January 26, 2009

BofA/Merrill and Disclosure About an Incomplete Quarter

– by John Jenkins, Calfee, Halter & Griswold LLP

Merrill Lynch’s catastrophic fourth quarter performance and Bank of America’s decision to close the Merrill deal notwithstanding those results have resulted in the filing of a class action lawsuit against Bank of America and certain of its and Merrill’s executives. The complaint alleges that the defendants violated the anti-fraud provisions of the proxy rules by failing “to update, amend or correct the proxy statement to reflect, among other things, the risk or existence of Merrill Lynch’s fourth quarter losses, prior to the December 5, 2008 vote by Bank of America shareholders to approve the Merger.”

The plaintiffs complaint raises a disclosure issue that’s concerned M&A and capital markets lawyers for a long time – when must a company issuing securities or seeking shareholder approval of a deal disclose information in its possession about an incomplete quarter that suggests that results for the quarter are going to be worse than expected?

This is an issue that has been addressed by several courts in the context of public offerings of securities, and this Wilson Sonsini article provides a good overview of the different ways in which courts have approached it. These cases tend to be very fact intensive, and I think nothing illustrates that point quite like two First Circuit cases decided less than three months apart.

In Shaw v. Digital Equipment, 82 F.3d 119 (1st Cir. 1996), the First Circuit held that disclosure of interim information about a substantially completed quarter could be required in a registration statement. However, the court limited that obligation to situations in which the information indicates that the quarter in progress “will be an extreme departure from the range of results which could be anticipated based on currently available information.” In Shaw, the offering in question took place less than two weeks before the end of the quarters, and the results for that quarter reflected, in the court’s words, “more than a minor business fluctuation.”

In contrast, the same court found only a few months later that, under somewhat different circumstances, information about an incomplete quarter could not be regarded as material. In Glassman v. Computervision, 90 F.3d 617 (1st Cir. 1996), the plaintiffs alleged that the issuer should have disclosed in its prospectus interim financial information for the first seven weeks of an incomplete quarter that called into question the viability of the issuer’s internal projections. The court disagreed. Citing its decision in the Shaw case, the court stated that “when the allegedly undisclosed information… is more remote in time and causation from the ultimate events of which it supposedly forewarns, a nondisclosure claim becomes “indistinguishable from a claim that the issuer should have divulged its internal predictions about what would have come of the undisclosed information.” Consequently, the court held that this information was not required to be disclosed.

Obviously, a critical factual question in this case will be “what did the parties know about the fourth quarter and when did they know it?” But the cases that have addressed disclosure of information about an incomplete quarter suggest that even if BofA and/or Merrill were aware of potential fourth quarter problems in advance of the shareholders meeting, that information would not necessarily be “material” for securities law purposes.