Just a little $4 billion error

05/06/2014 5:55 PM

05/06/2014 6:08 PM

If you’re a bank executive, it’s never going to be easy to tell your shareholders: Oops, we made a $4 billion mistake!

But the disclosure last week by Bank of America that it had $4 billion less in regulatory capital than it thought came at a particularly awkward time, just days before its annual shareholder meeting, scheduled for Wednesday in Charlotte, N.C.

Brian T. Moynihan, the company’s chief executive, must not be happy. For the first time in years, the annual meeting was expected to be upbeat. The bank’s stock had rallied and regulators had recently approved the company’s plan to increase its dividend and buy back billions of dollars of shares. Best of all, its never-ending mortgage woes seemed to be winding down.

But the billion-dollar boo-boo makes a victory lap premature. Instead, the bank’s top management and 13 outside directors may well face upset owners wondering how so many people inside the company could have overlooked an accounting error that grew — and grew — over five years.

Yes, the size of the mistake may be considered trivial when judged against Bank of America’s $2 trillion balance sheet. And the bungled accounting didn’t affect the bank’s earnings. Moreover, even if the error had been deducted from its capital position, it would have passed its recent regulatory stress tests.

But the failure to account properly for losses still confounds. The mistake was in a portfolio of debt securities acquired by the bank when it bought Merrill Lynch all the way back in 2008. And the bank’s capital position, overstated by the error, is crucial to its ability to raise its dividend or to conduct other activities that could benefit shareholders. Indeed, the bank had to put off the planned dividend increase and share buyback after disclosing the mistake.

In addition, the bank’s increased capital position was one reason for its top executives’ sizable 2013 pay. Moynihan, for example, received total compensation of $13.1 million last year, up from $8.3 million in 2012. The proxy said, “We closed 2013 with a strong balance sheet reflecting improved levels of capital and liquidity,” adding that the company’s crucial regulatory capital position “increased $11.8 billion to $145.2 billion.”

Included in that figure was the erroneous $4 billion.

The proxy also discusses the committees of Bank of America’s board charged with protecting shareholders from ugly surprises like this one. They are the audit committee, headed by Susan S. Bies, a former governor of the Federal Reserve System, and the enterprise risk committee, overseen by Frank P. Bramble Sr., a former vice chairman of MBNA Corp., a financial services company acquired by Bank of America in 2006.

The enterprise risk committee, for example, “oversees management’s responsibilities to identify, manage and plan for material risks including market risk (which includes interest rate risk), liquidity risk, operational risk and reputational risk, as well as capital management.” Bies also serves on this committee, as does Jack O. Bovender Jr., a former chairman of HCA, the for-profit hospital operator; Thomas J. May, chairman and chief executive of Northeast Utilities; and Clayton S. Rose, a Harvard Business School professor and former senior executive at JPMorgan Chase.

Those are some pretty heady resumes. “One look at the proxy and all those recitations and you’d think, ‘They really have their eye on the ball,’ ” said Brian T. Foley, a compensation consultant in White Plains, N.Y. “Then you see this $4 billion thing go rolling by. It’s a little disconcerting when, armed with 10 fingers and 10 toes, you can miss a number like that.”

Jerome F. Dubrowski, a Bank of America spokesman, declined to make the directors available for comment. But in an interview, he emphasized that the bank, not an outside regulator or auditor, had identified the error; he said the board was actively reviewing the bank’s control processes.

Nevertheless, the $4 billion miss raises some questions for Bank of America’s management and its directors:

Does the accounting mistake indicate that Bank of America is too big to manage?

Dubrowski said no, suggesting that the error could just as easily have happened at a smaller bank. Since 2010, he added, bank management has worked to streamline the company and to reduce complexity. “We have shed $70 billion in noncore assets and reduced the number of legal entities by 36 percent,” he said.

He said the board and management were working to ensure that such a problem wouldn’t crop up again, but shareholders ought to know the specifics of what is being done to remedy the dysfunctional reporting system in the bank that allowed this error to grow undetected for five years.

Why should shareholders vote to reappoint PricewaterhouseCoopers as auditor, as the company urges?

One job of an auditor is to ferret out errors, not to miss them, and PwC was paid $94 million last year to do just that. How can shareholders be confident that other disasters are not lurking in Bank of America’s books? (PwC declined to comment.)

Will anyone at Bank of America be held to account for the blunder?

To this question, Dubrowski said: “A decision was made to apply a certain treatment to a certain liability, and that process perpetuated over time. Rather than focus on who is to blame, we would prefer to focus on encouraging our people when they find mistakes to identify them quickly, to notify proper management and then to fix it. That’s what happened in this case.”

Still, Bank of America clearly has some explaining to do. Its shareholders cannot be blamed for putting its management and board back in the penalty box for a while.

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