Bank of America's chief executive, Kenneth D. Lewis. has been on the hot seat since mid-January when the bank reported large losses at Merrill Lynch that it apparently knew about prior to the merger of the companies.
Now, Attorney General Andrew M. Cuomo of New York has revealed that Mr. Lewis said the Treasury secretary at the time, Henry M. Paulson Jr., and the Federal Reserve chairman, Ben S. Bernanke, put pressure on him to complete the Merrill merger while keeping quiet about the losses until an additional government bailout. This raises serious questions whether the government caused the company to violate the federal securities laws.
The antifraud provisions of the Securities Exchange Act of 1934, Sections 10(b) and 14(a), prohibit misstatements or omissions of material facts in connection with the solicitation of proxies from shareholders and in public statements made by a company. A company has a duty to ensure that shareholders have truthful information, and if a prior disclosure is no longer correct or complete, then additional information must be disclosed to ensure the market is not operating on false data.
It seems clear that Mr. Lewis knew about the burgeoning problems in Merrill's assets before the shareholder vote and sought to bail out of the deal prior to its closing. This is information any shareholder would want to know. It is usually not a good defense to a securities fraud claim that one had good intentions for not making the required disclosures or for disclosing inaccurate information.
When the government tells you not to disclose information, however, the analysis may be different. In the criminal law, there is a defense that the federal courts now recognize called "entrapment by estoppel" that might be a means for Mr. Lewis and Bank of America to avoid liability in the securities suits and in connection with the Securities and Exchange Commission's investigation of its disclosures.
The usual defense of entrapment arises when a defendant claims a government agent enticed him into engaging in criminal conduct that the person was not otherwise disposed to commit. For example, a drug addict cooperating with the police repeatedly cajoles an old friend into furnishing drugs, finally wearing the person down and then having him arrested once he succumbs to the requests. In such a case, the defendant can be acquitted because of entrapment. There is something unsavory about the government creating a crime that otherwise would not have occurred.
Entrapment by estoppel is a more recent development in the criminal law that concerns the increase in government regulation and licensing. There are four basic elements of the defense: (1) that a government official told the person the act was legal; (2) the person relied on that advice; (3) the reliance was reasonable; and (4) given the reasonable reliance, prosecution would be unfair.
The doctrine is most often asserted in gun possession cases in which the defendant claims that a dealer or other authorized seller said it was permissible to buy the weapon and later the person is arrested because of some condition, like a previous conviction, that makes it illegal to possess the weapon. Unlike regular entrapment, this defense is based on reasonable reliance on a statement by someone acting on behalf of the government approving conduct that turns out to be criminal.
The first and third elements of the entrapment by estoppel defense are the key. It is not Mr. Lewis's interpretation of what the government officials said that counts, but whether he was told that Bank of America should not make any disclosure and that the conduct would be legal. This may be a matter of nuance, and already a Federal Reserve spokeswoman denied that the Fed told Bank of America that it should not make any disclosures otherwise required by law.
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