The facts and circumstances surrounding Bank of America’s credit crisis-induced acquisition of Merrill Lynch remain among the highest profile and most controversial events during the global financial crisis. In a July 29, 2011 opinion (here), Southern District of New York Judge Kevin Castel granted in part and denied in part the defendants’ renewed motions to dismiss in the consolidated Bank of America securities litigation arising out of BofA’s acquisition of Merrill.


Judge Castel’s opinion deals with two of the most controversial aspects of the events surrounding the deal – BofA’s alleged failure during the fourth quarter of 2008 to disclose Merrill’s deteriorating financial condition after the deal was announced but prior to the shareholder vote; and BofA’s alleged  failure to disclose the commitments of key government officials of financial inducements offered to BofA to complete the deal.



In mid-September 2008, at the height of the global financial crisis, BofA agreed to acquire Merrill Lynch. In October and November 2008, while shareholder approval of the transaction was pending, Merrill suffered losses of over $15 billion and also took a $2 billion goodwill impairment charge. The Complaint alleges that BofA’s senior officials were aware of these losses as they occurred. The Complaint alleges that the losses were so significant that BofA management discussed terminating the transaction, prior to the December 5, 2008 shareholder vote on the merger, in which BofA shareholders approved the merger.


On December 17, 2008, BofA Chariman and CEO Kenneth Lewis called Treasury Secretary Henry Paulson to advise him that BofA was "strongly considering" invoking the “material adverse change” clause in the merger agreement, in order to terminate the deal prior to its scheduled January 1, 2009 close date.  At Paulson’s invitation, Lewis flew to Washington for a face-to-face meeting, at which Paulson and Federal Reserve Board Chair Ben Bernanke urged Lewis not to invoke the MAC clause.


In subsequent conversations, Lewis again advised the government officials that BofA intended to invoke the MAC clause. According to the plaintiffs’ allegations, BofA’s board voted on December 21, 2008 to invoke the MAC clause, but on the following day, the Board voted to approve the merger, apparently in part based on Lewis’s statement that he had received verbal assurances from Paulson that BofA would received a capital infusion and a guarantee against losses from risky assets if the merger concluded.


On January 16, 2010, BofA disclosed the fourth quarter losses of both BofA and Merrill and also revealed the federal funding package, which included $20 billion in capital and protection against further losses on $118 billion in assets. In following days, news reports revealed that in the days prior to the deal’s close, Merrill employees had been paid massive bonuses. 


In response to this news, BofA’s share price declined, and shareholder litigation ensued. The plaintiffs alleged that the defendants misstated and concealed matters related to the Merrill bonuses, the losses that accrued in the Fourth Quarter of 2008 after the merger was announced, and the pressure to consummate the deal from government officials. After the securities and derivative lawsuits were consolidated, the defendants moved to dismiss.


In a lengthy August 27, 2010 opinion (about which refer here), Judge Castel denied in part and granted in part the defendants’ motions to dismiss. First, he denied the defendants’ dismissal motions with regard to the plaintiffs’ allegations concerning the disclosures of the Merrill bonuses. Next, he concluded that while the plaintiffs had also alleged that there were materially misleading misrepresentations or omissions about Merrill Lynch’s deteriorating 4Q08 financial condition and about the promised government financial inducements, the plaintiffs had not adequately alleged scienter as to these topics, and so he denied the defendants’ motion to dismiss as to these allegations.


Thereafter, the plaintiffs filed a Consolidated Second Amended Class Action Complaint (hereafter, the “complaint”). The amendments in the complaint were primarily intended to address the court’s concerns regarding the scienter allegations. The defendants renewed their motions to dismiss.


The July 29 Opinion

In his July 29 ruling, Judge Castel denied the defendant’s dismissal motion as to the allegations surrounding Merrill’s declining 4Q08 financial condition, but granted the dismissal motion as to the allegations about the government bailout. He held that the plaintiffs’ amended complaint adequately alleged scienter as to the Merrill’s financial condition in the fourth quarter of 2008, but did not adequately allege a duty to update prior disclosures  as to the financial support the government officials offered in order to facilitate the deal.


