A judge’s condemnation of the Securities and Exchange Commission in rejecting its $33 million settlement with Bank of America over bonuses at Merrill Lynch dealt a stinging rebuke to an agency seeking to mend its image after its failure to detect Bernard Madoff’s fraud scheme.
The SEC must weigh its options after the judge’s finding that it was too gentle with one of the biggest U.S. banks. It must also struggle anew to gain credibility for its enforcement efforts. The ruling also marks a setback for the SEC’s relatively new chairman, Mary Schapiro.
The agency may be forced to mount a court fight against Bank of America over one of the touchiest issues of the financial crisis — executive pay.
The case stemmed from revelations that Merrill, with the knowledge of Bank of America executives, paid employees $3.6 billion in bonuses just before the bank acquired Merrill on Jan. 1.
In his ruling Monday, U.S. District Judge Jed Rakoff of New York said the SEC’s accusations of inadequate disclosure by Bank of America over the bonuses must now go to trial. Rakoff earlier had ordered the SEC to explain why it didn’t pursue charges against individual Bank of America executives.
The prospect of a trial is “putting the agency in a very tough situation,” said Ross Albert, a former SEC senior special counsel and federal prosecutor who is now a private attorney in Atlanta.
Albert said the agency may have to go to trial — which “it’s not clear what it would accomplish at this point” — or possibly charge individual Bank of America executives.
Schapiro, appointed by President Barack Obama, took over the agency in January — a month after the Madoff scandal and several months after the financial crisis erupted. She installed a new enforcement director and took other steps with an eye toward strengthening the pursuit of fraud and protecting investors.
“The buck stops with her,” Albert said. “She is the senior official ... and anything that reflects badly on the agency is going to reflect badly on her.”
Rakoff called the proposed settlement with Bank of America Corp. a breach of “justice and morality” and ordered the case to trial on Feb. 1. Some saw the ruling as a defeat for Schapiro personally as well as for the agency.
“The first thing Mary Schapiro was trying to do when she came in” was to restore the credibility of the SEC’s enforcement division, said Barbara Roper, director of investor protection at the Consumer Federation of America. “This has to be seen as a pretty serious setback in that area.”
Normally, the five SEC commissioners, including Schapiro, vote to approve or reject settlements with companies or individuals. The agency’s enforcement staff negotiates the deals and recommends how the commissioners should vote. Their votes aren’t made public.
In seeking approval to buy Merrill, Bank of America told shareholders that Merrill wouldn’t pay year-end bonuses without Bank of America’s consent. But in its civil complaint filed in August, the SEC said Bank of America had already authorized Merrill to pay up to $5.8 billion in bonuses and didn’t share that information with shareholders.
Charlotte, N.C.-based Bank of America agreed to pay the $33 million in the settlement without admitting or denying wrongdoing. The bank has said it didn’t violate disclosure rules but wished to avoid litigation with the SEC at a time of market uncertainty.
Rakoff, in his ruling, found that the 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,” he wrote.
The SEC now must consider its next moves.
The agency could seek to renegotiate the deal with Bank of America. But it may be hard to find revised terms that would satisfy Rakoff if bank executives weren’t individually charged. Some legal experts said the SEC can’t appeal his ruling. But it could consider filing a petition to overturn it — a maneuver used in extraordinary circumstances when a judge is alleged to have exceeded his authority.
Or the SEC could go to trial against Bank of America. Rakoff’s setting of a trial date could be aimed at prodding the parties to come back with a new settlement or for the SEC to charge bank executives.
The SEC wasn’t tipping its hand as to its likely next move.
“We believe the proposed settlement properly balanced all of the relevant considerations,” spokesman John Nester said in a statement Monday. “We will carefully review the court’s most recent order.”
While judges have on occasion sent back proposed settlements to the SEC and ordered them to be renegotiated, throwing an accord out entirely is highly unusual.
Rakoff’s ruling “raises really important questions about what the SEC enforcement process should be doing and should be accomplishing,” said Sam Buell, who was a member of the Justice Department’s task force in the Enron prosecution and is now a visiting law professor at Duke University.
At the same time, the rejection of the Bank of America accord could hang over the SEC as its enforcement attorneys seek to negotiate new settlements with other companies.