MANHATTAN (CN) - New York State Comptroller Thomas DiNapoli sued Merrill Lynch and Bank of America on Thursday, claiming that both companies knew that Merrill Lynch had tens of billions of dollars in unreported losses from the subprime mortgage meltdown. BofA shareholders, ignorant of the financial morass, authorized the $29.1 billion acquisition of Merrill Lynch, which quickly torpedoed profits, according to the federal complaints.
"BOA shareholders were deprived of information that was material to their vote, and an overwhelming 82 percent of votes, including those based upon all of plaintiff's approximately 18 million BOA shares, were cast in favor of the merger on December 5, 2008," DiNapoli wrote in one of two complaints - one against BofA and the other against Merrill Lynch.
As administrative head of the state and local retirement systems, and sole trustee of the state's common retirement fund, DiNapoli managed 18 million shares with BofA and 4.8 million shares with Merrill Lynch.
In addition to not reporting what it knew were at least $15.3 billion losses by end of the fourth quarter of 2008, Delaware-based BofA also authorized Merrill Lynch to pay out an additional $5.8 billion in bonuses to its employees on an accelerated schedule, DiNapoli says.
When BofA executives learned that Merrill Lynch's pretax losses had ballooned to $21 billion, it took a $138 billion government bailout "to salvage the merger" - but still did not enlighten investors about the bailout money or Merrill Lynch's true financial condition, DiNapoli claims.
On the last day of trading before Bank of America announced the merger, in September 2008, its shares closed at $28.03. By the time the facts had emerged, in late January 2009, shares had dropped to $5.71, according to the complaint.
Merrill Lynch imploded as it tried to stake ownership in mortgage origination companies amid a housing market in visible decline and escalating mortgage default levels, DiNapoli claims.
While the bank was giving mortgages to borrowers with poor credit histories and ignoring warnings from its own executives, it lied to the public that it was closely monitoring credit risks and extending loans only to borrowers with high credit, according to the complaint.
"Merrill, formerly one of the most revered financial institutions in the world, brought about its own demise by pursuing a reckless campaign to earn heightened fees through originating and proliferating subprime residential mortgages - loans extended to unqualified borrowers that presented an increased risk of default," according to the complaint. "Merrill was a leading participant in the mortgage finance industry until the company collapsed under the weight of the undisclosed and inordinate risk that it assumed in originating subprime mortgages and securitizing them into residential mortgage-backed securities ('RMBS') and collateralized debt obligations ('CDOs')."
Under the direction of E. Stanley O'Neal, Merrill Lynch became the world's largest producer of CDOs backed by subprime mortgages, underwriting $19 billion in CDOs in 2004, $44 billion in 2006 and $30 billion during the first half of 2007, DiNapoli claims.
As Merrill Lynch increased its CDO securitization, it also increased its underwriting fee income, from $400 million in 2005 to $700 million in 2006.
DiNapoli says Merrill Lynch lied to ensure that its stock traded at inflated prices, and ignored warning signs "of the impending collapse of the subprime mortgage market."
"Borrowers subject to these poorly underwritten loans were defaulting en masse by the end of 2006, forcing subprime lenders with which Merrill did business into bankruptcy," according to the complaint.
As Merrill Lynch made partial disclosures about its true financial condition, its shares lost value, eventually dropping to $11.64 by the end of 2008 from $76.67 about 15 months earlier.
Merrill Lynch had been reporting multibillion-dollar revenues, but it withheld hidden holdings that required the bank to take tens of billions of dollars in write-downs, DiNapoli claims.
Facing imminent collapse, O'Neal resigned - leaving with a $160 million benefits package - and Merrill Lynch negotiated a hasty merger with Bank of America, according to the complaint.
DiNapoli is suing the two banks, as well as their CEOs and CFOs, for compensatory damages, alleging violations of the Securities Exchange Act. He is represented by Andrew Entwistle with Entwistle & Cappucci.
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