NEW YORK - Bank of America Corp will likely face more embarrassing disclosures about bonuses paid at Merrill Lynch & Co after a federal judge refused to rubber-stamp a settlement over the $3.6 billion of payouts.

Judge Jed Rakoff's criticism of the $33 million settlement with the U.S. Securities and Exchange Commission prolongs the drama over bonuses that have prompted outrage in Congress and a probe by New York Attorney General Andrew Cuomo.

It also means Kenneth Lewis, Bank of America's embattled chief executive, may face more scrutiny over perhaps the most controversial aspect of the shotgun merger.

What the judge is trying to get at is, was there actual fraud here? said Cornelius Hurley, director of the Morin Center for Banking and Financial Law at Boston University. The risks are they go back to their corners, and the SEC really does attempt to prove wrongdoing.

At a hearing in Manhattan, Rakoff said the fine appeared strangely askew, representing only a tiny, tiny fraction of the bonuses, and might be unreasonable if the SEC were correct that the bank essentially lied about the bonuses.

Despite losing $27.61 billion in 2008, Merrill paid out 696 bonuses of $1 million or more, Cuomo said in a report in July.

GIVING UP THE GHOST

Rakoff questioned whether taxpayers footed the bill for the bonuses with some of Bank of America's $45 billion of bailout money, and whether it was fair for Merrill to pay bonuses, other than those required by contract, averaging $91,000 per person.

He also appeared dismayed by arguments that lawyers for Bank of America and Merrill somehow kept upper management out of the loop on many details of the bonuses.

Was this some sort of ghost who performed these actions, or were they human beings? Rakoff asked SEC lawyer David Rosenfeld at the hearing. Rosenfeld said the regulator chose in agreeing to settle not to allege wrongdoing by individuals.

Greater disclosure of who knew what could add ammunition to lawsuits against Bank of America as well as critics of Lewis.

Shares of Bank of America have fallen by roughly half since the announcement of the Merrill purchase after less than 48 hours of talks last September 15, at the height of the financial crisis.

Much of the anger concerns when Bank of America knew Merrill's fourth-quarter losses were soaring, why it did not disclose them sooner, and why it did not back out of the merger. Lewis has said regulators pressed him to complete the merger.

More disclosure might also shed light on the SEC's actions, at a time the Obama administration is mulling historic changes to federal oversight of financial companies.

JUDGE HAS LIMITED POWERS

BofA is already being forced to make radical changes in how it operates, but I see less of a risk to BofA than I do potentially to government officials, said Jill Fisch, a professor at the University of Pennsylvania Law School and co-director of its Institute for Law and Economics.
One of the things the settlement covers up is the government role, including that of the Federal Reserve, she added. More disclosure of what went on could provide a check on overreaching by any one regulator.

Fisch said Rakoff cannot force the SEC to impose a higher penalty, but has the authority to insist on greater disclosure because of the public interest.

Richard Bove, an analyst at Rochdale Securities who views the merger as a positive for Bank of America, said prolonging the legal battle actually hurts shareholders.

It is the stockholders who pay the fines, he wrote.

Rakoff ordered Bank of America and the SEC to submit new papers by August 24, and said he might hold another hearing.

The judge seems to have the feeling the SEC pulled a punch, and that's why he wants to get down to the facts of who knew what, and when, Hurley said. This comes as the SEC tries to recover some of its damaged reputation in the enforcement area. They're not getting a gold star for this one.

The case is SEC v. Bank of America Corp, U.S. District Court, Southern District of New York (Manhattan), No. 09-6829.

(Reporting by Jonathan Stempel; Additional reporting by Rachelle Younglai in Washington, editing by Gerald E. McCormick)

New York Merrill Lynch Investment Bank of america