Merrill Hit By Massachusetts Lawsuit

Massachusetts has filed a lawsuit against Merrill Lynch (MER Quote) alleging the bank committed fraud in selling esoteric debt securities to the city of Springfield.

The complaint, filed by the office of Massachusetts Secretary of the Commonwealth William Galvin, accuses Merrill of selling an investment that, although highly-rated, was unsuitable and unsafe from its own inventory of so-called collateralized debt obligations, or CDOs, via Merrill Lynch agents Carl Kipper of the investment bank's Albany, N.Y. office and Manuel Choy of Clifton Park, N.Y.

The city has lost some $13 million out of what was initially a $14 million investment in a trio of funky, mortgage-tainted paper, according to court documents. Springfield is aiming to recoup its losses and force Merrill to be stripped of any fees associated with the underwriting and sale of the debt.

Mark Herr, a Merrill Lynch spokeswoman in New York, said via an email that the firm is "puzzled by this suit," but added it was cooperating with Galvin.

The suit also implies that Kipper had a personal relationship with Steven Lisaukas, executive director of the Springfield finance control board, which may have given way to investment in the CDOs that may not have otherwise been approved by the city's finance committee.

Galvin's suit on behalf of Springfield implies the city, which was not on sound financial footing to begin with, was essentially hoodwinked into investing in debt that is typically the remit of sophisticated, high-net-worth investors and investment entities capable of assessing and withstanding the risks. Springfield had a $20 million deficit in 2004 and has been slowly trying to improve its finances.

Merrill has voluntarily agreed to return the initial investment to Springfield, the spokesman emphasized.

"The city of Springfield and the Springfield Financial Control Board have said that neither body approved the purchases of these investments," Herr wrote in his email. "After carefully reviewing the facts, we have determined the purchases of these securities were made without the express permission of the city. As a result, we are making the city whole and we have taken appropriate steps internally to ensure this conduct is not repeated."

A call to Galvin's office in Boston was not immediately returned.

The Massachusetts complaint indicates that the CDO investments in entities called Centre Square CDO, South Coast Funding CDO and Tabs CDO, were completed in April last year just before the market for CDO paper and other opaque mortgage debt began to plummet in value and the market for such securities ground to a halt.

Merrill was one of the largest issuers of CDO paper, originating some $31 billion in 2007 just ahead of the roughly $28 billion in paper structured by Citigroup (C Quote). Those firms along with UBS were among a trio of banks that collected fat fees for structuring and selling mortgage paper and have been forced to write down billions on those same securities which saw their values crater as the housing market bubble burst.