Does BofA's Story Hold Up?

In the face of a shareholder revolt over massive losses at Merrill Lynch, and a bonus controversy that has ignited voter outrage, shareholder lawsuits and regulatory probes, Bank of America's chief executive Kenneth Lewis has offered a compelling narrative in his defense to shareholders, a growing number of whom want him sacked.

The narrative:

That Lewis and his team of executives did not know about the $3.6 bn in Merrill bonuses that were paid out before the deal closed; that Bank of America only learned about the mounting Merrill Lynch losses in December; and when it did, Lewis marched down to Washington to speak to then Treasury Secretary Henry Paulson and Federal Reserve chairman Ben Bernanke and threatened to invoke the material adverse conditions [MAC] clause in the merger documents to spike the deal and save shareholders money.

Lewis has also said that he would not have done the deal without taxpayer money, and a regulatory report indicates that the government threatened to can him and his team if he didn't get his bank to buy Merrill Lynch because a Merrill failure would pose systemic risk.

There's a problem with this storyline though, based on confidential BofA-Merrill deal documents obtained by Fox Business.

The MAC clause in the deal contract prevented Lewis from walking away even in the event of losses at Merrill and negative marks to Merrill's assets, along with a wide range of other negative events. And it appears Lewis knew about the Merrill losses and bonuses all along.

BofA spokesman Scott Silvestri said: "Bank of America had only a right to consult with Merrill Lynch on the bonuses and urged Merrill to reduce its bonus numbers. Merrill reduced them 40% and ultimately it was their decision to make."

Silvestri continued: "We had a transition team in place that knew about Merrill’s financial performance, but financial results for November weren’t known until after the December shareholder meeting."

Although MAC clauses have been challenged in other merger deals, the BofA-Merrill Lynch MAC clause is fairly extensive, and appears to be near ironclad. To read it, see the bottom of this column.

Lewis faces increasing legal pressures.

New York Attorney General Andrew Cuomo is investigating Merrill's $3.6 bn bonus payments to employees in December, just before the merger was completed and deep losses were disclosed.

Shareholders have also alleged in lawsuits against the bank and its executives that Merrill's losses were fraudulently hidden from them when they voted on the deal last December.

And now the question is, if Bank of America felt that Merrill Lynch was so financially sick that it wanted to spike the deal, why didn't the bank not publicly disclose Merrill Lynch's mounting losses and the impact those losses would have had on the merger, much less the fact that it was ready to invoke the MAC clause to stop the deal?

BofA's contention is that the government instructed Lewis not to make public disclosures and threatened him with his job if the bank tried to invoke the MAC--and that it also threatened to remove his management team as well.

BofA's purchase of Merrill Lynch was financed by $20 bn in taxpayer funds from the Troubled Asset Relief Program. BofA also got a $118 bn taxpayer backstop to its combined balance sheet in December.

These sums came on top of the $25 bn in TARP money both BofA and Merrill had already received. BofA and Merrill entered into the merger agreement on Sept. 15, 2008, after Lehman Bros. collapsed and AIG was on the brink of going under.

What Bank Insiders Say

Merrill insiders as well as executives close to Merrill's former chief executive John Thain say the $3.6 bn bonuses at Merrill were part of the deal struck last September, and that Lewis knew about Merrill's bad P&L, given that he installed his own accounting and finance team at Merrill, who gave Lewis regular reports about Merrill's profit and loss problems.

And they say the media leaks about Thain's lavish $1.2 mn in office expenditures were done with one aim in mind--to preserve Lewis's job, as he saw Thain as a serious threat, these executives say.

"Who better to step into Lewis's CEO spot after a shareholder revolt over the bad deal than the man who shrewdly got Merrill sold at a good price--and who has already run a major business, the New York Stock Exchange, than Thain himself?" an executive says.

The notion that BofA executives leaked information about John Thain's lavish office spending "is completely false," says Scott Silvestri, BofA spokesman.

Did Lewis Know About the Merrill Bonuses?

BofA's Lewis told Congress in February that he had 'no authority' over billions in Merrill Lynch bonuses.

But documents outlining the payoffs bear his signature. Merrill handed out $3.6 bn in bonuses just before the deal closed January 1, 2009, and before Merrill revealed $15.5 bn in fourth-quarter losses, losses that were later restated to $15.8 bn.

Four top executives at Merrill split $121 mn, and nearly 700 employees got at least $1 mn each.

Rep. Carolyn Maloney (D-Manhattan) asked Lewis at a February Congressional hearing about New York Attorney General's Cuomo's discovery that Merrill execs got more than $3.6 bn in bonuses just before the merger.

"Did you know how big these bonuses were going to be?" she asked.

