Judge Rakoff wants facts! Notes from yesterday’s hearing

August 11, 2009

Hopped over to courtroom 14-B at 500 Pearl Street yesterday afternoon where I saw Judge Jed Rakoff hammer SEC and Bank of America lawyers over the proposed settlement regarding Merrill Lynch bonuses.

The news is that Rakoff refused to approve the settlement.  He ordered the lawyers to get to the bottom of the “who/what/where” of the case, saying the settlement “seems to be lacking in transparency.”  He’s asked them to file briefs answering those questions on the 24th, and then responses on September 9th.

The hearing itself was very interesting.  Rakoff was clearly very skeptical of the arguments presented by both legal teams, which seemed rather unimpressive.

The judge wondered immediately why, given the “serious questions” raised in its complaint, the SEC wasn’t going after more facts.  If BofA and Merrill conspired to lie to shareholders about bonuses that had been agreed to when the merger was signed, then why isn’t the SEC trying to figure out who is responsible?  “Was it some sort of ghost?  Who made the decision not to disclose [the bonuses]?” said Rakoff.

David Rosenfeld, lead lawyer for the SEC, meekly replied that they haven’t made any allegations against specific individuals.  This clearly didn’t satisfy Rakoff who argued that to make the complaint, they “must have determined who physically committed these acts.”

[By the way, Rosenfeld struck a few of us in the gallery as badly prepared.  He seemed to stumble a lot, and the judge and court reporter repeatedly told him to speak up.  He wasn't familiar with specifics so frequently had to defer to another SEC lawyer.  Even though the hearing revolved around BofA's proxy filing, Rosenfeld and his team didn't have a copy of the document with them.]

So who led the merger negotiations when the discussion of bonuses came up?  The SEC offered two names: Greg Curl for BofA and Greg Fleming for Merrill.  Of which the SEC says it has only spoken to one: Fleming.

Were details of those negotiations circulated to top management?  Yes, Merill CEO John Thain and BofA CEO Ken Lewis were aware of them according to the SEC’s lawyers.

But according to BofA’s lawyer, Cleary Gottlieb’s Lewis Liman, they apparently weren’t aware of what was in “the disclosure schedule,” the document where bonus details were laid out.  That schedule was supposed to be attached to the SEC filing detailing the merger.  Conveniently, it wasn’t.  And of course that’s nobody’s fault.

Oddly, given Liman’s insistence that the proxy was very thorough, Rakoff didn’t ask him why the disclosure schedule wasn’t attached.

Rakoff also asked the SEC lawyers why the settlement is so puny.  A $33m fine for $3.6 billion worth of misconduct?  “Why isn’t this a grossly unfair amount?” he asked.  SEC lawyer David Rosenfeld seemed badly prepared for this question.  He cited the Wachovia/First Union case, saying that $37 million settlement was the right precedent.  Again the judge was skeptical, noting it revolved around $500 million worth of misconduct.  Here you have $3.6 billion.

More to the point, perhaps, Rakoff asked why the settlement is being collected from the corporation and “not from individuals responsible for orchestrating the misleading [SEC filing]?”  Rosenfeld mumbled something about the degree of misconduct, the need for deterrence and finding the closest precedent to justify the structure of the settlement.  As for going after specific individuals, Rosenfeld says he can’t.  The executives are all hiding behind attorney-client privilege.  The judge was not impressed with this excuse, noting that if BofA execs are asserting they relied on advice of counsel, which they seem to be, then they have to waive privilege.

Liman offered some pretty pathetic arguments of his own…

  • People shouldn’t have been surprised by the Merrill bonuses because the company had already accrued $12 billion for that purpose through Q3.

What do you do with this?  Merrill may have had an accounting entry saying they owed their people bonus money, but Merrill wouldn’t have lasted long enough to PAY the bonuses had it not been for bailouts.

  • He argued that $3.6 billion wasn’t a lot of money.  After all it worked out to an average of $91k per recipient.

“I’m glad you think $91k isn’t a lot of money,” retorted the judge.  And in any case, as NY Atty General Cuomo reported two weeks ago, nearly 700 Merrill employees got bonuses north of $1 million.  149 got more than $3 million.

  • Liman also trotted out the cliché about bonuses being necessary for “retention.”  To this Rakoff responded with the obvious: “how many banks were hiring people when the bonuses were paid?”
  • My least favorite defense argument was about the structure of TARP.  Since it came in the form of preferred stock, which has a fixed dividend, Liman argued its value wasn’t impacted by expenses like bonuses.

Liman forgets that besides preferred, TARP investments included warrants, essentially options to buy common stock.  Of course the common is impacted by expenses.

And how is the value of preferred stock not impacted when $3.6 billion is subtracted from the balance sheet?  That’s a lot less cushion protecting preferred stockholders in bankruptcy.  Not exactly a far-fetched scenario only a few months back.

  • Last Liman argued that no one could have been misled by the bonuses because they weren’t a surprise.  He waved his hands in the air suggesting it would be impossible to find anyone, anywhere in the press who didn’t expect Merrill employees to get incentive comp.  This is Wall Street(!) he protested.

Indeed it is.

12 comments

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Doing some good ol’ fashioned reporting, eh? Nice.

btw, looks like this is the same judge who presided over SEC vs. WorldCom:

http://en.wikipedia.org/wiki/Jed_S._Rako ff#sec_v._worldcom

“The reforms were implemented, and Rakoff later credited Breeden with ‘helping to transform a fraud-ridden company into an honest, well-governed, economically viable entity, MCI, Inc.’ WorldCom was purchased by Verizon in January 2006.”

