More questions about Merrill merger

New information about Bank of America's decision to progress with the Merrill Lynch acquisition raises further questions about whether the best interests of BoA's stakeholders were considered and about the role played by regulators.

The findings "raise questions about the transparency of Tarp [Troubled Asset Relief Program] as well as about corporate governance and disclosure practices at BoA", said Andrew Cuomo, attorney general of New York, in a letter on April 23. Cuomo's investigation into the Bank of America merger with Merrill Lynch initially focused on fourth-quarter bonus payments at Merrill.

Cuomo's letter is addressed to Christopher Dodd, the chairman of the Senate committee on banking; Mary Schapiro, chairperson of the Securities and Exchange Commission; Barney Frank, chairman of the House Financial Services Committee; and Elizabeth Warren, chair of the Congressional Oversight Panel. In the letter, Cuomo highlights the events of December 2008 and how important it is that "taxpayers have transparency into decision-making and that investor interests are protected and respected".

In addition to the letter, Cuomo has released minutes from two BoA board meetings, a 100-page transcript of the questioning of Kenneth Lewis, BoA's chairman and chief executive officer, by Cuomo's office on February 26, and Lewis's correspondence related to the Merrill acquisition.

In the transcript, Lewis details a meeting he attended in Washington DC with former US Treasury secretary Hank Paulson, chairman of the Federal Reserve Ben Bernanke and other Federal Reserve and Treasury officials. Lewis explains that in December, after learning that Merrill's projection of its fourth-quarter loss had escalated significantly to around $12 billion (actual losses were almost $16 billion) in just six days, he considered invoking the material adverse change (MAC) clause to prevent the merger from proceeding.

Lewis says he was dissuaded to do so by Paulson, who said that the BoA board and management would be changed if BoA decided not to proceed with the merger. BoA decided to proceed with the merger and has, to date, received $45 billion of Tarp funding.

Cuomo also discloses that in an interview with Cuomo's office, Paulson "largely corroborated Lewis's account", but said he acted on a request from Bernanke. Paulson has also said that he did not keep the SEC informed of any of the BoA discussions.

In his testimony, Lewis says that by proceeding with the Merrill merger he took a decision that would yield benefits to BoA shareholders over two to three years and says he decided to go ahead with the merger so that the financial system in the US would not be subject to systemic risk.

But Lewis is unable to answer why he did not renegotiate the merger ratio, apart from saying that he was told by either Bernanke or Paulson -- he does not remember which -- that the deal needed to close on schedule. At the agreed merger ratio, BoA issued 1.4 billion new shares at a rate of 0.8595 BoA share for each Merrill share, significantly diluting existing BoA shareholders.

On an earnings call with analysts in January, posted on seekingalpha, Lewis responds to an analyst query about proceeding with the merger saying: "A re-pricing, assuming it could be agreed, would have required a new stockholder vote both at Bank of America and at Merrill Lynch and therefore it (the deal) would have been delayed by at least a couple of months. That would have led to considerable uncertainty and could have well cost more than the re-pricing would have saved."

Despite ongoing consultation on the situation with the BoA board through December, including two board meetings, it seems the possibility of disclosing the Merrill losses to shareholders never came up.

Pension fund advisory group CtW Investment Group said that the new information "underscores why Bank of America needs a CEO and board of directors that will put the interests of shareholders ahead of their own interest in self-preservation".

CtW goes on to say: "Lewis and the board owe their fiduciary obligation to the corporation and its shareholders, not to the regulators who reportedly pressed them to close the deal and who may or may not have also pressed them not to disclose manifestly material facts."

At issue is whether Lewis, by withholding so much information about the financial situation at Merrill Lynch, failed in his responsibility to keep shareholders informed of material facts which might have influenced their vote on the merger.

The fate of Lewis and the rest of the BoA board will be decided at BoA's annual shareholder meeting on April 29.

But the sequence of events also raises questions about the impact on stakeholders of relatively healthy financial institutions when they are forced to bail out weaker firms. Some specialists have speculated that this may be one reason why firms such as Goldman Sachs and J.P. Morgan are so eager to repay Tarp funding. Their balance sheets could become significantly -- and maybe even irreversibly -- impaired if they are requested by those in positions of authority to take over one of the floundering firms.