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Bank of America Deathwatch: $50 Billion Securities Fraud Suit Over Merrill Acquisition

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If mortgage litigation and losses on second mortgages aren’t enough to put Bank of America in a terminally impaired state, the $50 billion private lawsuit filed earlier today represents another major blow.

In short form: when Bank of American bought Merrill, the suit claims failed to disclose $15.31 billion loss around the time of the acquisition. It further alleges that this loss was deliberately hidden to assure the deal would be approved by shareholders. The suit charges that senior executives, including the former CFO, Joseph Price, didn’t tell the general counsel, Timothy J. Mayopoulos, about the full extent of the losses. Mayopoulos had been told the losses were roughly $5 billion. He had initially wanted them to be presented, but later decided against it (one has to assume due to pressure from CEO Ken Lewis and others) because it was within the range of recent Merrill quarterly losses. He was told two days before the shareholder vote the losses would be $7 billion, but that was still in a range that investors would arguably expect. They were actually $11 billion the day of the vote. Four days later, at a board meeting, Mayopoulos found out about the larger loss figures and tried to meet with Price. Mayopoulos was fired the next day.

Note that that the SEC sued the Charlotte bank over the very same issue. Judge Jed Rakoff rejected the initial $33 million settlement as inadequate, and reluctantly approved the sweetened $150 million deal, noting it didn’t impose enough costs on the executives involved.

This is a particularly clear-cut case. Steven Davidoff, a former deal lawyer turned law professor who writes regularly for the New York Times’ Dealbook, and tends to be conservative in his assessment of litigation, says that if certain facts alleged in the lawsuit prove to be accurate, “…this is a prima facie case of securities fraud.” And he continues:

Plaintiffs in this private case have the additional benefit that this claim is related to a shareholder vote. It is easier to prove securities fraud related to a shareholder vote than more typical securities fraud claims like accounting fraud. Shareholder vote claims do not require that the plaintiffs prove that the person committing securities fraud did so with awareness that the statement was wrong or otherwise recklessly made. You only need to show that the person should have acted with care.

This case is not only easier to establish, but the potential damages could also be enormous. Damages in a claim like this are calculated by looking at the amount lost as a result of the securities fraud. A court will most likely calculate this by referencing the amount that Bank of America stock dropped after the loss was announced; this is as much as $50 billion. It is a plaintiff’s lawyer’s dream.

Bank of America is facing a huge liability from this claim. It is also facing even more liability for those who bought and sold stock during this period up until Jan. 15. In a ruling on July 29, the judge in this case allowed these claims to proceed against Bank of America, Mr. Price and Mr. Lewis. The judge had already ruled that the disclosure claim related to the proxy vote could proceed.

This case is on a relatively fast track, with an October 2012 trial date.

Bank of America is expected to argue that the losses were consistent with what shareholders expected, given that a good will write off of $2 billion was already disclosed, and they didn’t know the full extent of the damage at the time of the vote. My guess is that if that is the best defense they can mount, they are going to have to write a very large check.

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43 comments

  1. Paul Tioxon

    Why does it take so long? Submitted for your approval, the strange case of the Philadelphia Savings Fund Society, PSFS, founded in 1816 and destroyed by the Federal regulators due to faulty judgement on their part, most likely due to political pressure from Mellon, which would up with all their branches. The aggrieved shareholders are a few days away from a court order payout that has been 20 years in litigation. So why so long, it just seems that’s the way it is when you’re living with the animals in the jungle.

    http://articles.philly.com/2011-09-14/business/30154567_1_psfs-employees-meritor-financial-group-shareholders

    1. Jesse

      I get that litigation can take decades (Exxon Valdez?), but in the case you mentioned, they sued within a year of being shut down.

  2. readerOfTeaLeaves

    Okay, so first the BoA execs didn’t tell their own general counsel the extent of the Merrill losses? Did I read that correctly?!
    How do you not tell your own GC the extent of the losses…?

    Then, after the BoA execs *finally* started to tell their general counsel, they lowballed the amount by more than half. In other words, they lied to him. Although he started to say something about the losses, he backed off because — given the lies he’d been told — he assumed that the losses were ‘within realm of possibility’, so he held his tongue?
    In other words, he could not give correct advice, because he’d been lied to. By the execs.

    Then, as soon as he learned the full amount of the losses, he tried to tell the Big Boss, but then he got fired for trying to tell about the mushrooming size of the losses?!

    Do I understand the sequence of events correctly?

    It is easier to prove securities fraud related to a shareholder vote than more typical securities fraud claims like accounting fraud. Shareholder vote claims do not require that the plaintiffs prove that the person committing securities fraud did so with awareness that the statement was wrong or otherwise recklessly made. You only need to show that the person should have acted with care.

