Once upon a time, economic whiz bangs said subprime distress would pass through the financial system like you-know-what through a goose. Subprime was only a relatively small part of the mortgage market and not all borrowers were defaulting. Sure, a few mortgage lenders might go down, but only the ones who churned out exotic mortgage product sans any underwriting standards. The winnowing process would prove beneficial to the good guys such as Countrywide Financial, who kept their virtue intact while peddling exotic. Banks and investment firms that supplied lines of credit to bad lenders and securitized their mortgages would take a hit. As would some investors in mortgage-backed securities and related, derivative investment instruments. But the worst would be over in a few quarters.

Those were the days. By the second half of 2007, we were in it for the long haul.

As 2008 rolls along, every day seems to bring another astounding story of subprime sickness in far flung places. Though transparency types on Wall Street are urging players to bring out their esoteric dead, the full body count isn’t yet known. Meanwhile, attorneys in public office and private practice are launching investigations and lawsuits. Soldiers for a class action war on greed are being recruited. Merrill Lynch is among the top targets. Ready, aim, fire, their name is desire!

Last October, the US Securities and Exchange Commission (SEC) opened a preliminary investigation on Merrill. One point of interest: Merrill’s possibly dodgy reports to shareholders in the third quarter of 2007 re writedowns on collateralized debt obligations (CDOs) containing mortgage-backed securities (MBS). After a string of reports claiming lesser numbers, Merrill ultimately announced writedowns totaling $16 billion (resulting in an overall loss of $9.8 billion). In early 2008, the SEC probe of Merrill turned formal. Broad subpoena powers are part of the package. The Justice Department, as represented by the US Attorney’s office in Manhattan, is also investigating Merrill and wants access to any evidence gathered by the SEC. The US Attorney’s investigation is only preliminary. Though criminal charges could result, criminal intent can be difficult to ascertain and prove.

Out here in the fields…

Law firms specializing in securities arbitration and litigation want to hear (call now!) from institutional investors who’ve taken hits from Merrill Lynch. A recent press release* by Klayman and Toskes, who represent “investors throughout the world in securities arbitration and litigation matters against major Wall Street brokerage firms” announced that the firm is investigating whether CDOs marketed by Merrill Lynch (and by Swiss banking giant UBS) were “suitable for the institutions, fund of funds, and pension funds that invested in the products”. And Hagens Berman Sobol Shapiro (HBSS) is investigating “the marketing and sales of consolidated debt obligations (CDOs) by Merrill Lynch and whether the company inappropriately offered high-risk CDOs to municipalities and other qualified institutional investors without making the appropriate disclosures, and/or knowing the unsuitability of the investment”. In their 02/05/08 press release** HBSS references investments in CDOs made by the city of Springfield, Massachusetts, as an example of Merrill bad.

Time out for a CDO brush-up. Quoting Jacob Zamansky (his blog calls him “Jake”) of Zamansky & Associates: “CDOs are packages of debt such as asset-backed securities, or other investments that are sold as bonds and are structured to pay out at different rates of interest based on a different level of risk …. many CDOs have a large stake in only subprime mortgages. Although riskier investments yield higher returns, the potential default on a subprime mortgage is significant and can lead to enormous losses.”***

As in– Danger Will Robinson! CDOs full of subprime are gambles on complex, structured layers of risky debt. Profits can be stellar, losses the pits. As the housing bubble deflates, loss is the surer bet.

In Spring 2007, the city of Springfield invested roughly $14 million in several subprime-backed CDOs created, underwritten, and marketed by Merrill Lynch. Most of the investment was in a Cayman Island based fund called Centre Square, Ltd., a CDO put together by Merrill and the New York hedge fund firm, Petra Management Capital. By Autumn, the Merrill CDOs had lost almost all value. City officials hit the ceiling. Saying Merrill had misled them. Springfield had wanted triple-A rated, conservative investment instruments that yielded more than Merrill’s money market account, and which could be sold when necessary at an assured auction. But the Merrill investments, while triple-A, were CDOs chock full of risky subprime. A real no-no since Massachusetts forbids municipal investment in mortgage-backed securities. As for the assured auction, forget it. There were no interested buyers.

Springfield began to lawyer up. By the beginning of 2008, Massachusetts state Attorney General Martha Coakley had joined the fray and was investigating the deal. After initially denying anything was amiss, Merrill admitted that two brokers from Merrill Lynch in Albany, New York screwed up in Springfield. The brokers had been dismissed and Merrill would reimburse Springfield for losses and legal fees. Alas. Too little too late. Massachusetts Secretary of State William F. Galvin went ahead and filed a civil suit through his agency’s Securities Division. Charging Merrill Lynch with securities fraud.

