Bank of America’s acquisition of Merrill Lynch went through, so we will (fortunately) never know what would have happened if the deal had collapsed. But as detailed in the April 23, 2009 letter (here) from New York AG Andrew Cuomo to Sen. Chris Dodd, Rep. Barney Frank and others, if it had been up to BofA, the deal would not have closed, and it was only as a result of a combination of threats and inducements from Henry Paulson and Ben Benanke that BofA and its Chariman, Kenneth Lewis, were convinced to complete the deal.

In his letter, Cuomo urged Congressional and regulatory officials to examine the pressure that Paulson and Bernanke applied to Lewis and to BofA. Cuomo wrote that the federal officials’ actions "raise fundamental questions about the interactions of regulators and those they regulate, as well as important issues of corporate responsibility and shareholders’ rights." 

The information in the April 23 letter and accompanying documents is fascinating, but the still-incomplete picture of the December meetings in which BofA was convinced to complete the deal raise a number of serious questions. The letter and the accompanying exhibits can be found here.

1. Why did Lewis contact Paulson and Bernanke to tell them that BofA wanted to invoke the "material adverse event" clause and kill the deal? Presumably, the merger agreement was a private transaction between two private parties. Right? Well, maybe not. Apparently, as a result of its role in having brokered the Merrill deal, the government retained something more than a gaming interest in the transaction.

But why did Lewis have to report to the feds? Doesn’t it seem like he was asking their permission? Why? Was there a prior strong-arm session, perhaps back in September, where the government previously offered threats and inducements to BofA to get them to accept the deal in the first place? Did BofA make a commitment to the feds, and vice versa, as part of the events that led to the original deal?

2. Did Lewis and the BofA board accede to the fed officials’ demands in order to preserve their positions? Cuomo’s letter certainly intends to communicate that Lewis was convinced to go through with the deal in order to be able to keep his job. Lewis undeniably testified when examined by NYAG’s office personnel that Paulson threatened BofA’s board and Lewis with a loss of their positions. (A transcript of Lewis’s testimony can be found here.)

BofA’s December 22, 2008 Board of Directors Meeting minutes (here) reflect that Lewis reported to the board that Paulson had threatened them (Lewis and the board) with the loss of their positions if the deal failed to go through. Cuomo’s letter also reports that Paulson told the NYAG’s officials that the job threat to Lewis "changed his mind about invoking the MAC clause and terminating the deal."

To be sure, the December 22 board minutes also very carefully recite that "the Board clarif[ied] that is [sic] was not persuaded or influenced by the statement by federal regulators that the Board and management would be removed if federal regulators if the Corporation were to exercise the MAC clause and failed to complete the acquisition by Merrill Lynch." And both the December 22 and December 30, 2008 board minutes (here) reflect concerns about the possible damage to the global economy if the deal failed to go through.

But there doesn’t seem to be any doubt that the threats were made, that Lewis reported the threats to the BofA board, that the board and Lewis discussed the threats, and Paulson at least seems to think the threats had the effect he intended.

3. Realistically, could BofA have turned down the fed officials’ demands? It is not as if just that the Secretary of the Treasury and the head of the Federal Reserve Board alone were strong-arming BofA. BofA’s December 30 board minutes reflect that Bernanke was communicating about the deal to the Office of the Comptroller of the Currency, the FDIC, and the "incoming economic team of the new administration." The existence of these communications were revealed to reassure BofA that it could count on promised additional TARP money, but the existence of the communications also carried an unsubtle implied threat for a high profile company in a highly regulated industry.

At a minimum, BofA had to wonder how regulators might respond, at a very precarious time for the company, if it walked away.

4. Who said what to whom about disclosure? The April 23, 2009 Wall Street Journal led with the story, supported by the transcript from Lewis’s testimony before NYAG officials, that Paulson directed Lewis to withhold disclosure of BofA’s concerns with the deal in order to ensure that it went through. Whether or not these directions took place will be the central issue in the investigative frenzy that is no doubt about to unfold.

The one thing that is clear is that the BofA board was concerned about disclosure. Among other things, the minutes of the BofA’s December 30 board meeting show that the reason the federal officials could not give BofA written assurance that additional TARP funds would be forthcoming if the deal closed is that "written assurances would require formal action by the Fed and the Treasury, which formal action would require public disclosure." The wording of this sentence makes it unclear whether it is BofA or the feds that were worried about disclosure, but it seems clear that the feds were aware of and involved in the disclosure question.

A December 22 email from Paulson to the BofA board (here) seems to suggest that Lewis and the board was concerned about preventing disclosure, but the email arguably is ambiguous. In the email Lewis told the board that Paulson "could not send a letter of any substance without public disclosure, which of course, we do not want." The problem with this sentence is the question of who the word "we" refers to? Is Lewis reporting that Paulson used the word "we" (referring, perhaps, Paulson and his fellow regulators, or perhaps, to Paulson and Lewis), or is does the statement attributed to Paulson stop at the comma, and is the clause after the comma a statement of Lewis’s own, with the word "we" referring to BofA’s board?

Cuomo’s letter and Lewis’s transcript both seem to suggest that disclosure was not just a concern on the part of the BofA board, but that it was also a concern of Paulson’s, and that he actibvly sought to avoid disclosure related to the unreported Merrill losses. Disclosure was a concern, a topic of discussion and focus in discussions between Lewis and Paulson. Which leads to my next two questions.

