Merrill Lynch executives will not be sanctioned individually for the firms dealings with Orange County, Calif. , prior to the countys 1994 bankruptcy, according to former SEC Pacific Regional Director Elaine Cacheris.
In an interview during her final days as a regional director for the SEC, Cacheris told Registered Representative the commission viewed Merrill Lynchs failings with respect to Orange County as a firmwide pattern of negligence--from the trading desk and sales personnel to the investment banking side--that constituted unintentional fraud.
We made a determination that this case was about a collective failure at Merrill Lynch, Cacheris said. Weve brought the case we had, and were not taking further action.
The SEC accepted a $2 million civil penalty from Merrill in August, settling charges that the firm misled investors when it underwrote $875 million worth of Orange County municipal securities before the countys $1.6 billion bankruptcy.
The commission charged Merrill Lynch with omitting key information about Orange Countys financial status from offering documents for municipal bonds the county sold to investors. Because the firm had conducted a significant amount of securities business with Orange County, Merrill Lynch executives, including sales managers and risk managers, knew about the countys risky investment portfolio, the SEC said.
Cacheris said the SEC intentionally focused on the bond offering and ignored allegations of the firms wrongdoing in selling Orange County the risky derivative investments that led to the financial collapse. Those allegations of wrongdoing were the subject of a civil suit Orange County filed against Merrill Lynch, which the firm settled for $437 million in June.
Depositions in that suit show several Merrill senior executives were intimately aware of Orange Countys risky strategy of buying derivatives using leverage. In a series of meetings beginning in late 92, and continuing in 93 and 94, Merrill executives, including the firms chief risk manager Daniel Napoli and head of bond trading at the time, David Komansky (now CEO) discussed on several occasions ways of reducing the countys risk. Although a risk-rnanagement group was given responsibility for reviewing derivatives sold to Orange County, in mid-1993 that oversight was turned over to institutional sales.
When you have limited resources and finite opportunities, you need to focus attention on matters of greatest interest to the investing public, Cacheris said. Given the commissions emphasis on municipal markets, our great concern was the lack of disclosure made on a municipal offering. We took note that the county had brought its own lawsuit over the sale of securities and was well-equipped to cover its losses.
Cacheris sald the commission also deliberately chose not to pursue G-37 charges against Merrill for alleged illegal contributions made by Merrill employees to Orange County Treasurer Robert Citrons 1994 campaign. Weve told the courts we would narrowly interpret G-37 because of First Amendment concerns. We want to avoid cases that would create questions of constitutionality.
Some securities attorneys find it curious that the SEC could justify a finding of unintentional fraud and name no individuals as responsible.
Fraud is an intentional act, says Jonathan Schwartz, a former SEC attorney in Marina del Rey, Calif., who now represents brokers. You cannot accidentally commit fraud.... Savvy people at Merrill Lynch must have known that there was a potential for disaster to occur with Orange Countys money... and recklessly disregarded the consequences.
Furthermore, Schwartz says, individuals usually are sanctioned at the same a firm is. Firms dont commit fraud, individuals do.... This type of resolution appears to be a very thoroughly massaged compromise in which it appears the SEC didnt want to hurt Merrill Lynch too much, Schwartz adds.
Harry Weiss, another former SEC attorney, now doing firm defense work with Wilmer Cutler and Pickering in Washington, D.C., says the SEC does have a precedent for naming firms instead of individuals in fraud cases. This case, in the view of the SEC, must not have met the standard of fraud, he said, but for negligence.
Merrill Lynch has stated that this latest penalty has finally put the matter behind the firm. The firm has already paid a record $467 million to settle private suits and criminal charges in connection with its dealings with Orange County, in addition to reimbursing institutional investors who invested in the failed bond offering.