Corporate Governance

SEC v. Bank of America: The Issue of Material Misrepresentation of Losses in the Acquisition of Merrill

By Ashley Dietrich

The Race to the Bottom discussed here the SEC's original complaint against Bank of America ('BofA'), in which the SEC alleged that BofA failed to disclose bonuses to Merrill Lynch ('Merrill') executives and employees.  We have also examined a portion of the proposed settlement here.   In this post, we take a look at the SEC's second amended complaint against BofA.  In that complaint, the SEC alleges that, in addition to failing to disclose the aforementioned bonuses, BofA also failed to disclose extraordinary financial losses at Merrill prior to a shareholder vote to approve a merger between the two companies.

As the SEC notes in its complaint, the two parties negotiated, approved and announced the deal terms over a three day period in September 2008.  As a result of the terms of the agreement, BofA needed to issue new shares of common stock to provide to Merrill shareholders.  To register the shares that were to be exchanged in the merger, BofA filed a Form S-4 in October 2008 that incorporated a proxy statement jointly prepared by BofA and Merrill.  BofA and Merrill filed that same joint proxy statement in November 2008 and each mailed copies of the proxy statement to their respective shareholders.

The SEC claims that this proxy statement is false and misleading, in part, because BofA failed to disclose Merrill's fourth quarter losses.  The proxy statement and registration statement described Merrill's financial condition as of the end of September 2008.  The SEC argues, however, that in November 2008 BofA had become aware of $4.5 billion in losses that Merrill had incurred in October 2008.   Moreover, in early December 2008, two days before the shareholder vote, BofA received a report from Merrill estimating that Merrill lost $6.4 billion total during October and November.  

The SEC's complaint includes details from discussions beginning in early November 2008 among BofA's management, in-house counsel and outside counsel.  The parties discussed the company's disclosure obligations with respect to the losses sustained by Merrill.  According to the complaint, BofA's lawyers 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' and that the 'proxy statement and incorporated filings describing the challenging market environment provided adequate warning to shareholders.'  As a result, BofA did not disclose the losses.  

Sometime after the shareholder vote, management learned that Merrill's fourth-quarter net losses would exceed $12 billion.  The SEC alleges that at this point, BofA management 'considered terminating the merger agreement on the ground that a material change in Merrill's financial condition had accrued.'  Nevertheless, the company continued with the merger without disclosing any of Merrill's losses.  On January 16, 2009, over six weeks past the shareholder vote and two weeks after the merger closed, BofA finally disclosed Merrill's fourth-quarter performance.  Merrill suffered a $15.3 billion net loss in that quarter alone.  Consequently, Bank of America's stock price fell 30% the next day.

The primary materials, including the original complaint and the proposed settlement, can be found on the DU Corporate Governance website.

Full post as published by The Race to the Bottom on February 21, 2010 (boomark / email).