5. Did Paulson or Bernanke provide Lewis with immunity assurances? We are talking about some very smart guys, and they were fully aware of the legal requirements of disclosure, even if they didn’t pause to analyze the legal particulars. Lewis had to have known that by going through with the deal even though the Company felt entitled to invoke the MAC clause, and that by withholding disclosure of Merrill’s huge and unexpected fourth quarter losses, he and even perhaps the BofA board were potentially undertaking a massive legal exposure – at a minimum, a civil lawsuit exposure, and possibly even much worse exposures.

Did Lewis raise these issues with Paulson and Bernanke? (I find it almost impossible to believe that he did not.) Did they provide any assurances to him? Was he given assurances of immunity or indemnity? Did they promise him a "get out of jail free" card? Without these assurances, how could he possibly have been persuaded to "take one for the team"? Doesn’t it seem wildly improbable that these issues were not discussed?

6. Are Paulson and Bernanke or others potentially exposed to aiding and abetting liability? This question is not facetious and in fact it is particularly important to me, because I have former colleagues from GenRe, people whom I knew and whom I respect, who are going to jail for their complicity in a deal that seems miniscule and trivial compared to this minuet. Certainly, if the federal regulators directed Lewis and BofA not to disclose material nonpublic information, their involvement in nondisclosure that is later found to constitute securities fraud could implicate them as well.

But could they be implicated even if they did not direct the nondisclosure but simply accommodated and facilitated it (for example, by not following through on required federal processes that would have compelled public disclosure)? That is certainly all the Gen Re officials did, and as a result they are going to be spending some serious time in the federal penitentiary.

Let me hasten to add that I am not suggesting that criminal prosecution is something that I think will happen here, or even that I think should happen here. But if these kinds of questions are later raised, the questions clearly should be followed all the way to their logical conclusion.

7. The strong-armed deal may have hurt BofA shareholders, but could it have been worse for them if the deal crumbled? There is no doubt that Paulson’s demand that BofA go through with the deal despite the BofA’s view that it was entitled to invoke the MAC clause had the effect of requiring the BofA shareholders to take a big hit for the sake of the global economy. But that does not necessarily mean it was contrary to the BofA’s shareholders’ interests for BofA to go through with the deal.

Given how massively disruptive Lehman Brothers’ collapse was to the global financial marketplace, it is almost inconceivable how disruptive it could have been if the Merrill deal had fallen through. Merrill would have been cast off, and the revelation of its staggering and unexpected fourth quarter losses would have triggered its immediate collapse – or maybe federal officials could have tried a huge AIG-style rescue of Merrill while somehow trying to reassure that global financial marketplace that there was no reason to panic.

My point is that if the Merrill deal had fallen through, the collateral damage from the ensuing firestorm could have substantially damaged BofA’s near and longer term interests.. It is impossible to know now, but the fact is that it may well have been in the BofA shareholders overall best interests for the firestorm to have been averted. Of course, it does seem like the BofA shareholder ought to have had the right to decide for themselves, doesn’t it?

8. Is there a national interest exception to the disclosure requirements in the federal securities laws? Imagine for a second if BofA had come right out and disclosed that it felt entitled to invoke the MAC clause but that in order to support the global economy and in exchange for some additional TARP money, it was going through with the deal anyway. Now basic principles dictate that they should have disclosed all of this. But if they had, the chaos that would have followed might have been as bad or even worse than what happened if the deal failed to close – which might well have happened anyway in the wake of these kinds of disclosures.

It is easy for commentators to try to argue now what should have been done, as if this were just an amusing question in a parlor game. At the time, however, the principals had no way of knowing how close they were running to potentially catastrophic financial disruption. In view of the weakness in the financial markets and the economy, it was no time for any experiments.

But do their fears, even if well founded, earn them a pass for their silence? If they get a pass, on what basis? What is the legal justification and where is it found? On what standard is it based? And who gets to decide when interests are sufficiently important to override the securities laws – can any government official decide that national interests override disclosure requirements? And what precedent would be set for the future? And isn’t it a duty of public officials to ensure compliance with the law, rather than encouraging noncompliance?

9. Given the facts on the table at the time and the surrounding revelations about Merrill’s fourth quarter losses, how is it possible that the controversial Merrill bonuses were permitted? Obviously, there is a lot more to be told on this score, but if the federal regulators had the authority to tell BofA it had to complete the deal, and if they felt empowered simply to override federal disclosure requirements, surely these same people had the clout to shut down the bonuses? If they felt they had the ability to trample, or simply disregard, BofA shareholders’ rights, why would they hesitate to bar the payment millions in bonuses for billions of losses?

Given all that was going on, that the bonus payments happened seems even more incomprehensible to me – and I am sure I am not the only one.

10. How long will it be before this all gets sorted out? I suspect this will go on for years and years to come. Expect the most immediate steps to include a cycle of sessions in Congressional hearing rooms, replete with the revolting spectacle of speechifying politicians grandstanding at the expense of public dignity. The various judicial processes, some of which are already well underway, some of which will be launched in the months ahead, will grind on for years, with at least two or three round trips to the Supreme Court. My prior post about lawsuits already filed about these circumstances can be found here.

At some point, possibly in the near future, a coalition of crusaders, a lynch mob, or a gang of zealots will try to organize Lewis’s ouster, and who knows, maybe they may well succeed this time. Indeed, for those wondering why all of this is coming to light all of the sudden now, the timing was obviously due to the fact that the BofA shareholders’ meeting is next week — leaving just enough time for the voices of outrage to get fully tuned up for the meeting.

Whatever else you want to say about these circumstances, the spectacle to which we are all about to be subjected will not be pretty and is unlikely to be edifying.