SEC accuses Merrill Lynch of misleading investors in CDO

The Securities and Exchange Commission today charged Merrill Lynch make defective disclosures on secondary selection to two obligations (CDO) claims that it backed structured and marketed to investors and inaccurate bookkeeping records for one-third of CDO.

Merrill Lynch has agreed to pay 131.8 million $ to settle the SEC charges.

Introductory order of the settled SEC administrative proceedings finds that Merrill Lynch failed to inform investors, this office of hedge fund Magnetar Capital LLC has played a role of third party and exercised a significant influence over the selection of securities for the CDO entitled octant I CDO Ltd. and Norma CDO I Ltd..  Magnetar bought the net value of the CDO and its interests were not necessarily aligned with those of other investors because it covered its holdings by shorting against the CDO.

"Merrill Lynch marketed complex CDO investments using misleading materials depicting an independent process for secondary selection which was in the interest of long-term debt investors," said George S. Canellos, Co-Director of the Division of Enforcement of the SEC.  "Investors did not have the advantage of knowing that a company of prominent hedge funds with his own interests was heavily involved behind the scenes by selecting the underlying portfolios."

According to the SEC order, Merrill Lynch engaged in misconduct in 2006 and 2007, when its CDO group is a lead arranger of the structured product CDO.  After four representatives of Merrill Lynch met with a representative of Magnetar in May 2006, an internal e-mail, explained the arrangement that "we choose mutually acceptable [Accessories] managers work with, Magnetar plays an important role in the structure and composition of the portfolio... and in return [Magnetar] keep class [s] fairness and we distribute the debt. ''  The indicated email that they have agreed in principle to a series of agreements with warranty largely synthetic and a short list of collateral managers.  The piece of equity of a CDO transaction is usually the most difficult to sell and the biggest obstacle to the closure of a CDO.  Will of Magnetar net worth of a series of CDOS buying therefore gave the effect of firm substantial leverage to influence the composition of the portfolio.

According to the SEC order, Magnetar has a contractual right to oppose the inclusion of guarantees in quadrant I chosen by the supposedly independent collateral Advisory LLC Harding Manager during the storage phase preceding the closure of a CDO of CDOS.  Merrill Lynch, and Magnetar Harding had finalized an agreement tripartite warehouse which was sent to external consultants, but the disclosure provided to investors hurt Merrill Lynch said that the agreement of the warehouse is only between Merrill Lynch and Harding.  TheSEC has accused Harding and owner of fraud to accommodate trades requested by Magnetar despite its interests necessarily aligning with debt investors.

Order of the SEC estimated that one-third of the assets of the portfolio underlying the CDO Norma have been acquired during the phase of the warehouse by Magnetar rather than the designated collateral NIR Capital Management LLC Manager.  NIR initially had no knowledge of the purchases of Magnetar, but finally accepted them and allowed Magnetar to exercise approval rights on some other assets for the CDO of Norma.  The disclosure provided to investors hurt Merrill Lynch said that the guarantee will consist of a portfolio selected by NIR.  Also, Merrill Lynch failed to disclose in marketing materials that the CDO gave Magnetar a 35.5 million $ discount on its investment in shares and separately contributed 4.5 million $ to the company that has been referred to as "fresh supply."  The SEC also today announced charges against two partners-managers of NIR.

According to the SEC order, Merrill Lynch violated requirements for books and records into another CDO called Auriga CDO Ltd., which was managed by one of its subsidiaries.  As done in quadrant I and Norma CDO deals, Merrill Lynch has agreed to pay interest Magnetar or returns accumulated stored CDO auriga property, a type of payment, known as a "use".  To benefit himself, however, Merrill Lynch avoid ill save lot of trades stored when they delay the registration of these trades and products.  Therefore, obligation of Merrill to pay carry has been delayed until after the Auriga CDO pricing when it became quite clear that the trades would be included in the portfolio.

"Keep the books and adequate records is not an optional requirement of the federal securities laws, and brokers who fail to properly record transactions will be held accountable for their violations, said Andrew M. Calamari, Director of the regional office in New York of the SEC.

Merrill Lynch has consented to the entry of the order finding that he violated voluntarily 17 Sections and (3) of the Securities Act of 1933 and section 17 of the Securities Exchange Act of 1934 and rule 17A - 3 (a) (2).  The firm has agreed to pay restitution of $56,286,000, interest before judgment of $19,228,027 and a penalty of $56,286,000.  Without admitting or denying the findings of the SEC, Merrill Lynch agreed to censorship and will have to cease future violations of these provisions of the Securities Act and the Securities Exchange Act.

The SEC investigation was conducted by the staff of the regional office in New York and unity complex financial Instruments, including Steven Rawlings, Gerald Gross, Tony Frouge, Elisabeth Goot, Brenda Chang, John Murray, Sharon Bryant, Kapil Agrawal, Douglas Smith, Howard Fischer, Daniel Walfish and Joshua Pater.  Several reviewers in the Office of New York with assistance, including Edward Moy, Luis Casais, Thomas Shupe, William Delmage, George DeAngelis, Syed Husain and James Sawicki.