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Tuesday, September 15, 2009
Judge Rakoff and Judicial Meddling
Judge Jed Rakoff (SDNY) rejected the settlement proposed by the SEC and the Bank of America for allegations that the Bank of America lied to shareholders during its merger with Merrill Lynch. Specifically, the SEC claimed that Bank of America falsely told shareholders that Merrill would not be permitted to pay its executives year-end bonuses when, in fact, BoA had given Merrill approval to pay up to $5.8 billion in bonuses. Here is the key graf:
In other words, the parties were proposing that the management of Bank of America -- having allegedly hidden from the Bank's shareholders that as much as $5.8 billion of their money would be given as bonuses to the executives of Merrill who had driven the company nearly into bankruptcy -- would now settle the legal consequences of their lying by paying the S.E.C. $33 million more of their shareholders' money.
This could be characterized as a Howard Beale moment for Judge Rakoff -- a cri de couer against the system. After all, his criticism could be leveled against every SEC settlement in which a corporation (opposed to individuals) pays the fine. Seasoned observer David Zaring reacts with outrage of his own against officious judicial meddling. But instead of viewing this as grandstanding or obstreperousness, I think it's a useful opportunity to reconsider the basics of securities regulation. After all, it does seem somewhat absurd to have the "victims of the violation pay an additional penalty for their own victimization." Perhaps Judge Rakoff's opinion will prompt a reexamination of this basic facet of the system.
Judge Rakoff's opinion is a brief but wide-ranging discussion of executive compensation, corporate wrongdoing, the TARP bailout (see n.1), and the role of the SEC. Judge Rakoff wants individual accountability, and he thinks the settlement is an effort to evade it. It remains to be seen whether this is merely an interesting blip or a catalyst for further action. But I hope it's more than merely some extra work for the SEC.
Posted by Matt Bodie on September 15, 2009 at 12:46 AM in Corporate | Permalink
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Comments
"After all, his criticism could be leveled against every SEC settlement in which a corporation (opposed to individuals) pays the fine."
And consider that in such settlements amounting to millions and sometimes billions of dollars, there is no admission of wrongdoing. Why, why would a corporation pay such big bucks if there was no wrongdoing?
Posted by: Shag from Brookline | Sep 15, 2009 5:40:40 AM
It helps to know a little bit about a judge's background... such as what he did before becoming a judge.
In this particular instance, Judge Rakoff was in the Enforcement Division at the SEC, and was one of the major players in the Milken debacle. That is, he knows what the code phrases might really mean!
Posted by: C.E. Petit | Sep 15, 2009 11:25:45 AM
Judge Rakoff is understandable in policing an SEC settlement more rigorously than one with private parties involved. The SEC like the other major players in this case, is playing with other people's money, not their own.
Indeed, the SEC has conflicted motives. It has an interest in protecting market stability in a deal that the federal government's regulatory power was a driver in creating, with two of the biggest financial system participants whom it appropriately doesn't want to imperil at a critical time. It also has an interest in investor protection. The SEC is not an agent of the allegedly injured parties.
This doesn't mean that a high fine (ca. $5.8 billion) is necessarily appropriate. Management apparently knew about the bonuses and presumably consider them when pricing the buy of Merrill. Full disclosure would almost certainly not have changed the result; it is almost unthinkable that the shareholders would have voted down the purchase, with or without the bonuses, in the face of a management recommendation. The dramatic change in the banking industry generally at the time make it virtually impossible to accurately parse the financial market's reaction to this information from other things going on in the financial markets for banks generally.
Probably the only way that the bonuses could have been scratched would have been for BOA to buy Merrill out of bankruptcy in a pre-packaged Chapter 11, and at the time, at la Lehman Brothers. Federal regulators and a fair share of market observers were terrified that this approach would trigger a loss of confidence in the financial markets generally (I'm skeptical and think Chapter 11 was probably underused in these cases).
If you got down to brass tacks and figured out which lawyers, accountants and executives were really responsible for the non-disclosure, they very likely wouldn't be good for $5.8 billion, or anything more than a small share of that number.
The whole situation is a disaster, but the best remedy isn't obvious.
Posted by: ohwilleke | Sep 15, 2009 1:51:37 PM
