Merrill CEO in Hot Seat

The hot seat atop Merrill Lynch (MER) just got hotter for CEO Stan O'Neal.

Shares in the big brokerage firm jumped 6% Friday morning as investors bet O'Neal will be forced out by the board. The run-up came after reports made it clear that O'Neal's credibility problems may go well beyond this week's $8 billion mortgage-securities writedown.

The New York Times reported Friday that O'Neal angered Merrill directors by calling Wachovia (WB) chief Ken Thompson to broach the issue of a possible merger without first consulting Merrill's board. The Times said directors were so angered by the executive's apparent disregard for board authority that they are considering replacing him and even discussed the names of possible replacements such as Blackrock's (BLK) Larry Fink and the NYSE's (NYX) John Thain.

Merrill didn't comment, but the news puts O'Neal in an increasingly untenable spot following a series of black eyes tied to the brokerage firm's expansion into risky debt markets. Merrill spent $1.3 billion buying subprime mortgage shop First Franklin from National City (NCC) last September, at a point when U.S. house prices had already peaked and defaults on riskier mortgages were already rising sharply. The firm also pushed hard into the business of packaging together various bonds as so-called collateralized debt obligations. Merrill's sales of CDOs jumped in recent years, making the firm the top peddler of the debt on Wall Street.

Merrill's a Takeover Target, Says Mark DeCambre

Both those moves have backfired recently, as the subprime mortgage business has all but ground to a halt and investors have fled CDOs, in part because the instruments are so opaque that holders are often unsure of what exactly they own.

Those problems came home to roost this month. On Oct. 5, Merrill stunned Wall Street by saying it would post a loss for the third quarter -- making it the only brokerage house to do so in a quarter that was marked by August's credit market unrest. Even Bear Stearns (BSC), which had two in-house hedge funds collapse under the weight of bad subprime bets, managed to report a profit, albeit one 61% below year-ago levels.

Then, this week, Merrill posted a sharply expanded loss, saying its writedown of bad mortgage debt had expanded in the intervening weeks by an eyebrow-raising $3 billion. O'Neal and finance chief Jeff Edwards claimed blithely on a conference call Wednesday morning that they had simply moved to a more conservative valuation of their subprime and CDO positions. Analysts bridled, saying that despite Merrill's expanded disclosure it was hard to know how much more pain the firm might yet feel.

>To order reprints of this article, click here: Reprints