It’s been almost a year since Bank of America agreed to buy Merrill Lynch, on September 15, for $50 billion in stock, in what now looks like one of the most fraught deals in the history of American business. The deal was announced on the same day that Lehman Brothers filed for bankruptcy protection and the day before Treasury and the Federal Reserve decided to throw an $85 billion lifeline to AIG, the global insurer that had foolishly underwritten the risks of the financial system. Although the end of Wall Street was imminent, Bank of America’s offer valued Merrill Lynch at $29 per share—a 70 percent premium over the stock’s closing price on the previous Friday, and nearly twice its book value.
Bank of America’s generosity allowed Merrill to dodge a bullet, as it was just days away from following Lehman into bankruptcy court. Merrill’s CEO, John Thain, had spent much of the previous weekend at the New York Federal Reserve Bank’s Italianate palazzo in downtown Manhattan, in strained discussions about the financial industry’s mounting distress, and he knew his firm’s future was imperiled. Like Lehman and Bear Stearns, which had failed six months earlier, Merrill had a balance sheet chock-full of problem assets that it had been using as collateral in the overnight-financing markets.
Thain knew the willingness of short-term lenders to keep funding Merrill would disappear rapidly if his firm lost the market’s confidence, as both Lehman and Bear Stearns had. Without short-term financing, Merrill would not be able to meet its obligations as they became due and the firm would fail. “I anticipated that the failure of Lehman would have caused very severe problems for Merrill Lynch,” Thain said afterward, “and the potential withdrawal of cash” would cause a severe liquidity crunch for the firm, with no easy solution.
By Sunday night of that infamous September weekend, Thain and Ken Lewis, the CEO of Bank of America, had cut their deal. “Acquiring one of the premier wealth-management, capital-markets, and advisory companies is a great opportunity for our shareholders,” Lewis said the next morning. “Together, our companies are more valuable because of the synergies in our businesses ... I look forward to a great partnership with Merrill Lynch.” Added Thain: “Merrill Lynch is a great global franchise, and I look forward to working with Ken Lewis and our senior management teams to create what will be the leading financial institution in the world, with the combination of these two firms.”
Even at the time, it looked to many like an odd union—a formerly high-flying Wall Street firm, founded in 1914, scooped up by the Wal-Mart of the banking industry, a Charlotte-based bank known for its brawn in commercial banking. Nonetheless, champagne toasts and all the usual corporate euphoria accompanied the announcement of the deal. For Bank of America, it was a move into the fast lane of high finance, and a validation of sorts: on October 19, a triumphant Lewis appeared on 60 Minutes, and to the question of whether he had conquered Wall Street, he responded, “We have, yes, we have won in that sense.” For Merrill, it was—if nothing else—a second lease on life.
Three months later—even before the deal closed—the engagement was on the rocks, the mood soured by staggering losses at Merrill, and Bank of America’s executives were looking for a way to break it off. What followed was an unprecedented series of steps, taken in December by Federal Reserve Board Chairman Ben Bernanke and Treasury Secretary Henry Paulson, to keep the two companies together.
Many of the most stunning details of the hidden negotiations between Paulson, Bernanke, and Lewis would have remained secret if not for the singular persistence of Andrew Cuomo, the New York attorney general, who in February took the depositions of both Lewis and Thain as part of his investigation into why Merrill, though reeling financially, had paid some $3.6 billion in bonuses to its employees before the deal closed. Cuomo has since released large portions of the depositions. The following account of the events that transpired during the waning days of the Bush administration comes from those transcripts, from the subsequent testimony of Lewis and Bernanke before Congress in June, and from interviews with insiders and knowledgeable observers. (Paulson, Bernanke, and Lewis all declined to be interviewed.) The narrative that emerges is troubling. It raises serious questions about the sanctity of legal contracts in post-crash America, and about the fast-evolving relationship between American government and industry.
At the time Lewis struck the deal with Thain, in September, he was plenty sanguine about Merrill’s financial prospects—and boasted about them publicly. In a February 2009 interview with Maria Bartiromo, on CNBC, Lewis said he and his team had seen “everything we needed to see” about Merrill. He pointed out that he had the benefit of the “very, very extensive” analysis done by Bank of America’s financial adviser, J. Christopher Flowers—the billionaire private-equity investor and former Goldman Sachs banker—who had first studied Merrill’s books in December 2007, when he was considering making an investment in the firm, and then again over the weekend the deal was struck. In a press conference on the morning of September 15, Lewis said that Flowers had told him Merrill’s balance sheet was becoming much more stable. “He was very complimentary of what [Thain] and his team had done,” Lewis said, “in many cases not only reducing the marks”—the value placed by Merrill on the securities on its balance sheet—“but getting rid of the assets, which is the best thing to do. So [Merrill had] a much lower risk profile than he’d seen earlier on.”
But in fact the firm’s finances were rapidly deteriorating. Lewis and his executive team began receiving weekly reports about Merrill’s condition immediately after he inked the deal in September. By the end of November, Merrill’s losses had ballooned to $9 billion, and some Bank of America officials had begun to doubt seriously the wisdom of the deal. Most of the losses were coming from wrong-way bets in the firm’s sales-and-trading department and from the continued write-down of squirrelly securities. But even Merrill’s crown jewel—its global network of stockbrokers—had suffered a severe decline in monthly revenue, from more than $1 billion in October to $797 million in December. Apparently, these losses were well beyond what Lewis or Flowers had thought possible.
