SEC Probes $1.5 Billion Merrill CDO Sale

The Securities and Exchange Commission is investigating Merrill Lynch’s sale of a complex mortgage-related security it created for Magnetar, an Illinois hedge fund, and the collateral manager involved in the deal, according to people familiar with the matter.

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The investigation is one of several SEC probes into banks that helped underwrite billions of dollars of collateralized debt obligations, securities comprised of mortgages or derivatives linked to them.

It also marks a broadening of the SEC’s investigation into the role of collateral managers, institutions that help select the assets included in CDOs.

NIR Capital Management, a Roslyn, New York firm run by Corey Ribotsky, served as manager for the security under scrutiny, a $1.5 billion CDO known as Norma. Neither Mr Ribotsky nor his attorney returned calls seeking comment.

Regulators are looking at whether collateral managers, which are supposed to serve CDO investors’ interests, fulfilled their obligations, these people say.

Last year, the SEC sued another collateral manager, ICP Asset Management, and its founder Thomas Priore for allegedly defrauding investors in CDOs it managed. Mr Priore has denied wrongdoing and is fighting the charges.

The SEC, which is looking at several deals banks structured for Magnetar, is investigating whether Merrill told buyers that Magnetar helped select the assets included in the Norma CDO and bet against those same assets, these people say.

Magnetar has denied claims it selected the Norma portfolio.

Regulators are also looking into whether Merrill mispriced assets in the CDO, these people say. Bank of America, which acquired Merrill Lynch, declined to comment. The bank previously said it lost $900m on the Norma CDO.

In 2009 Dutch bank Rabobank, which invested in Norma through a loan, sued Merrill in a New York state court, alleging the bank overvalued some assets by marking them at face value even though their market value had already deteriorated by 15 per cent.

The banks reached a settlement last year.

According to Rabobank’s lawsuit, Merrill allegedly created Norma as a “tailor-made way to bet against the mortgage-backed securities market”. The suit said: “Merrill Lynch hand-picked a beholden collateral manager that was willing to ignore its fiduciary duties to Norma’s investors by selecting Norma’s collateral pool at Merrill Lynch’s behest rather than on the basis of the rigorous independent analysis.”

The US Financial Crisis Inquiry Commission concluded: “Merrill failed to disclose that Magnetar was paid $4.5 million or that Magnetar was selecting collateral when it also had a short position that would benefit from losses.”

The US attorney’s office in Brooklyn is also investigating NIR’s pricing of private investment in public equities, or PIPE, transactions. One former NIR analyst has pleaded guilty.