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Can BofA Shareholders Exact Revenge?

When Bank of America Corp. recently agreed to pay a $33 million government fine for failing to disclose pivotal information to shareholders before its merger with Merrill Lynch, my thoughts turned to revenge.

The $33 million would be paid out of corporate assets--that means out of shareholder's pockets. And it would add to hundreds of millions in legal fees and settlement costs that shareholders have shouldered as the direct result of boneheaded decision making by BofA's Chief Executive Ken Lewis and his rubber-stamp board of directors.

I wanted shareholders to be able to pull at least some of this money out of Lewis' pocket--and the pockets of the other highly-paid managers who made decisions that have cost shareholders dearly. Bank of America's stock price has sunk from more than $52 per share in October of 2007 to roughly $17 last week. To be sure, the overall market is also down from that point, but by half as much.

Unfortunately the deal BofA struck with the Securities and Exchange Commission allowed the company to skirt the issue of guilt and likely would have made such revenge impossible. But U.S. District Judge Jed Rakoff gave shareholders hope last week, when he refused to approve the settlement and is demanding a hearing at the end of this month with details about who approved what and when. That's got some calling the judge a hero. I'd agree. With information about who was culpable for the deception, shareholders may be able to get the last laugh. Not a great laugh, to be sure. But at least a small chuckle of revenge.

How so? For the past two years, BofA has had a policy of "recoupment" that would allow the company's board of directors to take back incentive compensation that turned out to have been awarded to managers based on fraud or misrepresentation. When the policy was initiated in 2007, the fraud had to be so bad that it caused an earnings restatement. The recoupment policy was revised last year when BofA turned to the government to bail out its flagging finances through TARP, which stands for "Troubled Assets Relief Program." (TARP is a corporate welfare program that gives taxpayer dollars to ailing banks in the hope that the banks will become rich enough to lend money back to the taxpayers who financed their bailout. I think that's a circuitous route to economic relief, but that's another story.)

Now BofA's directors can recover "any incentive compensation paid that was based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria."

Given BofA's miserable performance in 2008, no incentive pay was "awarded" last year. But plenty of incentive pay was paid, according to the company's 2009 proxy statement.

In addition to his generous $1.5 million salary, Lewis got $7.34 million in stock. Chief Financial Officer Joe Price received $3.2 million in stock in addition to his $800,000 salary. Barbara Desoer, president of Bank of America Mortgage, earned an $800,000 salary and got $3.8 million in stock. Liam McGee, president of consumer banking, got $4.5 million in stock in addition to his $800,000 salary and Bruce Hammonds, former president of the bank's card services division, got $2.8 million in stock in addition to his $700,000 salary.

The incentive pay, the cumulative $21.6 million in stock awards paid last year but "granted" in previous years, admittedly isn't even enough to cover the SEC's $33 million fine. But would strike me as something of a shareholder victory to get that money back anyway.

I'll mention here that I have no individual stake in BofA, although I do own index mutual funds that own BofA shares. My interest in revenge is more a matter of fairness. Over the past 25 years writing about executive compensation, I've watched as top executives have reaped astounding rewards for "pay for performance," claiming that their brilliance is what created all the company's value when times were good. When times were bad, they blamed "market conditions" and took home a fortune anyway.

Lewis, for example, got paid a total of $62.7 million over the past three years as he bought Countrywide Financial Corp. of Calabasas and Merrill Lynch--both failing companies that have since managed to ravage BofA's balance sheet. Not only were these disastrous business decisions, a series of revelations about the Merrill Lynch deal indicate that Lewis mislead shareholders to accomplish that merger.

Two days before shareholders were slated to vote on the Merrill deal, internal forecasts warned that the company's losses were mounting and likely added to $2 billion more than previously projected. The additional losses were not disclosed to shareholders before the vote.

The SEC's proposed $33 million fine was designed to punish the bank for a separate issue allegedly kept strategically secret--the billions in bonuses that BofA agreed to pay Merrill executives after the merger was approved. Although the bank pre-approved up to $5.8 billion in bonuses, the proxy statement given to shareholders said Merrill bonuses wouldn't be paid without BofA consent, according to the SEC. BofA attorneys said they did disclose the promise to pay bonuses in a separate document, the official merger agreement, but that wasn't included in the proxy materials.

Merrill eventually handed out $3.6 billion in bonuses amid widespread furor. Add that to the $2 billion in undisclosed projected losses and I'd call those financial disclosures materially inaccurate, wouldn't you?

There's one thing stopping shareholders from getting those incentive payments back. BofA's board of directors, who are paid a minimum of $240,000 annually to represent shareholder interests, must demand the recovery. A Bank of America spokesman refused comment about whether they might.

Shareholders, who stripped Lewis of the BofA board chairmanship in April, might argue that the time for directors to act in their interest is long past due. Unfortunately, shareholders often find that they have to sue to get their boards to move against the chief executive. And shareholder suits against directors often are an uphill battle. The reason is something called the "business judgment rule," which securities lawyer C. Dana Hobart says can operate as an Imbecile Protection Act.

Hobart, a partner at Hennigan, Bennett & Dorman in Los Angeles, explains that the business judgment rule says that most board decisions are presumed to be made in the best interest of shareholders, even when they appear boneheaded to everyone else. (It's what protected the Walt Disney board from liability in the mid-1990s when shareholders sued the board for awarding super-agent Michael Ovitz a $140 million severance package for his 14 month tenure.)

The courts, which used to simply toss shareholder derivative cases based on the business judgment rule, are letting more go to trial but Hobart admits that it's still tough to win. Still shareholders didn't have the benefit of official recoupment policies in the past. He thinks that could make all the difference.

"What this language does is give more ammunition to shareholders if the board doesn't act," he said. "This provides a specific remedy that shareholders could ask for."

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