* BofA accused of hiding Merrill losses, earnings dilution
* Investors who owned stock, call options claimed losses
* Ex-CEO Lewis says relied on legal advice
* Bank says shareholders were not deprived of voting rights
By Jonathan Stempel
June 4 (Reuters) - Top executives at Bank of America Corp did not tell shareholders just prior to a 2008 vote on its purchase of Merrill Lynch & Co that losses were mounting and expected to weigh down earnings for years, papers filed in private shareholder litigation show.
But the bank and former Chief Executive Kenneth Lewis said in their own court papers that they should not be liable to shareholders who claimed to have lacked information they needed to vote on the once $50 billion merger.
Lewis also said he had been advised by the bank's law firm and chief financial officer that no disclosure was necessary.
The papers, including sworn testimony from Lewis, were filed on Sunday night in class-action litigation accusing the second-largest U.S. bank of fraudulently misleading holders of shares and call options about Merrill's losses and bonus payouts.
They may also strengthen the contention that Bank of America withheld material information just prior to the Dec. 5, 2008 merger vote, a characterization that Lewis resisted in a March 27 deposition by the shareholders' lawyers.
"In all cases of securities fraud, the fight is always about who knew what, when," said Hillary Sale, a law and business professor at Washington University in St. Louis School of Law. "This deposition shows that before the actual shareholder vote, there was knowledge that the numbers were different. Call it large, call it substantial, but it is likely material."
The New York Times earlier reported some of the court papers, which were filed with the federal court in Manhattan.
Other defendants are former Chief Financial Officer Joe Price; former Merrill Chief Executive John Thain, and outside Bank of America directors. A trial before U.S. District Judge Kevin Castel is scheduled for Oct. 22.
Andrew Ceresney, a lawyer for Lewis, declined to comment. Court papers said his client relied on Price and the law firm Wachtell, Lipton, Rosen & Katz as to how much to disclose.
Bank of America spokesman Lawrence Di Rita declined to comment. The bank in court papers said shareholders failed to show damages as a result of "any alleged impairment to voting rights." It also said that to the extent it overpaid for Merrill, it is Bank of America that can assert that claim.
Lawyers for Price, Thain and the outside directors, as well as Wachtell, did not respond to requests for comment. Steven Singer, a lawyer for the shareholders, declined to comment.
Merrill's fourth-quarter loss at the time of the vote was expected to be $9 billion, according to court papers, and ultimately reached $15.84 billion.
It forced Charlotte, North Carolina-based Bank of America to get a second, $20 billion taxpayer bailout, and fueled a 93 percent drop in its share price over six months. The share price remains close to 80 percent below its level prior to the merger.
LARGE, BUT MATERIAL?
When Bank of America agreed to buy Merrill on Sept. 15, 2008, the same day Lehman Brothers Holdings Inc went bankrupt, it expected the purchase would dilute earnings by 3 percent in 2009, and be "break even" or slightly better in 2010.
According to court papers, Lewis echoed this forecast at the Dec. 5 shareholder vote. But Lewis testified in the deposition that by this time, the bank believed that the merger would be 13.1 percent dilutive in 2009 and 2.8 percent in 2010.
"That's a significant change in the dilution and accretion analysis; you would agree with that?" he was asked.
"Yes," Lewis responded.
The bank's former treasurer Jeffrey Brown testified that Merrill's shrinking of its balance sheet, under Bank of America's orders, could reduce the combined companies' annual earnings power by $1 billion before taxes, court papers show.
Lewis appeared to resist the thought that the projected $9 billion Merrill loss had a "material" impact on that company's capital and tangible common equity, which had been $26 billion.
"I would say -- I mean, there was an effect," Lewis said.
"You would agree with me that is a substantial amount?"
"I would say that's a large amount, yes."
In a filing, Lewis maintained that he knew of "no red flags" for him to reject the "considered judgment" of Price and the lawyers about disclosing Merrill's fourth-quarter performance.
Shareholders, however, said Lewis' sworn statements "leave no genuine dispute" that his statement at the Dec. 5 meeting regarding dilution was "materially false" at the time.
"Reliance on a lawyer's advice is an interesting argument," Sale said. "It could give you a defense that you did not intend to mislead, and therefore did not commit fraud. That causes a problem for Wachtell. It could admit it gave that advice, but that raises a specter of malpractice. It's pretty messy."
Merrill has more recently aided Bank of America's results, offsetting losses from mortgages and other litigation.
In 2010, U.S. District Judge Jed Rakoff approved the bank's $150 million settlement over Merrill with the Securities and Exchange Commission, which included no admission of wrongdoing.
Bank of America, Lewis and Price also face a civil fraud lawsuit by New York Attorney General Eric Schneiderman, under a state law that does not require proof of intent. Schneiderman's office did not immediately respond to a request for comment.
Lewis retired at the end of 2009 and was replaced by Brian Moynihan, who remains chief executive. Thain is now chief executive of the business lender CIT Group Inc.
Bank of America shares traded Monday afternoon down 14 cents at $6.88. They traded at $33.74 when the merger was announced.
The case is In re: Bank of America Corp Securities, Derivative, and Employee Retirement Income Security Act (ERISA) Litigation, U.S. District Court, Southern District of New York, No. 09-md-02058.