BofA CEO Lewis Not Off the Hook

Bank of America (BAC:NYSE) CEO Ken Lewis may well have been pressured by regulators into completing the Merrill Lynch deal late last year, but ultimately the decision -- and the consequences -- rested with the embattled executive.

Lewis had in September agreed to acquire the troubled investment bank for a $50 billion all-stock deal, but by December Merrill's losses were spiraling out of control. In the three months since the deal was announced, Merrill lost over $15 billion on bad mortgage holdings, and its future was unclear.

But when Lewis informed regulators that he was considering using a "material inverse change," or MAC, provision to walk away from the deal, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson reportedly demanded that he go forward.

A House committee investigating their actions said on Wednesday that the Fed made "inappropriate threats" to fire BofA managers. Findings implicate Bernanke as well as then-New York Fed President Timothy Geithner, who would eventually become Treasury Secretary. Federal Deposit Insurance Corp. Chairwoman Sheila Blair, however, expressed a "strong discomfort" with the situation.

Documents disclosed by the Oversight and Government Reform Committee also reportedly show that the Fed tried to keep all the information under wraps, something that Lewis has said in testimony.


Bernanke is scheduled to appear before a congressional panel on Thursday to discuss the documents covered by the subpoenas. But as a result of the findings so far, Representative Darrell Issa (R., Calif.) alleges that the Fed "engaged in a cover-up and deliberately hid concerns and pertinent details regarding the merger from other federal regulatory agencies," according to Reuters.

One report, citing documents uncovered by the committee's subpoenas, said a Fed staffer demanded a "pound of flesh" from Lewis, adding that the company would have "a price to pay" in exchange for government support to seal the Merrill deal.

And seal the deal he did.

While evidence uncovered by the committee certainly throws rotten egg all over the face of regulators, Lewis could have walked away from the deal. Instead, he went ahead with the merger, accepting another $20 billion from the Troubled Asset Relief Program, and putting BofA in a vulnerable position.

The bank is still encumbered by $45 billion in debt to the government, not including dividend payments. It must boost Tier 1 capital levels by nearly $34 billion before it can consider raising funds to pay those TARP dollars back. Though Wells Fargo (WFC:NYSE) also remains under TARP's shackles, other competitors like JPMorgan Chase (JPM:NYSE), Goldman Sachs (GS:NYSE), Morgan Stanley (MS:NYSE), Capital One (COF:NYSE) and US Bancorp (USB:NYSE) have already begun to pay back bailout cash.

The key question for BofA shareholders is whether Lewis invoking the MAC clause and disclosing regulatory tactics would have done his company more bad than good. Given what he knew at the time -- that Merrill was in deep trouble, the markets would dive further if BofA abandoned it, and that regulators would not be happy if he came clean -- did Ken Lewis do the right thing?

"If he represents the shareholders then he should have walked away from this deal," says Dan Seiver, finance professor at San Diego State University. "You say, 'Merrill Lynch is going down the tubes and I'm going to walk away.' But I think it's a stretch to assume that any CEO would do that. He wanted to keep his job; he didn't want to fall on his sword."

The opposite argument can easily be made -- and has been, by none other than Lewis himself.

Since first stating in sealed testimony that Paulson and Bernanke threatened to replace him and BofA's board if he walked away from the deal -- implying that he had no choice -- Lewis has adopted a softer tone in public. He has since worked to emphasize concern for shareholders over concern for his own salary and reputation.

In testimony before the same House committee on June 11, Lewis asserted that abandoning the Merrill deal would have caused "systemic havoc or necessitated an AIG-style government bailout" -- neither of which would have served BofA shareholders well. He also said that Merrill will ultimately add great value to the company, noting its huge profitability in 2009. Merrill contributed over $3 billion, or 88%, of Bank of America's first-quarter profit.

"Certainly the acquisition of Merrill came with risks, and some of those risks materialized in the fourth quarter of 2008, when Merrill began recognizing significant losses," said Lewis. "The Merrill acquisition, however, also came with the promise of significant long-term rewards -- rewards that Bank of America and its shareholders are already beginning to reap."

But in December of 2008, Lewis didn't know that for certain. His options were to close the deal and keep quiet about regulators' heavy-handed tactics, or come clean about what was going on behind closed doors, and decide that BofA would not acquire Merrill after all.

Today, Merrill's "thundering herd" of brokers and executives -- its chief source of profits -- are flocking out the door for sweeter deals at competitors that aren't facing the same scrutiny, or TARP-related salary caps as BofA. Lewis knows this and knows that angry shareholders voted to strip him of his chairmanship at BofA's annual meeting in April.


He also knows that his board has undergone a massive shakeup, ejecting some of his loyal supporters in favor of outside leaders with more banking or regulatory experience. He has pledged to stay at the helm of BofA until it begins repaying TARP dollars, but he knows that may be a long road ahead, and that his days may be numbered.

"I think he made two ill-advised acquisitions that were going to build his empire and his prestige and such," says Seiver, referring to Merrill and BofA's other troubled acquisition, Countrywide Financial. "But I don't think they were going to help shareholders of Bank of America and in the end, maybe it didn't help him."

The decision to finalize the Merrill deal wasn't an easy one and wasn't lightly made. Whether it was the right choice is up for debate. It may not be determined until many years ahead, when it's clear how Merrill performs as a fully integrated component of a private, independent financial institution.

Perhaps the answer lies in how long that takes.