Look out, SEC, cozy settlements won't fly anymore

If the Securities and Exchange Commission won't protect shareholders, then the courts must — and they will. That is the clear meaning of the decision by Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York to reject a proposed settlement be-tween Bank of America Corp. and the Securities and Exchange Commission under which the bank would have paid $33 million to settle charges that it lied to shareholders about its takeover of Merrill Lynch & Co. Inc. In particular, the bank is accused of lying to shareholders about $5.8 billion in bonuses paid by Merrill Lynch in December 2008. BofA officials before the merger allegedly gave Merrill approval to pay bonuses, but didn't disclose that to the bank's shareholders, who were about to vote on the Merrill acquisition. The judge ordered the case to go to trial, something both the bank and the SEC seemed eager to avoid. He recognized that the $33 million BofA would have handed over to the SEC would, in effect, have come from shareholders' pockets. “It is quite something else for the very management that is accused of having lied to its shareholders to determine how much of those victims' money should be used to make the case against the management go away,” he wrote. The judge then got to the heart of the problem with the SEC when he wrote that the proposed settlement “suggests a rather cynical relationship between the parties: the SEC 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. And all this is done at the expense, not only of the shareholders, but also of the truth.” This says clearly what many have suspected about the SEC — that it has at times become too close to the companies it is supposed to regulate. But perhaps the SEC had another motive for approving the soft deal. Perhaps it approved of the settlement because it knew the pressure BofA officials were under from the Department of the Treasury and the Federal Reserve Board to complete the merger, and decided to cut them some slack. It is unlikely the bank's shareholders would have approved of the deal if they had known about the bonuses, and the deal's failure might have triggered a broader financial collapse. The judge might have approved the settlement if the $33 million had come out of the pockets of the BofA board members and executives who decided to withhold the information about the bonuses from the shareholders. Even in that case, though, the shareholders might have paid in the end. The officers and directors of BofA no doubt are covered by insurance against such matters, and a claim might well push up the premiums the company pays. We hope that the judge's two-by-four to the head of the SEC has got its attention, and that it will no longer agree to settlements that favor company executives at the expense of shareholders. Further, the SEC, or Congress, if necessary, should ensure that settlements and fines for bad corporate behavior are paid by company directors and senior executives in the future, not the ordinary shareholders. Finally, we hope the decision will serve as a model for other judges when they are presented with similar soft settlements in cases where shareholders have been lied to or misled.