A U.S. federal judge has refused to approve a settlement between regulators and Bank of America Corp related to the acquisition of Merrill Lynch & Co, stating that it could be unfair to the public.

The decision late Wednesday by Judge Jed Rakoff of the federal district court in Manhattan is an unusual step, according to lawyers, in what has already been a storied takeover, marred by investor lawsuits and billions in losses since it was completed January 1.

The U.S. Securities and Exchange Commission and the largest U.S. bank will now attend a court hearing on August 10 to answer questions about the $33 million settlement, which would resolve SEC allegations that Bank of America made false and misleading statements to shareholders about bonuses promised to Merrill employees.

Bank of America had agreed to pay the fine to settle the civil lawsuit and, along with the SEC, had sought the judge's approval for the settlement.

It certainly is a rare instance when a federal Judge refuses to approve a settlement in a case particularly, at its initial filing, said Jacob Frenkel, former SEC enforcement lawyer and now a partner at Shulman, Rogers, Gandal, Pordy & Ecker.

The penalty was less than the $50 million that General Electric Co agreed to pay to settle fraud charges a day after the Bank of America settlement was announced.

The judge is focused on whether the fine agreed between the SEC and Merrill is in the public's interest -- particularly given that Bank of America has received $45 billion in taxpayer funds, making it one of largest beneficiaries of the U.S. government's bank bailout program, lawyers explained.

The bottom line is that this fine is small in comparison to even the bonuses that Bank of America is probably still paying out to its various employees, said James Cox, a professor in corporate and securities law at Duke University.

The hearing is a responsible action on the part of the judge, Cox said, but he expects the settlement to be approved. The public interest is not likely to be found jeopardized or harmed by the fine that's going to be imposed, he said.

Spokesmen for both the bank and the SEC said they look forward to appearing at the hearing and answering the judge's questions.

PUBLIC FUNDS

The SEC alleged the bank had authorized Merrill Lynch to pay up to $5.8 billion in bonuses, while it told investors in proxy documents for the merger that Merrill had agreed not to award year-end performance bonuses or incentive pay before the merger closed.

Merrill would ultimately pay $3.6 billion, according to regulators; and shortly after the acquisition closed, crippling losses on mortgage securities and other debt instruments at Merrill prompted Bank of America to accept $20 billion from the federal Troubled Asset Relief Program.

Despite the public importance of this case, the proposed consent judgment would leave uncertain the truth of the very serious allegations made in the complaint, Rakoff wrote in his two-page order.

The proposed consent judgment in no way specifies the basis for the $33 million figure or whether any of this money is derived directly or indirectly from the $20 billion in public funds previously advanced to Bank of America as part of its 'bailout,' the judge added.

The Wall Street Journal, citing company emails and people familiar with the situation, reported that the Charlotte, North Carolina, bank's loss projections for Merrill had bulged by nearly $2 billion two days before the takeover was approved by shareholders.

The bank's executives, however, decided that the losses were not severe enough to be disclosed publicly before the vote, the paper said.

Bank of America spokesman Robert Stickler was quoted by the paper as saying that the internal documents it reviewed support what we have said all along.

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 with additional reporting by Ajay Kamalakaran in Bangalore, Rachelle Younglai in Washington and Elinor Comlay in New York; Editing by Gerald E. McCormick and John Wallace)

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