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Home > Cases > Merrill Lynch > How Merrill Lynch Squandered the Funds of Springfield, Massachusetts — and Charged Multiple Fees

How Merrill Lynch Squandered the Funds of Springfield, Massachusetts — and Charged Multiple Fees

Part 1: Merrill Lynch recasts mortgage-backed securities as CDOs.

Working with hedge fund firm Petra Capital, Merrill slices and dices a number of its existing CDOs to create a $462 million set of collateralized debt obligations, registered in the Cayman Islands and named the Centre Square CDO.

Merrill stands to collect an underwriting fee and an additional selling fee when its CDOs are sold on the secondary market.

Part 2: Merrill sells subprime-backed CDOs to the City of Springfield.

Later, in a pitch to win the city's cash management account, Merrill Lynch brokers propose a conservative mix of money market funds, U.S. government debt and other safe investments, with a return no higher than 5.2%. Massachusetts state law strictly limits the cash accounts of municipalities to prudent, low-risk, easily tradable investments. Seeing nothing in the Merrill Lynch proposal that violates the law, Springfield's City Treasurer hands over $50 million.

Weeks later, Merrill Lynch brokers use $13.9 million of Springfield's money to buy into the Centre Square pool and two others from the firm's own inventory. The fact that the investments are CDOs consisting of subprime securities — and not the safe, money-market-type investments authorized by the city — is not disclosed.

Next: Merrill runs for cover as CDO values plummet.

A subtle but telling distinction appears on Springfield's July statement from Merrill Lynch: investments that were previously listed by other names are now relabeled as CDOs. The disclosure is a line item on the statement — you have to look for it.

Meanwhile, mortgage backed securities begin their steep decline. In August, the CDOs Merrill Lynch improperly sold to Springfield lose 25% of their value. By November they're down more than 90%, and the city is in trouble. Investigations begin.

At present, the brokers who sold the CDOs to Springfield have left the firm. Merrill Lynch has admitted wrongdoing and agreed to reimburse the city for its losses. The State of Massachusetts has filed charges, accusing Merrill of violating the Massachusetts Uniform Securities Act.

We'll keep you posted.

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