It seems while Merrill Lynch (MER) was losing all of that money on mortgage-backed financial instruments it was trying to unload them to save the company’s skin. Nice idea if you can make it work.

Not only did it not work, but it appears that Merrill’s plan is going to lead to an SEC investigation.

Merrill went around to a number of hedge funds and asked them to buy commercial paper issued by a company-linked entity containing mortgages. This would take the investment off the brokerage’s balance sheet. Merrill  would agree to buy the securities back in a year with a nice return for the hedge funds.

Merrill probably hoped that the mortgage-backed market would improve and that, a year out, the securities would be worth much more.

But, that’s cheating, isn’t it?

As The Wall Street Journal points out: "At issue with any hedge-fund deals is whether there was an attempt by Merrill to sweep problems under the rug through private transactions kept out of view from investors."

But, why mince words? Merrill wanted to trick its shareholders into thinking that its problems were less than they appeared.

Several big banks are trying to get up enough money so that they can offer short-term loans to funds with illiquid securities operating by companies like Citigroup (C). It may be a bad idea and it may create an artificial floor under the price of the asset, but at least it is done in the full light of day.

If Merrill’s move with hedge funds was not an attempt at fraud, it was at least in the neighborhood.

Being Merrill Lynch just got much harder. So did finding a world-class CEO. Merrill may have thought big losses were the worst of it problems. Now that may not be true.

Douglas A. McIntyre

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