Federal District Judge Jed S. Rakoff was supposed to a approve a $33 million settlement between the SEC and Bank of America over the issue of the financial firm making inaccurate statements regarding Merrill Lynch compensation. These statements were made in the BAC proxy that was sent to shareholder to approve the Merrill buyout.

It turns out that the judge believes that the SEC let the bank off too easily and that the seriousness of BAC’s actions warrants more than a $33 million slap on the wrist.

The judge made a lucid comment about something that the SEC neglected to consider. “It does not comport with the most elementary notions of justice and morality, in that it proposes that the shareholders who were the victims of the bank’s alleged misconduct now pay the penalty for that misconduct, ” Rakoff wrote. Why should BAC shareholders be screwed twice?

The SEC and Bank of America will have to return to court for a trial on February 1. The most important issue at hand will be that the judge says that BAC “materially lied” in its disclosures about the Merrill bonuses.

The unexpected action by the judge threatens to kill a time-honored gentlemen’s agreement between the SEC and major American public companies. The SEC catches corporations doing something that violates the securities laws. Rather than take up the commission’s time which could be better used chasing people like Bernard Madoff, the companies are allowed to settle charges by paying large fines. This usually means that the company does not admit to anything, although its guilt is generally assumed. Why would a firm that is entirely innocent make a payment to settle charges?

The decision by the judge may have broad implications. The SEC may have to spend more of its time in court actually prosecuting companies for misdeeds. Corporate America is going to find it is more expensive to cross the solid white line of regulation. The trend will still cost shareholders plenty. All those new legal fees spent in defense of  bad behavior will come out of their pockets.

The shareholders who have the least to say get a beating again.

Douglas A. McIntyre

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