Bank of America agreed to pay $2.43 billion to settle a class-action lawsuit with investors who owned or bought its shares when the bank purchased Merrill Lynch (Countrywide Financials, which was America’s largest mortgage lender) in 2008. Bank of America acquired Merrill Lynch in late 2008 during the financial crisis. The $50 billion deal came as Merrill Lynch was within days of collapse, effectively rescuing it from bankruptcy. This settlement ended a three-year fight with a group of five plaintiffs, including the State Teachers Retirement System of Ohio and the Teacher Retirement System of Texas. They accused the bank and its officers of making false or misleading statements about the health of Bank of America and Merrill Lynch and were planning to seek $20 billion if the case went to trial. Bank of America denied these allegations and agreed to pay the settlement as a way of eliminating extended litigation.

After the acquisition was finalized, without a public announcement, Bank of America allowed Merrill Lynch’s executives to distribute bonuses of approximately $3.6 billion before the deal closed. Perhaps indicating how these bank executives live in an elite bubble of their own making, neither Lewis nor Thain realized that this small amendment to the contract would eventually spark a state investigation. Oddly, Thain did not seem to understand it was wrong to pay bonuses out to poorly performing employees (whose actions led to the damaging losses), while accepting taxpayers’ money to bail out the bank.

At Bank of America’s request, most of the money would be paid out in cash before the deal closed. The early payment would actually reduce expenses for Bank of America in 2009, ­making it easier for the bank to hit its first-­quarter numbers. Thain had also negotiated a new title for himself: President of Global Banking, Securities and Wealth Management. He would be responsible for planning and executing the merger of Merrill Lynch’s banking and trading business with that of Bank of America. With this deal, Merrill Lynch employees would emerge as winners, with thousands of Bank of America staffers laid off and replaced by their Merrill Lynch counterparts.

After word of the acquisition got out and the bonuses were paid, criticism focused on the price and potential risks, both of which were very high. Some argued that regardless of pressure from the U.S. government, Bank of America should have waited for the markets to adjust after the news of Lehman Brothers bankruptcy.

Question 2:

Describe the incentive and sorting effects at Merrill Lynch and how changes to the compensation strategy might affect them?