Bank of America Corp.'s Merrill Lynch agreed to pay about $131 million to settle U.S. regulatory claims it failed to tell investors that hedge fund Magnetar Capital LLC had a role in selecting assets for two 2006 mortgage-backed securities.
Magnetar, which held both equity and short positions in the collateralized debt obligations known as Octans I CDO Ltd. and Norma CDO I Ltd., exercised significant influence over the selection of collateral for the investments, the Securities and Exchange Commission said today in a statement.
The SEC also sanctioned two managing partners of investment adviser NIR Capital Management LLC, which handled the collateral selection for Norma. The executives agreed to pay collectively more than $472,000 and were suspended from working in the securities industry, the SEC said in a separate statement.
The settlement stems from a U.S. crackdown on Wall Street firms for misconduct during the creation of mortgage-backed securities that fueled investor losses during the housing slump and ensuing market turmoil of 2008. The SEC has brought cases against banks including Goldman Sachs Group Inc. (GS), Citigroup Inc. and JPMorgan Chase & Co. (JPM) related to their roles in structuring and marketing investments tied to faulty home loans.
"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 Canellos, co-director of the SEC's 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 in selecting the underlying portfolios."
Merrill Lynch and the NIR managers agreed to settle the SEC's accusations without admitting or denying wrongdoing.
"We are pleased to resolve this matter, which pre-dated Bank of America's acquisition of Merrill Lynch," said Bill Halldin, a Bank of America spokesman. The lender agreed to buy Merrill Lynch at the height of the credit crisis in 2008.
Scott Shannon and Joseph Parish, the NIR managers, compromised their independent judgment by allowing a third party with its own interests to influence the portfolio-selection process of Norma, the SEC said. Shannon accepted assets chosen by Magnetar and Parish allowed the hedge fund to influence the selection of some other assets, according to the agency.
David Kornblau, an attorney at Covington & Burling LLP representing the NIR managers, declined to comment.
Magnetar, which wasn't accused of wrongdoing, has been involved in other deals that regulators targeted, including a CDO called Squared. JPMorgan agreed to pay $153.6 million in 2011 over SEC claims the bank marketed Squared without disclosing Magnetar's role in selecting the portfolio.
Magnetar had a contractual right to object to the inclusion of collateral in the Octans CDO, even though marketing materials indicated Harding Advisory LLC would manage it independently, the SEC said. The SEC accused Harding and its owner Wing F. Chau in October of having accommodated Magnetar's requests to include certain assets.
Merrill Lynch engaged in the misconduct in 2006 and 2007, when its CDO group was a leading arranger of structured-product CDOs, the SEC said. After four Merrill Lynch representatives met with a Magnetar employee in May 2006, an internal e-mail described the arrangement, according to the SEC's statement.
"We pick up 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 SEC quoted the message as saying.
About one third of the assets for the portfolio underlying the Norma CDO were amassed by Magnetar rather than by NIR, the designated collateral manager, according to the SEC. While NIR was initially unaware of Magnetar's purchases, it eventually accepted them and allowed the hedge fund to exercise approval rights over other assets, the regulator said.
Merrill Lynch told investors that the portfolio would be selected by NIR and also failed to disclose in marketing materials that the CDO gave Magnetar a $35.5 million discount on its equity investment. Merrill Lynch also violated books-and-records requirements in another CDO called Auriga CDO Ltd. by delaying the recording of certain trades, the SEC said.
SEC investigators have finished examining Magnetar's CDO dealings and don't plan to recommend any claims against the firm or its personnel, the company said today in a statement, citing a letter it received from the agency.
"Magnetar has cooperated with the SEC on CDO matters since 2008," the company said. "We are pleased that these matters are now behind us, and look forward to continuing to serve the interests of our investors with the highest regard to ethical, industry and legal standards."