A federal judge on Monday rejected Bank of America Corp's and the U.S. Securities and Exchange Commission's $33 million settlement over Merrill Lynch & Co bonuses as a contrivance that deprives shareholders of the truth.

In rejecting the settlement for a third time, saying it cannot remotely be called fair, U.S. District Judge Jed Rakoff ordered the SEC and the largest U.S. bank to prepare for a trial by next February 1.

He said he had a distinct impression that the settlement was a contrivance designed to provide the SEC with the facade of enforcement and the management of the bank with a quick resolution of an embarrassing inquiry -- all at the expense of the sole alleged victims, the shareholders.

Rakoff's decision comes as the Charlotte, North Carolina-based bank and its Chief Executive Kenneth Lewis face a deadline by the end of Monday from New York Attorney General Andrew Cuomo to provide more details about Bank of America's purchase of Merrill.

The attorney general is preparing charges against some of the bank's executives, including perhaps some of the very highest-ranking, according to a person familiar with Cuomo's probe, who requested anonymity because the probe is ongoing.

Cuomo also is seeking information about the scope of Merrill's $15.8 billion fourth-quarter loss, including who knew what before December 5 shareholder votes at both companies to approve the merger. The merger closed on January 1.

Rakoff faulted the SEC for accepting the bank's effort to invoke attorney-client privilege and avoid disclosing what its executives and lawyers knew about its authorization for Merrill to pay up to $5.8 billion of bonuses, though it was clear the bank blatantly lied about the payouts.

The judge also questioned why shareholders victimized by the bank's management should be responsible for any fine, especially as the bank would not admit to wrongdoing.

It is a body blow to the SEC's credibility, said James Post, a governance and ethics professor at Boston University School of Management. The bank, meanwhile, has no coherent strategy. Cuomo will not let go until he has the full story, and we don't have that yet.

Bank of America spokesman Scott Silvestri said the bank is prepared to litigate to show that its disclosures were proper, and will consider its legal options in the coming days.

SEC spokesman John Nester said the regulator will review Rakoff's order. Cuomo's office declined to elaborate on its September 8 letter to bank lawyers demanding more disclosure.

Rakoff's decision came as U.S. President Barack Obama, marking the one-year anniversary of Lehman Brothers Holdings Inc's bankruptcy, urged financial companies on Monday not to fight regulatory reform.

CYNICAL RELATIONSHIP

The settlement was to resolve SEC charges that the bank misled shareholders about having authorized the bonuses by not mentioning it in proxy statements for the merger.

Yet Rakoff said it suggests a rather cynical relationship between the parties: the SEC gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger; the bank's management gets to claim that they have been coerced into an onerous settlement by overzealous regulators. And all this is done at the expense, not only of the shareholders, but also of the truth.

Professor James Cox, a securities law professor at Duke University in Durham, North Carolina, said: Not enough judges are doing what Judge Rakoff is doing. Way too often, the true miscreants do not contribute anything toward the settlement.

Bank of America agreed to buy Merrill after less than 48 hours of talks on the same weekend that Lehman was collapsing.

Many of the bank's alleged disclosure shortfalls, however, came around the December 5 shareholder vote on the merger, when markets remained unsettled. The merger closed on January 1.

The niceties about disclosures to shareholders were considered to be secondary, said Ronald Gilson, a law professor at both Columbia University and Stanford University.

Rakoff called it absurd to accept the SEC argument that a fine would help shareholders better assess the quality and performance of management, after they were lied to blatantly over the purchase of Merrill.

Bank of America has received $45 billion of federal bailout money, including $20 billion to help absorb Merrill. Its shares closed up 2 cents at $16.99 on the New York Stock Exchange.

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

(Additional reporting by Elinor Comlay and Joe Rauch; editing by Leslie Gevirtz, Steve Orlofsky, Bernard Orr and Carol Bishopric)

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