For BofA, a Year of Living Dangerously

When your only tool is a hammer, every problem looks like a nail. The same goes for opportunity-or so it seems with Ken Lewis, the beleaguered chief executive officer at Bank of America who announced in October that he would resign his position by December 31st after 40 years with the company, eight of them as CEO.

The 62-year-old Lewis has spent much of the last 12 months in the news headlines and usually, with a banker, that’s not a good thing. His annus horribilis began in September 2008 when he negotiated the stunning acquisition of the troubled investment bank Merrill Lynch & Co. in the midst of a capital markets meltdown.

Lewis tried to scuttle the deal two months later when Merrill’s financial condition worsened, but relented after former U.S. Treasury Secretary Hank Paulson threatened to remove him as CEO if he bailed out.

It’s unclear exactly when Bank of America learned the full extent of Merrill’s deteriorating health, and the bank says it met all disclosure requirements, but a troubling sequence of events would later unfold. The bank’s shareholders approved the acquisition on Dec. 5, 2008. On Dec. 29, Merrill paid out $3.6 billion in bonuses to its employees, apparently with Bank of America’s acquiescence. And in mid-January of this year Merrill reported a whopping $15.3 billion net loss for the fourth quarter of 2008 -which led some institutional investors to grumble that Bank of America withheld information about Merrill’s rapid deterioration and also shouldn’t have allowed those bonuses to be paid. The Securities and Exchange Commission, state attorneys general in New York and Ohio, and the House Oversight Committee have all been investigating the deal.

Why would Lewis place his company at risk by acquiring a large market-sensitive investment bank in the middle of an economic pandemic? This was a once-in-a-lifetime opportunity to acquire a trophy franchise that many bank CEOs had lusted after for years, just like adolescent boys of my generation once fantasized of marrying Rachel Welch. Remember also that Lewis is the product of an aggressive corporate culture that in a little over two decades grew a small North Carolina bank into the largest bank in the United States through an ongoing series of deals. The takeover has always been Bank of America’s strategic hammer, and Merrill was the golden spike.

What, you might ask, was the board’s role in all of this? That’s a great question, and it’s one that others have asked as well, including the RiskMetrics Group, which interviewed Bank of America’s general counsel and former lead director, along with two dissident shareholder groups and issued a detailed report prior to the bank’s annual meeting in April. Bank of America completed its due diligence investigation in just two days, and officials there attributed this startling brevity to the bank’s “knowledge of Merrill’s businesses” and its “seasoned deal team.” But RiskMetrics argues that a thorough due diligence process usually takes several weeks to accomplish, and becomes even more complicated during periods of extreme market volatility. As for Bank of America’s board, it was not apparent to RiskMetrics that directors played a major role in examining the merits and risks of the transaction.

“On balance, we believe that the board failed to provide adequate oversight of management,” RiskMetrics said. The report also criticized the board for failing to disclose Merrill’s worsening condition prior to shareholders’ vote on the acquisition. In short, the report concluded, “shareholders’ only representatives of the company failed to fulfill a key obligation to them.”

Some important changes have occurred on the Bank of America board since the report was released. RiskMetrics had recommended that six directors-including Lewis-not be reelected when the full board came up for approval at the last annual meeting. Shareholders voted to strip Lewis of his chairman’s title, although the other directors were retained. But since then, three directors that RiskMetrics opposed for reelection have resigned. And under prodding from federal banking regulators, four new directors with banking industry experience have been brought on board.

Only the principals themselves truly understand the culture of Bank of America’s board. But RiskMetrics noted that many of its recent directors joined the board after Lewis had acquired their institution, which is not the ideal way to build an effective board. Bank of America will soon have a new CEO, and hopefully the board will discharge its fiduciary duty more forcibly when the next big deal comes along. While some might resent it, strong CEOs sometimes need strong boards to protect them from themselves. It keeps everyone from getting hammered.