With losses mounting, Lewis began to speak with his top managers and lawyers about the possibility of invoking the merger agreement’s material adverse-change clause—or MAC, as it is known on Wall Street—if Merrill’s condition continued to worsen. This legal escape hatch, built in one form or another into nearly every merger agreement, theoretically could have let Bank of America walk away at any point before the deal officially closed, on January 1, 2009. The MAC clause was nothing to trifle with; a slew of lawsuits by Merrill Lynch and its shareholders would almost certainly follow, and prevailing in court after invoking a MAC clause is exceedingly difficult. Still, if it came down to it, battling a lawsuit would be better than trying to inhabit a house aflame.
Another out was available, but it was only days from disappearing. On December 5, Bank of America’s shareholders would formally vote on the deal. If they voted no, the merger would be dissolved, with no legal obligations on either side.
The termination of the merger agreement with Bank of America would likely have meant the end of Merrill, since the firm was unlikely to be able to meet its debts as they became due. And presumably the termination would have been an embarrassment for Lewis, who had long coveted Merrill, and had championed the deal. With the shareholder vote nearing, and despite Merrill’s deteriorating finances, Bank of America’s executives and lawyers decided to move forward, with considerable “mixed emotions,” according to one of them, as reported in The Wall Street Journal in February: “Everyone wanted to see the deal go through.”
On December 5, the shareholders of Bank of America approved the deal, as did the shareholders of Merrill Lynch. No information about Merrill’s growing losses was provided to Bank of America’s shareholders before the vote, as several members of Congress noted at a June hearing to investigate the merger.
Lewis “had an easy out before the shareholder vote,” a senior Wall Street mergers-and-acquisitions banker, who was also trained as a Wall Street lawyer, told me. “He could easily have disclosed to his shareholders that ‘We have done two months of due diligence now, and look at the 600 things we’ve found.’ I’ve always wondered how could it be that they did not disclose to the world what they knew before December 5.”
Some observers say Lewis’s failure to disclose to his shareholders the extent of the problems at Merrill before the shareholder vote may have constituted securities fraud: a violation of the Securities and Exchange Commission’s rule 10b-5, which prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of any security. “He committed classic securities fraud,” the senior Wall Street mergers banker says flatly. “He had a material knowledge of a material event in the middle of a shareholder vote.” A Bank of America spokesperson, in an e-mail response to my questions about the company’s disclosures, simply said, “We believe we made the required disclosures before the December 5 shareholders meeting.” At least eight shareholder lawsuits have been filed against Lewis, Bank of America, and Thain. CalPERS and CalSTRS, two California pension funds that together own 38.5 million Bank of America shares, are seeking to lead a consolidated class-action lawsuit against the bank for failing to disclose the facts about Merrill before the December 5 vote.
After the vote, Lewis was nearly euphoric. “It puts us in a completely different league,” he said. Meanwhile, Bank of America’s internal lawyers and its external counsel at Wachtell, Lipton, Rosen, & Katz continued to debate whether the Merrill losses would constitute a MAC or were, as some believed, comparable to what other Wall Street firms were experiencing. It was not an easy call, given the high stakes and the plenty ambiguous wording of the clause, which expressly excluded, as reasons to void the contract, changes in “general business, economic or market conditions.”
Based on recent case law, most litigators had concluded that nothing short of a metaphorical nuclear war would allow the MAC’s successful invocation. “In my mind, there were several minuses,” Lewis said in his February deposition, recapturing his earlier thinking as the days passed and the news of Merrill’s losses grew worse still. “We could have done the MAC and then have [Merrill] go bankrupt. Then you would lose your case, and you have a company that’s damaged pretty badly and you have to take it anyway.”
On December 9, Joe Price, Bank of America’s CFO, reported Merrill’s still-increasing losses to the bank’s board of directors. On December 14, Price called Lewis and told him that Merrill’s losses were now $12 billion. (By the end of December, they reached $15.3 billion.) Lewis later said that what he mainly remembered from the conversation with Price was just the “staggering amount of deterioration” in Merrill’s financial performance.
Shortly after the December 14 call from Price, Lewis began to worry that Merrill’s losses had simply become too great to bear. He consulted with counsel and again considered how he might abandon the deal. Ed Herlihy, the partner at Wachtell Lipton who had helped initiate the Merrill deal, and who had long acted as an adviser to Lewis, called Ken Wilson, a just-retired Goldman vice chairman and a friend and confidant of Hank Paulson, the Treasury secretary and former Goldman CEO. Wilson had joined the Treasury Department a few months earlier as an adviser to Paulson, and he listened in awe as Herlihy told him the magnitude of Merrill’s losses, and with dread as Herlihy told him that Bank of America was thinking about walking away from the deal. “The amount of devastation to the financial system if Merrill blew up would have been unfathomable,” Wilson told me in May. “It would have been Lehman squared. Just horrific.” He told Herlihy that Lewis should call Paulson directly.
On the morning of December 17, Lewis called the Treasury secretary from his office in Charlotte. “I told him that we were strongly considering the MAC and thought we actually had one,” Lewis recalled in his deposition.
“We probably should talk,” Paulson replied. “Could you be here by six o’clock?”