proxy statement said that Merrill had agreed not to pay bonuses before the Merrill-Bank of America acquisition closed without the bank’s consent. The SEC claims that bank had actually approved payment of up to $5.8 million in bonuses.
In his order, Rakoff wrote that “The parties’ submissions, when carefully read, leave the distinct impression that the proposed consent judgment was a contrivance designed to provide the SEC with the façade of enforcement and the management of the bank with a quick resolution of an embarrassing inquiry.” Rakoff indicated that he wouldn’t accept a settlement that would effectively require shareholders to pay for the alleged infractions of bank executives, and ordered the case to go to trial on Feb. 1. The SEC has previously stated that they did not have sufficient evidence to take action against individual executives.
The ruling raises interesting questions about the case and how the SEC handles regulatory infractions. I think Rakoff has a valid point that it is unfair to penalize shareholders for the sins of wayward executives. I find it hard to believe that the SEC would have sufficient evidence to go after the firm (such as internal emails or memos), but could not attribute that evidence to specific individuals. I suspect it is more that the SEC lacks the appetite to go after individual executives that they have close relationships with. The regulator has a history of settling such cases through a monetary settlement with the company without requiring any claim of guilt or innocence. Such settlements make sense if the SEC’s objective is to raise revenues, but it is my opinion that it is not an effective way to deter executives from committing regulatory violations.
One could argue that the Board and/or shareholders can hold the executives responsible, but experience indicates that that is not likely. And why should the SEC shift that burden to the private sector?
I suppose it is possible that the SEC had little evidence, and the bank felt it was more efficient to take the settlement, but I would then question why the SEC would bring on a lawsuit without sufficient evidence. The last thing a weakened bank needs is to have to pay $33 million, as well as legal expenses, if it may be innocent. I believe the SEC should either go after the responsible parties, or not take action that accomplishes little more than the transfer of wealth.
Please share your thoughts.
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The irony of this situation is, if this claim with the SEC is settled, there is a distinct possibility it would cost the bank a nominal portion of that. In all reality, except for any deductible that would need to be covered, the firms Director’s and Officer’s insurance could very well cover the fine as well as legal costs associated with the investigation.
The executives have a conflict, in that there defense is covered by the indemnity agreement in the corporate bylaws, i.e. BofA has to defend them. Where this changes though, is when the executive is found guilty in the eyes of the law, and most states will not allow the company to continue to indemnify the executive. In addition, the insurer can come back and claim any and all legal fees it has paid after final adjudication. It is the executives best interest to settle without admitting wrong doing.
It’s not that the SEC can’t make a case, they can make a very strong one. The reason any talk dealing with capital market transaction are highly documented, is just for this very reason. I applaud Judge Rakoff, as the $33 million settlement was anything but a joke, and continues to maintain the belief, true or not, that executives never have to worry about anything but a slap on the wrist. The SEC is there to maintain the confidence in our capital markets, which means an arms length relationship with those executives.
The executive acts as the agent of the principals, yes the owners. There needs to be a certain amount of fear so that the agent (i.e. the executive) acts in the fiduciary interest of the principal. Right now their is a large disconnect. In my opinion (which doesn’t mean much), it is easy to understand how BofA/Merrill Lynch outright mislead and lied.
The other reason the SEC wants to settle this case, is they do not want to have to call Paulson or Geitner to the bench to testify. Whether you believe it or not, the Fed was not going to let BofA out of the merger agreement. The SEC is, in this case, trying to protect their own as well, as BofA counsel will subpoena and depose both those individuals at the Fed.
I welcome your thoughts.
Judge Rakoff’s rejection on August 3, 2009 of the proposed USD $33 Million settlement by the SEC and Bank of America to settle the SEC’s claim that Bank of America violated the proxy statement rules is a lesson in plain common sense which could potentially help shake the typical settlement process and trigger interesting corporate governance discussions in Board rooms.
Judge Rakoff’s decision follows a few recent cases where the SEC was able to hold corporate executives responsible for their actions. On July 31, 2009, the SEC was filing before the same U.S. District Court for the Southern District of New York a civil action for stock option backdating against the former General Counsel and former Chief Accounting Officer of Take-Two Interactive Software, Inc., a video-game company. The SEC claimed that both defendants, Kenneth Selterman and Patti Tay, were directly and indirectly engaged in practices violating Section 10(b) of the Securities Exchange Act, Rule 10b-5 and that they “knowingly, recklessly or negligently solicited proxies by means of a proxy statement … containing statements which, at the time and in light of the circumstances under which they were made, were false and misleading with respect to material facts or which omitted to state material facts which were necessary in order to make the statements made not false or misleading.” Around the same time, came the filing of a settlement for FCPA violation by Nature’s Sunshine Products, Inc. (NSP) and its CEO and former CEO, both of whom had been charged under Section 20(a) of the Exchange Act as control persons. Was Judge Rakoff puzzled over the fact that the SEC could build a case for violation of Section 14(a) of the Securities Exchange Act and Rule 14a-9 against the executives of Take-Two, the company known for the Grand Theft Auto and Mafia II video games, but not against those of Bank of America? In any event, Judge Rakoff clearly questioned the SEC’s investigation process in the case against Bank of America, the SEC’s departure from its own policy to go after company executives and pointed to the many contradictory arguments made in favor of a settlement.
One of the arguments of the SEC for not pursuing Bank management was that “lawyers of Bank of America and Merrill drafted the documents at issue and made the relevant decisions concerning disclosure of the bonuses.” Personally, as a former in-house counsel, I find difficult to believe the argument that “the lawyers (whether outside or in-house counsels) made all the decisions” in such a significant matter without involvement from the senior management and/or the Board itself. If outside counsels were engaged in the drafting of the proxy materials, most likely, in my opinion, the final draft would have been reviewed and approved by an in-house corporate counsel or someone from senior management. In the Matter of W.R. Grace & Co., SEC Release No 39,157 (September 30, 1997), senior executives (who, without being lawyers, had reviewed proxy statements prepared by counsel) had not been exonerated from the lack of disclosure of management retirement perks. Would it be possible that no one, no one at Bank of America reviewed the proxy materials, so that the argument could be made that executive could not be found personally liable?
Assuming, for the sake of argument, that outside counsels did take the decision not to disclose the bonuses and to draft the proxy materials they way they did, couldn’t we entertain the thought that the management could be held liable for its failure to instruct and supervise those outside counsels?
If the in-house counsels were those lawyers making all the decisions, how could the SEC exonerate Bank of America’s management (in particular its General Counsel) from its responsibility to provide shareholders with proxy materials that do not omit material information likely to be considered important by a reasonable investor about to vote? These in-house lawyers making all the decisions, weren’t they coming dangerously close to become control persons?
Judge Rakoff’s order touches upon another issue: whether Bank of America’s decision to try to settle for US $33 Million could be protected under the Business Judgment Rule. First he questions whether the decision to settle rather than litigate was really an informed decision (as required under the duty of care), taking into account the costs associated with both alternatives. Second, he questions whether management is truly disinterested, i.e. whether the Board meets its duty of loyalty and is making a decision to settle for a true rational business purpose rather than its own personal benefit. One could add that the duty of care and oversight would have required a more thorough internal investigation and analysis of how the misleading proxy statement had been allowed to be released, combined with some “house cleaning” measures that would have given the settlement a greater chance to proceed. This should bring Boards across the country to ask themselves the question: settle, yes but on what grounds?