In considering the plaintiffs’ amended allegations concerning Merrill’s 4Q08 losses, Judge Castel first found that the plaintiffs’ had not adequately alleged   that the defendants had a “motive” to mislead. The plaintiffs had alleged that BofA CEO Kenneth Lewis wanted to complete the deal to realize a “long-time business goal.” Lewis, the plaintiffs had alleged, was also motivated to complete the deal to keep his position, after Paulson had “bluntly told Lewis that the Federal Reserve would remove BofA’s senior management if it tried to terminate the transaction.” Judge Castel said neither of these “raised a strong inference of scienter” as there is no allegation that Lewis or BofA’s CFO Joe Price “could personally have profited from either the delay or the closure of the Merrill transaction.”


However, Judge Castel concluded that, with respect to the BofA’s alleged omissions regarding Merrill’s deteriorating 4Q08 financial condition, that the plaintiffs had adequately alleged “recklessness” as to both Lewis and Price.


With respect to Price, Castel concluded based on the plaintiffs’ allegations that the CFO, upon receiving the initial recommendation of the company’s General Counsel that Merrill’s deteriorating results should be disclosed, kept the GC “out of the loop” which “impeded counsel from making a fully informed analysis.’ These allegations are sufficient to infer that upon receiving the GC’s initial discourse recommendation, Price “engaged in ‘conscious recklessness’ amounting to ‘an extreme departure from the standards of ordinary care.’”


Castel concluded, based on the plaintiff allegations that Lewis had full information regarding Merrill’s declining results and that, in light of the transaction’s importance and the magnitude of Merrill’s losses, and that Lewis was reckless in failing to seek guidance of BofA’s disclosure obligations, that  the complaint adequately alleges that “Lewis’s inaction on the disclosure issue raises a strong inference of recklessness.”


In granting the defendants’ motion to dismiss with plaintiffs’ allegations concerning the financial benefits the government officials had offered, Judge Castel said that the plaintiffs had to show that the defendants had a duty to update prior disclosures when subsequent events rendered prior statements misleading. Judge Castel said that the plaintiffs’ complaint “does not, however, allege which statements were rendered misleading by the non-disclosure of federal financial assistance.” Because the complaint “does not allege which statements were allegedly rendered fraudulent by the defendants’ omissions,” the plaintiffs failed to satisfy the PSLRA’s pleading requirements.



One of the reasons the BofA/Merrill merger remains so controversial is that, only after the deal closed, the information came out about Merrill’s losses, the governmental financial inducements, and the payment of the Merrill bonuses. The shocked reaction of the financial marketplace reflected in part an expectation that this information should have been disclosed previously to BofA’s shareholders and to the investing public. While the actual facts and circumstances remain a matter of proof, the plaintiffs portray a set of circumstances in which BofA officials were straining to avoid disclosing potentially disruptive information in order to try to preserve the deal – in part because of threats and inducements from senior government officials.


But no matter how compelling this version of the events may be, they still have to fit within the analytic framework required in order to state a claim under the federal securities laws. Judge Castel’s careful consideration tests the allegations against this analytic framework. Nevertheless, plaintiffs’ suggestion that it was misleading not to tell BofA shareholders that the deal was competed only because of massive government financial inducements, as well as threats to senior BofA officials, does present its own kind of narrative plausibility.


It is probable worth noting that by concluding that the defendants’ had no duty to update prior statements in order to disclose the government financial inducements, Judge Castel avoided the need to get into the questions, which he had addressed in his prior opinion, whether or not the defendants acted with scienter in withholding this information. Indeed, one of the more controversial aspects of Judge Castel’s prior opinion was his conclusion that, in part because the BofA officials had been ordered by the government officials not to disclose the government bailout, they had not acted with scienter in withholding the information. 


In any event, plaintiffs have now succeeded in at least two respects in fitting their plausible narrative into the analytic framework required in order to pursue a securities class action lawsuit. The case will now go forward with respect to the claims relating to the alleged failure to disclose the Merrill bonuses and the alleged failure to disclose Merrill’s massive 4Q08 losses. Even without the provocative allegations regarding the actions of the government officials, this will remain an interesting and high-profile case.