Stung by a federal judge's rejection of settlement efforts with Bank of America Corp, the U.S. Securities and Exchange Commission has a few ways to proceed in the case. None is good.

U.S. District Judge Jed Rakoff blasted the $33 million accord to resolve charges the bank lied to shareholders about bonuses it let Merrill Lynch & Co pay while it was buying that company, calling it a contrivance that violates the most elementary notions of justice and morality. The Manhattan judge ordered the case to go to trial by February 1.

The SEC can avoid this, but no option guarantees victory.

It may ask the Second Circuit Court of Appeals to review Rakoff's decision. It may go to trial, and lose. It may dismiss the case despite saying the bank broke the law. It may craft a new accord, which Rakoff could reject. Or it may sue individual executives and lawyers after saying it lacked evidence.

None of these options are great for the SEC, said Adam Pritchard, a law professor at the University of Michigan in Ann Arbor. The standard for approving settlements where there is no class-action is deferential and I think the SEC would have a good chance at the Second Circuit. But it keeps the case in the public eye. The SEC wants to make this case go away.

The case is one of many arising from Bank of America's purchase of Merrill, which was announced last September 15 and which closed on January 1.

By keeping the case alive, Rakoff's decision complicates SEC Chairman Mary Schapiro's effort to restore the agency's reputation in the wake of damage from the financial crisis and missing Bernard Madoff's $65 billion Ponzi scheme.

The SEC had effectively ceded some of its mantle as an advocate for investors to state regulators such as New York Attorney General Andrew Cuomo and predecessor Eliot Spitzer.

Cuomo may soon sue Bank of America officers, perhaps including Chief Executive Kenneth Lewis, as well as lawyers involved in deciding what to disclose.

Marcel Kahan, a law professor at New York University, said Cuomo's push makes it looks like the SEC was not vigorous in protecting shareholders. That's the danger.

SHORTAGE OF TRUST

Rakoff was upset that the SEC did not require the bank to disclose the names of executives and lawyers who vetted the bonuses and the decision not to disclose them.

Accusing the SEC of creating a facade of enforcement, he said the pact essentially left shareholders on the hook for a penalty more fairly borne by individuals.

The bank's shares have fallen by about half since the merger was announced a year ago.

It is unclear how much disclosure or what terms the judge would require before accepting any settlement.

Kahan said the SEC could push the bank to take prophylactic measures, such as by establishing board committee to review disclosures, rather than have shareholders pay for the bank's wrongs. Yet even this might be too little, too late.

The question is what is going on in the judge's mind? he said. It seems he thinks the public is entitled to know more. The judge may decide, 'I don't trust you and I want you to put all your cards on the table, and therefore no settlement will make me happy.'

Some professors said that, in light of the losses caused by the financial crisis and the resulting anger of investors, the SEC erred in acceding to a seemingly gentle settlement.

James Post, a professor at Boston University's School of Management, faulted SEC staff for accepting the bank's argument that a heavy penalty would further punish shareholders.

The SEC commissioners should be embarrassed and livid with the agency's staff, who betrayed the public trust by endorsing this argument, he said.

SEC spokesman John Nester said the regulator would review the judge's order. Bank of America said it is prepared to litigate. To what end remains to be seen.

Judge Rakoff is right that the settlement victimized shareholders again, Pritchard said. The SEC has a policy to go after wrongdoers and has been deviating for no apparent good reason. If the Spitzer years are any indication, the SEC will eventually demand a settlement where individuals pay.

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