Corporate Governance

SEC v. BofA: The Other Shoe Drops (The Merrill Lynch Losses) (Part 2)

By J. Robert Brown

The Commission's complaint alleges the failure of BofA to disclose substantial losses incurred by Merrill Lynch just before the shareholder vote on December 5.  The Commission filed a single claim under Rule 14a-9 and did not name any individuals. 

The allegation was not that BofA knew of the losses on Nov. 3 (the date that the proxy statement was filed with the Commission) but learned of them afterwards and failed to "update" the proxy and registration statement.  Shareholders had learned about Merrill's third quarter losses (in a Form 10-Q filed on Nov. 5 and incorporated by reference into the proxy statement.  The quarter reflected a loss of $5.2 billion.  According to the complaint, the market largely viewed Merrill's problems as over. 

• After Merrill released its third quarter results, the price of its publicly-traded stock rose ~ reflecting the market's assessment that Merrill's financial prospects had improved. In addition, analysts who covered Merrill forecasted that Merrill's net income in the fourth quarter of 2008 would range from a gain of $1 billion to a loss of $1.8 billion -echoing the market's view that Merrill's fourth quarter performance would be a substantial improvement over its $5.2 billion loss in the third quarter.

In fact, according to the complaint, losses ballooned.  By the second week in November, "Bank of America was advised that Merrill had closed its books for the month of October with a net loss of $4.5 billion." 

On November 12, BofA received a report projecting that Merrill would have a fourth quarter loss of approximately $5.4 billion.  The news only got worse.  As the complaint contends, "[o]n December 3, two days before the shareholder vote, Bank of America received an updated report reflecting an estimated net loss of $6.4 billion at Merrill for October and November, and forecasting a quarterly net loss of over $7 billion."  Ultimately (but not before the meeting), the total amount of the net losses for the fourth quarter reached $15.3 billion. 

Yet these losses were never disclosed to shareholders (BofA shareholders were voting on whether to approve the issuance of the shares needed to complete the merger).  Why not?  The complaint asserts that officials at BofA relied on outside counsel.  As the complaint described:

• Between November 12 and November 20, Bank of America's in-house and outside counsel conferred on whether a disclosure had to be made in light of the forecasted $5 billion quarterly loss at Merrill. On November 20, the lawyers erroneously and negligently concluded that no disclosure was necessary because the projected quarterly loss was within the range of losses that Merrill had sustained in the preceding five quarters. In addition, the lawyers concluded that the proxy statement and incorporated filings, which described the challenging market environment and the adverse impact that Merrill could experience as a result, provided adequate warning to shareholders. Although Bank of America and its attorneys determined that disclosing Merrill's forecasted quarterly performance would be risky and speculative, they did not consider disclosing solely the enormous $4.5 billion monthly loss that Merrill had sustained in October, which was known. Nor did Bank of America or its attorneys seek any additional financial data from Merrill to better ascertain the extent of known, as opposed to merely projected, losses as of mid-November, or to learn of any updates as of November 20 (the day they determined that no disclosure was necessary) to the forecasted net loss of $5 billion.

As for the projected losses known to the Bank a few days before the meetings (that the next loss would be $7 billion, more than the prior quarter), management apparently did not consult outside counsel.  Instead, "management again consulted the company's in-house counsel and was erroneously advised that no disclosure was necessary because the forecasted quarterly loss, though larger than before, was still within the range of losses that Merrill had sustained in prior quarters."

Yet things got even worse.  With this update [on Dec. 4, the day before the meeting], the known October net losses and estimated November net losses exceeded $7.5 billion.  This time officials apparently did not consult counsel of any kind. As the complaint alleged:  "Yet Bank of America did not consider whether the update warranted disclosure or otherwise affected Bank of America's prior conclusion that no disclosure was necessary."

In short, there are periods when lawyers apparently advised management that they did not need to disclose the losses.  There was at least one period when management apparently chose not to disclose without consulting counsel. 

The letters and other primary materials are posted at the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on January 18, 2010 (boomark / email).