SEC Announces $131.8 Million Settlement With Merrill Lynch

SEC Announces $131.8 Million Settlement With Merrill Lynch

 WASHINGTON, D.C. — (Mealey’s) The Securities and Exchange Commission announced on Dec. 12 that Merrill Lynch, Pierce, Fenner & Smith Inc. has agreed to pay $131.8 million to settle claims that it made “faulty disclosures about collateral selection for two collateralized debt obligations (CDO) that it structured and marketed to investors, and [maintained] inaccurate books and records for a third CDO” in violation of federal securities laws (In the Matter of Merrill Lynch, Pierce, Fenner & Smith Inc., No. 3-15642, SEC).

Under the terms of the settlement, Merrill Lynch consented to the entry of the order finding that it willfully violated Sections 17(a)(2) and (3) of the Securities Act of 1933 and Section 17(a)(1) of the Securities Exchange Act of 1934 and SEC Rule 17a-3(a)(2).  It will pay $56,286,000 in disgorgement, $19,228,027 in prejudgment interest and a penalty of $56,286,000.  

“Without admitting or denying the SEC’s findings, Merrill Lynch agreed to a censure and is required to cease and desist from future violations of these sections of the Securities Act and Securities Exchange Act,” the SEC said.

The SEC found that Merrill Lynch failed to “inform investors that hedge fund firm Magnetar Capital LLC had a third-party role and exercised significant influence over the selection of collateral for the CDOs entitled Octans I CDO Ltd. and Norma CDO I Ltd.  Magnetar bought the equity in the CDOs and its interests were not necessarily aligned with those of other investors because it hedged its equity positions by shorting against the CDOs.”

Norma CDO

Moreover, the SEC found that “one-third of the assets for the portfolio underlying the Norma CDO were acquired during the warehouse phase by Magnetar rather than by the designated collateral manager NIR Capital Management LLC.”

“Magnetar bought the equity in the CDOs and its interests were not necessarily aligned with those of other investors because it hedged its equity positions by shorting against the CDOs,” the SEC said.

Leading Arranger

In its order, the SEC alleges that Merrill Lynch “engaged in the misconduct in 2006 and 2007, when its CDO group was a leading arranger of structured product CDOs.”

“After four Merrill Lynch representatives met with a Magnetar representative in May 2006, an internal email explained the arrangement as ‘we pick mutually agreeable [collateral] managers to work with, Magnetar plays a significant role in the structure and composition of the portfolio . . .  and in return [Magnetar] retain[s] the equity class and we distribute the debt.’  The email noted they agreed in principle to do a series of deals with largely synthetic collateral and a short list of collateral managers.  The equity piece of a CDO transaction is typically the hardest to sell and the greatest impediment to closing a CDO.  Magnetar’s willingness to buy the equity in a series of CDOs therefore gave the firm substantial leverage to influence portfolio composition,” the SEC said.

The SEC further found that Magnetar “had a contractual right to object to the inclusion of collateral in the Octans I CDO selected by the supposedly independent collateral manager Harding Advisory LLC during the warehouse phase that precedes the closing of a CDO.”

“Merrill Lynch, Harding, and Magnetar had finalized a tri-party warehouse agreement that was sent to outside counsel, yet the disclosure that Merrill Lynch provided to investors incorrectly stated that the warehouse agreement was only between Merrill Lynch and Harding.  The SEC has charged Harding and its owner with fraud for accommodating trades requested by Magnetar despite its interests not necessarily aligning with the debt investors.”  

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