The Securities and Exchange Commission is broadening its investigation into the world of “built to fail” collateralized debt obligations (CDOs) by looking at Merrill Lynch’s CDO business, according to articles by Marian Wang of Pro Publica (“Merrill Lynch Investigated for CDO Deal Involving Magnetar”) and Kara Scannell of the Financial Times (“SEC Probes $1.5 Billion Merrill CDO Sale). The news is apparently “sending chills” through other banks that put together deals with Magnetar, such as Citigroup, UBS, Wachovia (now Wells Fargo) and Deutsche Bank, according to John Carney of CNBC (“Who Else Did Magnetar Deals?”).
The CDO under scrutiny is called Norma, one of more than 24 CDO deals that Magnetar, who invested in the riskiest equity tranches of the CDO, was allowed to help select the underlying assets of the CDO, while having a $600 million side bet that would pay off big if the CDO failed, according to the Pro Publica article.
Norma’s offering materials reportedly did not disclose Magnetar’s role, and investors were told that another independent collateral manager, NIR Capital Management, would select the assets in accordance with the investors’ best interests. With Merrill Lynch’s knowledge, NIR abdicated its role in favor of Magnetar.
JP Morgan Chase is reportedly the subject of another SEC investigation into a Magnetar CDO deal. It was reported in May 2011 that JP Morgan was close to settling the probe into a CDO known as Squared, which was a CDO comprised of other CDOs.
Last year, Goldman Sachs agreed to pay a record $550 million and admitted to making a “mistake” in its disclosures about a subprime-linked CDO.
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