"My...involvement was very limited," Lewis said. "[Merrill] had a separate board, separate compensation committee and we had no authority to tell them what to do; just urge them what to do. So we did urge."

However, the merger document signed by Lewis and then-Merrill Lynch CEO John Thain includes an attachment stating 2008 Merrill bonuses could not top $5.8 bn, bank executives said.

The merger agreement that Lewis signed Sept. 15 specifically authorized bonuses of up to $5.8 bn to Merrill employees, according to a nonpublic document reviewed by the Daily News.

"His statement that Bank of America had no authority to tell Merrill what to do with respect to bonuses seems to be contradicted," the paper quotes a source familiar with Cuomo's probe. "It appears obvious that the bonus issues were part of the acquisition negotiations."

"Bank of America had only a right to consult with Merrill Lynch and it exercised that right proactively to urge Merrill to reduce its bonus numbers," a BofA spokesman has said.

In the earnings conference call disclosing Merrill's disastrous fourth quarter losses of $15.5 bn, Lewis revealed that the bank would not have acquired Merrill Lynch without the government's assistance-despite assuring the markets that he and his executives had conducted due diligence on Merrill's assets, with the help of J.C. Flowers, when the deal was announced September 15, 2008.

Specifically, Lewis revealed that in December, late in the fourth quarter, he and other executives suddenly discovered that the problem assets at Merrill had soured worse than expected, to the point where BofA wanted to walk away from buying the brokerage.

"As we saw the anticipated fourth quarter losses accelerating we did evaluate our rights under the merger agreement and during that time we spoke to and were in close coordination with officials from both Treasury and Federal Reserve," Lewis said on the conference call.

He added: "The government was firmly of the view that terminating or delaying the closing of the transaction could lead to significant concerns and could result in serious systemic harm. We went to our regulators and told them that we could not close the deal without their assistance."

BofA-Merrill MAC Clause and Merger Restrictions

However, the MAC clause (for the full clause, see bottom) was unusually binding. The merger documents, obtained by Fox Business, indicates BofA could not walk away from buying Merrill even in the event of:

Changes to Merrill's "asset marks"

Merrill's "failure...to meet earnings projections"

Losses at Merrill Lynch

Changes in the price of Merrill's "common stock"

"Acts of terrorism or war"

"Losses of employees"

Also, the deal appears not to have contained any reference to a breakup fee, as Iflove Finance notes.

What Did Lewis Lnow About Merrill's Losses?

New York Attorney General Cuomo has sent Senate Banking committee chairman Christopher Dodd (D-Conn.), House Financial Services committee chairman Barney Frank (D-Mass.), Mary Schapiro, chairman of the Securities and Exchange Commission, and Elizabeth Warren, chair of the TARP Congressional Oversight Panel a letter stating that, a week after BofA shareholders approved the Merrill merger on December 5, and days after the Merrill bonus payments:

"Merrill Lynch quickly and quietly booked billions of dollars of additional losses. Merrill Lynch's fourth quarter 2008 losses turned out to be $7 bn worse than it had projected prior to the merger vote and finalizing its bonuses. These additional losses, some of which had become known to Bank of America executives prior to the merger vote, were not disclosed to shareholders until mid-January 2009, two weeks after the merger had closed on January 1,2009."

"On Sunday, December 14, 2008, Bank of America's CFO advised Ken Lewis, Bank of America's CEO, that Merrill Lynch's financial condition had seriously deteriorated at an alarming rate. Indeed, Lewis was advised that Merrill Lynch had lost several billion dollars since December 8, 2008. In six days, Merrill Lynch's projected fourth quarter losses skyrocketed from $9 bn to $12 bn, and fourth quarter losses ultimately exceeded $15 bn."

"Immediately after learning on December 14, 2008 of what Lewis described as the "staggering amount of deterioration" at Merrill Lynch, Lewis conferred with counsel to determine if Bank of America had grounds to rescind the merger agreement by using a clause that allowed Bank of America to exit the deal if a material adverse event ("MAC") occurred."

On December 17, 2008, Lewis informed then-Treasury Secretary Henry Paulson that Bank of America was seriously considering invoking the MAC clause. Paulson then asked Lewis to come to Washington that evening to discuss the situation, which he did at a meeting with Secretary Paulson, Federal Reserve Chairman Ben Bernanke, Bank of America's CFO, and other officials.

Invoke the MAC Clause, and We'll Can You?

Cuomo's letter states that federal government officials "pressured Bank of America not to seek to rescind the merger agreement" but that his offices does "not yet have a complete picture of the Federal Reserve's role in these matters because the Federal Reserve has invoked the bank examination privilege."

