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3 Troubling Questions About Bank of America's Epic Acquisition of Merrill Lynch

By John Reeves - Sep 14, 2013 at 9:00AM

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A look back at a notorious Wall Street deal.

Bank of America (BAC 0.72%) and Merrill Lynch hammered out one of the biggest deals in Wall Street history in less than 36 hours during the weekend of September 13th and 14th in 2008. Five years later, troubling questions remain about the notorious merger.

With Lehman Brothers on the verge of bankruptcy, executives for both Bank of America and Merrill Lynch knew they needed to act quickly. It was generally understood that Merrill Lynch would be the next financial institution to fall, so there was a real desire to get a deal done before markets opened on Monday, September 15.

Looking back, the acquisition has been a mixed bag for Bank of America. On one hand, Merrill Lynch has been extremely profitable, earning six times the profits of the total bank since 2009, according to The Wall Street Journal. On the other hand, the deal resulted in Bank of America having to settle for $2.43 billion a shareholder lawsuit that alleged the bank had failed to provide sufficient disclosures to investors.

While Bank of America understandably wants to put all of the allegations and unpleasantness behind it, there are still a few remaining questions relating to the deal for investors and taxpayers to consider. Here are three of them.

1. Why did Bank of America pay so much for Merrill Lynch?

Bank of America agreed to pay $29 per share for Merrill Lynch, which was a 70% premium to what Merrill's stock closed at on the previous Friday. The total price was $50 billion (since it was an all-stock deal, the ultimate price actually turned out to be around $21 billion). 

When Merrill's co-president Greg Fleming initially planned on asking for $30 per share, he was advised by a colleague to prepare for a counteroffer of just $3 per share. Everyone on Wall Street knew Merrill Lynch would be hit hard after a Lehman bankruptcy, so the thought of getting a premium on its current share price seemed unrealistic to say the least.

When the final details of the deal became known, JPMorgan's (JPM 2.98%) CEO Jamie Dimon said, "Who pulled that ****** rabbit out of the hat?" More recently, Warren Buffett has asked why Bank of America would, "pay X for Merrill Sunday when you could have had it for pennies on Monday?"

It's even more curious to consider that Bank of America's CFO Joe Price and investment bank head Brian Moynihan, as reported in the book Crash of the Titans, didn't even ask about Merrill's fourth-quarter forecast when they were going over its financials on Saturday, September 13. Bank of America apparently really wanted Merrill Lynch, regardless of the cost. 

2. Why didn't Bank of America fully disclose Merrill Lynch's losses to shareholders?
Bank of America and Merrill Lynch announced their deal on Monday, September 15, but Bank of America's shareholders didn't approve it until December 5. According to a lawsuit filed by the state of New York, Bank of America's management team, led by CEO Ken Lewis, failed to disclose to investors that Merrill Lynch had incurred losses of more than $16 billion, and kept shareholders "in the dark about fundamental changes at Merrill that were obviously important to their voting decision."

Management has argued that it wasn't aware of the magnitude of the losses, and that it wasn't legally required in any event to disclose losses that hadn't been made public. Various lawsuits have challenged that defense, however.

In fact, some of the details mentioned in both the shareholder and New York state lawsuits raise some serious questions. For example, Bank of America's corporate treasurer Jeffrey Brown actually recommended disclosing Merrill's losses to shareholders prior to the vote on December 5. At one point, he said to CFO Price that he "didn't want to be talking [about Merrill's losses] through a glass wall over a telephone."

Just four days later, on December 9, general counsel Timothy Mayopoulos was surprised by the extent of Merrill's losses, which were discussed at Bank of America's board meeting that day. He tried to talk to the CFO, but was told it would have to wait until the following day. The next day, Mayopoulos was fired before he had a chance to discuss the increased losses. Mayopoulos was replaced by Brian Moynihan, who is now Bank of America's CEO. This particular episode leads us to our third and final question.

3. Why was Timothy Mayopoulos terminated by Bank of America's management?
With the economy reeling and a difficult merger to complete, it seems odd that Bank of America would terminate its general counsel "without notice or explanation" in December of 2008. It seems odder still when you consider that top management testified before Congress less than a year later that Mayopoulos, currently CEO of Fannie Mae, "was a good lawyer and had done good work in his five years at B of A."

Bank of America executives have said the termination was part of an overall downsizing plan at the bank. In Crash of the Titans, Greg Farrell suggests firing Mayopoulos allowed Ken Lewis to find a role for future CEO Brian Moynihan, who had just resigned after being offered a new position he wasn't pleased with.

So in the midst of one of the toughest mergers in Wall Street history, Moynihan became general counsel, even though he hadn't practiced law in 15 years, and had an inactive bar membership. He would only stay in the role for 44 days. Ironically, Farrell reports that Lewis had assured Mayopoulos during the Merrill negotiations back in September 2008, "you're my general counsel. I'm happy with you."

New York State's lawsuit offers up one detail that might be relevant here. In addition to wanting to discuss Merrill's increased losses, Mayopoulos had also advised Bank of America's management team that it "couldn't call a material adverse change under the provisions" of the deal with Merrill. Calling an MAC was a way for Bank of America to possibly get out of the merger, but Mayopoulos was on the record of saying such a course wasn't a possibility. Did Bank of America perhaps want to get rid of a general counsel whose advice was too conservative?

The pain of the deal
Bank of America's share price took a serious hit as a result of this deal. And the U.S. government ultimately provided Bank of America with an additional $20 billion in aid as a result of the bank taking on Merrill's losses. While taxpayers were ultimately repaid, investors paid dearly for that epic merger that was put together in less time than it takes many of us to choose a new appliance.

Despite the apparent rottenness of it all, Warren Buffett has said that Ken Lewis' decision to buy Merrill "may have helped avert a total meltdown."

That takeaway from Buffett, which is widely shared by other observers, might just be the bitterest legacy of the financial crisis. Wall Street created a horrible mess, and then we all had to stand back while the bankers and government policymakers salvaged what was left of our teetering financial system. Somehow, we were supposed to feel grateful that things didn't turn out worse. Unsurprisingly, not many people feel like celebrating that dubious outcome.

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