The SEC is investigating whether or not Merrill Lynch made deals to hide its exposure to high-risk mortgage debt. The investigation began on October 24 and may be related to deals Merrill Lynch allegedly struck with hedge funds to hide its vulnerability to subprime mortgage debt. However, the SEC has not confirmed this allegation.
According to the [Wall Street Journal,] Merrill Lynch allegedly made deals with hedge funds that allowed the company to delay disclosing its exposure to that risk. As an example, Merrill Lynch engaged a hedge fund to lend a Merrill-related entity one billion dollars. In most circumstances, the hedge fund would assume the risk if the Merrill-related entity did not repay the loan. In this case, Merrill Lynch guaranteed it would purchase the loan a year later, thereby assuming the risk without reporting it on the books.One analyst, Mike Mayo from Deutsche Bank, has now down-graded his rating on Merrill Lynch stock, noting that the company may have been engaged in questionable transactions, making its financial statements unreliable. He also speculates that Merrill Lynch could face additional write-downs of $5 billion to $10 billion in the fourth quarter.
The SEC investigation follows an announcement of serious write-downs for Merrill Lynch in its third quarter. Participants and beneficiaries of Merrill Lynch's 401(k) plan are now investigating whether the plan's assets were invested in Merrill Lynch common stock when they should have been invested elsewhere. They are also investigating whether Merrill Lynch executives encouraged them to invest in Merrill Lynch stock even though the executives knew that the company would be announcing massive losses.
Currently, Merrill Lynch faces a class action lawsuit filed by shareholders and a shareholder-derivative suit. The lawsuits claim that the company did not inform them of important information about its collateralized debt obligations (CDOs). CDOs combine a variety of risks and can result in high returns in the short term but high losses due to risky loans.
A derivative lawsuit occurs when a shareholder sues on behalf of the company itself. This lawsuit accuses former Merrill Lynch CEO Stan O'Neal of allowing Merrill Lynch to become the world's leading underwriter of CDOs. Furthermore, the lawsuit alleges Merrill Lynch directors issued "false and misleading public financial statements to conceal the exposures Merrill Lynch faced from this strategy." The suit argues that the defendants breached their fiduciary obligations of due care, loyalty and diligence and also accuses them of abuse of control and gross mismanagement.
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Meanwhile, Merrill Lynch has sent letters to public employee pension funds in Florida, noting that the SEC is investigating it for potential violations of federal regulations. Those violations include engaging in conflicts of interest and charging hidden fees. Such actions would result in less money available to retirees from their pension fund and would require taxpayers to pay for the shortfall.Merrill Lynch acts as a pension consultant to over 100 pension boards in Florida. A pension consultant helps the board, which may consist of people who are not familiar with finances, to choose money managers. A conflict of interest could occur if the pension consultant recommends a specific money manager but is actually receiving payments from that manager.
If Merrill Lynch has violated ERISA laws and breached its fiduciary duty to employees, the company and its executives must be held accountable. Employees who participate in 401(k) plans should not have to worry that their plan administrator is mishandling their money.
