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Judge Says SEC Failed Investors
Settlement Over Merrill Lynch Bonuses Would Put Burden on Victims, He Says

By Zachary A. Goldfarb
Washington Post Staff Writer
Tuesday, September 15, 2009

A federal judge on Monday rejected a $33 million settlement between the Securities and Exchange Commission and Bank of America, asserting that the agency bungled its basic job of protecting investors from the wrongdoing of executives.

In a scathing critique, Judge Jed S. Rakoff said the costs of the settlement would essentially be borne by the victims, in this case Bank of America's shareholders. The SEC had accused Bank of America of failing to adequately disclose plans to allow billions of dollars in bonuses to be paid to Merrill Lynch executives before shareholders were asked to approve a marriage between the two companies.

The SEC agreed to allow Bank of America -- and by extension its investors -- to pay $33 million to settle the charges without admitting fault. Rakoff called this arrangement a "contrivance designed to provide the SEC with the facade of enforcement" that nonetheless "victimizes" shareholders.

The ruling is a setback for an agency that is seeking to burnish its image after being roundly criticized for inaction in the months leading up to the financial crisis. And it comes as other regulators appear to be eyeing charges against top Bank of America executives. New York Attorney General Andrew M. Cuomo sent sharply worded letters to Bank of America recently that strongly signaled his intent to file securities fraud charges against the bank's executives related to the disclosures.

A person familiar with the Cuomo's investigation said Monday that his office is in the final stages of drawing up charges against senior Bank of America executives.

Rakoff did not only direct his criticism at the SEC. He also attacked Bank of America's top executives for attempting to shield themselves at the expense of the company's shareholders.

"This case suggests a rather cynical relationship between the parties: the S.E.C. 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," Rakoff wrote in his order. "And all this is done at the expense, not only of the shareholders, but also of the truth."

February Trial Ordered

Rakoff ordered that the case go to trial in February. The SEC and Bank of America each said Monday that they are reviewing their next legal steps. The SEC could move forward, drop the matter, appeal Rakoff's decision or renegotiate the agreement.

In reviewing the settlement, Rakoff said he wanted to know why the SEC didn't charge individual executives at Bank of America and Merrill Lynch who oversaw the allegedly faulty disclosures. The SEC said that Bank of America's executives relied on advice from their lawyers and that there was no evidence they intended to mislead shareholders. Bank of America, meanwhile, said it was settling to avoid the hassle of an extended, expensive case against one of its regulators. It also claimed that it had done nothing wrong.

Rakoff was not persuaded.

"It is not fair, first and foremost, because it does not comport with the most elementary notions of justice and morality, in that it proposes that the shareholders who were the victims of the Bank's alleged misconduct now pay the penalty for that misconduct," Rakoff wrote.

Rakoff also had harsh words for the SEC's contention that the settlement would punish Bank of America's executives by diminishing their reputation in the eyes of the bank's shareholders.

"The notion that 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 [quoting from the SEC's brief] 'better assess the quality and performance of management' is absurd," Rakoff wrote.

Injunction Criticized

In addition, as part of the settlement, the SEC is seeking an injunction barring Bank of America from violating securities laws again. But because Bank of America maintains that it did nothing wrong, such an injunction would mean nothing, Rakoff said.

"Notwithstanding the injunctive relief here sought by the S.E.C., the Bank would feel free to issue exactly the same kind of proxy statement [omitting bonuses] in the future," he wrote.

SEC spokesman John Nester said the agency continues to believe the proposed settlement "balanced all of the relevant considerations" and said it would review Rakoff's order.

Bank of America spokesman Scott Silvestri said the firm disagrees with Rakoff's ruling. "Bank of America believes the facts demonstrate that proper disclosure was made to shareholders about Merrill bonuses. We are prepared to prove that through litigation," he said.

Rakoff, of the Southern District of New York, is said to be a bit of a legal agitator who injects his views into settlements between other parties. For example, in 2003, he refused to consent to an SEC settlement with the telecommunications company WorldCom, which was accused of a massive accounting fraud. Rakoff boosted the financial penalty and altered the terms of the settlement to benefit shareholders.

Staff writer Tomoeh Murakami Tse in New York contributed to this report.

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