BofA Between a Rock and a Hard Place

CHARLOTTE, N.C. ( TheStreet) -- Bank of America ( BAC) has a difficult choice to make: wrangle with the government or with litigious shareholders. Neither option is particularly desirable and both appear to have become increasingly costly.

The Charlotte, N.C.-based bank is locked in battles with an array of government investigators over its acquisition of Merrill Lynch. It is also locked in at least 21 shareholder lawsuits directly related to the merger, not including a handful of legal skirmishes against Merrill individually, or others that have been filed since Dec. 31. While BofA has not given a cost projection for all these cases, the lawyer fees alone accelerate along with added legal headaches.

The government probes have discovered many juicy tidbits that were unknown when shareholders approved the merger on Dec. 5. But they have so far been unable to pinpoint an individual to "blame" for what went wrong.

Among the revelations so far: BofA knew about Merrill's spiraling losses, but did not disclose that information immediately. It knew Merrill planned to distribute $5.8 billion worth of bonuses before the merger, but did not object to the pay packages or disclose them, either. Former Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke pressured Ken Lewis, the bank's CEO, to move forward with the deal, despite his reservations.

Bank of America has said repeatedly that it did nothing wrong. When asked who was responsible for making controversial decisions, the bank has said top executives based ultimate decisions on consultations with one another, with regulators, and with legal counsel. When asked for evidence of what, specifically, lawyers had advised, Bank of America has said the information is protected by attorney-client privilege.

While the Securities and Exchange Commission was satisfied with BofA settling the issue by paying a $33 million fine, federal Judge Jed Rakoff would not approve the deal, calling it "neither fair, nor reasonable, nor adequate" to ask shareholders to shoulder the punishment. His mind seemed to be boggled by BofA's arguments, as well as the decision by regulators to assess a fee to the bank just because it couldn't -- or chose not to -- figure out who had done something wrong.

Legal experts say BofA's argument may appear circular, but it is not uncommon, nor is it unwise. And when considered another way, the government's argument is pretty topsy-turvy itself.

Regulators have pressed banks for privileged information since the dawn of their relationship and were often successful. The investigatory creep has been fought by coalitions of banking, legal and rights advocates, including the American Bar Association and American Civil Liberties Union.

"The Justice Department keeps saying it'll only do this in serious circumstances, but they end up doing this a lot," says Ronald Rotunda, an expert on jurisprudence at Chapman University's School of Law.

Advocates have had success with acts passed by Congress in recent years that strengthened privilege law or allowed banks to disclose information to agencies without waiving attorney-client privilege rights. Still, in an environment where leaks are commonplace, few occurrences in the financial crisis appear to have remained confidential.

For instance, Lewis' sealed testimony to New York Attorney General Andrew Cuomo, which revealed discussions with regulators about the Merrill deal, was leaked to the press. Unrefined correspondence between federal officials -- one about getting a "pound of flesh" from Lewis -- met the same fate.

"Some things are not crimes or fraud, but are embarrassing, and that's a concern," says Rotunda.

A bank may be compelled to disclose legal information if it relies on such documents as a defense, according to Rotunda. But a lawyer who works with BofA says that if the firm cooperates, it risks revealing information that could be used against it in lawsuits directly related to the merger as of Dec. 31.

On the other hand, if BofA doesn't cooperate, it risks boosting the appearance that it's hiding something, and damaging a delicate relationship with regulators and lawmakers who are already unhappy with the deal.

"It really gets very, very dicey when you're boxed into that kind of a corner," says the lawyer.

Another point made evident by the proceedings so far is that while investigators are looking for a scapegoat, they may come up with a whole farm -- including some of its own people.

Lewis was the ultimate decision maker when it came to BofA acquiring Merrill Lynch, but he was advised by lawyers, his board, top executives from both firms, and regulators. Ironically enough, Paulson and Bernanke both told Congress that government lawyers had deemed it legally indefensible for Bank of America to invoke a material adverse change clause to walk away from the Merrill deal.

"If you've got the Federal Reserve chairman and Treasury secretary browbeating you into doing this, I can see why you'd do it," says Rotunda. "Especially when you're getting legal advice that says walking away from this deal will buy you a lot of lawsuits instead."

-- Written by Lauren Tara LaCapra in New York.