    Well, lying to your lawyer, and then later firing him for trying to tell you the bad news that you earlier lied to him about does kind of seem like it would qualify for ‘reckless’, to say nothing of failing to ‘act with care’.

    These are the MOTFU we bailed out?!
    Makes me seethe.

    1. Yves Smith Post author

      Yes, you have it right, except it was his merely trying to talk to the CFO (who should be more like a peer, but to your point, appears to have had more clout) that got him fired. That is why Davidoff was uncharacteristically emphatic. If the allegations pan out, BofA is in a heap of trouble.

      1. Typing Monkey

        Dumb question, but does DnO insurance cover this type of behavior? Or are the executives going to be facing a hell of a lot of personal liability soon?

      2. ReaderOfTeaLeaves

        Thanks, Yves.
        Mind boggling.

        I can definitely see why Davidoff is sympathetic.

        If lying to you lawyer — and then firing him when he tries to tell you the gig is up, doesn’t qualify as criminal, then I can’t imagine what would.

    1. Typing Monkey

      Good point.

      I’m sort of wondering why they don’t write off more of that $70bn in goodwill though (if this isn’t impaired, then what the hell would be??). Goodwill is ~1/3 the amount of their equity…

  3. Manto

    Sorry but shareholder lawsuits agains the Company (not execs) are stupid – its about time this stuff stops, they are suing themselves in effect.

    1. Typing Monkey

      As an fyi, execs might be covered under DnO insurance, in which case they wouldn’t really be punished. I’m not sure about the extent of coverage generally received, though.

      1. Justicia

        D&O doesn’t cover fraud or gross negligence. As the Deal Professor indicates in his article, Lewis and Price may have to cough up some cash.

    2. Yves Smith Post author

      You are assuming all shareholders are equal and long term. The average holiding time of a stock is well under four months. There is a very specific group that held shares through the period when the stock fell that would benefit.

  4. theadr

    Not to piss on the parade, but in order to prove that you had a loss, you have to prove that you sold your interest (or a portion) in the 2 week period that the stock declined 50%. This will be settled for less than 10% of the $50B. Of course, I bet anyone $90 to your $10 that some lawyer(s) will get rich enough off this case to retire, say $1 million dollars or more. (If they can’t retire on a million, I’d be happy to shorten their lives to what it takes for them to go through it.)

    1. Yves Smith Post author

      Davidoff, a law professor, does not seem to agree:

      Damages in a claim like this are calculated by looking at the amount lost as a result of the securities fraud. A court will most likely calculate this by referencing the amount that Bank of America stock dropped after the loss was announced; this is as much as $50 billion.

      In a class action, you decide the total amount of damages, then you have to tell the court who gets how much (the judge may make the attorneys come up with a different formula). It’s top down. You are assuming bottom up

      1. anon

        Just because the stock dropped doesn’t mean every investor lost money. Only investors who sold post drop will count and I doubt their claims would add up to $50B.

        1. Yves Smith Post author

          You are being obtuse. Davidoff is VERY clear. What about “class action suit” don’t you understand?

          Damages are based on the fall in market cap. The lawyers then have to come up with a formula for apportioning payments among the relevant parties, which the court must approve. This is NOT a bottoms up process of accumulating individual claims. You have the wrong model for how this works.

  5. Linus Huber

    The mood turns down step by step. That is the reason why things are starting to happen.

    I have one question on this aspect. You sue BofA and let us assume if they loose, they will have to cough up the money. Is this not some self-defeating act as you will reduce the value of your own shares while you get paid.

    And what about the looters who are responsible. Do they still get away with their loot?

    1. financial matters

      The cards are way too stacked in favor of management over shareholders in general, not only BofA. Shareholders need to demand more power over management esp executive compensation, stock option manipulation etc.

      1. Linus Huber

        Agreed. I do not understand but share holders have the power; they only have to apply it. Or are the laws so screwed up that the owners of a company cannot control their own managers anymore?

        1. financial matters

          Over half of US publicly traded companies and nearly two-thirds of it Fortune 500 are incorporated in Delaware which has laissez-faire standards of corporate governance that give tremendous power to corporate managers. An office at 1209 North Orange Street, Wilmington houses 217,000 companies. (Treasure Islands)

  6. cathy

    I am trying to e-mail several articles and I can’t locate the e-mail image verification in order to finish the email.

  7. Brett

    It’s kind of ironic, in my opinion, that Merrill Lynch is now the most profitable part of the Bank of America cesspool. If the shareholders that are a part of this lawsuit are still BAC shareholders, in many ways they should be happy about the Merrill Lynch acquisition. It’s the Countrywide acquisition that was the real killer.