BofA's attempt to bolt from the deal stopped on December 21, 2008, Cuomo says. "That day, Lewis informed Secretary Paulson that Bank of America still wanted to exit the merger agreement. According to Lewis, Secretary Paulson then advised Lewis that, if Bank of America invoked the MAC, its management and Board would be replaced," the letter says.

Lewis Testifies

Cuomo quotes Lewis as saying Paulson told him: "I'm going to be very blunt, we're very supportive on Bank of America and we want to be of help, but' --as I recall him saying "the government," but that may or may not be the case -"does not feel it's in your best interest for you to call a MAC, and that we feel so strongly," --I can't recall if he said 'we would remove the board and management if you called it' or if he said 'we would do it if you intended to.' I don't remember which one it was, before or after, and I said, "Hank, let's deescalate this for a while. Let me talk to our board." And the board's reaction was of 'that threat, okay, do it. That would be systemic risk.'"

Paulson Corroborates

Cuomo's letter continues:

"In an interview with this Office, Secretary Paulson largely corroborated Lewis's account. On the issue of terminating management and the Board, Secretary Paulson indicated that he told Lewis that if Bank of America were to back out of the Merrill Lynch deal, the government either could or would remove the Board and management."

"Secretary Paulson told Lewis a series of concerns, including that Bank of America's invocation of the MAC would create systemic risk and that Bank of America did not have a legal basis to invoke the MAC (though Secretary Paulson's basis for the opinion was entirely based on what he was told by Federal Reserve officials)."

Lewis Swayed by Paulson and Bernanke Pressure

Cuomo's letter says:

"Secretary Paulson's threat swayed Lewis. According to Secretary Paulson, after he stated that the management and the board could be removed, Lewis replied, 'that makes it simple. Let's deescalate.' Lewis admits that Secretary Paulson's threat changed his mind about invoking that MAC clause and terminating the deal."

Cuomo's letter says: "Secretary Paulson has informed us that he made the threat at the request of Chairman Bernanke. After the threat, the conversation between Secretary Paulson and Lewis turned to receiving additional government assistance in light of the staggering Merrill Lynch losses."

Cuomo's letter says on December 22,2008, the BofA "board met and was advised of Lewis's decision not to invoke the MAC," due to the "systemic risk to the financial system," as well as the government's threat to remove the board and management. The board was also told that the bank "can rely on the Fed and Treasury to complete and deliver the promised [taxpayer] support by January 20, 2009, the date scheduled for the release of earnings by the Corporation."

Paulson's discussions "centered on the Fed lawyers' opinion that BofA's merger contract with Merrill was binding," a Wall Street Journal article dated Friday (April 24) cited a spokeswoman for Paulson as saying, as well as centering on "the Treasury's commitment to ensuring that no systemically important financial institution would be allowed to fail."

No Disclosure

Cuomo's letter adds: "Despite the fact that Bank of America had determined that Merrill Lynch's financial condition was so grave that it justified termination of the deal pursuant to the MAC clause, Bank of America did not publicly disclose Merrill Lynch's devastating losses or the impact it would have on the merger."

"Nor did Bank of America disclose that it had been prepared to invoke the MAC clause and would have done so but for the intervention of the Treasury Department and the Federal Reserve."

Cuomo's letter also states: "Lewis testified that the question of disclosure was not up to him and that his decision not to disclose was based on direction from Paulson and Bernanke: 'I was instructed that 'We do not want a public disclosure.'"

He Said-He Said

Cuomo's letter says: "Secretary Paulson, however, informed this Office that his discussions with Lewis regarding disclosure concerned the Treasury Department's own disclosure obligations."

It adds: "Lewis testified that there was no discussion with the board about disclosure to shareholders. However, on the night of December 22, 2008, Lewis emailed the board, 'I just talked with Hank Paulson. He said that there was no way the Federal Reserve and the Treasury could send us a letter of any substance without public disclosure which, of course, we do not want.'"

The letter adds: "The December 30 Board meeting minutes further reflect that Bank of America was trying to time its disclosure of Merrill Lynch's losses to coincide with the announcement of its earnings in January and the receipt of additional TARP funds."

"'Mr. Lewis concluded his remarks by stating that management will continue to work with the federal regulators to transform the principles that have been discussed into an appropriately documented commitment to be codified and implemented in conjunction with the Corporation's earning [sic] release on January 20, 2009.'"

It also bears noting that while no public disclosures were made by Bank of America, Lewis admitted that Bank of America's decision not to invoke the MAC clause harmed any shareholder with less than a three year time-horizon: 4

Q. Wasn't Mr. Paulson, by his instruction, really asking Bank of America shareholders to take a good part of the hit of the Merrill losses?

