Rakoff's Bank of America Opinion: "The Tipping Point"

In September 2013 when we look back on Lehman Bothers’ demise, will we also see a “reformed” financial system and regulatory structure? One that may be hard to recognize compared to today’s structure? If “yes,” look to Judge Jed S. Rakoff’s opinion on the Bank of America-SEC $33 million settlement as the tipping point–the rhetorical and regulatory event that paved the way for change.

Judge Rakoff’s total rejection of the settlement frames, far more powerfully than any argument to date, the moral basis for reform in compelling terms that resonate with ordinary investors.

Rakoff found the settlement just awful. “It does not comport with the most elementary notions of justice and morality,” because it proposes that the shareholders, who were victims of the alleged misconduct, “now pay the penalty for that misconduct.” The SEC’s response? “A corporate penalty sends a strong signal to shareholders that the unsatisfactory corporate conduct has occurred and allows shareholders to better assess the quality and performance of management.”

You can almost see the Judge cringing. “The notion that the Bank of America shareholders, having been lied to blatantly in connection with the multi-billion dollar purchase of a huge, nearly bankrupt company, need to lose another $33 million of their money in order to ‘better assess the quality and performance of management’ is absurd.” And rolling his eyes hearing the SEC’s reply, offered by spokesman John Nester, that the proposed settlement, “properly balanced all the relevant considerations.” Instead, Rakoff called it as he saw it, “A contrivance designed to provide the SEC with the facade of enforcement and the management of the Bank with a quick resolution of an embarrassing inquiry.”

And Bank of America’s reply to the central allegation (view SEC Complaint) that it failed to disclose the bonuses in its proxy statement? A two-pronged rebuttal. First, Bank of America “said” it didn’t do it, i.e.: mislead investors. Second (if you don’t buy the first argument), Bank of America falls back on the Lewis Liman defense. The Lewis Liman defense for non disclosure of material facts (introduced by Bank of America’s attorney, Lewis Liman, in the hearing before Judge Rakoff in early August), is brilliant in its simplicity, and outrageous in its logic. The defense is this: even if these bonuses were allegedly “material” and were not appropriately disclosed by Bank of America it doesn’t matter. It doesn’t matter because, as Judge Rakoff quotes Bank of America in its written reply, “(it) was widely acknowledged in the period leading up to the shareholder vote that Merrill Lynch intended to pay year-end incentive compensation.” Or, in other words, since shareholders already “knew” about the ML bonuses, no disclosures were needed.

Judge Rakoff’s blunt critique of the fairness and logic of the proposed settlement runs for 12 pages. The precision in his words leaves no doubt as to the issue at hand. The 27^th word in his opinion is “lied.” He repeats it (or a form of it) another seven times, before saying the “cynical relationship” between the parties is at the direct expense “not only of the shareholders, but also of the truth.”