Bank of America Settlement on Hold

In a blog post last week I questioned the fairness of the $33 million settlement Bank of America had agreed to with the SEC for concealing information related to its merger with Merrill Lynch. Now U.S. District Court Judge Jed Rakoff has put that settlement on hold, saying he is not convinced the settlement is fair to the public.

Rakoff correctly noted that the accusation was that Bank of America effectively lied to its shareholders, and was concerned that the $33 million would come from the $20 billion in TARP money the bank got in January.

Money is fungible, so if the settlement is actually paid there would be no way to say “this dollar came from this source and that dollar came from over there.” But the judge’s concern about taxpayers paying the settlement is misguided. As long as the TARP money is repaid—which ultimately Bank of America wants to do, to regain their independence from partial federal ownership and control—the taxpayers will get their TARP money back, and the bank’s stockholders will be the ones who will pay the settlement.

Judge Rakoff is almost on the right track here. He is right to question who bears the ultimate burden of the settlement, and he is right to be concerned that taxpayers might be putting up that money. On further analysis, however, we can see that his concern for the taxpayers is unfounded. Bank of America’s TARP liability will remain the same regardless of whether the settlement goes through.

So, take the next step, Judge Rakoff. Ask, if it’s not the taxpayers who will pay the settlement, who is it? The answer, I argued before, is Bank of America’s shareholders, the very people the SEC said were harmed by the concealment of information. If we conclude that it is unfair to penalize again the very people who were originally harmed through no fault of their own, the settlement should be voided.

A more difficult question is: Who, if anyone, should actually be penalized? I don’t have a good answer for that, because I don’t have all the facts. It was reported that when the merger was under consideration, Treasury Secretary Henry Paulson threatened Bank of America CEO Ken Lewis that he would lose his job if he backed out of the deal, as Lewis was considering doing once he found out how costly it would be. If the merger was effectively engineered by the Secretary of the Treasury, it would be hard to fault Bank of America’s execs for its terms. Meanwhile, Lewis said he was unaware of the bonuses until after they had been distributed. The case is made more complicated because the SEC settlement did not identify who, if anyone, actually did anything wrong.

If the settlement goes through, will the taxpayers unfairly be footing the bill? No. Will Bank of America’s shareholders be unfairly footing the bill? Yes. Should the settlement be voided? Yes. Should someone else be penalized for wrongdoing? I don’t know, because the facts in this case are murky. And one odd thing about the case is that while the SEC did cite wrongdoing in concealing information from Bank of America’s shareholders, it never said who was to blame for this concealment.