Springfield, the largest city in western Massachusetts and third largest in the state, is a post-industrial place. When US manufacturing shipped out, so did a big chunk of Springfield’s economy. Fiscal mismanagement and corruption on the home front haven’t helped. In the first half of this decade, a veritable chorus line of public servants perp-walked off to prison. Some had been skimming Springfield since disco days. In 2004, the city faced financial collapse. The state stepped in and appointed the Springfield Finance Control Board (FCB) and provided a $52 million interest-free loan. To be paid back by 2012, with the first payment due in June, 2008. Though the FCB helped Springfield achieve a financial turnaround, and reserves are on hand, officials representing Springfield want the repayment date moved back to 2027.

As said, the brokers who sold CDOs to Springfield were from Merrill’s office in Albany, New York. The state capital and seat of state government. Albany is about 85 miles west of Springfield (where Merrill also has an office) on Interstate 90. The Merrill men were Carl J. Kipper and Manuel Choy. Prior to being fired, Kipper’s title was Vice President, Global Private Client Group. Manuel Choy was a wealth management advisor.

Kipper and Choy gained their share of Springfield’s investment business through the Springfield Finance Control Board and its executive director, Stephen Lisauskas. In 2006, Lisauskas invited Kipper and Choy into Springfield and allegedly helped them prepare their pitch. Lisauskas is a long time friend of Carl Kipper and his wife, Maureen Kipper. In the late 1990’s, Stephen Lisauskas was executive assistant in the Office of the State Comptroller in Albany, where he worked with Ms. Kipper. Maureen Kipper has been an executive at the agency for years. By 2003, she was Senior Investment Manager-Equities at the New York State Common Retirement Fund (CRF). The fund is under the aegis of the state comptroller.

The New York State Common Retirement Fund, Albany, is one of the largest pension funds in the nation. A January 2007 article (Solid growth pushes assets above $50 billion) in Pensions & Investments cited CRF as the second largest benefit fund investor in hedge funds in the nation. The same article states that this was the first time CRF reported hedge fund investments and refers to Maureen Kipper as “director”. According to the New York State Comptroller’s website, Maureen Kipper heads External Equity Management at CRF. The External Management Unit hires, fires, and oversees external equity managers, and is responsible for “recommending structural changes to the domestic equity and international equity classes”.

Obviously, Stephen Lisauskas moves in erudite institutional investor circles. He also has an impressive resume of public service in Massachusetts. Lisauskas has served as administrative assistant to former Newburyport Mayor Lisa Mead (with whom he authored an American City & County piece on financial management and investment policy in Newburyport) and Massachusetts State Senator Steven Baddour. Lisauskas has also been policy director for the state Executive Office of Public Safety. While in the latter position, he was tapped to help save the town of Haverhill from slipping into financial receivership. Prior to being appointed to the Springfield Finance Control Board in 2006, Lisauskas was deputy town administrator in Natick, Mass. His duties included assisting Natick in financial planning. When Carl J. Kipper came calling in Natick, Lisauskas passed his name along to the city treasurer. An account was opened with Merrill but no investments were made. Whew. Natick may have dodged a bullet…

Stephen Lisauskas was in the small circle of officials who decided to invest Springfield’s 14 mil with Merrill Lynch. Scary to think that even such a financially sophisticated public servant could be blindsided by secret CDOs. And secret they were. The initial paperwork on Centre Square etc. that Merrill gave Springfield completely left out the term “CDO”. Nor was the City supplied with Merrill’s own 2006 prospectus which stated that no auction market currently existed for the CDOs and Merrill was under no obligation to create one. And according to the civil complaint filed by the office of Secretary of State William Galvin, Carl Kipper and Manuel Choy made no verbal attempt to clarify these matters. Nor did they mention that the CDOs were created and underwritten by Merrill Lynch. Heck– the former vice president of global wealth management and his wealth management advisor sidekick didn’t even look at Merrill’s disclosure statements for the CDOs, or know how the CDOs were collateralized. Which means they missed the subprime mortgage thing too!

If only someone in the small circle of officials who invested the 14 mil with Merrill had done some independent research. Merrill’s prospectus on Centre Square was out there to be found– particularly by savvy fiscal types who know how to seek. And though “CDO” was left off the initial paperwork Merrill gave Springfield in 2007, a Google search would have turned up a Standard & Poors report from December, 2006, describing Centre Square as a “CDO of CDOs backed primarily by investment grade tranches of CDOs.”

