How BofA was forced to settle $2.43 bln Merrill class action

October 1, 2012

Brad Karp of Paul, Weiss, Rifkind, Wharton & Garrison and Max Berger of Bernstein Litowitz Berger & Grossmann share an elevator bank at 1285 6th Avenue in New York City. Bernstein Litowitz, a 50-lawyer plaintiffs’ firm, has space on the 36th and 38th floors. Paul Weiss’s 750 lawyers occupy much of the rest of the office building. Karp and Berger are also old frenemies: In 2004, they negotiated Citigroup’s $2.65 billion settlement of shareholder claims in the WorldCom accounting fraud case. Over the last several months, with Karp representing Bank of America and Berger one of the lead counsel for shareholders suing over the bank’s acquisition of Merrill Lynch in 2008, the two have spent a lot of time riding the elevator between Berger’s office on the 36th floor and Karp’s on the 30th, discussing a resolution of the class action.

With an Oct. 22 trial date looming and no sign from U.S. District Judge Kevin Castel that he would end the case by granting summary judgment to either side, those elevator rides (and sessions with mediator Layn Phillips of Irell & Manella) led to the $2.43 billion settlement that Bank of America announced Friday. It’s the fourth-largest-ever securities class action settlement by a single defendant (behind Tyco’s $2.975 billion deal in 2007, Cendant’s $2.83 billion settlement in 1999, and the Citi agreement in 2004) and the largest in a case that involved no accounting fraud or criminal convictions. The settlement is vindication for Richard Cordray of the Consumer Financial Protection Bureau, who launched the litigation on behalf of two Ohio pension funds back in 2009, before he was voted out of office as Ohio’s attorney general, and for the three shareholders’ firms that litigated the case for almost four years: Bernstein Litowitz; Kessler Topaz Meltzer & Check; and Kaplan Fox & Kilsheimer.

The plaintiffs in this case will be asking Castel to approve $150 million in fees, and they’ve earned them. Remember, the SEC was originally willing to settle allegations against BofA for disclosure failures in the Merrill acquisition for $33 million. This settlement reflects the nuanced understanding of Bank of America’s failure to disclose billions of dollars in escalating Merrill Lynch losses that shareholders’ counsel gained through dozens of depositions and millions of pages of discovery. The plaintiffs survived motions to dismiss by the bank and individual defendants, motions to reconsider the denial of their dismissal motions, and opposition to class certification. They clearly persuaded Castel of the value of their claims; his class certification ruling rejected defense arguments that shareholders weren’t injured by the alleged disclosure failures. Bank of America repeated those arguments in its motion for summary judgment, but there’s little chance the judge would have granted the motion. From all indications, Castel had cleared his calendar and planned to try this case, in what would surely have been one of the most celebrated trials stemming from the financial crisis.

And for Bank of America, that was a risk it couldn’t afford to take. Plaintiffs were prepared to assert claims that shareholders lost $4.75 per share as a result of the defendants’ failure to disclose Merrill’s $16 billion in late-2008 losses, (as well as the billions BofA set aside to pay bonuses to Merrill executives). Bank of America had about 5 billion shares outstanding at the time of the merger. Not every shareholder would have been in the class, and some plaintiffs’ claims might have been knocked out before reaching a jury. But it’s clear that if the case had gone to trial, the plaintiffs would have been demanding at least $10 billion to $15 billion.

Even more significantly, most of the damages that shareholders asserted came not from alleged securities fraud but from violations of Section 14(a) of the Securities Exchange Act of 1934, which involves misstatements in proxy materials. To succeed on the Section 14 claims, plaintiffs would only have had to show that the defendants were negligent in failing to disclose Merrill’s mounting, multibillion-dollar losses, not that they deliberately defrauded investors. That’s a much lower bar than the standard for securities fraud, which requires proof of intent to deceive.

Then there was the spectacle Bank of America would have faced if the case had gone to trial. The bank wasn’t the only defendant in the class action. Former CEO Kenneth Lewis and former CFO Joe Price were also named, along with former Merrill Lynch CEO John Thain and BofA independent directors. We already saw, in summary judgment briefs by Lewis and Price, that various former BofA officials have quite different recollections of who made the decision not to add disclosure of Merrill’s escalating loss estimates to the merger proxy materials. Lewis laid responsibility on Price, former BofA general counsel Timothy Mayopoulos and, implicitly, Bank of America’s outside counsel at Wachtell, Lipton, Rosen & Katz. Price has said he talked to Mayopoulos. Mayopoulos, who was abruptly dismissed from his post after the merger, has since tangled with BofA as the new CEO of Fannie Mae. All of them would have been called to testify at trial, a prospect BofA would surely rather not endure.

Wachtell partners would also have been called as witnesses, even though Wachtell remains one of the bank’s counsel in the case. (Cleary Gottlieb Steen & Hamilton is also on the bank’s papers, but Paul Weiss was expected to take the lead at trial.) As I’ve discussed, this case has put Wachtell in the peculiar position of insisting that it was cut out of the disclosure analysis after November 2008 — that its longtime client, BofA, didn’t ask for the advice of one of the most sophisticated M&A firms in the country as bank officials decided whether to tell shareholders about Merrill’s losses. Testimony from Wachtell partners would have been fascinating for those of us in the legal press, but it’s not hard to understand why the bank would rather not see its own lawyers adding support to the allegations of the shareholders.

Against those risks, Bank of America must have seen little upside from a trial before a Manhattan federal-court jury that’s spent four years marinating in bad news about the financial industry. (One additional point, while we’re on the subject of accountability for the meltdown of 2008: The settlement resolves claims against all of the individual defendants, and none of them will contribute personally to shareholders’ recovery.)

One lawyer in the class action told me Friday that this case should stand as a response to anyone who criticizes plaintiffs’ firms for trying to make a quick buck. “This is a message to defendants — institutional investors and their lawyers are serious about these things,” he said. “This shows how vigorously we prosecute the cases we get involved in. We are willing to go the distance.”

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