Dec. 19 (Bloomberg) -- Bank of America Corp.’s plan to sell about $2.8 billion of shares in China Construction Bank Corp. was undone by a Chinese securities law provision that would have forced it to forfeit profits from the sale, two people familiar with the matter said.

Bank of America, which raised its stake in China Construction in June and November, on Dec. 15 halted the sale of as many as 5.5 billion shares in the Chinese bank after discussions with lawyers, one of the people said, declining to be identified because the talks are private.

China’s securities law bans investors holding more than 5 percent of a locally incorporated, publicly traded company from selling shares within six months of buying the stock. Shareholders who fail to observe the rule may be forced to hand over any profits from a sale to the company whose stock they sold.

“The provision in China’s securities law is in line with a number of other countries in the world, including some developed markets,” said Hubert Tse, a Shanghai-based managing director at Yuan Tai PRC Attorneys. “It intends to regulate substantial shareholders who might have access to exclusive information from carrying out short-term trading activities.”

Bank of America wouldn’t have been the first to fall foul of the rule. Martin Currie Investment Management Ltd., a Scottish money manager, in June had its local bank deposits frozen by a Chinese court after buying 5.9 percent of Nanning Sugar Manufacturing Co. and selling part of it five months later, according to an exchange filing by the Chinese company. The case is still pending trial, Nanning Sugar said on Dec. 16.

UBS AG was advising Bank of America on the scrapped sale, one of the people said. UBS spokesman Chris Cockerill declined to comment, as did Bank of America spokesman Scott Silvestri.

$15 Billion Profit

Bank of America, which will become the U.S.’s biggest lender when it acquires Merrill Lynch & Co. on Jan. 1, needs to cut its quarterly dividend to a penny from 32 cents and conserve as much cash as possible to offset rising loan losses, Friedman, Billings, Ramsey Group Inc. analyst Paul Miller said this week.

The bank, based in Charlotte, North Carolina, is sitting on paper profits of almost $15 billion from its investment in China Construction Bank, according to data compiled by Bloomberg.

Bank of America first invested in China Construction in June 2005, buying a $3 billion stake before the lender went public. It invested another $1.9 billion in June. The value of its holding almost tripled to $14.5 billion as of Sept. 30, according to a regulatory filing.

In November, Bank of America spent another $7 billion to raise its stake in China Construction to 19.13 percent by exercising an option that was part of its first investment agreement in 2005.

Buying at Discount

That option gave Bank of America the right to buy China Construction shares at 1.2 times book value. On Nov. 28, Bank of America completed raising its stake at the equivalent of HK$2.79 per share -- a 32 percent discount to that day’s closing price.

Bank of America boosted its holding a month after a lockup on 19.1 billion China Construction shares purchased in 2005 expired, fueling expectations Chief Executive Officer Kenneth Lewis would move to sell that stock to raise funds.

The Financial Times today reported that Lewis ordered the sale pulled after China Construction Chairman Guo Shuqing protested, citing people it didn’t identify. China Construction spokesman Yu Baoyue denied the bank objected to the sale.

Bank of America now owns 44.7 billion Hong Kong-traded shares in China Construction, making it the second-largest owner. Out of that holding, 19.1 billion shares can be freely traded while the rest will be locked until Aug. 29, 2011.

Absolute Control

The Chinese securities law provision applies to shares of China-incorporated firms traded in Hong Kong as well as on the mainland exchanges. Central Huijin Investment Co., a unit of China’s $200 billion sovereign wealth fund, has a controlling 57.06 percent stake in China Construction. The Chinese government has said it wants to keep absolute control of the nation’s biggest lenders.

Bank of America has plunged 66 percent this year, compared with a 51 percent decline in the KBW Bank Index. China Construction has dropped 30 percent since Jan. 1, making it the second-best performer among the nation’s six largest banks traded in Hong Kong.

Lock-Ups Expire

More disposals of China bank shares may occur next year when the lock-up for foreign investors expires. Temasek Holdings Pte can sell its 9.9 billion Construction Bank shares anytime as its lock-up agreement expired in August, according to Construction Bank’s listing document.

Royal Bank of Scotland Group Plc, controlled by the U.K. government after a bailout, owns 20.9 billion shares in Bank of China, or 8.47 percent, while Temasek owns 11.9 billion shares, or 4.8 percent. Their stakes can be sold after Dec. 30 this year, according to the Chinese bank’s listing prospectus.

Goldman Sachs Group Inc. owns 16.5 billion shares in Industrial & Commercial Bank of China Ltd. and has agreed not to sell the shares until after April 28, 2009, according to the Chinese bank’s listing document.

To contact the reporter of this story: Luo Jun in Shanghai at jluo6@bloomberg.net; Cathy Chan in Hong Kong at kchan14@bloomberg.net

Last Updated: December 19, 2008 01:52 EST