Opinion

Alison Frankel

New SJ motion in BofA/Merrill case: The boon of discovery

By Alison Frankel
June 5, 2012

There’s a good reason the exchange of information in civil litigation is called discovery. If you want an example of the kind of powerful facts shareholders can obtain once they’re finally allowed to take depositions from securities class-action defendants – and remember, they only get there after surviving defense motions to dismiss – look no further than the motion for summary judgment that plaintiffs’ lawyers filed Sunday against Bank of America in the securities class action over the Merrill Lynch merger. There’s nothing like a former CEO’s admission that insiders withheld dire predictions from shareholders to boost the class’s case.

Shareholder lawyers always knew they’d have more information than usual in the securities litigation against BofA, which allegedly failed to warn investors about Merrill Lynch’s precarious finances before shareholders approved the Merrill merger in the fall of 2008. When plaintiffs’ lawyers first filed lead counsel motions in the spring of 2009, the Securities and Exchange Commission, the New York Attorney General, the North Carolina AG and even Congress were all already poking at the Merrill merger. They were focused on whether BofA adequately disclosed the billions of dollars it had agreed to set aside for bonuses to Merrill executives, in addition to the bank’s communications with shareholders about Merrill’s mounting losses in the last quarter of 2008.

Just weeks after Denny Chin (then a federal district judge in Manhattan, now on the 2nd Circuit Court of Appeals) appointed lead counsel – Bernstein Litowitz Berger & Grossmann; Kaplan Fox & Kilsheimer; and Kessler Topaz Meltzer & Check – the SEC announced a settlement with BofA for disclosure violations. And when U.S. Senior District Judge Jed Rakoff rejected the SEC’s initial settlement and demanded more information about BofA’s disclosure decisions, plaintiffs’ lawyers in the class action pounced. In October 2009, they asked Chin to order the defendants to give them whatever BofA, Merrill and bank officials were turning over to regulators and congressional investigators. In November 2009, Chin granted the motion. Whatever documents the defendants were producing to anyone else, he said, they also had to turn over to shareholders.

That’s a lot more than plaintiffs usually get in the early stages of securities class actions. As you know, when Congress revised the law governing private securities litigation in 1995, it imposed an automatic discovery stay: Shareholders aren’t permitted to conduct any depositions or demand any documents from defendants until they’ve survived a defense motion to dismiss their case. Given that Congress simultaneously set the bar for alleging fraud very high, that discovery stay means lots of securities class actions have died before plaintiffs’ lawyers even got a chance to uncover what defendants really knew.

In the BofA case, shareholders’ lawyers took full advantage of Chin’s directive. Their first and second amended complaints, each weighing in at more than 150 pages, cited, for instance, memos and notes from BofA’s counsel at Wachtell, Lipton, Rosen & Katz, which had advised the bank on the Merrill merger. That material had been produced to Rakoff in the SEC case (or to Congress), so plaintiffs’ lawyers in the securities class action were able to get their hands on Wachtell’s advice on what to tell shareholders about those infamous Merrill bonuses, as well as Merrill’s escalating losses. It was juicy stuff, and in August 2010 U.S. District Judge Kevin Castel, who took over the case from Chin, found that most of the shareholders’ allegations included enough factual specificity to survive the defendants’ motions to dismiss.

But here’s how you can tell the significance of smart plaintiffs’ lawyers working with real discovery, not secondhand documents someone else asked for. Neither of the shareholders’ monster amended complaints – which relied on regulatory investigations for specifics – spends any time at all discussing Bank of America’s disclosure of the Merrill merger’s impact on its share price. Yet that’s the only issue the summary judgment brief addresses. According to the shareholders’ memo, when Bank of America announced the proposed Merrill merger on Sept. 15, 2008, it predicted that the deal would dilute the value of its shares by 3 percent in 2009, with shares recovering (or “accreting”) to breakeven levels in 2010.

Those projections didn’t hold up. By November 2008, bank officials were forcing Merrill to liquidate “hundreds of billions of dollars of assets” to shrink its balance sheet in the face of escalating losses. The asset sales, according to shareholders, reduced the earning prospects of the combined company so severely that BofA’s shares wouldn’t recover for years. And by the time of the shareholder vote on the merger in December 2008, the summary judgment motion asserts, BofA and its executives knew full well that the dilution/accretion analysis in the September proxy was wrong.

To back that assertion, the shareholders quoted from their deposition of former BofA CEO Kenneth Lewis, which took place in March 2012, almost three years after the first BofA securities case was filed. According to the motion, Lewis admitted that on Dec. 5, 2008, when a shareholder asked him specifically about the impact of the Merrill deal on BofA’s share price, BofA board members already knew that the dilution analysis in the proxy, to which he directed the inquiring shareholder, was no longer accurate. “They were not these numbers, no,” Lewis said in the deposition.

“These numbers [from September] were not accurate, correct?” Lewis was asked.

“They had changed,” he said.

According to the plaintiffs’ brief, Lewis said that the board knew by Dec. 5 that the latest projections indicated BofA shares would be diluted by 13.1 percent – not by 3 percent – in the year following the merger, and down 2.8 percent, not back to breakeven, in 2010.

Indeed, according to the brief, Bank of America had to issue billions of dollars in debt to cover Merrill’s losses, and Wachtell and BofA concluded that the bank would be within its rights to walk away from the merger. “As set forth in a set of talking points drafted by Wachtell in December 2008, BofA had determined that Merrill’s fourth-quarter losses were so catastrophic that its earnings ability had been impaired for years to come, and that consummating the merger could constitute a breach of fiduciary duty,” shareholders contend. They asked Castel to grant summary judgment on the material falsity of five BofA statements on the Merrill deal’s dilutive effect on BofA’s share price, citing Lewis’s deposition testimony.

In fairness to the bank, the plaintiffs’ brief is advocacy, not a judicial ruling. The bank is sure to respond that the dilution analysis was only one of at least a dozen factors in its consideration of the Merrill merger and that its revised projections were merely subjective forecasts, not facts that had to be disclosed to shareholders. “The issues around disclosure of Merrill Lynch’s financial condition were scrutinized and explored in numerous venues nearly three years ago and made the subject of numerous suits,” the bank said in an email statement responding to the summary judgment motion. “There is nothing new here. It was clear that Merrill Lynch’s deteriorating financial condition was widely appreciated by shareholders before voting for approval.”

Moreover, Bank of America notes, Merrill has turned out to be a valuable addition to BofA, “providing billions in earnings in the quarters immediately post-closing.” Here’s the bank’s summary judgment motion, in which its lawyers – at Paul, Weiss, Rifkind, Wharton & Garrison; Cleary, Gottlieb, Steen & Hamilton; and Wachtell – argue (among other things) that the plaintiffs can’t tie their supposed losses to alleged misstatements by BofA. Lewis’s lawyers at Debevoise & Plimpton, in the former CEO’s new summary judgment motion, assert that their client relied on the disclosure advice of his CFO, who, in turn, relied on Wachtell and BofA lawyers.

We’ll have to wait for Castel to sort out the rival summary judgment motions, but as you read the shareholders’ brief, consider how unusual it is to read a securities class-action filing with this kind of specificity. Then ask whether that’s a good thing.

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