The US Securities and Exchange Commission (SEC) will aggressively pursue a trial against Bank of America Corp. (BAC) for allegedly misleading investors during the acquisition of Merrill Lynch & Co. late last year. The SEC accused BofA of failing to disclose to shareholders that it had authorized Merrill to pay up to $5.8 billion in bonuses to employees in 2008 even after it lost $27.6 billion that year.
Last month, the SEC and BofA had reached a settlement on the charges that required the bank to pay a $33 million fine. But US District Judge Jed Rakoff condemned the deal, saying the corporate fine would further unfairly penalize the shareholders instead of the people actually guilty of misleading investors.
Both the SEC and BofA have defended the earlier settlement proposal as appropriate. But after Rakoff’s ruling, the SEC weighed its options – to go to trial, drop the charges or attempt to renegotiate the deal with BofA.
The SEC also said that it could bring additional charges against BofA on the basis of evidence that might develop in course of the trial. This indicates that regulators may draft civil fraud charges against top bank executives in the coming weeks.
Bank of America, however, continues to defend itself by proclaiming that disclosures on the Merrill deal met all legal requirements. The bank had earlier agreed to pay a fine to avoid legal hassles with the SEC at a time of market uncertainty.
The SEC lawsuit comes as an added blow to Bank of America. The New York Attorney General’s office is carrying out its own investigation into the Merrill deal and has been drafting what are likely to be civil fraud charges against top bank executives in the coming weeks. The bank also missed a Monday noon deadline to provide additional information about the deal to a congressional committee.
Separately, Bank of America agreed to pay $425 million to government agencies, including the Treasury Department, to exit an arrangement under which public funds might have been used to shoulder losses on risky assets worth $118 billion associated with the Merrill takeover.
This step was part of the bank’s broader effort to loosen various forms of government support. While the option was never used, the government has argued that the bank benefited from the promise of protection.BofA has been one of the largest beneficiaries of the federal bailout program, receiving $45 billion from a total of the $700 billion.
Bank of America did overpay for Merrill but the deal makes strategic sense now. BofA gained a global investment-banking platform, profitable retail brokerage addition and significant equity-underwriting capacity, all of which it lacked earlier. For the first half of 2009, Merrill contributed $1.84 billion.
We anticipate continued synergies from the company’s large scale operation and balance sheet restructuring. However, higher credit costs, various legal issues and worsening credit quality will be a drag on BofA’s upcoming results. As such, we are maintaining a Neutral recommendation on the stock.
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