Andrew Cuomo has filed his long-awaited civil suit against Bank of America, its former CEO, Kenneth Lewis, and its former chief financial officer, Joseph Price. Cuomo’s 86-page complaint alleges that the bankers defrauded both shareholders and federal officials during the controversial merger between Bank of America and Merrill Lynch at the height of the financial crisis. (For background on that complicated melodrama, see this article.)
Despite its length, Cuomo’s complaint raises as many questions as it answers. Below are a few new and lingering queries about the conflict that suggest a few more shoes have yet to drop.
WHO KNEW WHAT WHEN?
Last spring, Ken Lewis testified that he did not become aware of Merrill’s “accelerating losses” until after the December 5 shareholder vote approving the merger. In his civil complaint, Cuomo reveals testimony and documentary evidence suggesting that Lewis’s testimony wasn’t true. According to Cuomo, both Lewis and Price were following Merrill’s day-to-day financial condition with obsessive interest and were having conversations with the bank’s lawyers about whether they were legally required to disclose the mounting losses to shareholders for several weeks prior to the December 5 vote.
DID BERNANKE AND PAULSON PRESSURE LEWIS?
Treasury Secretary Henry Paulson promoted the Bank of America–Merrill merger as an integral part of his plan for stabilizing the financial system. Paulson has admitted that he strong-armed Lewis into proceeding with the deal after the shareholder vote. But new revelations about what Lewis knew and when he knew it may yield similar — and similarly damaging — revelations about improper Washington influence. Did Paulson or Fed chairman Ben Bernanke pressure Lewis not to disclose Merrill’s losses to shareholders before the vote? A source close to Lewis’s legal-defense team informed the Daily Beast that the banker plans to call both men to the stand if this case proceeds to trial, so we may find out.
WAS DISCLOSURE REQUIRED?
Probably, but the answer is not as obvious as one might think. Cuomo’s complaint spills a lot of ink showing that the defendants didn’t try very hard to answer to this question correctly but devotes very little to the task of explaining why the answer they did come up with was wrong. Bank of America’s general counsel, Timothy Mayopoulos, had decided that shareholders could not reasonably be surprised by an after-tax quarterly loss that fell within the range of losses that Merrill had suffered in recent quarters: between $2 billion and $10 billion. Even by Cuomo’s calculations, after-tax losses didn’t pass the $10 billion mark until the afternoon of December 5 — the very day of the shareholder vote. If Mayopoulos’s rough-and-ready standard was an acceptable interpretation of the vague law governing such disclosures, the court will have to address a pretty fine-grained legal question about exactly when the duty to disclose accrues. Must management disclose a loss that is rapidly approaching the threshold size to be reportable but hasn’t yet reached that size?
WHY WOULD LEWIS AND PRICE LIE?
Cuomo claims that Lewis and Price fiddled with their accounting in a report to Treasury shortly after the shareholder vote. Their alleged goal was to create the false impression that a large share of Merrill’s fourth-quarter losses had accrued after the December 5 vote and that the losses were “accelerating.” Both of those claims would bolster their legal argument that Bank of America could back out of the merger under the co-called “MAC clause,” a provision in the contract allowing a party to walk away from the deal if there were a “material adverse change” in circumstances.
But why would Lewis and Price have done this? Cuomo claims that they did so in order to bolster their case that they could invoke the MAC clause. He also claims that the defendants never intended to actually invoke the MAC clause, which they had privately determined would be a disastrous course of action, but in fact intended to make an empty threat to the Treasury in order to compel it to provide more bailout dollars. This explanation doesn’t make much sense. Cuomo himself alleges that the combined bank would have gone bankrupt without the additional bailout money, so Paulson already had a surefire incentive to provide needed funds to Bank of America after the merger he had orchestrated himself as part of his plan to stabilize the financial system.
WAS THERE A CONFLICT OF INTEREST?
Cuomo alleges that Lewis and Price failed to disclose a personal conflict of interest that Paulson created between the two executives and their bank when he threatened to fire the entire Bank of America management team if they invoked the merger agreement’s MAC clause. But Cuomo also claims that the defendants knew that the MAC claim was “impossible” and intended to use it only as “a bargaining chip” to secure additional bailout funds. These two claims are inconsistent: If Lewis and Price were privately sure (as Cuomo claims) that invoking a MAC would be against the interests of their shareholders, then Paulson’s threat didn’t actually create any conflict: The shareholders’ interest in proceeding with the agreed merger and the executives’ interests in keeping their jobs were perfectly aligned. This conflict-of-interest claim may be an emergency back-up charge, so that Cuomo can win on a technicality even if the fact-finder decides that a MAC claim was justified in the course of finding for the defendants on other charges.
WHO WAS HURT?
Finally, what are the damages in this case? Cuomo requests attorney’s fees for his office as well as injunctive relief amounting to a stern warning to the defendants not to mislead shareholders and the federal government about multi-billion-dollar losses suffered by a merger partner in the midst of an unprecedented financial crisis ever again. Done, and done! Other than these items, it is not clear that much relief is due. Fraud statutes authorize the disgorgement of ill-gotten gains, but Bank of America has already repaid all of its TARP money with interest, and Lewis and Price were not enriched by the merger, which ruined their reputations and cost them their jobs (Price now works for Bank of America in a lesser role).
Nor do many people appear to have been damaged by the defendants’ conduct. The taxpayers came to no harm: The additional $20 billion that Treasury committed to Bank of America in January 2009 would likely have been used to bail out Merrill separately if Bank of America shareholders had rejected the merger, and the funds have been fully repaid in any event. Short-term shareholders at Bank of America were indeed hurt if they sold their shares last year, but long-term shareholders may have benefited from the merger now that the acquired Merrill assets are turning profits again. While earlier cases provide little guidance on the question of balancing the interests of short- and long-term shareholders, Delaware corporate law gives managers wide latitude to strike an appropriate balance between them.
Public prosecutors, like corporate managers, frequently face professional conflicts of interest. They may be tempted to pursue cases of little substantive value to the government if those cases feature unpopular defendants and garner favorable media attention. Let us hope that Andrew Cuomo’s better angels will lead him to handle this high-profile case in a manner consistent with the best tradition of prosecutorial discretion.
– Marie Gryphon is a senior fellow at the Manhattan Institute