Adapted from “Bank of America’s Game of Chicken,” first published in the January 2010 issue of Negotiation.
What’s the difference between an effective bluff and an ineffective one? Last year’s financial
meltdown offered an example of each.
In last month’s issue, we described how a bluff by then–U.S. Treasury Secretary Henry Paulson scared off potential buyers for failing investment bank Lehman Brothers in September 2008.
After Paulson told Wall Street CEOs that no government funds were available for a Lehman deal—a claim he later admitted was a bluff—the firm fell into bankruptcy.
The same weekend Lehman was collapsing, Bank of America’s (BofA) CEO, Kenneth Lewis, made a high offer for a different troubled bank, Merrill Lynch.
The takeover was scheduled to close on January 1, 2009, pending approval by BofA’s shareholders.
The tumultuous months before closing culminated in an effective—but ethically questionable—bluff.
A MAC attack?
As the shareholder vote approached, BofA executives grew nervous. Estimates of Merrill’s fourth-quarter after-tax losses ranged from $3 billion to $9 billion.
Documents later revealed that BofA executives considered threatening to back out of the deal by invoking a material adverse change (MAC)—a provision that protects acquirers from targets whose fortunes sour before closing.
Would the threat of a MAC convince Merrill to renegotiate its price?
The bank’s general counsel, Timothy Mayopoulos, argued that the case for a MAC was weak, according to the Wall Street Journal.
Lewis followed Mayopoulos’s advice and did not threaten a MAC, but fired him just days later.
On December 5, BofA shareholders, still in the dark about Merrill’s mounting losses, voted to approve the takeover.
The bank’s outside counsel, the law firm Wachtell, Lipton, Rosen & Katz, quietly put the idea of a MAC back on the table.
On December 17, Lewis informed Paulson and Federal Reserve Board Chairman Ben Bernanke that, surprised by the magnitude of Merrill’s losses, he might invoke a MAC. Shaken, Paulson warned Lewis that a MAC could bring down not only Merrill Lynch but also the global economy.
He promised to look into securing more government bailout funds for BofA, which had already received $20 billion, according to Corporate Counsel magazine.
The next day, a lawyer from Wachtell warned BofA that it didn’t have a strong case for a MAC, for several reasons.
First, the Delaware courts, which would rule on the matter, had never allowed a MAC before.
Second, it was common knowledge that Merrill was already deep in debt when BofA made its offer.
Third, Merrill would likely sue BofA in response to a MAC.
After making these arguments, the same lawyer turned around and tried to convince Federal Reserve officials that BofA had a strong argument for invoking a MAC.
Lewis and his staff stressed the same point with Paulson, Bernanke, and their respective staffs.
Bernanke told colleagues that he viewed BofA’s threat as a mere “bargaining chip.” Paulson even threatened to replace Lewis and his team if they used a MAC.
But on December 22, the government blinked. Bernanke cut a secret deal with Lewis.
In return for BofA’s dropping the MAC threat, Bernanke would help secure a “support package” in time for the bank’s January earnings statement.
BofA’s takeover of Merrill was finalized on January 1.
On January 16, BofA disclosed that Merrill had lost $15.3 billion during the fourth quarter of 2008. The bank also revealed that it was getting another $20 billion in federal bailout funds and further protection on future losses.
Shares in the bank plummeted.
In the short term, Lewis’s bluff effectively took advantage of the threat of a nightmare scenario.
Over time, though, the bluff was exposed as just one example of BofA’s controversial negotiating behavior throughout the Merrill takeover—behavior that led to a string of investigations and lawsuits, as well as Lewis’s forced retirement.