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 Thursday's settlement marks the latest enforcement action against
Wall Street banks over the marketing of collateralized debt
obligations prior to the 2008 financial crisis.
Regulators have said hedge fund firms helped structure some of these
CDOs, and then used them to bet against the housing market. These
firms have not been targets of formal enforcement actions in the
higher-profile cases against the banks.
The SEC said Merrill failed to tell investors that hedge fund firm
Magnetar Capital LLC exercised significant influence in choosing
collateral underlying two $1.5 billion CDOs, Octans I CDO in 2006
and Norma CDO I in 2007.
According to the regulator, Magnetar took equity positions in the
CDOs that gave it "substantial leverage" to influence the holdings,
and hedged them with short positions.
It said this meant Magnetar's interests might not have been aligned
with the interests of investors who wanted the CDOs and their
collateral to perform well.
The case included various communications between Merrill and
Magnetar, including a July 13, 2006 message from a Merrill sales
representative to a Magnetar principal.
"Extremely important to us that you know this partnership is the top
priority of the cdo group (top to bottom)," the Merrill
representative wrote. "Their ultimate goal is to maximize your
return with the best structure possible."
Merrill "portrayed an independent process for collateral selection
that was in the best interests of long-term debt investors," George
Canellos, co-director of the SEC enforcement division, 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."
MAGNETAR NOT CHARGED
Merrill was also charged with maintaining inaccurate books and
records by delaying the recording of various trades tied to a third
$1.5 billion CDO, Auriga, which closed in 2006.
Bank of America did not admit or deny wrongdoing. The second-largest
U.S. bank will pay a $56.3 million civil fine, $56.3 million of
disgorged funds and $19.2 million of interest.
A spokesman, Bill Halldin, said the Charlotte, North Carolina-based
bank is pleased to settle.
Also settling with the SEC were Scott Shannon and Joseph Parish,
managing partners of Charlotte-based NIR Capital Management LLC and
the collateral manager for the Norma CDO.
Without admitting or denying wrongdoing, Shannon and Parish agreed
to pay nearly $474,000 and exit the securities industry temporarily
over charges they let Magnetar influence the makeup of Norma. Their
lawyer David Kornblau declined to comment.
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Magnetar was not charged, and the Evanston, Illinois-based firm said
in a statement that the SEC issued a "closing letter" indicating
that its staff will not recommend charges against the firm, its
funds or its employees.
"We are pleased that these matters are now behind us," Magnetar
said.
SEC spokesman Kevin Callahan declined to comment.
In October, the regulator charged collateral manager Harding
Advisory LLC and its owner Wing Chau, a character in Michael Lewis'
book "The Big Short," with fraud in connection with the Octans CDO.
The SEC estimated it has recovered about $3 billion for investors
over misconduct linked to the financial crisis.
JPMORGAN, GOLDMAN, CITIGROUP
Magnetar had previously been identified by the SEC as having chosen
some assets for and then bet against the Squared CDO 2007-1
structured by JPMorgan Chase & Co <JPM.N>.
JPMorgan agreed in June 2011 to pay $153.6 million to settle SEC
civil fraud charges that it misled investors about that CDO. In
November 2012, the SEC dropped its related civil case against Edward
Steffelin, the only individual charged.
Separately, Goldman Sachs Group Inc <GS.N> agreed in July 2010 to
pay $550 million to settle SEC charges over the Abacus 2007-AC1 CDO,
which hedge fund manager John Paulson helped structure and bet
against.
Former Goldman vice president Fabrice Tourre is appealing an August
1 jury verdict finding him liable for civil fraud over the marketing
of Abacus.
Citigroup Inc <C.N> and the SEC are awaiting a federal appeals court
decision on whether to reinstate their $285 million settlement over
a CDO, Class V Funding III, that the bank structured and then bet
against.
The case is In re: Merrill Lynch, Pierce, Fenner & Smith Inc, SEC
Administrative Proceeding No. 3-15642.
(Reporting by Jonathan Stempel and Peter
Rudegeair in New York; editing by Gerald E. McCormick; Editing by
David Gregorio and Andre Grenon)
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