A federal judge on Monday rejected a $33 million settlement between the Securities and Exchange Commission and Bank of America, saying the SEC's accusations of inadequate disclosure by the bank over bonuses paid at Merrill Lynch must now go to trial.
Separately, New York Attorney General Andrew Cuomo's office is preparing to file charges within the next couple of weeks against several high-ranking executives at Bank of America, claiming they failed to disclose details about the bank's acquisition of Merrill Lynch, according to a person familiar with the investigation.
The ruling in the SEC case comes one month after the agency and Bank of America thought they had put a thorny issue behind them, and leaves the SEC with the task of mounting a case against BofA over one of the most sensitive issues of the financial crisis—executive pay on Wall Street.
The SEC announced last month that it had settled its civil charges against BofA, which agreed to buy the New York investment bank last year, without the bank admitting or denying guilt in the case.
BofA has said it didn't violate disclosure rules.
U.S. District Judge Jed Rakoff held up his approval of the settlement, however, and ordered the SEC last month to explain why it didn't pursue charges against specific executives at Bank of America over the accusations.
Rakoff, in his ruling, found that the settlement "suggests a rather cynical relationship between the parties: the SEC 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."
Cuomo's office is likely to file civil charges against the executives over their role in failing to alert shareholders to mounting losses and accelerated bonus payments at Merrill, said the person, who requested anonymity because no charges have been filed yet.
The AG's office has also questioned whether Bank of America failed to tell shareholders about its consideration of backing out of the deal and mounting write-downs at one of Merrill's mortgage lending subsidiaries.
Both the attorney general's office and Rakoff have questioned whether the bank knowingly hid details about the acquisition from shareholders ahead of a vote to approve the deal.
After receiving additional statements from the SEC and BofA last week, Rakoff ruled Monday that the proposed settlement "cannot remotely be called fair," and ordered that the case go to trial beginning Feb. 1.
"We disagree with today's ruling," Bank of America told CNBC, adding that the bank would consider its legal options in the coming days.
The SEC said in a statement the agency believes the proposed settlement "properly balanced all of the relevant considerations."
Bank of America agreed to acquire Merrill Lynch in a hurried deal exactly one year ago today at the height of the financial crisis, just as Lehman Brothers was preparing to file for bankruptcy. It was later revealed that Merrill, with the knowledge of Bank of America executives, accelerated $3.6 billion in bonus payments before the deal closed on Jan. 1.
Merrill wound up paying the bonuses for 2008 despite losing $27.6 billion that year, a record for the firm. Those losses affected the bottom line at Bank of America, one of the largest recipients of U.S. government bailout funds.
In seeking approval to buy Merrill Lynch, Bank of America told investors that Merrill would not pay year-end bonuses without Bank of America's consent. But in its complaint filed Aug. 3 in federal court in Manhattan, the SEC said BofA had already authorized Merrill to pay up to $5.8 billion in bonuses and didn't share that information with shareholders.
That rendered a statement Bank of America mailed to shareholders of both companies "materially false and misleading," the SEC said.
"BofA is in serious, serious trouble now," said Anthony Sabino, professor of law and business at St. John's University in New York, saying the bank is at war on two fronts. "One, Judge Rakoff, by refusing to countenance the settlement, is forcing the SEC to go back and demand more details and more money. The other battleground is with New York Attorney General Andrew Cuomo."
Rakoff's move was unprecedented. While judges have on occasion sent back proposed settlements to the SEC, ordering them to be renegotiated, experts said, throwing an accord out entirely breaks new legal ground.
"I've never seen this," said James Cox, a Duke University law professor and securities law expert.
"To me, it's long overdue," he added, saying that the SEC and the Justice Department have tended to accept settlements from companies "without drilling down to find out who the culpable parties were."
Bank of America, among the banks hardest hit by loan losses and the recession, is received $45 billion, including $20 billion in January, and guarantees to protect it against losses on hundreds of billions of dollars in loans to help it absorb mounting losses at Merrill.
BofA's stock has underperformed the market since it announced the deal to acquire Merrill, losing about half its value during the past year.
The losses accelerated in January shortly after regulators began looking into the deal, but have rebounded since this spring as the market rallied.
The SEC could seek to renegotiate the deal with Bank of America, though it may be difficult to find revised terms that would satisfy Rakoff if bank executives weren't individually charged.
The imminent move by Cuomo against executives intensifies the pressure on the bank.
"It's truly a come-to-Jesus moment for Bank of America and its relationship with its various officers," Duke's Cox said. "They need to hang up a scalp or two."
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