    Sidenote: I assume the Countrywide acquisition had to be voted on as well. Was there no deceit involved in that one? Or was everyone who had any power in this company just completely clueless that Countrywide was ground zero for housing bubble fraud?

    Also, how do they know for a fact that Merrill Lynch was the main cause of the falling stock price? Bank of America was doing so many things wrong during this time that the aggregate of the badness (so to say) was likely the real cause. Ken Lewis’ sheer ignorance and stupidity was probably responsible for $10 billion drop in market cap.

    But if this lawsuit takes a significant chunk of wealth from some of the top executives, including Lewis, then that sounds good to me.

    1. Susan the other

      And projecting from BAC to the other big banks. Surely they hid their losses in similar ways, misrepresented the value of their “acquisitions” and the health of their own corporation to every investor; fudged their books to smooth over the relentless drop in their stock prices; extended the pain out over 4 years now. And we are told that Hank Paulsen made these guys take the bail out money and they did so reluctantly. Please. They were already dead in the water. So if BAC finally gets prosecuted for this fakery, all of them should. Especially if it is this straight-forward to make the case.

  8. todd

    Yves,

    I have to honestly say your typically detailed pro/con analysis is sorely lacking in your BofA posts and it is disappointing. Not trying to insult or start a war, just commenting as a long time reader.

    This is also my first comment ever

    Since 2001 securities suits have settled for between 1%-3% of claimed damages and taken ~4yr to settle (the settlement time is lengthening in recent years). “Credit Crisis” suits, of 200 filed 2007-09 have seen ONLY 15 settled to date. Using the historical averages, one would expect BofA to be on the hook for ~$1.5B around 2016. Given they make ~$30B yr pre tax/provision, a billion & half 4 years from now is nothing (can be reserved for @$450m/yr). Even if we double it from the historical high to 6%, that is $3B toward the end of the decade or only 4% of earnings assuming greater than worst case settlement/no cash flow growth between now and then.

    The paradox is, the sooner it settles and the larger the claim, the lower the % settled for. Claims >$5B in 2010 saw just over a 1% recovery. So, if it settles earlier, one might expect closer to the 1% # or ~$500M, again ,a drop in the bucket and a far cry from the “death knell” headlines

    For reference, see the work Cornerstone Research has done on Securities Lawsuits 2010 Review

    I understand people hate BofA and have good reason to and are in no way defending past practices/acquisitions etc. But the conversations here masked as “analysis” of them seems to be turning into SoapBox “hang em all” screeching rather than the rational detailed commentary I have come to enjoy over the years……..

    Just my 2 cents

    1. readerOfTeaLeaves

      I appreciate your perspective. Honestly.
      I am not being snarky.

      Probably like many people, I had zero interest in finance until sometime in 2008. Simply as ‘a story’, what I was seeing was so mind-boggling that I began to pay attention. We’re still getting up to speed, but we’re getting there.

      Your data going back to 2001 is probably accurate; I don’t dispute it. But I would offer the observation that as of Sept 2008, the context changed .

      Your observations make a lot of sense, are rational, and are probably correct. But that was 2001. Even 2007.

      As of the moment in 2008 when the TBTF expected their reckless conduct and big bonuses to be salvaged by taxpayers, they overreached, and that $h!t is still leaking onto the fan. Not just in US, but globally. (Indignados, Arab Spring, #OccupyWallStreet, etc.)

      Then they did something even more stupid — took record bonuses. In other words, rubbed every cop, teacher, small biz person, government employee, surgeon, dentist, etc’s nose in it.

      Again, I think that you make some very important points. You seem to make a very good case that things have worked like “X” in the past. Now, they should continue to work like “X”, and here are the complications and problems with “X”. Again, all good points.

      I’m saying, once BoA took money from taxpayers, the kinds of low penalties you mention became socially unacceptable. Yes, the courts can enforce those, but as such small percentages — particularly for deliberate fraud — they are going to further delegitimize the banking system, the financial system, and the government (courts, legislative, and exec).

      I apologize if I sound like a screamer; this is all incredibly frustrating and the process of trying to figure it out is somewhat trying. Your comment is certainly interesting, and I hope that my comment is read as a sign of respect for your evident authority in these matters.

      I just think the rules changed in Sept 2008, and we have yet to see the end game. The lack of legal action and penalties are, IMVHO, functioning to build up social frustrations about inequality and fairness. That may turn out to be a good thing, but if the low percentages you mention as penalties are applied, it seems as if that would probably feed more social instability.