Incidentally, CDOs backed by CDOs are called “CDO-squared”. That’s tranch talk for balling the jack.

City Treasurer Salvatore Calvanese was another member of the small circle of officials who invested the 14 mil with Merrill Lynch. Calvanese signed a form which falsely certified Springfield as a Qualified Institutional Buyer. Without that form, the investments couldn’t have gone through. Under federal securities law only sophisticated institutional buyers are allowed to buy complex, high risk CDOs such as Centre Square. The form Calvanese signed claimed Springfield was an “Investment Company” and a conduit “such as a bank, foreign bank, broker dealer, or investment advisor”. City Treasurer Calvanese says he didn’t know the form was for CDOs; he thought the City would be getting Money Market. Why he thought Springfield was an investment company and like unto a foreign bank, hasn’t been explained. Some newspaper stories seem to suggest the men (in black) from Merrill made Calvanese sign the false statement. But no accounts of waterboarding have surfaced. Yet.

Apparently, not a single Springfield official involved in the Merrill deal said whoa Nelly, this is a struggling city not an investment company. And nobody at Merrill Lynch, from Carl Kipper and Manuel Choy on up to the Auction Market Securities Trading Desk, asked how a struggling city could be an investment company, or like unto a foreign bank.

In June, 2006, Stephen Lisauskas dropped Carl Kipper an email saying Springfield might be “in the mood” for higher investment returns. Cue Glen Miller. In November, after Kipper pitched Springfield on letting Merrill handle a piece of the city’s action and was heading back to Albany (most likely on zippy I-90, cue Born To Be Wild) Lisauskas called him with the news that Springfield was gonna go Merrill. Cue Turn the Beat Around. Lucky for the good citizens of Springfield, heat made the beat do just that.


In August 2007, the State of Maine invested $20 million in a triple A-rated securities firm named Mainsail II. They did so on the recommendation of a Merrill Lynch financial advisor approved by MBIA Inc., the bond insurer serving as Maine’s investment advisor. Twelve days later Mainsail was junk. State Treasurer David G. Lamoine says he wasn’t aware Mainsail was a structured investment vehicle full of subprime, headquartered in the Cayman Islands. Treasurer Lamoine, the state Attorney General, and Maine’s Office of Securities are investigating. Springfield’s reimbursement by Merrill Lynch has been referenced wistfully. A lawsuit by Maine could loom for Merrill, or for MBIA, the world’s largest bond insurer. MBIA, which once insured only municipal debt, now insures corporate CDOs as well. In January, Massachusetts Secretary of State William Galvin subpoenaed MBIA (and Ambac Financial Group, Inc.) seeking info on whether the insurance companies told municipalities the straight poop re their exposure to mortgage related investments. Cue Bang a Gong.

Carola Von Hoffmannstahl-Solomonoff
Mondo QT

*Notice to All Investors Who Purchased CDOs from Merrill Lynch And UBS from the Securities Law Firm of Klayman & Toskes

**Hagens Berman Sobol Shapiro Investigating Merrill Lynch’s Sales of CDOs to Municipalities and Other Public or Taft Hartley Pension Funds

***The Subprime Meltdown Litigation Tsunami, Jacob H. Zamansky, Zamansky & Associates

Sources include but are not limited to:

In the matter of Merrill Lynch, Pierce, Fenner, & Smith Incorporated, Carl Kipper And Manuel Choy, Docket No.2008-0001, Commonwealth of Massachusetts, Office of the Secretary of the Commonwealth, Securities Division

“Maine’s $20 Million,” Bangor Daily News, 02/18/08

“Regulators’ Subprime Mortgage Cases,” Associated Press/Newsday, 02/18/08

“Prosecutors Widen Probes Into Subprime,” Amir Efrati, Susan Pulliam, Kara Scannell, Craig Karmin, Wall Street Journal, 02/08/08

E-mails detail investment connections, Peter Goonan, The Republican, 02/07/08

“Springfield left its fate to Merrill, Firm called shots in complex, costly investments,” Beth Healy, Boston Globe, 01/28/08

State to probe Springfield official’s ties with broker, Megan Woolhouse, Boston Globe, 01/18/08

Treasurer Lemoine Speaks to Appropriations and Financial Affairs committee regarding Mainsail II investment, Office of the Treasurer 12/12/07

“Change Agent: New Control Board Director Says There’s Still Much Work to be Done,” George O’Brien, Business West Online, 10/01/07

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