As you may have heard, Judge Rakoff did not like the proposed SEC settlement with Bank of America (neither did I) in part because it blamed the bank’s lawyers while refusing to waive attorney-client privilege and explain what, exactly, went wrong. A week ago, he rejected it entirely:

In a 13-page order available here at the New York Times’s DealBook blog, Rakoff variously calls the settlement "trivial," "absurd," and "neither fair, nor reasonable, nor adequate." His primary objection seems to be that shareholders would indirectly pay for the alleged failure to disclose the bonuses, since the bank, not the individual executives who struck the merger agreement, would pay the fine. The SEC, according to Rakoff, says it cannot punish BofA executives because those executives did not craft the merger agreement in a way that–according to the agency–violated disclosure rules. Who did craft the merger agreement in such a way?

According to the SEC, that would be the lawyers who wrote the agreement–Wachtell, Lipton, Rosen & Katz for BofA and Shearman & Sterling for Merrill. Rakoff responds with a sentence that must frighten any M&A lawyer: "If that is the case, why are the penalties not then sought from the lawyers?"

As we’ve written at length, the pointing of the finger at outside counsel has raised serious questions about whether the bank waived attorney-client privilege in its talks with the SEC, and whether Rakoff may try to extend that waiver into his courtroom. The bank, for its part, has denied any wrongdoing, saying it is routine to conceal sensitive information, such as bonus payments, in confidential statements filed at the same time as public merger agreements.

Now Congress has jumped in:

The chairman of the House Committee on Oversight and Government Reform on Friday told Bank of America that it has questions concerning disclosures made surrounding the bank’s purchase of Merrill Lynch. The panel’s chairman, Edolphus Towns (D-NY), told the bank it can’t use the attorney-client privilege when dealing with Congress. Click here for more, from the NYT; here for earlier coverage of BacMerSaga, from the LB.

In a letter on Friday, Towns (pictured) said the bank must divulge when it became aware of the enormous losses at Merrill last year, when it received a commitment from the federal government for a second round of bailout money and what legal advice its management received about whether it had to disclose those developments to the bank’s shareholders. (Legal advice? Yipes! It means that, at least for the moment, the roles of Wachtell, Lipton and Shearman & Sterling will likely stay firmly in the spotlight.)

Bank of America acknowledged that Congress had the authority to disregard attorney-client privilege. That said, the bank’s Washington law firm, WilmerHale, argued that that would set a bad precedent. It’s a sentiment shared, writes the NYT, by the Association of Corporate Counsel, which came to BofA’s defense this month when the New York attorney general Andrew Cuomo asked the bank to give up its claim that its legal advice should remain private. The group issued a statement saying that it would be an “outrageous precedent” for other public companies if the bank had to give up its right to legal privacy.

As I wrote back when Judge Rakoff was still considering the settlement,

Courts often hold that clients cannot use attorney-client privilege as both a sword and a shield. That is, clients can either use lawyers’ advice as a "sword" to defend themselves or they can use the privilege as a "shield" to keep communications private, in which case they’re off limits entirely.

But they can’t have it both ways. If they could, every defendant would just blame their lawyers and call it a day.

Bank of America’s (current) lawyers have it exactly backwards: it would set a "outrageous precedent" if privilege was not waived here, because the bank itself interjected legal advice into the matter by blaming its lawyers for what happened.

The principle involved is not complicated. If you want to keep your legal advice out of the case, then do not use it in your defense. If you want to blame your lawyers and raise advice of counsel as a defense, then you lose the privilege.

Sword or shield. Not both.