      The long timelines in investigating fraud, charging crimes, and any sign of punishing people who obviously **deliberately, and with premeditation** committed acts of fraud appears to me to be eroding the legitimacy of international (and national) systems of banking, finance, and government.

      This does not give me pleasure; it’s simply the best sense that I can make of what I see.

      I think that you are probably providing important expertise in a technical way, about a very specific system.

      And someone like myself is looking at the meta-issues of social cohesion and institutional limitations.

    2. Yves Smith Post author

      First, the overwhelming majority of the litigation against Bank of America is against Countrywide, either reps and warranties suits or other types of structured credit litigation. This is a cutting edge area of the law and I am in touch with some of the leading players. The calls on this blog regarding chain of title litigation and mortgage litigation generally have been consistent ahead of the pack and accurate.

      Your comment is close to ad hominem. You criticize my coverage of BofA generally, yet fail to cite a single post which you deem to be erroneous. On this one, you cite GENERAL statistics about securities litigation (which BTW includes a lot of suits filed by aggrieved small shareholders. To cite an aggregate across disparate claims because they are all “securities law claims” is sprurious.

      You aren’t arguing here with me, you are arguing with a former securities lawyer at a top white shoe law firm and now a law professor. This Bank of America suit, as he points out, is different from most suits in that the claims are pursuant to a shareholder vote, and courts have looked on those much more favorably than those relating to accounting fraud. And despite your four year average, Davidoff also points out that this suit IS moving forward quickly.

      You thus cite general factoids that have little bearing on this case and try to mount a broader attack against my credibility. That strongly suggests you have an axe to grind. And you’ve never commented on this blog before. Your objection fits the pattern of a troll.

    3. Linus Huber

      Your comment represents clearly linear thinking. You base your assumptions on the basis of past results which is not really a smart way to do considering the change of mood that is influencing actions.

      Until 2007 the mood was positive as we were at least in nominal terms in a bull market. That made people more docile and cooperative and generally less hostile.

      However today, in my opinion, we are in a bear market that may last a few more years. In such periods attitudes change enormously and leniency disappears while hostility increases. Even judges are exposed to these changes in the general mood.

      Of course, I am never to be sure to be correct on this, but linear thinking is definitely not the way we should apply today.

  9. Roger

    Suing lenders over mortgages that the government encouraged banks to supply is only going to put more people out of work. BAC has already initiated the layoffs of 30,000 plus. The government suing them is going to help nothing but to further recess America’s economy. The simple fact that the government is even involved is the underlying problem in the whole situation. If they would stay out of it, bad loans would not be an issue; people who cannot pay would not be able to qualify.

    1. John M

      Read “Econned”. Bad mortgages occurred because there was a huge demand for mortgages to fuel CDOs and CDSs. People were making huge money off them.

    2. Binky the Bear

      Think of how many jobs will be created when the right thing is finally done, BoA and Citi are broken up into smaller and more easily regulated entities with investment banking firewalled off. The naive model you appear to have (e.g. some “government” forced banks kicking and screaming to loan money to people who couldn’t pay it back) is simply untrue and serves as propaganda for the criminals who manufactured fraudulent mortgages for resale as securities.
      federalreserve.gov/communitydev/craloansurvey.htm shows that CRA loans performed as well as any.

      Dragging out the ongoing racketeering of our business class is simply adding more laps around the bowl as we spiral down the drain.

    3. orionATL

      in an earlier column at NC, y.s. pointed out that the proposed 30k layoffs at boa were, in my terms here not hers,

      essentially a boa head-feint to give the markets/stockholders/et.al. the impression that boa was engaged in belt-tightening when in fact it was already a very, very thriftily run bank.

      the objective, if i understood correctly, was to divert attention away from boa’s real problems which stemmed from bad paper it unloaded on customers, not from too high operating costs.

  10. J Shannon

    The FED and the SEC are also a culpable parties to this fraud and knew BoA was buying a piece of S–t as did BoA. The government knew what was going on and allowed the deal – to put the US depositors at ease. Merrill was not Lehman and had to be saved. The entire US banking system was at risk of failure due to the systemic crisis a run on BoA and all other banks would have caused. The Fed loaned $Trillions as we now know. This suit will go away or we will all pay when BoA fails. I see a meltdown coming if operation twist can’t reverse the death spiral in home values caused by the Fed’s ignorant support of corruption on Wall Street. As we all now know – Credit default swaps were totally unregulated and worthless. No one was insured for what Wall Street caused.

  11. ch

    October 2012 may be too late. I think BOfA will go BK before then. If not at that time they will wait until the outcome of this lawsuit and if they end up losing, then they will file for BK.

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