Great reporting, Rolfe! The court should put the hearings on the web! I would pay to watch it.

Posted by Phil Goldstein, Bulldog Investors | Report as abusive

[...] Winkler of Reuters and Louise Story of the New York Times sat in on the hearings on the SEC-Bank of America settlement today. Those who have followed this little drama may recall: [...]

v.good Rolfe,keep on it.

The judge asks ““how many banks were hiring people when the bonuses were paid?”; well the surprising answer is several. Barcap got the NY side of Lehman and Nomura got the European side. Both were looking for the otehr fit. Then there were always the other players who will always hire genuine rainmakers (and make mistakes along the way). Your good people are always, repeat, always, in demand.

Posted by oj | Report as abusive

“My least favorite defense argument was about the structure of TARP. Since it came in the form of preferred stock, which has a fixed dividend, Liman argued its value wasn’t impacted by expenses like bonuses.”

Yes! That is BS and one that should have all American tax payers demanding that the $3.6 billion be disgorged and utilized for a new government agency with teeth; one that could phase out the SEC ASAP. It won’t be long before BofA will need more money to pay the “fixed dividend”

Imagine the budget a new enforcement agency could have if they did their damn job. How long would $3.6 billion fund the SEC?

Unfortunately, they would probably cause a 30% cut to GDP because financial fraud has become such a huge part of our economy.

Regardless of what happens to GDP and our foreign debt obligations we need to reboot and become more self sufficient. We can survive as a bankrupt nation, but not with out rule of law.

Posted by Michael Blomquist | Report as abusive

“This is Wall Street(!)”

Funny. Did he say it like in the movie 300? Or did it sound more like a spoiled child whining for mommy taxpayer to continue funding obsolete crony capitalism?

Wall Street, like a buggywhip only less practical.

Concerning your “More to the point, perhaps, Rakoff asked why the settlement is being collected from the corporation and not from individuals responsible for orchestrating the misleading [SEC filing]? Rosenfeld mumbled something about the degree of misconduct, the
need for deterrence and finding the misconduct, the need for deterrence and finding the closest precedent to justify the structure of the settlement. As for going after specific individuals, Rosenfeld says he can’t. The executives are all hiding behind attorney-client privilege. The judge was not impressed with this excuse, noting that if BofA execs are asserting they relied on advice of counsel, which they seem to be, then they have to waive privilege.”

Hooray for Judge Rakoff. What I would wish a judge (and Congress as well) to ask, and the SEC to explain, is not only for details behind BofA Settlement with the SEC, but for the SEC to explain how fining (penalizing) the Company, which means fining (penalizing) the owners, the shareholders, is of benefit to the shareholders who are the very ones damaged.

The SEC always fines the perpetrators of wrongdoings, keeps the multi dollar fines for themselves and sees to it that the victims receive zero benefits. In other words crime does pay – for the SEC – but out of the very pockets of the victims of the crime.

What is the rationale for this? SEC, Congress, Judges, how does this make any sense to you?

As President Barak Obama has been saying for years; “It is time for change”

[...] NYC judge refuses to rubber stamp paltry fine against Bank of America Judge in NYC decides not to rubber stamp a paltry fine against Bank of America for not disclosing pending bonuses prior to acquisition of Merrill Lynch. Nice to see some cogitation by the judge for a change. This case is a window into what has happened to the structure of the financial sector in the US economy. PROFOUND CORRUPTION! Rolfe Winkler

thank you judge rakoff

finally there is someone within the world’s greatest democray who is actually representing the interests for the greater good of society

the SEC has really shown its true colours here – corrupted, self-centered and toothless

Posted by ernest | Report as abusive

[...] Judge Rakoff wants facts! Notes from today’s hearing (Source) [...]

My ex-wife is concerned that my car insurance and storage unit payments of $700.00 will effect her good credit if the money I provided (“WHILE WALL STREET STOLE ALL MY INTELLECTUAL PROPERTY TO PROVIDE THEIR BONUS MONEY”) runs out before a FINANCIAL SETTLEMENT.

Well I do have available the LC2-SFR ignitor mechanism and my bills today are $700.00

Very interesting! Btw, I love the mix of funny, educational, and all things financial in your blog.

Posted by RS | Report as abusive

Thanks R.W. for showing that bloggers can be good reporters.

If Mr. Lewis doesn’t face criminal charges, at least, this hearing should provide ammo for civil action by shareholder lawyers.

It would be some consolation if Mr. Lewis was forced to spend most of the rest of his life & all his fortune in court defending charges of malfeasence & failure to excersize the most basic due diligence.

Posted by StevenKs | Report as abusive

I have read 8-10 articles on this court hearing and this is the best so far. I can’t help but wonder why the media gives the hearing and questioning such incomplete coverage? I hope that Judge Rakoff continues his common sense approach in a couple of weeks.

Posted by Fireman1979 | Report as abusive

[...] the settlement deal between the SEC and Bank of America. He clearly wasn’t happy with it to begin with, and subsequent briefs from the two parties did nothing to allay his concerns. At the end of the [...]

[...] last August’s hearing, he complained that SEC had failed to address the “who/what/where” of its case. “Was [...]

[...] Co employees.  The mis-handling of this case by the SEC was best described by Rolfe Winkler of Reuters.  The moral outrage over this entire matter was best expressed by Karl Denninger of The Market [...]