A Wall Street Journal report that claims Merrill Lynch used hedge fund dealings to delay subprime losses has hit the brokerage hard.
The story claims Merrill Lynch has been trying to sell off as much as $5 billion in mortgage-related securities to hedge funds in recent weeks as a means to postpone write-downs.
The story cites one particular deal in which the Wall Street firm sold $1 billion in commercial paper containing mortgages to a hedge fund, promising a minimum return and the right to sell it back after just one year.
By shifting the securities, Merrill was essentially able to delay a possible write-down until next year, minimizing the perceived loss in the near-term.
Such dealings could explain why the brokerage’s mortgage-related exposure dropped in the third quarter despite the ongoing mortgage crisis.
Merrill Lynch & Co. denied the allegations in a press release issued Friday saying, “We have no reason to believe that any such inappropriate transactions occurred. Such transactions would clearly violate Merrill Lynch policy.”
The brokerage also said the story lacked specificity and relied upon unidentified sources, but the report has led to many questions about how these firms gauge their exposure to bad debt.
The Securities and Exchange Commission is currently looking into the way Merrill has been “marking”, or valuing its mortgage securities, and how they have been disclosed to investors.
Last week, Merrill Lynch announced its worst quarter in its 93-year history, a $2.24 billion loss, including a $7.9 billion write-down spurred by mortgage-related activity, leading to the exit of its CEO Stan O’Neal.
Shares of Merrill Lynch were down a hefty $5.24, or 8.43%, falling to $56.95 in late trading Friday on Wall Street, marking the brokerage’s lowest share price since 2005.