Banking Scapegoat of America. WSJ Editorial
Ken Lewis takes the fall for bonuses and bailouts.
The Wall Street Journal, page A18
When Bank of America bought Merrill Lynch last winter, the political class applauded and called CEO Ken Lewis a solid citizen. Now, from the safety of noncrisis hindsight, our politicians claim the bank's shareholders may have been mistreated. Few of those shareholders are complaining, given the profits Merrill has been generating for the bank in recent months, but the pols apparently want a scapegoat for bailouts and bonuses. Mr. Lewis fits the bill.
The Securities and Exchange Commission has already taken a whack at BofA and pounded out a $33 million fine, with the bank not admitting or denying guilt. However, a federal judge tossed the settlement last week on grounds that it hit shareholders a second time (for the cost of the fine) rather than fingering the individual corporate culprits. If the SEC doesn't appeal, the case is headed to court on the merits next year.
Meanwhile, New York Attorney General Andrew Cuomo and House Oversight and Government Reform Chairman Edolphus Towns are also investigating whether BofA properly disclosed details of the transaction. Mr. Cuomo claims BofA "allowed Merrill to make $3.6 billion in undisclosed bonus payments." The SEC and the AG say that the proxy materials sent to BofA shareholders prior to their December 5, 2008 vote for the transaction didn't make clear that these checks would soon be heading out the door.
Of course, proxies rarely make anything clear, because, like all SEC-mandated disclosures, they are created to ensure regulatory compliance rather than to inform investors. Was this one worse than the average? Reasonable people could probably disagree, but let's look at the context: Was it surprising to investors that Merrill paid $3.6 billion in bonuses?
This figure leaned toward the low end of estimates that had appeared in the press, and it was significantly less than the $6.7 billion that some news outlets had forecast. Just two days before the shareholder vote last December, the Wall Street Journal's Deal Journal cited a Bloomberg report estimating a 50% cut in Merrill bonuses compared to 2007 (a year when the firm also lost billions and also paid billions in bonuses). A 50% cut suggested Merrill bonuses in the range of $3 billion—not too far from the actual amount paid.
A week earlier, the Journal reported that 4,500 Merrill brokers would receive retention bonuses for agreeing to stick around after the deal closed. Anyone who cared enough to read the proxy probably consumed enough financial news to understand that BofA was willing to pay to maintain Merrill's principal asset—its employees. Ironically, Ken Lewis is one bank CEO who didn't pay himself a bonus last year, yet he's the one who may have to pay this political bill.
Mr. Cuomo also claims that the rising trading losses at Merrill that ultimately motivated Mr. Lewis to consider breaking the deal were known to BofA before the shareholder vote. The record suggests that from late November through much of December the estimates of Merrill's losses kept rising. Since losses could more easily be used to justify a lower price for Merrill before the vote, rather than after the deal was approved, it defies explanation why the acquirer would not wish to disclose and use this information, if he thought it was truly material.
Mr. Cuomo has already interviewed senior BofA managers and received close to 450,000 pages of documents. Mr. Towns has given the bank a Monday noon deadline to cough up even more records, and who knows what these will reveal. But count us as skeptical that BofA managers would risk violating securities laws in order to make sure that other people could collect large bonuses, or to hide another firm's losses so they could have the privilege of overpaying to acquire it.
Messrs. Cuomo and Towns are nonetheless going further and demanding that BofA release documents protected by attorney-client privilege, barely more than a year after the U.S. Department of Justice repudiated such a demand in its guidelines for prosecutors.
If Messrs. Towns and Cuomo use political muscle to force the bank to waive this privilege, the damage will be felt far beyond the banking world. The ability to communicate candidly with a lawyer and to seek legal advice has been recognized by the Supreme Court as a valuable means of facilitating compliance with the law. If there is no longer any zone of privacy for such contacts, expect all sensitive legal matters in business to be driven to oral communications, with all of the inefficiencies and misunderstandings sure to result.
If Mr. Cuomo wants to do a public service, he could focus on the government's own role in this episode. In late December then-Treasury Secretary Hank Paulson threatened that Mr. Lewis and the board would be fired if they didn't complete the Merrill deal. Mr. Lewis was considering invoking his rights under a material adverse condition (MAC) clause to kill the merger.
Mr. Paulson has argued that his intervention helped everyone, including BofA shareholders, because in fact the MAC clause would not have allowed Mr. Lewis to get out of the deal. A more likely scenario is that Mr. Lewis would have used Merrill's exploding losses and the threat underlying the MAC to get Merrill CEO John Thain to lower his price.
Under oath, Mr. Lewis told the New York AG's office that he would have tried to renegotiate for a better price—if Mr. Paulson hadn't told him not to. When asked several times if this were true at a July Congressional hearing, Mr. Paulson refused to give a straight answer. After one such response, an exasperated Mr. Towns observed, "I'm still trying to find out whether that was a yes or no."
Here's a theory of this case that won't help Mr. Cuomo become governor, and won't help Mr. Towns make headlines, but might even be true and fair: Amid the autumn and winter financial panic, everyone involved was operating under enormous pressure with incomplete information. Federal officials all but ordered Mr. Lewis to buy Merrill and they certainly knew all about the bonuses.
Maybe this is a case in which instead of looking for a villain to punish, our political class should thank Mr. Lewis and BofA for coming to their rescue when they really needed it.