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 27th 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.”
In May, Vanguard’s Founder, John Bogle, spoke at the National Constitution Center, imploring his audience of the urgency to recapture the core values that comprise what he calls, a “Fiduciary Society.” What’s required is: “above all else it must be unmistakable that government intends and is capable of enforcing standards of trusteeship and fiduciary duty under which money managers operate with the sole purpose and in the exclusive benefit of the interests of their beneficiaries.”
Come 2013, if we look back and see that Bogle’s campaign and regulatory “reform” took hold this year, we should recall this: Judge Rakoff’s “straight talk” about Bank of America reverberated between Washington and Wall Street, and resonated around the world. Jon Favreau, take note.
Knut A. Rostad (firstname.lastname@example.org) is the regulatory and compliance officer at Rembert Pendleton Jackson (RPJ), a registered investment advisor in Falls Church, Virginia, and chairman of The Committee for the Fiduciary Standard. The views expressed here are his own and do not necessarily reflect views of the Committee.
See More of Knut Rostad’s Regulatory Reason Blog posts:
Listen to Chuck August 31, 2009 When Chuck Schwab talks do people listen? They ought to–even when he is off base, as he was in an August 19 opinion piece, “Brokers Aren’t Responsible for Bad Bets,” in The Wall Street Journal…. Disclosures and Evoking the Lewis Liman Defense August 14, 2009 Why did the SEC accept a $33 million settlement in light of its allegations that Bank of America failed to disclose that bonus payments were authorized for up to $5.8 billion? Judge Jed Rakoff wants to know. … The Authentic Fiduciary Standard–What’s the Fuss About? August 11, 2009 Recent discussion in some quarters has focused on the “similarities” between the fiduciary and “arm’s length” standards. The clear implication appears to be: What’s all the fuss about whether investors retain fiduciary advisors or not? … Blog: Talking the “Fiduciary Talk” in Washington July 07, 2009 The Obama Administration proposes that brokers giving investment advice should meet a fiduciary standard. SEC Chairman Mary Schapiro states strong support for a fiduciary standard. How will this translate into legislation?…