SEC Announces Preliminary Settlement With Merrill Lynch

by Mike Godfrey, for LawAndTax-News.com, Washington

28 August 2008

The Securities and Exchange Commission's Division of Enforcement announced on Wednesday that a preliminary settlement in principle has been reached with Merrill Lynch, Pierce, Fenner & Smith, Inc. that would enable investors who purchased auction rate securities from the firm to receive a total of up to USD7bn to restore their losses and liquidity.

In addition to helping individual investors, small businesses, and charities who were ARS customers of Merrill Lynch, the preliminary settlement would also require Merrill Lynch to use its best efforts to provide liquidity for approximately USD1.5bn worth of ARS purchased through Merrill Lynch by other business and institutional customers.

The terms of the settlement are subject to finalization, review and approval by the Commission.

The proposed charges involve alleged misrepresentations by Merrill Lynch to thousands of its customers that ARS were safe, highly liquid investments equivalent to money market instruments and cash. Merrill Lynch did not make adequate disclosures that the liquidity of these securities was based on Merrill Lynch supporting the auctions it managed when there was not enough demand.

Investors were left holding illiquid securities when Merrill Lynch stopped supporting auctions in February 2008. Furthermore, Merrill Lynch continued to tout the purported liquidity of ARS to customers despite its awareness of the escalating liquidity risks in the weeks and months preceding the collapse of the ARS market.

"Merrill Lynch's conduct harmed tens of thousands of investors who will have the opportunity to get their money back through this agreement pending Commission approval," explained Linda Chatman Thomsen, Director of the SEC's Division of Enforcement, who went on to state:

"We will continue to aggressively investigate wrongdoing in the marketing and sale of auction rate securities, and will seek prompt and meaningful relief to auction rate securities investors as a top priority."

Under the terms of the agreement in principle:

• No later than October 1st, 2008, Merrill Lynch will offer to liquidate at par all ARS from individual, charitable, and small business investors with account values up to USD4m who purchased ARS from Merrill Lynch prior to the collapse of the ARS market in mid-February 2008. This offer will include investors who held ARS in their Merrill Lynch account as of February 13th, 2008, but who subsequently transferred the account to another firm. The offer will remain open until January 15th, 2010, and investors may accept it at any time before that date.
• No later than January 2nd, 2009, Merrill Lynch will offer to liquidate at par all ARS from remaining individual and charitable investors, and from small businesses with account values up to USD100m who purchased ARS from Merrill Lynch prior to the collapse of the ARS market in mid-February 2008. This offer will include investors who held ARS in their Merrill Lynch account as of February 13th, 2008, but who subsequently transferred the account to another firm. The offer will remain open until January 15th, 2010, and investors may accept it at any time before that date.
• Until Merrill Lynch actually provides for the buy back of ARS on the schedule set forth above, Merrill Lynch will provide certain investors no cost loans that will remain outstanding until the ARS are repurchased or until an investor declines Merrill Lynch's offer to repurchase the securities at par.
• Merrill Lynch will reimburse customers for costs incurred under any prior loan programs the firm provided to its ARS investors.
• Merrill Lynch will make whole any losses sustained by any of the investors described above who sold ARS after February 13th, 2008, at a loss.
• To the extent that any of the investors described above has incurred consequential damages due to the loss of liquidity in the customer's ARS holdings, Merrill Lynch will participate in a special arbitration process that the investor may elect, and that will be overseen by the Financial Industry Regulatory Authority (FINRA), whereby Merrill Lynch will not contest liability for its misrepresentations and omissions concerning ARS.
• Merrill Lynch will use its best efforts to provide liquidity to its ARS institutional customers and business customers with accounts of more than USD100m by the end of 2009.
• Merrill Lynch will not liquidate its own inventory of a particular ARS before it liquidates investors' holdings in that security.
• Merrill Lynch will provide notice to all of its ARS investors of the settlement terms and will establish a telephone assistance line to respond to questions from investors concerning the settlement.
• Merrill Lynch will be permanently enjoined from violating the provisions of Section 15(c) of the Securities Exchange Act of 1934, and Rule 15c1-2 thereunder, which prohibit the use of manipulative or deceptive devices by broker-dealers.
• Merrill Lynch faces the prospect of a financial penalty to the SEC after it has completed its obligations under the settlement agreement. A determination as to the amount of the penalty, if any, will take into account, among other things, the extent of Merrill Lynch's misconduct in marketing and selling ARS, an assessment of whether Merrill Lynch has satisfactorily completed its obligations under the settlement, and the costs incurred by Merrill Lynch in meeting those obligations, including penalties incurred and the cost of remediation.

The SEC was assisted in the investigation by the Massachusetts Secretary of State, the North American Securities Administrators Association, the New York Attorney General and FINRA.

Merryl Lynch isn't the first bank to come to such arrangement with the SEC, as earlier this month, the SEC announced the distribution of nearly USD40mn to more than 600,000 investors who were harmed by undisclosed market timing and excessive short-term trading in certain mutual funds managed by Putnam Investment Management, LLC.

This was the first in a series of Fair Fund distributions that will ultimately return a total of more than USD150mn to more than 1.5 million affected Putnam mutual fund investors.

The SEC's investigation is continuing.

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