A. What he was doing was trying to stem a financial disaster in the financial markets, from his perspective.

Q. From your perspective, wasn't that one of the effects of what he was doing?

A. Over the short term, yes, but we still thought we had an entity that filled two big strategic holes for us and over long term would still be an interest to the shareholders.

Q. What do you mean by "short-term"?

A. Two to three years.

SEC Kept in the Dark

The letter adds: "Notably, during Bank of America's important communications with federal banking officials in late December 2008, the lone federal agency charged with protecting investor interests, the Securities and Exchange Commission, appears to have been kept in the dark. Indeed, Secretary Paulson informed this [Cuomo's] Office that he did not keep the SEC Chairman in the loop during the discussions and negotiations with Bank of America in December 2008."

The MAC Clause

3.8  Absence of Certain Changes or Events.  (a) Since June 27, 2008, no event or events have occurred that have had or would reasonably be expected to have, either individually or in the aggregate, a Material Adverse Effect on Company. As used in this Agreement, the term "Material Adverse Effect" means, with respect to Parent or Company, as the case may be, a material adverse effect on (i) the financial condition, results of operations or business of such party and its Subsidiaries taken as a whole (provided, however, that, with respect to clause (i), a "Material Adverse Effect" shall not be deemed to include effects to the extent resulting from (A) changes, after the date hereof, in GAAP or regulatory accounting requirements applicable generally to companies in the industries in which such party and its Subsidiaries operate, (B) changes, after the date hereof, in laws, rules, regulations or the interpretation of laws, rules or regulations by Governmental Authorities of general applicability to companies in the industries in which such party and its Subsidiaries operate, (C) actions or omissions taken with the prior written consent of the other party or expressly required by this Agreement, (D) changes in global, national or regional political conditions (including acts of terrorism or war) or general business, economic or market conditions, including changes generally in prevailing interest rates, currency exchange rates, credit markets and price levels or trading volumes in the United States or foreign securities markets, in each case generally affecting the industries in which such party or its Subsidiaries operate and including changes to any previously correctly applied asset marks resulting there from, (E) the execution of this Agreement or the public disclosure of this Agreement or the transactions contemplated hereby, including acts of competitors or losses of employees to the extent resulting therefrom, (F) failure, in and of itself, to meet earnings projections, but not including any underlying causes thereof or (G) changes in the trading price of a party's common stock, in and of itself, but not including any underlying causes, except, with respect to clauses (A), (B) and (D), to the extent that the effects of such change are

A-13

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disproportionately adverse to the financial condition, results of operations or business of such party and its Subsidiaries, taken as a whole, as compared to other companies in the industry in which such party and its Subsidiaries operate) or (ii) the ability of such party to timely consummate the transactions contemplated by this Agreement.

(b) Since June 27, 2008 through and including the date of this Agreement, Company and its Subsidiaries have carried on their respective businesses in all material respects in the ordinary course of business consistent with their past practice.

(c) Since June 27, 2008 through and including the date of this Agreement, neither Company nor any of its Subsidiaries has (i) except for (A) normal increases for or payments to employees (other than officers subject to the reporting requirements of Section 16(a) of the Exchange Act (the "Executive Officers")) made in the ordinary course of business consistent with past practice or (B) as required by applicable law or contractual obligations existing as of the date hereof, increased the wages, salaries, compensation, pension, or other fringe benefits or perquisites payable to any Executive Officer or other employee or director from the amount thereof in effect as of June 27, 2008, granted any severance or termination pay, entered into any contract to make or grant any severance or termination pay (in each case, except as required under the terms of agreements or severance plans listed on Section 3.11 of the Company Disclosure Schedule, as in effect as of the date hereof ), or paid any cash bonus in excess of $1,000,000 other than the customary year-end bonuses in amounts consistent with past practice and other than the monthly incentive payments made to financial advisors under current Company programs, (ii) granted any options to purchase shares of Company Common Stock, any restricted shares of Company Common Stock or any right to acquire any shares of its capital stock, or any right to payment based on the value of Company's capital stock, to any Executive Officer or other employee or director other than grants to employees (other than Executive Officers) made in the ordinary course of business consistent with past practice under the Company Stock Plans or grants relating to shares of Company Common Stock with an aggregate value for all such grants of less than $1 million for any individual, (iii) changed any financial accounting methods, principles or practices of Company or its Subsidiaries affecting its assets, liabilities or businesses, including any reserving, renewal or residual method, practice or policy, (iv) suffered any strike, work stoppage, slow-down, or other labor disturbance, or (v) except for publicly disclosed ordinary dividends on the Company Common Stock or Company Preferred Stock and except for distributions by wholly-owned Subsidiaries of Company to Company or another wholly-owned Subsidiary of Company, made or declared any distribution in cash or kind to its stockholder or repurchased any shares of its capital stock or other equity interests.