Merrill Lynch in $132 million SEC settlement over faulty disclosures on derivatives

Regulator alleges the brokerage failed to inform investors that a hedge fund influenced the selection of collateral backing two debt products

Dec 12, 2013 @ 2:40 pm

By Trevor Hunnicutt

Merrill Lynch will pay $131.8 million to settle charges it misled investors about three structured debt products before the financial crisis.

The Securities and Exchange Commission said Thursday that the largest brokerage by client assets failed in 2006 and 2007 to inform investors that a hedge fund influenced the selection of collateral that backed certain debt products.

The hedge fund, Magnetar Capital, hedged its stock positions by shorting against the collateralized debt obligations known as Octans I CDO Ltd. and Norma CDO I Ltd., that Merrill Lynch was selling to its clients, according to the SEC.

“Merrill Lynch marketed complex CDO investments using misleading materials that portrayed an independent process for collateral selection that was in the best interests of long-term debt investors,” George S. Canellos, co-director of the SEC's Division of Enforcement, said in a statement. “Investors did not have the benefit of knowing that a prominent hedge fund firm with its own interests was heavily involved behind the scenes in selecting the underlying portfolios.”

Merrill Lynch Pierce Fenner & Smith Inc. agreed to the settlement “without admitting or denying the SEC's findings,” according to the SEC.

Merrill was found to have maintained “inaccurate books and records” for an additional CDO called Auriga CDO Ltd. The SEC said Merrill Lynch failed to record trades properly when they occurred in the assets underlying the CDO in order to avoid paying interest and to allow it to trade out of positions.

“We're pleased to resolve this matter, which predated Bank of America's acquisition of Merrill Lynch,” said BofA spokesman William P. Halldin, noting that the cost of the settlement is covered by funds already set aside by the firm.

In a statement, Magnetar said it has cooperated with the SEC's investigations since 2008.

“We are happy to report that the SEC has issued a closing letter to Magnetar, which confirms that the staff has completed its investigation as to Magnetar's activities regarding the relevant CDOs and will not recommend any action against the firm, its funds or any of its personnel,” the firm said.

A spokesman for the SEC did not immediately respond to a request for comment.


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