Monday, August 24, 2009

The S.E.C. Explains

Can a chief executive whose company issues misleading disclosures get away with it by asserting the lawyers did it?

Yes, says the S.E.C.

When Judge Jed Rakoff of U.S. District Court took umbrage at the S.E.C.'s settlement with Bank of America, I thought he had one good point: that someone had to have done the deed, not just a company, and that someone should be sued by the S.E.C. as well. His points about the taxpayer bailout seemed irrelevant to me.

The facts are that B of A told its shareholders that Merrill could not pay bonuses without B of A approval, but failed to mention that it had already given such approval. (The requirement for approval was in a document disclosed to shareholders; the approval was in a document referred to but not disclosed.)

Now we have briefs from the S.E.C. and Bank of America on the issue.

First, B of A says it did nothing wrong. The way the bank sees it, the media had reported that Merrill planned to pay bonuses, and Merrill had said it was accruing for bonuses, so nobody was fooled. The bank only settled so that the bank "would not face the unnecessary distraction of a prolonged dispute" with the S.E.C.

The S.E.C. brief does a good job of demolishing that argument. As it points out, disclosure rules would be rendered meaningless if a company could get out of disclosing by referring to a confidential document.

An interesting sidelight is that by filing this brief, B of A gets to argue it did nothing wrong. Had the settlement simply gone through, it would have neither admitted nor denied it violated the law, and it would have been barred from saying it had not done so.

Where it gets interesting is when the S.E.C. explains why it could not charge top officials, such as Ken Lewis, the chief executive of B of A, or John Thain, then Merrill's boss.

Both of them blamed lawyers for putting together the disclosure documents, and told the S.E.C. they did not know why the disclosure at issue was left out. B of A refused to waive its attorney-client privilege, so the S.E.C. could not learn all the facts. B of A was represented by Wachtell Lipton and Merrill by Shearman & Sterling. B of A said the lawyers, perhaps including in-house lawyers from B of A, made the decisions.

The S.E.C. explains:

"The uncontroverted evidence established that Bank of America relied extensively on counsel in connection with the disclosure materials at issue and that counsel was primarily responsible for drafting the materials and developing the form of presentation in the proxy statement. The applicable scienter requirements and counsel's role in preparing and approving the relevant materials present substantial obstacles to pursuing a securities fraud charge . . . With respect to control person liability, a defendant cannot be held liable if he or she 'acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.'"

. . .

"All the relevant witnesses stated that the written merger agreement, the 'disclosure' schedule, and the proxy statement were negotiated and prepared by counsel for the two companies. The witnesses also stated they relied entirely on counsel to decide what was or was not included in the proxy statement. The commission found no evidence to the contrary. Nor did the commission find any evidence of internal deliberations or discussions, aside from consultations with in-house counsel, concerning the disclosures at issue in this case. Bank of America has not waived the attorney-client privilege. As a result, the investigative record does not include any specific rationale as to why the disclosure schedule or its contents were not disclosed in the proxy statement. Counsel for Bank of America has asserted that the method and format of disclosure was consistent with standard practice and undertaken in good faith."

In other words, we can't prove that anyone told the lawyers not to reveal the important fact. But then again, we can't ask about the conversations the bosses had with those lawyers, because the company has not waived its privilege. (It would have to waive the privilege if it admitted to doing something wrong, and blamed the lawyers, but it admits nothing.)

The lawyers assure us they acted properly. So Mr. Lewis can escape individual liability for misleading shareholders.

Personally, I'd like to see the S.E.C. force him to take that position in court. Mr. Lewis clearly knew of the agreement that was not disclosed, and he should have known what was disclosed in the proxy. If he wants to blame his lawyers, let him do so in court.