Massachusetts sues Merrill Lynch for fraud - 2-Feb-08 - Generational Dynamics

After Springfield, Mass., lost 91% of its $13.9 investment in near-worthless CDOs.

"This Complaint is focused on Merrill Lynch's sale, through agents Kipper and Choy, of certain esoteric financial instruments known as Collateral Debt Obligations ("CDOs") to the City of Springfield, Massachusetts, which were unsuitable for the City and which, within months ater the sale, became illiquid and lost almost all of their market value. ...

In November 2006, the City of Springfield hired Merrill Lynch ... to invest its surplus cash. The City ... hired Carl Kipper and Manuel Choy. ... The accounts ... were not discretionary accounts. It was understood that Merrill was supposed to invest only in safe money-market-like investments authorized by City personnel that would protect the City's principal.

However, in April and June of 2007, Kipper and Choy invested approximately $14,000,000 of the City's money into three CDOs, the "Centre Square CDO", the "South Cost Funding V CDO" and the "Tabs CDO". ...

The largest position was $12,600,000 in the Centre Square CDO, which had been underwritten by Merrill Lynch. Merrill Lynch received underwriting fees in connection with underwriting the CDO and remarketing fees in connection with selling pieces of it.

The City did not authorize these specific CDO purchases in advance. Kipper and Choy were, apparently, verbally instructed to pick instruments that yielded more than Merrill's money market account as long as the products were triple-A rated by the major credit rating agencies ....

At the time of the sale, Kipper and Choy did not discuss the risks of owning CDOs with the City, even though those risks were well known to Merrill Lynch. The basic fact that these instruments were CDOs was not even disclosed to the city until months after the sale. These instruments appeared on the City's account statements through June 2007 as "Centre Square Ltd." .... In July 2007, the exact same investments quietly began to appear on the account statements as "Centre Square CVO PVT" .... At the time of the sales, Kipper and Choy did not look at the disclosure documents for these CDOs. Nor did they make any attempt to understand what these CDOs were collateralized with. Nor did they evaluate the liquidity and other risks inherent in purchasing the CDOs or discuss the nature of the CDOs or the risks associated with owning them with City officials. ...

Within months after Merrill's sales of these CDOs to the City, the auction market for them began to dry up and their market value began to plummet. For example, the Centre Square CDO had been purchased in late April 2007. By august 2007, it was listed on the City's account statements as having an "estimated market value" of only 84 percent of its purchase price. By Spetember, it was down to 50 percent; by October it was down to 30 percent; and by December 2007, it was down to 5 percent. ... The City requested that these CDOs be sold, but City officials were informed that the auctions had failed and that there were no buyers. ...

The CDOs that Merrill sold to the City of Springfield were not the conservative, principal protected instruments that the City had sought when it opened its accounts with Merrill Lynch. ... The Centre Square CDO was a highly complex instrument that, according to its Offering Circular, should only be sold to sophisticated investors. ...

Merrill's underwriting fees earned in connection with the Centre Square CDO were in excess of $10,000,000."

Massachusetts is suing for additional fines, and to force Merrill to end its fraudulent practices. Merrill did, in fact, announce that it would terminate almost all of its CDO business.

It's hard to know what to make of some of this, but Merrill seems to be doing all it can to avoid being sued, and Galvin seems to be determined to push the suit forward.

It's easy to understand why Merrill doesn't want to be sued. If it can settle out of court, then other cases are unaffected. But if Merrill's conduct is found fraudulent by a court, then Merrill will be forced to settle up with the many other municipal governments around the country that have similarly been defrauded.

But it's also hard to understand why Galvin wants to go ahead with the suit -- for exactly the same reason that Merrill doesn't want to go through it.

I mention this because the "mark to market scam" is still going on, and it goes to the heart of all the fraud that's going on.

All of these financial firms are doing business with CDOs at nominal value, when their real market value is typically 10 or 20 cents on the dollar. By law, these CDOs must be "marked to market" under a wide variety of conditions. Any investor purchasing these CDOs believing that their real value is the nominal value, or who uses them as collateral at their nominal value, is participating in fraud.

So government officials and financial firms at all levels are doing everything possible to perpetuate the fraud, for fear that forcing too many writedowns will crash the stock market.

So Galvin is taking a step that will force a writedown of many more billions of dollars in these near-worthless CDOs. I wouldn't be surprised if someone from the Fed or the Administration gives Galvin a call and asks him to cool it for a while.

I've been writing about this stuff for a long time now, and the stench is really getting to me. I'm no investigative reporter turning over rocks that no one else has looked at. This activity is going on in the full view of the public. There's fraud at all levels, most disgustingly at state and federal government levels in full view of the public.

And what's worse is that these activities are just causing more harm. The bubbles are already leaking like mad, and they cannot be stopped from bursting completely. Every action to delay the inevitable only makes the inevitable worse.

From the point of view of Generational Dynamics, we're seeing the Principle of Maximum Ruin in full force. Every effort will be made to waste every remaining bit of money to keep the bubble from collapsing, until finally no one has any money left. The Principle of Maximum Ruin says that the maximum number of people will be ruined to the maximum extent possible. That's what's going on now, and apparently will continue. (2-Feb-08) Permanent Link
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Massachusetts sues Merrill Lynch for fraud

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Generational Dynamics Web Log for 2-Feb-08 Massachusetts sues Merrill Lynch for fraud

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Generational Dynamics Web Log for 2-Feb-08
Massachusetts sues Merrill Lynch for fraud